Solutions Manual to accompany
Accounting: Building Business Skills Fourth Edition Prepared by
Shirley Carlon, Rosina MladenovicMcAlpine and Chrisann Palm
Chapter 1: Introduction to accounting
CHAPTER 1 – INTRODUCTION TO ACCOUNITNG ASSIGNMENT CLASSIFICATION TABLE
Brief Exercises
Learning Objectives 1.
Define accounting, describe the accounting process and define the diverse roles of accountants.
2.
Explain the characteristics of the main forms of business organisation.
3.
Understand the Conceptual Framework and the purpose of financial reporting.
4.
Identify the users of financial reports and describe users’ information needs.
5.
Identify the elements of each of the four main financial statements.
6.
Describe the financial reporting environment.
7.
Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements
8.
Calculate and interpret ratios for analysing an entity’s profitability, liquidity and solvency.
Exercises
Problems
1
1
3
8
2A; 2B
4,5,6
2,3,4,5, 7,9,10
3A,4A,5A,6A 7A;8A;3B,4B 5B,6B,7B,8B
2
1
7
1.1
1A; 1B
6
3A; 3B
11,12,13
9A,10A 9B,10B
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 1 – INTRODUCTION TO ACCOUNTING ANSWERS TO QUESTIONS 1.
Advantages of company structure are limited liability (shareholders not being personally liable for corporate debts), indefinite life, easy transferability of ownership (through selling shares), and greater ability to raise funds. Disadvantages of a company are the establishment costs and ongoing fees and increased government regulations.
2.
External users are those outside the business who have an interest in knowing about the activities of the entity as resource providers, recipients of goods or services or parties performing a review of oversight function. Examples include investors, creditors such as banks and suppliers, taxing authorities, regulatory agencies, trade unions and customers.
3.
(a)
Income statement.
(b)
Statement of financial position.
(c)
Income statement.
(d)
Statement of financial position.
(e)
Statement of financial position.
(f)
Statement of financial position.
4.
The Conceptual Framework consists of a set of concepts to be followed by preparers of financial statements and standard setters. The Conceptual Framework provides guidance to preparers of financial information by defining who is required to report and who the users are likely to be.
5.
It is important to determine if a business is a reporting entity as it is only reporting entities that are required to prepare general purpose financial reports in accordance with the accounting standards. Three main indicators determine which of the forms of business organisation fall into the category of a reporting entity. That is, an entity is more likely to be classified as a reporting entity if it is (1) managed by individuals who are not owners of the entity, (2) politically or economically important, and (3) sizable in any of the following ways — sales, assets, borrowings, customers or employees.
6.
The three categories in the statement of cash flows are operating activities, investing activities and financing activities. The categories were chosen because they represent the three principal types of business activity.
7.
Retained earnings is the profit retained in a company. Retained earnings is increased by profit and is decreased by dividends and by losses.
8.
The going concern principle lends credibility to the cost principle; otherwise items would be reported at liquidation value. By assuming the entity will continue to operate, assets can continue to be reported at cost because they are expected to 1.2
Chapter 1: Introduction to accounting
bring benefits to the business through use even though they may have little or no resale value. 9.
Rose Ena is correct. Comparability means that financial statements can be compared between companies and over time. Using the same accounting principles and accounting methods from period to period with a company, facilitates comparability. When accounting methods are inconsistent, it is difficult to determine whether a company is better off, worse off, or the same from period to period.
10.
A company’s operating cycle is the average time taken to acquire goods and services and convert them to cash in producing revenues.
11.
(a)
Tia is not correct. There are three characteristics: • liquidity, • profitability; and • solvency
(b)
The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the business. In contrast, long-term creditors and shareholders are primarily interested in the profitability and solvency of the company. However, they may use the same financial statements as a source of information.
(a)
The increase in profit margin is good news because it means that a larger percentage of profit is generated for each dollar of net sales.
(b)
An increase in the current ratio generally signals good news because the company improved its liquidity.
(c)
The decrease in the debt to total assets ratio is good news because it means that the company has decreased the proportion of assets funded by creditors, thus reducing risk of being unable to repay debt.
(d)
An increase in current cash debt coverage ratio is good news because it means that the company has increased its ability to meet short-term obligations. The higher the current cash debt coverage the more favourable is the liquidity of the business.
12.
1.3
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1.1 (a)
P
Shared control, increased skills and resources.
(b)
SP
Simple to set up and maintain control with founder.
(c)
C
Easier to transfer ownership and raise funds, no personal liability.
BRIEF EXERCISE 1.2 (a)
False
(b)
True
(c)
False
BRIEF EXERCISE 1.3 1. Trying to determine whether the company complied with the Corporations Act. 2.
Trying to determine whether the entity can pay its obligations.
3.
Trying to determine whether a major investment proposal will be cost effective.
4.
Trying to determine whether the company’s profit will result in a share price increase.
5.
Trying to determine whether the entity should use debt or equity financing. (a)
3
Executive directors
(b)
2
Bank managers
(c)
4
Shareholders
(d)
5
Chief Financial Officer
(e)
1
ASIC
BRIEF EXERCISE 1.4 DFV Takeaway Pty Ltd Statement of financial position as at 31 December 2012 Assets Cash
$15 000
Accounts receivable
8 000
Inventory
17 000
Total assets
40 000
Liabilities Accounts payable
30 000
Net assets
$10 000
Equity Share capital
10 000
Total equity
$10 000
1.4
Chapter 1: Introduction to accounting
BRIEF EXERCISE 1.5 IS
(a)
Expenses during the period.
SFP
(b)
Accounts payable at the end of the year.
SCF
(c)
Cash received from borrowing during the period.
SCF
(d)
Cash payments for the purchase of property, plant and equipment.
BRIEF EXERCISE 1.6 Taylor Ltd Statement of financial position (Partial)
Current assets: Cash Short-term investments Accounts receivable Supplies Prepaid rent Total current assets Non-current assets: Property, plant and equipment Total non-current assets
$3,000 8,200 20,000 1,500 4,000 36,700 10,000 10,000
Total assets
$46,700
BRIEF EXERCISE 1.7 Return on assets ratio
=
Profit = Average total assets
$2,053,646 = 41.07% $5,000,000
Profit margin ratio
=
Profit Sales
$2,053,646 = 21.97% $9,346,911
=
1.5
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO EXERCISES EXERCISE 1.1 (a)
8
Auditor’s opinion
(b)
1
Company
(c)
6
Share capital
(d)
7
Accounts payable
(e)
3
Accounts receivable
(f)
2
Creditor
(g)
4
Sole trader
(h)
5
Partnership
EXERCISE 1.2 Geoff’s Gear Pty Ltd Income Statement for the year ended 31 December 2012 $ Revenues: Hire revenue Expenses: Advertising expense Electricity expense Rent expense Wages expense Total expenses Profit
$ 70,000
1,800 2,400 10,400 28,000 42,600 $27,400
Geoff’s Gear Pty Ltd Calculation of retained earnings for the year ended 31 December 2012 $ 45,000 27,400 72,400 (7,000) $65,400
Retained earnings, 1 January Add: Profit Less: Dividends Retained earnings, 31 December
1.6
Chapter 1: Introduction to accounting
EXERCISE 1.3 Quality Products Ltd Statement of financial position as at 30 June 2012
Assets: Cash Accounts Receivable Supplies Inventory Total assets
$20,000 10,000 8,500 44,000 82,500
Liabilities: Accounts payable Net Assets
20,000 $62 500
Equity: Share capital Retained earnings Total Equity
$40,000 *22,500
62,500 $62,500
*$27,500 – $5,000
EXERCISE 1.4 White Ltd (a)
Eq E E A L E E E L A R A Eq E Eq A
Retained earnings Cost of sales Wages expense Cash Current payables Interest expense Other expense Depreciation expense Non-current borrowings Inventories Sales revenue Accounts Receivable Reserves Income tax expense Contributed equity Property and Equipment
$1,000 12,800 9,400 1,200 4,500 1,100 600 1,400 12,000 2,800 26,000 5,000 1,000 200 10,000 20,000
1.7
Solutions manual to accompany Accounting: building business skills 4e
(b)
Calculation of profit for White Ltd for the year ended 30 June 2012 $ Sales revenue Expenses: Cost of sales Wages expense Interest expense Other expense Depreciation expense Income tax expense Total expenses Profit
$ 26,000
12,800 9,400 1,100 600 1,400 200 25,500 $500
EXERCISE 1.5 Bridges Ltd Note to solve the missing amounts the student needs to decide the order to solve the missing amounts 1. The Statement of changes in equity shows the ending retained earnings as $32,000 which then can be substituted into the Statement of financial position so that (b) equals $32,000. 2. Now (a) Contributed equity can be calculated. Accounts payable + Contributed equity + Retained earnings = Total liabilities and equity. $5,000 + (a) + $32,000 = $65,000 (a) = $65,000 – $32,000 – $5,000 (a) = $28,000 3. Items (d) and (e) are the same figure. Therefore solve (e) first in the Statement of changes in equity Beginning retained earnings+ Profit – Dividends = Ending retained earnings $10,000 + (e) – $5,000 = $32,000 (e) = $32,000 –$10,000 + $5,000 (e) = $27,000 and also (d) equals $27,000 4. Lastly now item (c) can be calculated Revenue – Cost of sales – Administrative expenses = Profit $80,000 – (c) – $10,000 = $27,000 $80,000 – $10,000 – $27,000 = (c) (c) = $43,000
1.8
Chapter 1: Introduction to accounting
EXERCISE 1.6 Cheong Pty Ltd (a)
This is a violation of the cost principle. The inventory was written up to its market value when it should have remained at cost.
(b)
This is a violation of the accounting entity concept. The treatment of the transaction treats Cheong Kong and Cheong Pty Ltd as one entity when they are two separate entities. The computer should not have been charged to the expense account. If paid for by the business, it should have been treated as a loan from the business to Cheong Kong.
(c)
This is a violation of the period concept. This concept states that the economic life of an entity can be divided into artificial time periods (months, quarters or a year). By adding two more days to the year, Cheong Pty Ltd would be misleading financial statement users. In addition, 2012 results would not be comparable to previous years’ results, and the problem would recur in 2013. The period should have been 52 weeks or 53 at the most. Retailers often use a complete number of weeks rather than an exact year. As a 365-day year consists of 52 weeks plus one day, many retailers use 52-week periods and then, approximately every 5 years, use a 53-week year. However, this is fully disclosed for comparative purposes. For example Woolworths Limited and Coles Myer Limited.
EXERCISE 1.7 AGL Ltd Statement of financial position (Partial) as at 30 June 2010 $M Current assets: Cash assets Receivables Inventories Other financial assets Other current assets Total current assets Non-current assets Receivables Equity accounted investments Deferred expenditure (non-current) Oil and gas assets Property, plant and equipment Intangibles Other financial assets *Other non-current assets Total non-current assets Total assets
480.4 1234.5 94.2 225.3 174.1 2208.5 0.6 200.8 607.5 333.4 2056.2 3149.0 106.5 28.4 6482.4 $8690.9
*SOME VERSION OF TEXT THIS FIGURE APPEARED AS $284M NOT 28.4M SO TOTAL ASSETS WOULD BE $8946.5M
1.9
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 1.8 Goodman Fielder Limited Statement of financial position (Partial) as at 30 June 2010 $M Current assets: Cash and cash equivalents Trade and other receivables Inventories Derivative financial instruments Current tax receivable Other current assets Total current assets Non-current assets Receivables Investments in jointly controlled entities Property, plant and equipment Intangible assets Deferred tax assets Other non-current assets Total non-current assets Total assets
73.3 247.4 166.1 0.1 16.0 6.5 509.4 5.3 1.8 602.5 1906.5 54.7 2.2 2573.0 $3082.4
EXERCISE 1.9 (a) Wellington Wall Coverings Pty Ltd Income Statement for the year ended 31 July 2012 $ Revenues: Sales revenue Less: Cost of sales Gross profit Other revenue Rent revenue Expenses: Salaries expense Depreciation expense Other expenses Total expense Profit
$ 100,000 60,000 40,000 50,000
40,000 7,000 38,000 (85,000) $5,000
Calculation of Retained Earnings for the year ended 31 July 2012 $ Retained earnings, 1 August 2011 Add: Profit Retained earnings, 31 July 2012
3,000 5,000 $8,000
1.10
Chapter 1: Introduction to accounting
(b) Wellington Wall Coverings Pty Ltd Statement of financial position as at 31 July 2012 $ Current assets: Cash Inventory Total current assets
$ 25,000 20,000 45,000
Non-current assets: Land Building Less: Accumulated depreciation Total non-current assets
120 000 140,000 (14,000)
126,000 246,000
Total Assets
291,000
Current liabilities: Accounts payable Rent received in advance Total current liabilities
11,000 2,000 13,000
Non-current liabilities Bank loan Total non-current liabilities Total liabilities Net Assets
110 000 110,000 123 000 $168 000
Equity Share capital Retained earnings Total equity
160,000 8,000 $168,000
1.11
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 1.10 (a) Bear Pty Ltd Income Statement for the year ended 31 July 2014 $ Revenues: Sales revenue Less: Cost of sales Gross profit Other revenue Rent revenue Expenses: Salaries expense Depreciation expense Other expenses Total expense Profit
$ 140,000 84,000 56,000 70,000
56,000 9,800 53,200 119,000 $ 7,000
(b) Bear Pty Ltd Calculation of Retained Earnings for the year ended 30 June 2014 $ Retained earnings, 1 July 2013 Add: Profit Retained earnings, 30 June 2014
4,200 7,000 $11,200
1.12
Chapter 1: Introduction to accounting
(b) Bear Pty Ltd Statement of financial position as at 30 June 2014 $
$
Current assets: Cash Inventory Total current assets
$ 35,000 28,000 63,000
Non-current assets: Land Building Less: Accumulated depreciation Total non-current assets Total Assets
196,000 19,600
Current liabilities: Accounts payable Rent received in advance Total current liabilities
15,400 2,800
168,000 176,400 344,400 407,400
18,200
Non-current liabilities Bank loan Total non-current liabilities Total liabilities Net Assets Equity Share capital Retained earnings Total equity
154,000 154,000 172,200 $235,200 224,000 11,200 $235,200
1.13
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 1.11 Retail Ltd (a)
(b)
Working capital = current assets – current liabilities Beginning of year $53,764,000
= $223,313,000 – $169,549,000
End of year: $78,485,000
= $208,426,000 – $129,941,000
Current ratio
= current assets/current liabilities
Beginning of year: 1.32:1
= $223,313,000 / $169,549,000
End of year: 1.60:1
= $208,426,000 / $129,941,000
These measures indicate that Retail Ltd’s liquidity improved during the year.
1.14
Chapter 1: Introduction to accounting
EXERCISE 1.12 AGL 2010 $M
2009 $M
(a) Debt to assets ratio
$2891.0 = 0.33 or 33.26% $8690.9
$3189.0 = 0.35 or 35.3% $9034.7
(b) Cash debt coverage ratio
$390 = 0.13 $2891 + $3189 2
$235.4 = 0.06 $3189 + $4473 2
(c)
The ratio of debt to total assets decreased, indicating decreased reliance on debt, and, AGL’s cash flows from operating activities increased and the coverage of total liabilities increased.
(d) In 2010 AGL’s cash provided by operations ($390.0M) was sufficient to cover the cash used in investing activities ($91.7M). If there was a cash deficiency AGL, being a publicly listed company, could raise more money from the public through the issue of shares. The company could also borrow money if required. In 2009 there was a large cash inflow from investing activities If the Statement of cash flows is downloaded then it can be seen that the cash from operating activities did cover investing outflows but was not sufficient to cover financing resulting in a net decrease in cash for the year of $142.7M. In 2009 cash increased by $522.2M. Cash flow from operating activities was $235.4M and a review of the statement of cash flows indicates that a further $1396.5M was raised from sale on Investments and $1201.8M from sale of subsidiaries. This was used to finance other investing activities and to meet financing commitments. $1420.8M was used to repay borrowings.
Note to instructor This exercise would be suitable for post graduate class and also provide the URL so that can complete the response in more depth. If students wish to investigate Wattyl’s annual report the web address is http://agl.com.au/about/InvestorToolkit/Pages/AnnualReports.aspx
1.15
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 1.13 NOTE: cash generated (used) by investing activities is not given in question 2010 used $83.8M and 2009 $64.9M Goodman Fielder Limited
(a) Debt to assets ratio (b) Cash debt coverage ratio
(c)
2010 $’000
2009 $’000
$1414 = 0.46 or 46% $3082
$1476.3 = 0.48 or 48% $3074.0
$319.7 = 0.22 $1414 + $1476.3 2
$285.1 = 0.28 $1476.3 + $540.5 2
The ratio of debt to total assets decreased slightly, indicating increased reliance on debt. The net cash flows from operations increased but the cash coverage of total liabilities decreased indicating a slight worsening of the solvency position.
(d) The investing cash flows were omitted from the text but are given above so either provide to students or they can look up accounts. However the cash flows from operating activities in both years is greater then required for investing activities and in both years the operating cash flows also were not sufficient to cover financing activities as further funds were borrowed in each year(see comment under part c) . Overall the cash position increased in both years If students wish to investigate Goodman Fielder’s annual report the web address is: http://www.goodmanfielder.com.au/index.php?q=node/91 .
1.16
Chapter 1: Introduction to accounting
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 1.1 (a)
The concern over legal liability would make the limited liability company form a better choice over a partnership. Also, the corporate form will allow the business to raise cash more easily which may be of importance in a rapidly growing industry.
(b)
Sarah and Andrew should adopt the partnership form because it facilitates bringing together the contribution of skills and resources. Also there does not appear to be any expected needs for further fund in the near future.
(c)
The fact that the combined business expects that it will need to raise significant funds in the near future makes the company form more desirable in this case.
(d)
It is likely that this business would form as a partnership. Its needs for additional funds would probably be minimal in the foreseeable future. Also, the three know each other well and would appear to be contributing equally to the firm. Service firms, like consulting businesses, are frequently formed as partnerships. Alternatively, they may prefer the company form to simplify subsequent expansion and take advantage of limited liability, but they would need to consider the additional regulation that it would involve.
(e)
One way to ensure control would be for Anthony to form a sole proprietorship. However in order for this business to thrive, it will need a substantial investment of funds early. This would suggest the company form of business. In order for Anthony to maintain control over the business, he would need to own more than 50 percent of the voting power. In order for the business to grow, he may have to be willing to give up some control.
PROBLEM SET A 1.2 (a)
In deciding whether to extend credit for 30 days you would be most interested in the Statement of financial position because it shows the assets on hand that would be available for settlement of the debt in the near-term.
(b)
In purchasing an investment that will be held for an extended period, the investor must try to predict the future performance of Domino’s. The income statement provides the most useful information for predicting future performance.
(c)
In extending a loan for a relatively long period of time, the bank is most interested in the probability that the company will generate sufficient income to meet its interest payments and repay its principal. The bank would therefore be interested in predicting future profit using the income statement. It should be noted, however, that the lender would also be very interested in both the Statement of financial position and the Statement of cash flows — the Statement of financial position would show the amount of debt the company has already incurred, as well as assets that could be liquidated to repay the loan. And the bank would be interested in the Statement of cash flows because it would provide useful information for predicting the company’s ability to generate cash to repay its obligations.
(d)
The finance director would be most interested in the Statement of cash flows since it shows how much cash the company generates and how that cash is used. The Statement of cash flows can be used to predict the company’s future cash-generating ability. 1.17
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 1.3 Ultimo Travel Goods Pty Ltd (a)
1. The accounting entity concept states that economic events can be identified with a particular unit of accountability. Since the Gold Coast villa is the personal property of Mark Austin – not Ultimo Travel Goods Pty Ltd – it should not be reported on the company’s Statement of financial position. Likewise, the loan is a personal loan of Mark Austin – not a liability of the company. 2. The cost principle dictates that assets are recorded at their original cost. Therefore reporting the inventory at $30,000 would be improper and violates the cost principle. The inventory should be reported at $10,000. 3. Including the personal telephone account payable is a violation of the accounting entity concept. The $5,000 payable is not a liability of Ultimo Travel Goods Pty Ltd. If the company pays the telephone account on behalf of Mark Austin, it should be accounted for as a loan to Mark.
(b) Ultimo Travel Goods Pty Ltd Statement of financial position as at 30 June 2012 $ Assets Cash Accounts receivable Inventory Total assets
$ 20 000 55 000 10 000 85,000
Liabilities Accounts payable ($40,000-$5,000) Notes payable Total liabilities Net Assets
35,000 15,000 50,000 $35 000
Equity Total equity
35,000 $35,000
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Chapter 1: Introduction to accounting
PROBLEM SET A 1.4 CSI Pty Ltd Income Statement for the month ended 31 May 2012 $ Revenues: Service revenue
$ 10,000
Expenses: Advertising expense Fuel expense Insurance expense Rent expense Repair expense Total expenses Profit
900 3,400 400 1,500 500 6,700 $3,300
CSI Pty Ltd Calculation of Retained Earnings for the month ended 31 May 2012 $ Retained earnings, 1 May Add: Profit
0 3,300 3,300 (1,500) $1,800
Less: Dividends Retained earnings, 31 May
CSI Ltd Statement of financial position as at 31 May 2012 $ Assets: Current Assets Cash Accounts receivable
$
7,800 11,400 19,200
Non-Current Assets Equipment Total assets
60,000 79,200
Liabilities: Current Liabilities Accounts payable
2,400
Non-Current Liabilities Bank loan Total liabilities Net Assets
30,000 32,400 $46,800
Equity: Share capital Retained earnings Total equity
45,000 1,800 $46,800
1.19
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 1.5 Dunstan Ltd Dunstan Ltd should include the following items in its Statement of cash flows: Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers
Dunstan Ltd Statement of cash flows for the year ended 31 December 2012
Cash flows from operating activities: Cash received from customers Cash paid to suppliers Net cash provided by operating activities
$185,000 (105,000) 80,000
Cash flows from investing activities: Cash paid to purchase equipment Net cash used in investing activities Cash flows from financing activities: Dividends paid Net cash used in financing activities Net increase in cash
(26,000) (26,000) (10,000) (10,000) $44,000
1.20
Chapter 1: Introduction to accounting
PROBLEM SET A 1.6 Bear Ltd Income Statement for the month ended 31 August 2013 $ Revenues: Service revenue
$ 11 800
Expenses: Advertising expense Fuel expense Insurance expense Rent expense Repair expense Total expenses Profit
800 3 600 600 2 500 ..800 8 300 $3 500
Bear Ltd Calculation of Retained Earnings for the month ended 31 August 2013 $ Retained earnings, 1 August Add: Profit
0 3 500 3 500 (1 000) $2 500
Less: Dividends Retained earnings, 31 August
Bear Ltd Statement of financial position as at 31 August 2013 $ Assets: Current Assets Cash Accounts receivable
$
12 300 25 400 37 700
Non-Current Assets Equipment Total assets
87 000 124 700
Liabilities: Current Liabilities Accounts payable
7 200
Non-Current Liabilities Bank loan Total liabilities Net Assets
40 000 47 200 $77 500
Equity: Share capital Retained earnings Total equity
75 000 2 500 $77 500
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Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 1.7 Pod Ltd Pod Ltd should include the following items in its Statement of cash flows: Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers
Pod Ltd Statement of cash flows for the year ended 30 June 2013
Cash flows from operating activities: Cash received from customers Cash paid to suppliers Net cash provided by operating activities
$296 000 (170 000) 126 000
Cash flows from investing activities: Cash paid to purchase equipment Net cash used in investing activities Cash flows from financing activities: Dividends paid Net cash used in financing activities Net increase in cash
(50 000) (50 000) (18 000) (18 000) $58 000
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Chapter 1: Introduction to accounting
PROBLEM SET A 1.8 Boral Ltd Statement of financial position as at 30 June 2010 $’m Current assets: Cash assets Accounts receivable Inventory Assets held for sale Other current assets Total current assets
157.0 783.7 548.5 59.5 63.3 1612.0
Non-current assets: Receivables Inventories Investments accounted for using equity method Other financial assets Property, plant and equipment (net) Intangible assets Deferred tax asset Other non-current assets Total non-current assets Total assets Current liabilities: Accounts payable Interest-bearing liabilities Current tax payable Provisions Liabilities held for sale Total current liabilities Non-current liabilities: Payables Interest-bearing liabilities Deferred tax liabilities Provisions Total non-current liabilities Total liabilities NET ASSETS Equity: Issued Capital Reserves Retained earnings Total parent entity interest Non-controlling interests TOTAL EQUITY
19.2 85.3 294.1 26.8 2785.1 277.6 43.3 66.0 3597.4 5209.4 640.9 8.9 98.9 246.0 9.9 1004.6
22.1 1330.7 118.9 107.0 1578.7 2583.3 $2626.1 1724.0 (38.9) 938.4 2623.5 2.6 $2626.1
If students wish to look up Boral’s annual report the web address is http://www.boral.com.au/PromoList/annual_sustainability_reports.asp
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Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 1.9 City Sales Pty Ltd (a) (b)
(c)
Working capital
= $474,500 – $250,000 = $224,500
Current ratio
=
$474,500 = 1.9 : 1 $250,000
Current cash debt coverage ratio
=
$260,000
$250,000 + $100,000 = 1.5 times 2
(d)
(e)
Debt to total assets ratio
=
$460,000 = 0.453 : 1 or 45.3% $1,014,800
Cash debt coverage ratio
=
$460,000 + $300,000 = 0.7 times
$260,000 2
(f)
(g)
Profit margin ratio
=
Return on assets ratio
=
$115,000 = 0.052 : 1 or 5.2 % $2,200,000
$115,000 $115,000 = = 0.127 : 1 OR 12.7% $790,800 + $1,014,800 $902,800 2 .
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Chapter 1: Introduction to accounting
PROBLEM SET A 1.10 AKA Ltd and UFO Ltd Ratio
AKA (All dollars are in thousands)
UFO
(a)
Working capital
$33,000 - $15,000 = $18,000
$20,000 - $10,000 = $10,000
(b)
Current ratio
2.2:1 ($33,000 ÷ $15,000)
2.0:1 ($20,000 ÷ $10,000)
(c)
Debt to total assets ratio
53.1% [($15,000 + $70,000) ÷ $160,000]
87.2% [($10,000 + $160,000) ÷ $195,000]
(d)
Return on assets
10.7% =
$16,000 ($160,000 + $140,000 ) / 2
2 .9 % =
$5,000 ($195,000 + $155,000 ) / 2
(e)
Profit margin ratio
13.3% =
$16,000 $120,000
5.0% =
$5,000 $100,000
(f)
The comparison of the two companies shows the following: Liquidity – AKA’s current ratio of 2.2:1 is better than UFO’s 2.0:1. AKA also has higher working capital than UFO. Solvency – AKA’s debt to total assets ratio is lower than that of UFO, indicating that AKA has better solvency. Profitability – AKA has a higher return on assets and profit margin ratio than UFO, indicating that it is more profitable than UFO. Note that UFO’s higher borrowing costs, resulting from its greater reliance on debt, has reduced its profitability.
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Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 1.1 (a)
One way to ensure control would be for Fiona to form a sole proprietorship. However in order for this business to thrive, it will need a substantial investment of funds early. This would suggest the company form of business. In order for Fiona to maintain control over the business, she would need to own more than 50 percent of the voting power. In order for the business to grow, she may have to be willing to give up some control, maybe her family would also invest or loan the business funds in the early stages of establishment.
(b)
Mark should incorporate the business to minimise tax plus he will need to prepare financial forecast to present to the financial institutions to borrow funds. It is likely Mark would not immediately have the advantage of limited liability as the financial institutions would usually require a personal guarantee from Mark for the debt borrowings.
(c)
It is likely that this business would form as a partnership. Its needs for additional funds would probably be minimal in the foreseeable future. Also, the three know each other well and would appear to be contributing equally to the business. Alternatively, they may prefer the company form to simplify subsequent expansion and take advantage of limited liability, but they would need to consider the additional regulation that it would involve.
(d)
Amanda and Jessica should adopt the partnership form because it facilitates bringing together the contribution of skills and resources. Also there does not appear to be any expected needs for further fund in the near future.
(e)
The fact that the combined business expects that it will need to raise significant funds in the near future makes the company form more desirable in this case.
PROBLEM SET B 1.2 (a)
The finance director would be most interested in the Statement of cash flows since it shows how much cash the company generates and how that cash is used. The Statement of cash flows can be used to predict the company’s future cash-generating ability.
(b)
In purchasing an investment that will be held for an extended period, the investor must try to predict the future performance of Woolworths’. The income statement provides the most useful information for predicting future performance.
(c)
In deciding whether to extend credit for 30 days you would be most interested in the Statement of financial position because it shows the assets on hand that would be available for settlement of the debt in the near-term.
(d)
In extending a loan for a relatively long period of time, the bank is most interested in the probability that the company will generate sufficient income to meet its interest payments and repay its principal. The bank would therefore be interested in predicting future profit using the income statement.
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Chapter 1: Introduction to accounting
It should be noted, however, that the lender would also be very interested in both the Statement of financial position and the Statement of cash flows — the Statement of financial position would show the amount of debt the company has already incurred, as well as assets that could be liquidated to repay the loan. And the bank would be interested in the Statement of cash flows because it would provide useful information for predicting the company’s ability to generate cash to repay its obligations PROBLEM SET B 1.3 Jupiter Pty Ltd (a)
1. The accounting entity concept states that economic events can be identified with a particular unit of accountability. Since the Port Macquarie villa is the personal property of Mary Eagle – not Jupiter Pty Ltd – it should not be reported on the company’s Statement of financial position. Likewise, the loan is a personal loan of Mary Eagle – not a liability of the company. 2. The cost principle dictates that assets are recorded at their original cost. Therefore reporting the inventory at $75,000 would be improper and violates the cost principle. The inventory should be reported at $25,000. 3. Including the personal electricity account payable is a violation of the accounting entity concept. The $2,000 payable is not a liability of Jupiter Pty Ltd. If the company pays the electricity account on behalf of Mary Eagle, it should be accounted for as a loan to Mary.
(b) Jupiter Pty Ltd Statement of financial position as at 30 June 2013 $ Assets Cash Accounts receivable Inventory Total assets
$ 56 000 84 000 25 000 165 000
Liabilities Accounts payable ($65,000-$2,000) Notes payable Total liabilities Net Assets
63 000 30 000 93 000 $72 000
Equity Total equity
72 000 $72 000
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PROBLEM SET B 1.4 Dowling Ltd Income Statement for the year ended 30 June 2013 $ Revenues: Service revenue
$ 350 000
Expenses: Advertising expense Depreciation expense Insurance expense Office expense Rent expense Repair expense Total expenses Profit
22 500 30 000 30 000 85 000 37 500 12 500 217 500 $132 500
Dowling Ltd Calculation of Retained Earnings for the year ended 30 June 2013 $ Retained earnings, 1 July 2012 Add: Profit
0 132 500 132 500 (37 000) $95 500
Less: Dividends Retained earnings, 30 June 2013
Dowling Ltd Statement of financial position as at 30 June 2013 $ Assets: Current Assets Cash Accounts receivable
$
270 500 105 000 375 500
Non-Current Assets Equipment Total assets
120 000 495 500
Liabilities: Current Liabilities Accounts payable
60 000
Non-Current Liabilities Bank loan Total liabilities Net Assets
90 000 150 000 $345 500
Equity: Share capital Retained earnings Total equity
250 000 95 500 $345 500
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PROBLEM SET B 1.5 Burbank Ltd Dunstan Ltd should include the following items in its Statement of cash flows: Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers Cash received from share issue
Burbank Ltd Statement of cash flows for the year ended 31 December 2012
Cash flows from operating activities: Cash received from customers Cash paid to suppliers Net cash provided by operating activities
$462 500 (262 500) 200 000
Cash flows from investing activities: Cash paid to purchase equipment Net cash used in investing activities Cash flows from financing activities: Cash from share issue Dividends paid Net cash provided in financing activities Net increase in cash
(165 000) (165 000) 30 000 (25000) 5 000 $40,000
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Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 1.6 Goodwin Ltd Income Statement for the month ended 31 May 2013 $ Revenues: Service revenue
$ 25 000
Expenses: Advertising expense Office expense Insurance expense Rent expense Repair expense Total expenses Profit
600 2 400 400 1 800 600 5 800 $19 200
Goodwin Ltd Calculation of Retained Earnings for the month ended 31 May 2013 $ Retained earnings, 1 May Add: Profit
0 19 200 19 200 (750) $18 450
Less: Dividends Retained earnings, 31 May
Goodwin Ltd Statement of financial position as at 31 May 2013 $ Assets: Current Assets Cash Accounts receivable
$
27 450 16 700 44 150
Non-Current Assets Equipment Total assets
57 000 101 150
Liabilities: Current Liabilities Accounts payable
2 700
Non-Current Liabilities Bank loan Total liabilities Net Assets
30 000 32 700 $68 450
Equity: Share capital Retained earnings Total equity
50 000 18 450 $68 450
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Chapter 1: Introduction to accounting
PROBLEM SET B 1.7 Spoon Ltd Spoon Ltd should include the following items in its Statement of cash flows: Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers
Spoon Ltd Statement of cash flows for the year ended 30 June 2013
Cash flows from operating activities: Cash received from customers Cash paid to suppliers Net cash provided by operating activities
$444 000 (255 000) 189 000
Cash flows from investing activities: Cash paid to purchase equipment Net cash used in investing activities Cash flows from financing activities: Dividends paid Net cash used in financing activities Net increase in cash
(75 000) (75 000) (27 000) (27 000) $87 000
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Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 1.8 (a) Retail Ltd Income Statement for the year ended 30 June 2012 $ Revenues: Sales revenue Less: Cost of sales Gross profit Expenses: Salaries expense Advertising Expense Insurance Expense Rent Expense Repairs Expense Other expenses Total expense Profit
$ 167 420 82 000 85 420
35 000 5 000 1 300 2 500 15 000 6 250 (65 050) $20 370
Retail Ltd Calculation of Retained Earnings for the year ended 31 July 2012 $ 12 500 20 370 32 870 7 800 $25 070
Retained earnings, 1 July 2011 Add: Profit Less: Dividend Retained earnings, 30 June 2012
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(c) Retail Ltd Statement of financial position as at 30 June 2012 $ Current assets: Cash Accounts receivable Inventory Total current assets Non-current assets: Equipment Intangibles Total non-current assets Total Assets
$ 24 250 8 320 21 500 54 070
83 000 6 300 89 300 143 370
Current liabilities: Accounts payable Total current liabilities Non-current liabilities Bank loan Total non-current liabilities Total liabilities Net Assets
3 300 3 300 15 000 15 000 18 300 $125 070
Equity Share capital Retained earnings Total equity
100 000 25 070 $125 070
(d)
Retail Ltd Statement of cash flows for the year ended 30 June 2012
Cash flows from operating activities: Cash received from customers Cash paid operating expenses Cash paid to suppliers Net cash provided by operating activities
$172 350 (65 050) (84 500) 22 800
Cash flows from investing activities: Cash paid to purchase equipment Net cash used in investing activities Cash flows from financing activities: Cash from borrowing Dividends paid Net cash provided in financing activities Net decrease in cash
(36 000) (36 000) 15 000 (7 800) 7 200 ($6 000)
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PROBLEM SET B 1.9 Nixon Pty Ltd (a) (b)
(c)
(d)
(e)
(f)
(g)
Working capital
= $711 750 – $375 000 = $336 750
Current ratio
=
$711 750 = 1.9 : 1 $375 000
Current cash debt coverage ratio
Debt to total assets ratio
=
Cash debt coverage ratio
=
Profit margin ratio
=
Return on assets ratio
=
=
$375 000 $375 000 + $150 000 =1.43 times 2
$690 000 = 0.453 : 1 or 45.3% $1 522 200
$375 000 $690 000 + $450 000 = 0.66 times 2 $172,500 = 0.052 : 1 or 5.2 % $3,300,000
$172,500 $172 500 = = 0.127 : 1 OR 12.7% $1522200 + $11862000 $1354200 2 .
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PROBLEM SET B 1.10 New Ltd and Old Ltd Ratio
New Ltd (All dollars are in thousands)
Old ltd
(a)
Working capital
$115 500 - $52 500 = $63 000
$70 000 - $35 000 = $35 000
(b)
Current ratio
2.2:1 ($115 500 ÷ $52 500)
2.0:1 ($70 000 ÷ $35 000)
(c)
Debt to total assets ratio
53.1% [($52 500 + $245 000) ÷ $560 000]
87.2% [($35 000 + $560 000) ÷ $682 500]
(d)
Return on assets
10.7% =
$56000 ($560000 + $490000 ) / 2
2.9% =
$17500 ($682500 + $542500 ) / 2
(e)
Profit margin ratio
13.3% =
$56000 $420000
5.0% =
$17500 $350000
(f)
The comparison of the two companies shows the following: Liquidity – NEW’s current ratio of 2.2:1 is better than OLD’s 2.0:1. NEW also has higher working capital than OLD. Solvency – NEW’s debt to total assets ratio is lower than that of OLD, indicating that NEW has better solvency. Profitability – NEW has a higher return on assets and profit margin ratio than OLD, indicating that it is more profitable than OLD. Note that OLD’s higher borrowing costs, resulting from its greater reliance on debt, has reduced its profitability.
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Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 1.1
FINANCIAL REPORTING PROBLEM
Domino’s Pizza Enterprises Ltd (a)
Domino’s total assets at 4 July 2010 were $148,674,000 and at 28 June 2009 were $149,260,000
(b)
Domino’s had $3,537,000 of inventory at 4 July 2010.
(c)
Domino’s had Trade and other payables totalling $25,282,000 at 4 July 2010 and $25,977,000 on 28 June 2009.
(d)
Domino’s reported sales in 2010 of $156,105,000 and in 2009 of $160,055,000. See note 5
(e)
Domino’s profit before tax increased by $3,459,000 from 2009 to 2010, from $20,263,000 to $23,722,000.
(f)
Domino’s accounting equation is:
Assets Liabilities Equity = + $148,674,0 00 $48,327,00 0 $100,347,0 00 (g)
Domino’s has current liabilities of $30,489,000 at 28 June 2009
BUILDING BUSINESS SKILLS 1.2
COMPARATIVE ANALYSIS PROBLEM
Domino’s Pizza Enterprises Ltd vs. Classic Food Ltd (a) (Amounts in thousands) 1. Return on Total assets 2. Profit Margin Ratio*
Domino’s Pizza Enterprises Ltd
Classic Food Ltd
$17,814 / [($148,674+$149,260)/2] = 11.95% $17,814 / $158,280 = 11.25%
$23,552/[($364,227+$170,296)/2] = 8.8% $23,552 / $650,738 = 3.6%
(b) The ratios indicate the Domino’s has a stronger profitability because both its return on total assets and profit margin ratio are greater than those of Classic’s. Overall Domino’s is a stronger performer although Classic is a larger entity. (c)
Working capital Current ratio
$17,858 ($48,959 - $31,101) 1.574:1 ($48,959 / $31,101)
-$20,300 ($174,700 - $195,000) 0.90:1 ($174,700 / $195,000)
(d) Domino’s appears to have better liquidity because it has a higher current ratio and more working capital. Classic Retail has negative working capital. * Revenue from the income statement was used here for the profit margin. If you used net Sales (Note 2a) the profit margin would be 11.4%
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BUILDING BUSINESS SKILLS 1.3
INTERPRETING FINANCIAL STATEMENTS
Innovative Technology Ltd (a)
Creditors lend money to companies with the expectation that they will be repaid at a specified point in time in the future. During 2012 and 2013 Innovative Technology’ operating activities used cash instead of generating it, which is not uncommon in start-up companies in this industry. The company has been reliant on borrowing and contributions from shareholders to meet its investing cash needs and provide cash for operations. Creditors may also be concerned about reduced cash holdings which occurred in both years. Creditors may be reluctant to lend to the company without having some additional assurance of repayment. (Although details were not provided in the question, Innovative Technology had not received any cash from customers in 2012 or 2013.
(b)
Shareholders are interested in the long-term performance of a company and how that translates into its share price. Shareholders may be concerned that the company’s operations have continued to drain cash flows in 2013. However, this may be reasonably expected during the start-up phase of a communications company.
(c)
More detailed information about the components of operating, financing and investing cash flows would be useful to determine how cash is being used and in particular, why investing cash flows were a net inflow in 2013. The Statement of cash flows reports information on a cash basis. An investor cannot get the complete story without looking at the income statement and Statement of financial position as well.
BUILDING BUSINESS SKILLS 1.4
FINANCIAL ANALYSIS ON THE WEB
Answers to this question will differ over time and depending on the accounting forms chosen by the student, choice of services (part b) and choices of news item (part d). We provide the following solution for Deloitte & Touche as at September 2011. (a)
Choose from – Australia:
“Deloitte Australia provides a broad range of audit, tax, consulting, and financial advisory services to public and private clients. It has expertise that spans industry sectors including automotive; consumer business; energy & resources; financial services; government services; life sciences & health care; manufacturing; real estate; and technology, media & telecommunications. The Deloitte Private practice of Deloitte is focused on Australia’s middle markets with more than 70 partners and 600 people across the country providing professional services to the nation’s burgeoning privately owned family businesses, as well as the increasing ranks of high net worth individuals. Given a strategic decision in the early 2000s Deloitte remains the largest independent management consulting firm in Australia with more than 700 consultants providing strategy and operations, technology, human capital, consulting and actuarial services for regional, national and global clients. Deloitte Analytics has carved a unique market niche that delivers deep industry expertise and advanced analytics capability, maximising the value of data. Analytics encompasses Information Management that assists clients to manage information to deliver systemsbased analysis capability; Performance Optimisation drives capability to deliver analytics process solutions and Analytics Insights provides customised analytics to unique and unstructured problems.”
New Zealand: 1.37
Solutions manual to accompany Accounting: building business skills 4e
Accounting and Advisory, Audit, tax Consulting, Finance, and e business (b)
Deloittes operate in 150 countries including Albania, Argentina, Aruba, Australia, Austria, Bahrain, Bangladesh, Belarus, Belgium, Bonaire, Belize, Bermuda, Bosnia and Herzegovina, Brazil, Brunei Darussalam, Bulgaria, Canada, Cayman Islands, Chile, China, Costa Rica, Croatia, Curacao, Cyprus, Czech Republic, Denmark, Ecuador, Estonia, Finland, France, Germany, Gibraltar, Guam, Hungary, Iceland, India, Indonesia, Ireland, Israel, Italy, Jamaica, Japan, Jordan, Korea, Kuwait, Latvia, Lebanon, Lithuania, Luxembourg, Macedonia, Malaysia, Marshall Islands, Malta, Micronesia, Moldova, Morocco, Netherlands, Netherlands Antilles, New Zealand, North Mariana Islands, Norway, Oman, Pakistan, Palau, Papua New Guinea, Philippines, Poland, Qatar, Romania, Russia, St Maarten, Saudi Arabia, Serbia and Montenegro, Singapore, Slovakia, Slovenia, South Africa, South Korea, Sri Lanka, Syria, Taiwan, Thailand, Turkey, Uruguay, Vietnam. Regions: Asia Pacific, Europe, North America, Latin America, the Middle East and Africa.
(c)
Australia: Careers information and student programs Those who participate in our student programs often secure a Deloitte graduate position well before their peers. Deloitte has three programs for students who are still studying. The Traineeship Program is open to Year 12 secondary school students. The Development Program is for students in their first and second year of university. The Summer Vacation Program is for students in their second last year of university. Students who participate in the programs gain invaluable insight into working life, as well as experience working with big clients on current client issues and the opportunity to network throughout a world-class consulting and advisory firm.
New Zealand: Careers information. Such as The Summer Intern Programme is designed to help you make a sound career choice by showing you what it’s like working with Deloitte and our clients. You’ll be paired up with a buddy to get you instantly involved in challenging and interesting projects.
(d)
Australia: June 2011: Road pricing could help manage demand and raise revenue for reinvesting in roads and public transport Also there was the September 2011 Asia Pacific Outlook; Technology Trends: August 2011 published the ;attest mining industry analysis August 2011 Hotel Market report looking at the economic landscape both in forecast f occupancy levels and room rates throughout Australia
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CRITICAL THINKING BUILDING BUSINESS SKILLS 1.5
GROUP DECISION CASE Permanent Press
(a)
(b)
(1)
This is an expense of the business because Permanent Press has provided its stationery, T-shirts and office decorations.
(2)
The donation of the grevilleas was an expense of the business; the planting of the gardens was likely on the employees’ own time and therefore a personal donation of time by the employees. If Permanent Press paid wages and salaries to its personnel for planting the gladiolas, that would be an expense of Permanent Press.
(3)
This is a business expense since the payment is made by Permanent Press to the charity.
(4)
As the executives are volunteering their own time, this is not an expense of Permanent Press. It is a personal cost to the executives.
(1)
Advertising Expense is the most likely category of those listed because the name, Permanent Press, and the company logo were on all the gifts.
(2)
Charitable Contribution Expense is the most likely account. It is not Grounds Maintenance Expense because the grounds maintained are not those of the company. If the employees were paid wages while planting grevilleas, the cost would be recorded as wages expense.
(3)
This is a Charitable Contribution Expense.
(4)
Not recorded in the company’s financial records at all.
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BUILDING BUSINESS SKILLS 1.6
COMMUNICATION ACTIVITY J. B. Hamilton Ltd
To:
Amy Joan
From:
Student
Date:
DD/MM/YY
I have reviewed the Statement of financial position of J. B. Hamilton Ltd as at 30 June 2011. The purpose of a Statement of financial position is to report a company’s assets, liabilities and equity at a point in time. It reports what the company controls (assets) and what it owes (liabilities) and the net amount attributed to owners (equity). A number of items in this Statement of financial position are not properly reported. They are: 1.
The Statement of financial position should be dated as at a specific date not for a period of time. Therefore, it should be stated ‘as at 30 June 2013’.
2.
Equipment is usually listed below Supplies on the Statement of financial position. In a classified Statement of financial position it would be shown as a non-current asset.
3.
Accounts receivable should be shown as an asset and is usually reported between Cash and Supplies on the Statement of financial positions.
4.
Inventory should be shown as an asset on the Statement of financial position.
5.
Liabilities and shareholders’ equity should be shown separately on the Statement of financial position. Contributed equity, Retained earnings and Dividends are not liabilities.
6.
Contributed equity, Retained earnings and Dividends are part of shareholders’ equity. The Dividends account is not reported on the Statement of financial position but is subtracted from Retained earnings to arrive at the ending balance.
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A corrected Statement of financial position is as follows: J. B. Hamilton Ltd Statement of financial position as at 30 June 2013 $
$
Assets Cash Accounts receivable Inventory Supplies Equipment Total assets
8,000 3,000 2,000 2,000 20,500 $35,500
Liabilities: Accounts payable Total liabilities
$10,500 $10,500
Equity: Contributed equity Retained earnings Total liabilities and equity
12,000 *13,000
* Retained earnings Less: Dividends Ending retained earnings
$17,000 (4,000) $13,000
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Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 1.7 Sustainability CSR Ltd The term sustainability is about making sure the social, economic and environmental needs of our community are met and kept healthy for future generations. Sustainable development must not just be about economic growth but also environmental quality and social equity. Corporate social responsibility (CSR) for business means companies must be aware and have a core understanding of CSR characteristics; an understanding of the basic issues and how they may affect decision making; to be able to apply this basic knowledge with competence to specific activities; and have strategic alignment ie have an in depth understanding of the issues and posses the expertise to embed CSR principles into the business decision making process. CSR LTD’ sustainability report- For demonstration purposes the 2010 report was the latest available when the solution were prepared. 1. CSR Ltd” approach to sustainability This is a copy from the report and full details are provided to enable marker to grade.. Student should us this information and write in their own words “Welcome to CSR’s Sustainability Report. This is the third stand-alone sustainability report for CSR. Once again, we have provided information on CSR’s sustainability record and new opportunities and challenges across our businesses. Approach • •
•
Reviewed CSR’s activities and operations across our businesses to collect data on energy use and emissions and prepared an inventory of greenhouse gas emissions. Referenced the Global Reporting Initiative (GRI) G3 Sustainability Reporting Guidelines, United Nations Global Compact and Federal Government policy towards sustainability reporting in Australia. Reviewed best practice sustainability reports both in Australia and globally, monitored and reviewed feedback from CSR’s previous Sustainability Reports and ongoing feedback from stakeholders including investors, corporate governance advisers, analysts, media and staff. “
Environment policy approach Our policy is to act responsibly, ensuring that CSR people follow appropriate procedures to minimise the company’s impact on the environment, and where possible contribute to its improvement. CSR has an active program to reduce its impact on the environment which is overseen by the Board and the Safety, Health & Environment Committee. Each business in CSR is committed to a plan which commits site management to: • • • •
Complying with government environmental regulations; Identifying and addressing key environmental risks; Improving environmental awareness of employees and contractors; and Reducing greenhouse gas emissions and use of resources.
CSR sites are committed to industry-specific best practice environmental performance and are required to have environmental performance measures, such as energy usage, air emissions, water consumption and waste generation. Each site is required to have plans in place for continuous improvement on these measures. Sustainability matters are also integrated into individual managers' objectives.
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1. 2010 report CSR’s achievement in health and safety and the environment. Health and safety again full details provided you would expect students to report outcomes and how they were measured. “HIGHLIGHTS •
• •
• •
CSR’s lost time injury frequency rate (LTIFR) was 4.7 to the end of the year – an improvement on the previous year’s rate of 6.1 but short of our targeted improvement of 25 per cent. Total recordable injuries (lost time; restricted work; medical treatment) decreased by 22 per cent, offset by a reduction in hours of 18 per cent. Building Products reduced its lost time injury frequency rate by 19.6 per cent, with significant improvements in the Bricks and Roofing business (improved by 65 per cent) and the Insulation business (improved by 55 per cent). Sucrogen reduced its lost time injury frequency rate by 14.5 per cent. There were no fatalities at CSR during the year – the last fatality at CSR was in 2002.
MANAGING SAFETY The CSR Safety, Health and Environment (SH&E) Management System is designed to prevent injuries and environmental incidents by ensuring a systematic approach to SH&E management, creating a positive culture and level of awareness and meeting legal and self insurance obligations. CSR places the same emphasis and importance on managing SH&E as any other business imperative. Safety, Health and Environment is a core value at CSR – we care for and protect each other, our business and our environment. While CSR’s safety record has improved in the past two years, the rate of improvement is less than our target and underscores the considerable work still required to achieve our ambition of zero harm across all our operations. CSR measures safety performance on traditional indicators such as Lost Time Injury Frequency Rate and Total Recordable Injury Frequency Rate and is increasingly adopting a number of lead measures to assess performance by specific business units. CSR is also reweighting its emphasis away from forms and systems, towards more actively working with its staff more closely to understand and rectify the hazards and risks faced across various operations. CSR is actively training more people in the skills required to lead safety and to reduce workplace injuries. As part of this approach, we are simplifying systems and processes across the company. Manual handling injuries such as back strains and muscular injuries continue to be the most significant cause of lost time injuries across CSR, and our safety teams are concentrating on developing initiatives to eliminate these and other injuries. CSR has a formal Safety, Health and Environment Policy, which applies across all CSR businesses, outlining our intent in respect to Safety, Health and the Environment.
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CSR’s SH&E Management System details the minimum requirements to ensure consistent practice across our businesses while enabling each division and business unit to develop systems to address their individual requirements. The SH&E Management System embodies the requirements contained within Australian Standards 4801:2001 and 4804:2001. This approach incorporates a framework outlining the company commitments, management system and reporting and auditing, which ensures that CSR and its people are responsibly discharging their SH&E responsibilities in line with legislation and as a self insurer in Australia. CSR’s vision is zero harm. Our goal is also to minimise the impact of our activities on the environment and the communities in which we operate. We believe that all injuries, occupational illnesses and environmental incidents can be prevented. CSR management is accountable for safety performance and all employees are expected to take personal responsibility and be involved in setting and complying with our standards and instigating improvement initiatives. Safety performance is one of the key criteria in determining short term incentives of management across business units. Managers are responsible for leading safety in the workplace and actively demonstrating commitment as safety role models, by undertaking management safety walks and observations on a regular basis, as part of the CSR behavioural safety program. During the year a total of 1,940 management safety walks were conducted across the business – over 90 per cent of the total planned at the start of the year.
CONTINUOUS IMPROVEMENT CSR constantly reviews its health and safety performance to ensure it continues to improve across the business, including performance against leading and lagging indicators, as well as review of Management System audit outcomes to ensure compliance standards are maintained. This ensures we continually improve our processes in respect to: •
•
•
•
Communication and consultation – to allow effective dissemination of safety information, as well as providing mechanisms for feedback from our people at all levels. Having in place regular SH&E management and committee meetings to review and consult on all matters relating to health and safety. Holding effective Occupational Health and Safety (OH&S) Committee and team meetings ensures all members of our workforce are able to raise issues, see these reviewed and receive feedback on status on a regular basis; Management of risk at all levels of the business by ensuring our people understand the need for identification of hazards and putting in place the mechanisms to assess and control (to an acceptable level) the risk these hazards present. This includes ensuring that minimum performance expectations are in place for managing those activities that are high consequence and low frequency and are not negotiable. These include but are not limited to: entry into confined spaces; machine guarding; working at heights and electrical safety; Incident Management, ensuring incidents are reported in a timely manner and investigated with a desired outcome of reoccurrences being eliminated. Identifying root causes and implementing corrective actions, including assigning responsibility for addressing these actions and having realistic timeframes for implementation; and 1.44
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Behavioural based safety to increase the engagement with our people and the visibility of our management and supervision in the workplace. Implementation of those safety behaviours that display our commitment to safety and provide the example to our workforce of those behaviours we expect to be our business norms.
PERFORMANCE MEASUREMENT AND MONITORING CSR ensures its safety performance is afforded the highest priority through formal reporting to the Board Safety, Health & Environment Committee. It is the policy of the Board that a majority of the members of this Committee be independent directors, and that the Committee be chaired by an independent director. The Committee receives regular reports from management and regularly inspects sites. The Committee reviews the adequacy of management systems and performance, ensures that appropriate improvement targets and benchmarks are in operation and monitors potential liabilities, changes in legislation, community expectations, research findings and technological changes. Monthly reviews of business performance are conducted, with actual performance measured against annual targets. Reports are reviewed monthly by the senior leadership team of the business, as well as by the divisional, business unit and site leadership teams. Performance is measured in line with both lead and lag indicators and monthly data is then consolidated quarterly to form the basis of reporting to the Board SH&E Committee. Remedial actions are instigated to ensure targets are kept on track when performance to target falls below the expected requirement. COMPLIANCE REVIEW AND REPORTING External auditors conduct an independent audit every year to assess the implementation of the SH&E Management System, comprising: • •
•
Three yearly cyclical audits of major sites, in line with and submitted annually as part of our self insurance requirements in each state jurisdiction; Assessment of all major sites; distribution and trade centres, using the National Self Insurance Audit Tool to benchmark sites and put in place corrective actions to meet our requirements as a self insurer and prepare these sites for auditing as part of the three yearly cyclical program; and Auditing of sites to ensure ongoing environmental compliance.
All audits are conducted by external auditors and reports are prepared, outlining findings identified and the recommendations to meet the required standard. Audit outcomes are reviewed by site management to ensure the findings are understood and corrective action plans are developed to address identified deficiencies. In total, 44 external assessments were conducted in the year. A status report is completed by the external body overseeing the audit program and tabled as part of the SH&E Board Committee’s quarterly review. CSR is increasingly focusing on the fitness and wellbeing of its workforce. As part of this commitment, CSR provided financial incentives for its people to participate in the Global Corporate Challenge – the world’s largest corporate health and wellbeing initiative that combines exercise, fun and virtual interactive experiences. CSR entered 96 teams in the challenge representing 672 employees across the company. “
1.45
Solutions manual to accompany Accounting: building business skills 4e
Environment
CSR undertakes audits of divisional environmental performance, with reporting directly to the SH&E Board Committee. As part of its sustainability reporting, CSR undertakes a limited independent assurance of energy use and greenhouse gas emissions. Environmental responsibilities are managed within CSR’s businesses and CSR’s environment and sustainability manager also provides advice to CSR’s businesses and also provides governance and audit procedures and reports to divisional management, the managing director and the SH&E Board Committee. CSR remains committed to providing transparent and accurate reporting on how our operating activities impact the environment. We provide information through a number of channels: • • • •
Annual reporting as part of site licensing activities; Emissions data to the National Pollutant Inventory; Reports to various state Government departments’ programs on energy and water savings; and Continuing our voluntary participation in the Carbon Disclosure Project.
CSR also continues its involvement with the Federal Government’s National Greenhouse and Energy Reporting scheme and the Energy Efficiency Opportunities program. ENVIRONMENTAL INCIDENTS Our goal is zero environmental incidents. CSR reports environmental incidents based on five levels of breaches of compliance with regulatory and CSR requirements. These are 1 minor, 2 significant, 3 serious, 4 severe and 5 extreme/catastrophic. There were 224 environmental incidents reported during YEM10. One of these was level 3, the remainder were levels 1 and 2. This was greater than the number reported in the previous year which was 192. The increase in incidents was due to increased reporting from Sugar Australia and a greater level of scrutiny around environmental events. The level 3 incident reported during the quarter, related to exceeding noise limits at the Viridian facility at Clayton, Victoria. The submission of a noise measurement report to the EPA showed a breach of noise limits as specified within the relevant State Planning Policy. Noise at the site had been a concern over a period and a noise measurement report referred to above was conducted to determine the effectiveness of the control plan which was submitted to the EPA in 2008. A number of actions have been completed and others are currently in progress which are expected to mitigate noise concerns. CSR is refocusing efforts on environmental inspections to identify and reduce potential environmental hazards as well as training to prevent incidents occurring. As per the previous two years, there were no level 4 or level 5 incidents.
1.46
Chapter 1: Introduction to accounting
CSR has strict policies in place regarding reporting procedures for environmental incidents. We have also improved our data monitoring, collection and training procedures to capture environmental incidents. All site employees are required to report all incidents. This allows improvements to be made to processes and procedures on-site to prevent similar occurrences. CSR is focused on improving our collection of environmental data across our businesses and this remains a key priority for the business. We also remain committed to verification of environmental data – for the past three sustainability reports, CSR’s total GHG emissions data has been subject to a limited assurance report by Ernst & Young.”
1.47
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 1.8 ETHICS CASE Mobile Phones Pty Ltd (a)
The stakeholders in this case are: You, as chief financial officer Jack Frost, managing director Users of the company’s financial statements.
(b)
The ethical issue is the continued circulation of significantly misstated financial statements. As chief financial officer, you have contributed to the preparation of misleading financial statements. Jack Frost and any other directors are responsible for the preparation of the financial statements issued by Mobile Phones Pty Ltd. You have acted ethically by telling the company’s managing director. The managing director has reacted unethically by allowing the misleading financial statements to continue to circulate.
(c)
As chief financial officer, you have a professional ethical responsibility to attempt to persuade the managing director not to issue misleading financial statements (they would mislead users, cause damage to the company’s reputation and possibly incur fines). Other actions that may be considered include reporting the matter to other directors and resigning. If the statements are audited, the matter may be referred to the auditors.
1.48
Chapter 2: The accounting information system
CHAPTER 2 – THE ACCOUNTING INFORMATION SYSTEM ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1
1,2,3,10
1A,2A,3A, 1B,2B,3B
4,6
4A,5A,6A,7A, 8A, 4B,5B,6B 7B,8B
5,7,9,10
4A,5A,6A,7A,8A, 4B,5B,6B,7B 8B
10
5A,6A,7A,8A, 5B,6B,7B, 8B
1.
Analyse the effect of accounting transactions and events on the basic accounting equation.
2.
Explain what an account is and how it helps in the recording process.
3.
Define debits and credits and explain how they are used to record accounting transactions.
2
4.
Identify the basic steps in the recording process.
3
5.
Explain what a journal is and how it helps in the recording process.
4,7
6.
Explain what a general ledger is and how it helps in the recording process.
7.
Explain what posting is and how it helps in the recording process.
5
8,10
5A,6A,7A,8A, 5B,6B,7B,8B
8.
Explain the purposes of a trial balance.
6,7
8,9,11,12, 13
5A,6A,7A,8A,9A, 10A,5B,6B,7B, 8B,9B,10B
2.1
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 2 – THE ACCOUNTING INFORMATION SYSTEM
ANSWERS TO QUESTIONS 1.
The system of collecting and processing transactions or data and communicating financial information to interested parties is known as the accounting information system. The first step of the accounting process is to identify transactions and events that are to be recorded. Once identified and measured, the transactions and events are recorded to provide a permanent history of the financial activities of the organisation. Recording begins with a chronological record of transactions and events in an orderly and systematic manner in a journal. The next step is to transfer the journal information to the appropriate accounts in the ledger. (Note further steps in the recording process are discussed in chapter 3.)
2.
Accounting transactions and events of the enterprise are recorded by accountants because they affect the basic equation (assets, liabilities and equity items).
3.
(a)
No, the death of a major shareholder of the company is not an accounting transaction or event. Applying the accounting entity concept from Chapter 1 and therefore it does not affect the basic equation.
(b)
Yes, Supplies purchased on account is an accounting transaction and it is recorded as an increase in an asset, supplies and an increase in liabilities, accounts payable .
(c)
No, an employee being fired is not an accounting transaction or event which is recorded. When the employee provides services (works), this is when the event is recorded. Upon ceasing employment it is only the services which have accrued which need to be accounted for.
(d)
Yes, paying a cash dividend to shareholders is an accounting transaction which is recorded as a decrease in an asset, cash and a decrease in equity, retained earnings.
(a)
Decrease assets, cash and decrease in equity, cleaning expenses.
(b)
Increase assets, equipment and decrease assets cash.
(c)
Increase assets, cash and increase equity, share capital
(d)
Decrease assets, cash and decrease liabilities, accounts payable.
4.
Charles is incorrect. The double-entry system merely records the dual (two-sided) effect of a transaction on the accounting equation. A transaction is not recorded twice; it is recorded once with a dual effect. In other words, for each transaction, debits must equal credits.
5.
Tanya is incorrect. A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favourable nor unfavourable.
2.2
Chapter 2: The accounting information system
6.
7.
8.
(a)
Asset accounts are increased by debits and decreased by credits.
(b)
Liability accounts are decreased by debits and increased by credits.
(c)
The share capital account is decreased by debits and increased by credits.
(d)
Revenue accounts are decreased by debits and increased by credits.
(e)
Expense accounts are increased by debits and decreased by credits.
(f)
Dividend account are increased by debits and decreased by credits.
(a)
Accounts Receivable – debit balance.
(b)
Cash – debit balance.
(c)
Machinery – debit balance.
(d)
Accounts Payable – credit balance.
(e)
Service Revenue – credit balance.
(f)
Advertising Expense – debit balance.
(g)
Share Capital – credit balance.
(a)
The entire group of accounts maintained by an entity company, including all the asset, liability, and equity accounts, is referred to collectively as the ledger.
(b)
The chart of accounts is important, particularly for an entity that has a large number of accounts, because it helps organise the accounts, identify their location in the ledger and facilitate the recording process.
9.
A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after all journalised transactions have been posted. A trial balance also facilitates the discovery of errors in journalising and posting. In addition, it is useful in preparing financial statements.
10.
(a)
The trial balance would balance.
(b)
The trial balance would not balance.
2.3
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2.1 Assets + + -
(a) (b) (c)
Liabilities + NE NE
Equity NE + -
BRIEF EXERCISE 2.2 Debit Effect
Credit Effect
Normal Balance
(a)
Accounts Payable
Decrease
Increase
Credit
(b)
Advertising Expense
Increase
Decrease
Debit
(c)
Service Revenue
Decrease
Increase
Credit
(d) (e)
Accounts Receivable Retained Earnings
Increase Decrease
Decrease Increase
Debit Credit
(f)
Dividends
Increase
Decrease
Debit
BRIEF EXERCISE 2.3 Dudley Advertising Ltd (a) Aug
Basic Analysis
(b)
Debit-Credit Analysis
1
The asset Cash is increased $15,000; Share Capital (equity) is increased.
Debits increase assets: debit Cash $15,000. Credits increase equity: credit Share Capital $15,000
4
The asset Prepaid Insurance is increased; the asset Cash is decreased.
Debits increase assets: debit Prepaid Insurance $1,800. Credits decrease assets: credit Cash $1,800.
16
The asset Cash is increased; the revenue Service Revenue is increased.
Debits increase assets: debit Cash $9,000. Credits increase revenues: credit Service Revenue $9,000.
27
The expense Salaries Expense is increased; the asset Cash is decreased.
Debits increase expenses: debit Salaries Expense $500. Credits decrease assets: credit Cash $500.
2.4
Chapter 2: The accounting information system
BRIEF EXERCISE 2.4 Dudley Advertising Ltd DATE Aug.
1
4
16
27
Description Cash Share Capital Being the issue of share for cash Prepaid Insurance Cash Being the payment of the insurance premium Cash Service Revenue Being the receipt of cash for services Salaries Expense Cash Being the payment of salaries
Debit 15,000
Credit 15,000
1,800 1,800
9,000 9,000 500 500
BRIEF EXERCISE 2.5 Gonzales Ltd
5/5
Service Revenue*
Accounts Receivable 13,200 12/5 Cash
*Service Revenue is the cross-reference. explanation.
See pp. 105-109 of the text for further
Service Revenue 5/5 Accounts Receivable 15/5 Cash
12/5 15/5
Accounts Receivable Service Revenue
Cash 12,400 12,000
2.5
12,400
13,200 12,000
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 2.6 Carland Ltd Trial Balance as at 30 June 2013 Account name
Debit $ 3,800 3,000 17,000
Cash Accounts Receivable Equipment Accounts Payable Share Capital Dividends Service Revenue Salaries Expense Rent Expense
Credit $
4,000 20,000 1,200 6,000 4,000 1,000 $30,000
$30,000
BRIEF EXERCISE 2.7 Jagoda Ltd Trial Balance as at 31 December 2012 Account name
Debit $ 20,800 3,500
Cash Prepaid Insurance Accounts Payable Revenue Received in Advance Share Capital Retained Earnings Dividends Service Revenue Salaries Expense Rent Expense
Credit $
5,000 4,200 10,000 9,000 4,500 11,600 8,600 2,400 $39,800
2.6
$39,800
Chapter 2: The accounting information system
SOLUTIONS TO EXERCISES EXERCISE 2.1 Speedy Lawn Care Pty Ltd 1. 2. 3. 4. 5. 6. 7. 8. 9.
Increase in assets and increase in equity. Decrease in assets and decrease in equity. Increase in assets and increase in equity. Increase in assets and increase in equity. Decrease in assets and decrease in equity. Increase in liabilities and decrease in equity. Increase in assets and decrease in assets. Increase in assets and decrease in assets. Increase in assets and increase in liabilities.
EXERCISE 2.2 Moscow Mowers Ltd (a)
1. Shareholders invested $27,000 cash in the business. 2. Purchased office equipment for $7,000, paying $3,000 in cash and the balance of $4,000 on account. 3. Paid $900 cash for supplies. 4. Recognised $18,500 in revenue, receiving $14,600 cash and $3,900 on account. 5. Paid $1,500 cash on accounts payable. 6. Paid $400 cash dividends to shareholders. 7. Paid $750 cash for rent. 8. Collected $500 cash from customers on account. 9. Paid salaries of $3,900. 10. Received invoice for $1500 electricity used.
(b)
Issued Share Capital Service Revenue Dividends Rent Expense Salaries Expense Electricity Expense Increase in Equity
$27,000 18,500 (400) (750) (3,900) (1,500) $38,950
(c)
Service Revenue Rent Expense Salaries Expense Electricity Expense Profit for the Month
$18,500 (750) (3,900) (1,500) $12,350
(d)
The profit for the month is part of the increase in equity. The profit is part of the retained earnings which has increased with the $12,350 profit and decreased by the payment of the dividend of $400 leaving a balance of $11,950. At month end equity is represented by the Share capital of $27,000 and the Retained earnings of $11,950 as per total equity of $38,950 as per part (b) above. 2.7
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 2.3 Moscow Mowers Ltd Income Statement for the month ended 31 August 2013 $ Revenues: Service revenue Expenses: Salaries expense Rent expense Electricity expense Total expenses Profit
$ 18,500 3,900 750 1,500 6,150 $12,350
Moscow Mowers Ltd Statement of financial position as at 31 August 2013 Assets: Cash Accounts receivable Supplies Office equipment Total assets Liabilities: Accounts payable Net Assets Equity: Share capital Retained Earnings Total equity
$ 31,650 3,400 900 7,000
$
42,950 4,000 $38,950 27,000 11,950 $38,950
Moscow Mowers Ltd Calculation of Retained earnings for the month ended 31 August 2013 $ Retained Earnings 1 August Add: Profit
0 12,350 12,350 (400) $11,950
Less: Dividends Retained Earnings 31 August
2.8
Chapter 2: The accounting information system
EXERCISE 2.4 Expensive Designs Pty Ltd Account debited
Transaction
(a) Basic type
(b) Specific account
(c) Effect
Account credited (d) Normal balance
(a) Basic type
(b) Specific account
(c) Effect
(d) Normal balance
1
Asset
Cash
Increase
Debit
Equity
Share Capital
Increase
Credit
2
Asset
Equipment/ Motor Vehicles
Increase
Debit
Asset
Cash
Decrease
Debit
3
Asset
Supplies
Increase
Debit
Liability
Accounts Payable
Increase
Credit
4
Asset
Accounts Receivable
Increase
Debit
Equity
Service Revenue
Increase
Credit
5
Equity
Advertising Expense
Increase
Debit
Asset
Cash
Decrease
Debit
6
Asset
Cash
Increase
Debit
Asset
Accounts Receivable
Decrease
Debit
7
Liability
Accounts Payable
Decrease
Credit
Asset
Cash
Decrease
Debit
8
Equity
Dividends
Increase
Debit
Asset
Cash
Decrease
Debit
2.9
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 2.5 Expensive Designs Pty Ltd General Journal Transaction Account Titles
Debit $ 10,000
1
Cash
2
Share Capital (Issued shares to investors for cash) Equipment/Motor Vehicles Cash (Purchased car for business for cash)
3
4
5
6
Supplies Accounts Payable (Purchased supplies on account) Accounts Receivable Service Revenue (Invoiced customers for services performed)
10,000 5,000 5,000
500 500
1,800 1,800
Advertising Expense Cash (Paid advertising expense)
200
Cash
700
200
Accounts Receivable (Received cash from customers on account) 7
8
Credit $
700
Accounts Payable Cash (Paid amount owing to accounts payable)
300
Dividends Cash (Paid dividends to shareholders)
400
2.10
300
400
Chapter 2: The accounting information system
EXERCISE 2.6 Better Books Pty Ltd Account debited (b) Specific account
(c)
Account credited
Transaction
(a) Basic type
1
Asset
Cash
Increase
Debit
Equity
Share Capital
Increase
Credit
2
Asset
Equipment/ Photocopier
Increase
Debit
Liability
Accounts Payable
Increase
Credit
3
Asset
Supplies
Increase
Debit
Liability
Accounts Payable
Increase
Credit
4
Asset
Accounts Receivable
Increase
Debit
Equity
Service Revenue
Increase
Credit
5
Equity
Advertising Expense
Increase
Debit
Asset
Cash
Decrease
Debit
6
Asset
Cash
Increase
Debit
Asset
Accounts Receivable
Decrease
Debit
7
Liability
Accounts Payable
Decrease
Credit
Asset
Cash
Decrease
Debit
8
Equity
Rent Expense
Increase
Debit
Asset
Cash
Decrease
Debit
Effect
(d) Normal balance
2.11
(a) Basic type
(b) Specific account
(c) Effect
(d) Normal balance
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 2.7 Better Books Pty Ltd General Journal Transaction Account Titles 1
2
3
4
5
6
Debit $ 20,000
Cash Share Capital (Issued shares to investors for cash) Equipment/Photocopier Cash (Purchased photocopier for business account) Supplies Accounts Payable (Purchased supplies on account) Accounts Receivable Service Revenue (Invoiced customers for services performed) Advertising Expense Cash (Paid advertising expense)
20,000 6,000 6,000 on
800 800
3,600 3,600
600 600
Cash
1,500
Accounts Receivable (Received cash from customers on account) 7
8
Credit $
1,500
Accounts Payable Cash (Paid amount owing to accounts payable)
6,300
Rent Expense Cash (Paid dividends to shareholders)
1,200
2.12
6,300
1,200
Chapter 2: The accounting information system
EXERCISE 2.8 Ink Pad Printers Ltd (a)
1/8 10/8 31/8 1/9
Share Capital Service Revenue Accounts Receivable Opening Balance
25/8
Service Revenue
1/9
Opening Balance
12/8
Cash/Bank Loan
31/8
Closing balance
Cash 17,000 12/8 12,400 31/8 600 30,000 29,000
Office Equipment Closing Balance
1,000 29,000 30,000
Accounts Receivable 1,500 31/8 Cash Closing Balance 1,500 900 Office Equipment 4,000
600 900 1,500
Bank Loan 12/8
Office Equipment
3,000
Share Capital 1/8
Cash
17,000
Service Revenue 13,900 10/8 Cash 25/8 Accounts Receivable 13,900 31/8 Balance
12,400 1,500 13,900 13,900
(b) Ink Pad Printers Ltd Trial Balance as at 31 August 2014 Account Name
Debit $ 29,000 900 4,000
Cash Accounts Receivable Office Equipment Bank Loan Share Capital Service Revenue
$33,900
2.13
Credit $
3,000 17,000 13,900 $33,900
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 2.9 Zebra Tours Ltd (a) General Journal Date Apr.
Account Titles and Explanation 1
Cash
Debit 10,000
Share Capital (Sold shares for cash) 4
7
12
10,000
Supplies Accounts Payable (Purchased supplies on account)
4,800
Accounts Receivable Service Revenue (Invoiced customers for services rendered)
2,400
Cash
1,900
4,800
2,400
Service Revenue (Received cash for services performed) 15
25
29
Salaries Expense Cash (Paid salaries)
1,900
750 750
Accounts Payable Cash (Paid creditors on account)
3,500 3,500
Cash
200
Accounts Receivable (Received cash from customers on account) 30
Credit
Cash
200
700
Revenue Received in Advance (Received cash for services to be performed in the future)
2.14
700
Chapter 2: The accounting information system
(b) Zebra Tours Ltd Trial Balance as at 30 April 2013 Account Name
Debit $ 8,550 2,200 4,800
Cash Accounts Receivable Supplies Accounts Payable Revenue Received in Advance Share Capital Service Revenue Salaries Expense
Credit $
1,300 700 10,000 4,300 750 $16,300
$16,300
EXERCISE 2.10 Landsdowne Ltd (a)
Cash Sept
1 5 25 30
Assets
=
+
=
+ 15,000 - 5,000 10,000 + - 3,000 7,000 + - 500 6,500 +
Equipment
Liabilities Accounts Payable
+
Equity
+
Equity +15,000 Issued shares
+ 10,000 10,000 = 10,000 =
+ 5,000 5,000 + - 3,000 2,000 +
10,000 =
2,000 +
$16,500
$16,500
2.15
15,000 15,000 - 500 Dividends 14,500
Solutions manual to accompany Accounting: building business skills 4e
(b) Landsdowne Ltd General Journal Date Sept
1
Account Titles and Explanation
Ref
Debit
Cash
100 300
15,000
Equipment Cash Accounts Payable (Purchased equipment part cash, part on account)
120 100 200
10,000
Accounts Payable Cash (Paid amount owed on account)
200 100
3,000
Dividends Cash (Paid cash dividend)
320 100
500
Share Capital (Issued shares for cash) 5
25
30
Credit
15,000
5,000 5,000
3,000
500
(c) General Ledger 1/9
5/9
25/9
30/9
Share Capital
Cash 15,000 5/9 25/9 30/9
Equipment Accounts Payable Dividend
100 5,000 3,000 500
Cash/Accounts Payable
Equipment 10,000
Cash
Accounts Payable 3,000 5/9 Equipment
200 5,000
Share Capital 1/9
300 15,000
Cash
Dividends 500
2.16
120
Cash
320
Chapter 2: The accounting information system
EXERCISE 2.11 Equipment Repair Pty Ltd (a) Error
(a) In Balance
1 2 3 4 5 6
No Yes Yes No Yes No
(b) Difference
(c) Column with larger total
$400 300 9
Debit Credit Credit
(b) The trial balance will not detect postings to the correct side of the ledger but the incorrect ledger account, omitted transactions, transactions posted incorrect amounts on both sides of the ledger. That is the trial balance detects when debits do not equal credits. EXERCISE 2.12 Sushi To Go Ltd Trial Balance as at 31 July 2013 Account Name Cash ($193,314 – Debit total without Cash $163,880) Accounts Receivable Prepaid Insurance Delivery Equipment Bank Loan Accounts Payable Salaries Payable Share Capital Retained Earnings Dividends Service Revenue Salaries Expense Fuel Expense Repair Expense Insurance Expense
2.17
Debit $ 29,434 27,184 3,836 118,620
Credit $
$56,800 14,692 1,530 79,900 9,172 1,300 31,220 8,756 1,416 1,822 946 $193,314
$193,314
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 2.13 Tyne Ltd Trial Balance as at 31 March 2014 Account Name Cash Accounts Receivable Prepaid Insurance Delivery Equipment Accounts Payable Salaries Payable Bank Loan Share Capital Retained Earnings ($289971– $276,213 ) Dividends Service Revenue Salaries Expense Fuel Expense Repair Expense Insurance Expense
2.18
Debit $ 44,151 40,776 5,754 177,930
Credit $
22,038 2,295 85,200 119,850 13,758 1,950 46,830 13,134 2,124 2,733 1,419 $289,971
$289,971
Chapter 2: The accounting information system
Key to Retained Earnings column above. (a) Rent Expense (b) Advertising Expense (c) Service Revenue (d) Dividends (e) Salaries Expense
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 2.1 a) Matrix Travel Agency Ltd Cash 1.
+
Accounts Receivable
+
Supplies
+
Office Equipment
=
-2,500 +
-600
=
20,000
+
(400)
=
20,000
+
(400)
2,500
+
2,500
=
300
+
20,000
+
(700)
+
+8,000
+
8,000
+
600
+
2,500
=
300
+
20,000
+
(700) +9,000
600
+
2,500
=
300
+
20,000
+
+
8,000
+
600
+
2,500
=
300
+
20,000
+
8,100
(c)
+
20,000
+
8,100
(d)
-300 +
8,000
+
600
+
2,500
=
0
-1,200
+8,000
(b)
8,300 -200
-300
15,800 10.
-300
-200
17,000 9.
+
+1,000
17,300
(a)
+600
16,500
8.
20,000
+300
17,500
Retained Profit
+2,500
17,100
7.
+
-400
4.
6.
Share Capital
-400
17,100
5.
+
+$20,000
19,600 3.
Accounts Payable
+$20,000 20,000
2
=
-1,200 +
8,000
+
600
+
2,500
=
0
-8,000 2.19
+
20,000
+
6,900
(e)
Solutions manual to accompany Accounting: building business skills 4e $23,800
+
$0
+
$600
+
$2,500
=
$0
2.20
+
$20,000
+
$6,900
Chapter 2: The accounting information system
(b) Calculation of profit or loss for the year Service Revenue Expenses: Salaries Expense Rent Expense Advertising Expense Profit
$9,000 $1,200 400 300
1,900 $7,100
OR Increase in retained earnings ($6,900 - $0) Add: Dividends Profit
2.21
$6,900 200 $7,100
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 2.2 (a) Bell Consulting Pty Ltd Assets Date
Cash
1/5
$20,000
2/5
(2,100)
+
Accounts Receivable
+
Liabilities
Supplies
+
Office Equipment
=
Bank Loan
+
Equity
Accounts Payable
+
Share Capital
+
Retained Earnings
$20,000 =
3/5
$500
($2,100)
Rent Expense
$500
5/5
(150)
(150)
Advertising Expense
9/5
2,500
2,500
Service Revenue
12/5
(200)
(200)
Telephone
7,000
Service Revenue
(4,000)
Salaries Expense
(250)
Electricity Expense
15/5
$7,000
17/5
(4,000)
20/5
(500)
23/5
4,500
26/5
5,000
(500) (4,500) $5,000
29/5 30/5
$2,400
2,400
(250) $24,800
+
$2,500
+
$500
+
$2,400
=
$5,000
2.22
+
$2,400
+
$20,000
+
$2,800
Chapter 2: The accounting information system
(b) Bell Consulting Pty Ltd Income Statement for the month ended 31 May 2013 $ Revenues: Service revenue Expenses: Salaries expense Rent expense Electricity expense Telephone expense Advertising expense Total expenses Profit
$ 9,500
4,000 2,100 250 200 150 6,700 $2,800
(c) Bell Consulting Pty Ltd Statement of financial position as at 31 May 2013 Assets: Cash Accounts receivable Supplies Office equipment Total assets Liabilities: Accounts payable Bank loan Total liabilities Net Assets Equity: Share capital Retained Earnings Total equity
$ 24,800 2,500 500 2,400
$
30,200 2,400 5,000 7,400 $22,800 20,000 2,800 $22,800
2.23
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 2.3 (a)
Ivan Izo Pty Ltd Assets
Liabilities
Cash
+
Accounts Receivable
+
Supplies
+
Office Equipment
=
Bal.
$4,000
+
$1,500
+
$500
+
$5,000
=
1.
+1,400
+
500
+
5,000
=
5,400 2
+
$4,200
+
4,200
Share Capital
+
Retained Earnings
$6,500
+
$300
100
+
6,500
+
300
+
6,500
+
300
-2,700 +
100
+
500
+
5,000
=
1,500
+6,400
+3,400 +
3,500
+
500
+
5,000
=
1,500
+1,000 +
3,500
+
500
+
6,000
+
6,500
+
6,500
+
(a)
6,700
+600 =
2,100
6,700 -1,500
(b)
-900
-900
(c)
- 350
- 350
(d)
+
3,500
+
500
+
6,000
=
2,100
+
6,500
+
+
3,500
+
500
+
6,000
=
+2,000 4,000
2,100
+
6,500
+
3,400
2,100
+
6,500
+
3,400
(e)
+$2,000 +
3,500
+
500
+
6,000
=
2,000
+
8.
-250
+250 $4,000
3,950 -550
-550 2,000
7.
+
-1,500
2,550 6.
+
-400 5,300
5.
Accounts Payable
-1,400
+3,000 5,700
4.
+
-2,700 2,700
3.
Bank Loan
Equity
+
$3,500
+
$500
+
$6,000
=
$2,000
Key to Retained Earnings column above: (a) Service Revenue. (b) Salaries Expense. (c) Rent Expense. (d) Advertising Expense (e) Dividends (f) Electricity Expense.
2.24
+
$2,350
+
$6,500
+
$3,150
(f)
Chapter 2: The accounting information system
(b) Ivan Izo Pty Ltd
Income Statement for the month ended 31 August 2013 $ Revenues: Service revenue Expenses: Salaries expense Rent expense Advertising expense Electricity expense Total expenses Profit
$ 6,400 1,500 900 350 250 3,000 $3,400
Ivan Izo Pty Ltd
Statement of financial position as at 31 August 2013 $ Current assets: Cash Accounts receivable Supplies Total current assets Non-current assets: Office equipment Total assets
$ 4,000 3,500 500 8,000 6,000 14,000
Current liabilities: Accounts Payable
2,350
Non-current liabilities: Bank loan* Total liabilities Net Assets Equity: Share capital Retained Earnings ** Total Equity
2,000 4,350 $9,650 6,500 3,150
* Loan could be current or non-current shown as non-current
**Retained earnings $300 + Profit $3,400-less dividend $550 =$3,150
2.25
19,600 $9,650
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 2.4 Fantasy Miniature Golf and Driving Range Pty Ltd Date
Post
Account Titles and Explanation
Debit
Credit
Ref Mar.
1
Cash
100 300
60,000
Land Buildings Equipment Cash (Purchased Lee’s Golf Land)
130 135 138 100
23,000 9,000 6,000
Advertising Expense Cash (Paid for advertising)
500 100
1,600
Prepaid Insurance Cash (Paid for one-year insurance policy)
112 100
1,480
Equipment Accounts Payable (Purchased equipment on account)
138 200
1,600
Cash
100 400
800
100
1,500
Share Capital (Issued shares for cash) 3
5
6
10
18
Golf Revenue (Revenue received in cash) 19
Cash
60,000
38,000
1,600
1,480
1,600
800
Golf Revenue received in Advance (Received cash for voucher books sold) 25
30
30
31
1,500
Dividends Cash (Payment of cash dividend)
320 100
500
Salaries Expense Cash (Paid salaries expense)
510 100
600
Accounts Payable Cash (Paid creditor on account)
200 100
1,600
Cash Golf Revenue (Revenue received in cash)
100 400
800
2.26
500
600
1,600
800
Chapter 2: The accounting information system PROBLEM SET A 2.5
Liu Advertising Pty Ltd (a) Date
Apr.
Account Titles and Explanation
1
Cash Share Capital (Issued shares for cash)
Post Ref
Debit
100 300
25,500 25,500
1
No entry – not a transaction.
2
Rent Expense Cash (Paid monthly office rent)
510 100
950
Supplies Accounts Payable (Purchased supplies on account from Speedy Art Supplies)
115 200
2,550
Accounts Receivable Service Revenue (Invoiced clients for services rendered)
110 400
1,350
Cash
100 209
550
100
3,150
3
10
11
Revenue Received in Advance (Received cash advance for future service) 20
Cash Service Revenue
Credit
950
2,550
1,350
550
400
3,150
(Revenue received in cash) 30
Salaries Expense
500
Cash
100
1,950 1,950
(Paid monthly salary) 30
Accounts Payable
200
Cash
100
(Paid Speedy Art Supplies on account)
2.27
1,150 1,150
Solutions manual to accompany Accounting: building business skills 4e
(b)
¼ 11/4
Cash 25,500 2/4 550 30/4
20/4
Share Capital Revenue Received in Advance Service Revenue
1/5
Opening Balance
3,150 30/4 30/4 29,200 25,150
110
Service Revenue
Accounts Receivable 1,350
115
Accounts Payable
Supplies 2,550
Accounts Payable 1,150 3/4 1,400 2,250 1/5
Supplies
200 2,550
Opening Balance
2,250 1,400
10/4
¾
30/4 30/4
Cash Closing Balance
2/4
Accounts Payable Closing Balance
1,150 25,150 29,200
Revenue Received in Advance 11/4 Cash
209 550
Share Capital 1/4
300 25,500
Service Revenue 10/4 20/4
30/4
Rent Expense Salaries Expense
100 950 1,950
Cash
Accounts Receivable Cash
400 1,350 3,150 4,500 500
Cash
Salaries Expense 1,950
510
Cash
Rent Expense 950
2.28
Chapter 2: The accounting information system
(c) Liu Advertising Pty Ltd Trial Balance as at 30 April 2012 Account Name
Debit $ 25,150 1,350 2,550
Cash Accounts Receivable Supplies Accounts Payable Revenue Received in Advance Share Capital Service Revenue Salaries Expense Rent Expense
Credit $
1,400 550 25,500 4,500 1,950 950 $31,950 $31,950
PROBLEM SET A 2.6 Pinky’s Beauty Centre Pty Ltd (a) & (c)
1/10 5/10
Opening Balance Accounts Receivable
1/11
Opening Balance
1/10 10/10
Opening Balance Service Revenue
1/11
Opening Balance
1/10
1/10
Cash 16,400 15/10 1,200 20/10 29/10 31/10 31/10 17,600 12,000
Salaries Expense Accounts Payable Dividend Electricity Expense Closing Balance
Accounts Receivable 3,800 5/10 Cash 6,400 31/10 Closing Balance 10,200 9,000
100 1,800 2,600 400 800 12,000 17,600
115 1,200 9,000 10,200
120
Opening Balance
Supplies 2,800
130
Opening Balance
Equipment 15,400
2.29
Solutions manual to accompany Accounting: building business skills 4e
20/10 31/10
17/10 31/10
Cash Closing Balance
Service Revenue Closing Balance
Accounts Payable 2,600 1/10 6,800 9,400 1/11
Cash
Opening Balance
9,400 6,800
Revenue Received in Advance 600 1/10 Opening Balance 200 800 1/11 Opening Balance Share Capital 1/10
29/10
Opening Balance
200 9,400
210 800 800 200 300 28,200
Opening Balance
Dividends 400
310
Service Revenue 10/10 17/10
400 6,400 600
Accounts Receivable Revenue Received Advance
in
7,000
15/10
31/10
500
Cash
Salaries Expense 1,800
510
Cash
Electricity Expense 800
2.30
Chapter 2: The accounting information system
(b) Date
Account Titles and Explanation
Post
Debit
Credit
Ref
Oct 5
Cash
100 Accounts Receivable
1,200
115
1,200
(Received cash from customers on account) 10
Accounts Receivable
115
Service Revenue
6,400
400
6,400
(Invoiced customers for services performed) 15
Salaries Expense
500
Cash
100
1,800 1,800
(Paid employee salaries) 17
Revenue Received in Advance
210
Service Revenue
400
600 600
(Performed services for customers who paid in advance) 20
Accounts Payable
200
Cash
100
2,600 2,600
(Paid creditors on account) 29
Dividends
310
Cash
400
100
400
(Payment of cash dividend) 31
Electricity Expense
510
Cash
100
(Paid electricity)
2.31
800 800
Solutions manual to accompany Accounting: building business skills 4e
(d) Pinky’s Beauty Centre Pty Ltd Trial Balance as at 31 October 2013 No.
Account Name
100 115 120 130 200 210 300 310 400 500 510
Cash Accounts Receivable Supplies Equipment Accounts Payable Revenue Received in Advance Share Capital Dividends Service Revenue Salaries Expense Electricity Expense
Debit $ 12,000 9,000 2,800 15,400
Credit $
6,800 200 28,200 400 7,000 1,800 800 $42,200 $42,200
PROBLEM SET A 2.7 Central Laundry Services Pty Ltd (a) & (c)
1/5 2/5
Opening Balance Accounts Receivable
1/11
Opening Balance
1/5 8/5
Opening Balance Service Revenue
1/11
Opening Balance
1/5
1/5
Cash 8,500 12/5 900 18/5 25/5 31/5 31/5 9,400 5,400
Salaries Expense Accounts Payable Dividend Electricity Expense Closing Balance
Accounts Receivable 2,200 2/5 Cash 3,500 31/5 Closing Balance 5,700 4,800
100 1,200 1,600 500 700 5,400 9,400
115 900 4,800 5,700
120
Opening Balance
Supplies 1,700
130
Opening Balance
Equipment 8,000
2.32
Chapter 2: The accounting information system
18/5 31/5
15/5 31/5
Cash Closing Balance
Service Revenue Closing Balance
Accounts Payable 1,600 1/5 3,400 5,000 1/11
12/5
31/5
Cash
Opening Balance
5,000 3,400
Revenue Received in Advance 600 1/5 Opening Balance 100 700 1/11 Opening Balance Share Capital 1/5
25/5
Opening Balance
200 5,000
210 700 700 100 300 14,700
Opening Balance
Dividends 500
310
Service Revenue 8/5 15/5
400 3,500
Accounts Receivable Revenue Received Advance
in 600 4,100
500
Cash
Salaries Expense 1,200
510
Cash
Electricity Expense 700
2.33
Solutions manual to accompany Accounting: building business skills 4e
(b) Date
Account Titles and Explanation
Post
Debit
Credit
Ref
May 2
Cash
100 Accounts Receivable
900
115
900
(Received cash from customers on account) 8
Accounts Receivable
115
Service Revenue
3,500
400
3,500
(Invoiced customers for services performed) 12
Salaries Expense
500
Cash
100
1,200 1,200
(Paid employee salaries) 15
Revenue Received in Advance
210
Service Revenue
400
600 600
(Performed services for customers who paid in advance) 18
Accounts Payable
200
Cash
100
1,600 1,600
(Paid creditors on account) 25
Dividends
310
Cash
500
100
500
(Payment of cash dividend) 31
Electricity Expense
510
Cash
100
(Paid electricity)
2.34
700 700
Chapter 2: The accounting information system
(d) Central Laundry Services Pty Ltd Trial Balance as at 31 May 2013 No.
Account Name
100 115 120 130 200 210 300 310 400 500 510
Cash Accounts Receivable Supplies Equipment Accounts Payable Revenue Received in Advance Share Capital Dividends Service Revenue Salaries Expense Electricity Expense
Debit $ 5,400 4,800 1,700 8,000
Credit $
3,400 100 14,700 500 4,100 1,200 700 $22,300 $22,300
2.35
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 2.8 The Drive-in Movie Palace Ltd (a) & (c)
1/3 9/3 20/3 31/3 31/3
Opening Balance Admission Revenue Admission Revenue Coffee Cart Revenue Admission Revenue
1/4
Opening Balance
31/3
1/3
1/3
1/3
10/3 31/3
Cash 19,100 2/3 11,600 10/3 10,300 12/3 1,110 20/3 21,600 31/3 31/3 63,710 25,710
Film Rental Expense Accounts Payable Advertising Film Rental Expense Salaries Expense Closing Balance
100 8,000 14,200 3,900 5,000 6,900 25,710 63,710
Accounts Receivable 1,110
105
110
Opening Balance
Equipment 19,100
120
Opening Balance
Land 45,100
130
Opening Balance
Buildings 21,100
Accounts Payable 14,200 1/3 8,000 2/3 22,200 1/4
Opening Balance
200 15,100 7,100 22,200 8,000
Opening Balance
300 89,300
Coffee Cart Revenue
Cash Closing Balance
Share Capital 1/3
Opening Balance Film Rental Expense
Admission Revenue 9/3 Cash 20/3 Cash 31/3 Cash
Coffee Cart Revenue 31/3 Cash/Accounts Receivable
2.36
400 11,600 10,300 21,600 43,500 410 2,220
Chapter 2: The accounting information system
500
12/3
Cash
Advertising Expense 3,900
510
2/3 20/3
Film Rental Expense Accounts Payable/Cash 15,100 Cash 5,000 20,100
31/ 3
Cash
Salaries Expense 6,900
2.37
520
Solutions manual to accompany Accounting: building business skills 4e
(b) Date Mar. 2
Account Titles and Explanation Film Rental Expense Accounts Payable Cash (Rented films for cash and on account)
3
No entry.
9
Cash Admission Revenue (Received cash for admissions)
10
Accounts Payable ($7,100 + $7,100) Cash (Paid creditors on account)
Post Ref 510 200 100
Debit 15,100
7,100 8,000
100 400
11,600
200 100
14,200
11,600
14,200
11
No entry.
12
Advertising Expense Cash (Paid advertising expenses)
500 100
3,900
Cash
100 400
10,300
Film Rental Expense Cash (Paid film rental)
510 100
5,000
Salaries Expense Cash (Paid salaries expense)
520 100
6,900
Cash Accounts Receivable Coffee Cart Revenue (Received cash and balance on account for coffee cart revenue)
100 105 410
1,110 1,110
Cash
100 400
21,600
20
Admission Revenue (Received cash for admissions) 20
31
31
31
Admission Revenue (Received cash for admissions)
2.38
Credit
3,900
10,300
5,000
6,900
2,220
21,600
Chapter 2: The accounting information system
(d) The Drive-in Movie Palace Ltd Trial Balance as at 31 March 2012 No.
Account Name
100 105 110 120 130 200 300 400 410 500 510 520
Cash Accounts Receivable Equipment Land Buildings Accounts Payable Share Capital Admission Revenue Coffee Cart Revenue Advertising Expense Film Rental Expense Salaries Expense
Debit $ 25,710 1,110 19,100 45,100 21,100
Credit $
8,000 89,300 43,500 2,220 3,900 20,100 6,900 $143,020 $143,020
2.39
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 2.9 Willoughby Ltd Trial Balance as at 30 June 2014 Account Name Cash ($5,980 + $300) Accounts Receivable ($6,762 - $300) Supplies ($1,900 - $980) Equipment ($6,300 + $980) Accounts Payable ($5,632 - $712 - $712) Revenue Received in Advance Share Capital Dividends ($1,900 + $1,100) Rental Revenue ($5,060 + $1,872) Salaries Expense ($7,100 + $1,500 - $1,100) Office Expense
Debit $ 6,280 6,462 920 7,280
Credit $
4,208 2,700 19,722 3,000 6,932 7,500 2,120 $33,562 $33,562
Explanation: The first number in the brackets is the balance as per the initial trial balance on page 137. The subsequent numbers are the corrections. Note that Cash should start in the debit and Revenue received in advance should start in the credit. Brief explanation of each error: 1.
$1440 – $1140 = $300. Need to decrease Accounts Receivable by $300 and increase cash by $300 to correctly record the collection of $1440 on account.
2.
Calculator should not be included in Supplies so decrease Supplies by $980. Calculators should be included in Equipment, so increase Equipment by $980.
3.
Rental Revenue needs to be adjusted upwards by $1872 ($2080 – $208).
4.
Increase Salaries Expenses by $750.
5.
A payment on account should be debit to Accounts Payable. The amount of $356 was incorrectly credited. To correct this entry, the balance of Accounts Payable must be reduced by $712. To correctly record the payment of $712 on account, Accounts Payable is reduced further by $712.
6.
Need to reduce Salaries Expense by $1100 and increase Dividends by $1100.
2.40
Chapter 2: The accounting information system
PROBLEM SET A 2.10 About Town Maintenance Services Ltd Trial Balance as at 30 June 2012 Account Name Debit Credit $ $ Cash ($2,840 + $180) 3,020 Accounts Receivable ($3,231 - $180) 3,051 Supplies ($800 - $340) 460 Equipment ($3,000 + $340) 3,340 Accounts Payable ($2,666 - $260 - $206) 2,200 Revenue Received in Advance 1,200 Share Capital 9,000 Dividends ($800 + $400) 1,200 Rental Revenue ($2,380 + $801) 3,181 Salaries Expense ($3,400 + $600 - $400) 3,600 Office Expense ……910 $15,581 $15,581
Explanation: The first number in the brackets is the balance as per the initial trial balance on page 127. The subsequent numbers are the corrections. Note that Cash should start in the debit and Revenue received in advance should start in the credit. Brief explanation of each error: 1.
$750 – $570 = $180. Need to decrease Accounts Receivable by $180 and increase cash by $180 to correctly record the collection of $750 on account.
2.
Calculator should not be included in Supplies so decrease Supplies by $340. Calculators should be included in Equipment, so increase Equipment by $340.
3.
Rental Revenue needs to be adjusted upwards by $801 ($890– $89).
4.
Increase Salaries Expenses by $600.
5.
A payment on account should be debit to Accounts Payable. The amount of $260 was incorrectly credited. To correct this entry, the balance of Accounts Payable must be reduced by $260. To correctly record the payment of $206 on account, Accounts Payable is reduced further by $206.
6.
Need to reduce Salaries Expense by $550 and increase Dividends by $550.
2.41
Solutions manual to accompany Accounting: building business skills 4e Key to Retained Earnings column a) Rent Expense b) Advertising Expense c) Service Revenue d) Dividends e) Salaries Expense f) Electricity Expense g) Service Revenue
SOLUTIONS TO PROBLEM SET B CRAZY BOB’S REPAIR SHOP LTD
PROBLEM SET B 2.1
(a)
Cash
+
(1)
+
16,000 16,000
(2)
-
(5,000) 11,000
(3)
-
(400) 10,600
(4)
-
(500) 10,100
Accounts Receivable
+
Supplies
+
Office Equip
+
5,000 5,000
(8)
(9)
-
-
-
500
4,100 14,200
500
Retained Earnings
16,000 16,000
-
(400) (a) (400)
5,000
5,000
550 550
-
(550) (b) (950)
+ 16,000
4,100 (c) 3,150
550
16,000
500
5,000
550
16,000
(500) (d) 2,650
(1,200) 12,500
500
5,000
550
16,000
(1,200) (e) 1,450
(140) 12,360
500
5,000
550
16,000
(140) (f) 1,310
+ 12,360 +
+
(500) 13,700
(10)
(11)
Share Capital
16,000
+
+
+
500 500
10,100
(7)
Accounts Payable
+
(5)
(6)
=
120
-
400 400
+ 500
5,000
(120)
2.42
550
16,000
400 (g) 1,710
Chapter 2: The accounting information system (a)
Cash
+
12,480
Accounts Receivable 280
+
Supplies
500
+
Office Equip
5,000
2.43
=
Accounts Payable 550
+
Share Capital 16,000
+
Retained Earnings 1,710
Solutions manual to accompany Accounting: building business skills 4e
(b)
Service Revenue Expenses Salaries Expense Rent Expense Advertising Expense Electricity Expense Profit
...........................................................
$4,500
................................................ $1,200 ................................................ 400 ................................................ 550 ................................................ 140 ...........................................................
2,290 $2,210
Increase in retained earnings ($1,710 – $0) Add: Dividends Profit
........................................... ........................................... ...........................................
2.44
$1,710 500 $2,210
Chapter 2: The accounting information system
PROBLEM SET B 2.2 (a)
Assets
Date
Cash
01/06
+
15,000 15,000
02/06
-
(2,000) 13,000
03/06
-
Liabilities +
Accounts Receivable
Delivery van
=
10,000 10,000
15,000
8,000
15,000
-
(500) (500)
a
+
1,000 500
b
-
c
15,000
(200) 12,300
1,000
10,000
8,000
15,000
(200) 300
15,000
300
300
750 13,050
-
1,000
150 150
+ 10,000
150 8,150
(750) 250
150
10,000
8,150
15,000
250
150
10,000
100 8,250
15,000
+
-
Retained Earnings
8,000
13,050 +
8,000 8,000
10,000
17/06
23/06
+
Share + Capital 15,000 15,000
10,000
12,300
20/06
Accounts + Payable
1,000 1,000
+
+
+
Shareholders Equity
12,500
12/06
15/06
Supplies
+
+
-
+
(500) 12,500
05/06
09/06
ALEX DELIVERIES LTD
1,500 14,550
250
150
10,000
(500) 14,050
250
150
10,000
-
2.45
-
(100) 200
d
+
e
8,250
15,000
1,500 1,700
(500) 7,750
15,000
1,700
Solutions manual to accompany Accounting: building business skills 4e
(a)
Assets
Date
Cash
26/06
29/06
30/06
Key: (a) (b) (c) (d) (e) (f) (g)
Liabilities +
Accounts Receivable
+
Supplies
+
Delivery van
=
(250) 13,800
250
150
10,000
7,750
15,000
Retained Earnings (250) 1,450
(100) 13,700
250
150
10,000
(100) 7,650
15,000
1,450
(500) 13,200
250
150
10,000
7,650
15,000
(500) 950
Rent expense Service revenue Dividend Petrol expense Service revenue Electricity expense Salary expense
2.46
Accounts + Payable
Shareholders Equity
Share Capital
+
f
g
Chapter 2: The accounting information system
(b)
ALEX DELIVERIES LTD Income statement for the Month Ended 30 June 2013 $ Revenues: Service revenue Expenses: Salaries expense Rent expense Electricity expense Petrol expense Total expenses Profit
$ 2,500 500 500 250 100 1,350 $1,150
(c) ALEX DELIVERIES LTD Statement of financial position as at 30 June 2013 Assets: Cash Accounts receivable Supplies Delivery Van Total assets Liabilities: Accounts payable Total liabilities Net Assets Equity: Share capital Retained Earnings* Total equity
$ 13,200 250 150 10,000
$
23,600 7,650 7,650 $15,950 15,000 950 $15,950
*Retained earnings = Profit $1150 less dividends $200 = $950
2.47
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 2.3
HEALTHY PAWS LTD Equity
(a) Cash
O/B 1
-
+ Accounts Receivable
9,000 (3,100)
1,700
Assets + Supplies
+
600
Office equipment
Liabilities = Accounts + Bank Loan + Share Payable Capital
6,000
+ Retained Earnings
1,700
600
6,000
3,600 (3,100) 500
(1,300) 400
600
6,000
500
13,000
700
3,300 3,800
13,000
700
-
13,000
700
13,000
700
5,900 2
+
1,300 7,200
3
4
5
-
+
-
6
(800) 6,400
+ 400
600
4,100 + 10,100
2,500 + 8,900
6,400 6,800
600
10,100
3,800
13,000
(600) 8,300
6,800
600
10,100
3,800
13,000
(600) (b) 9,000
3,800
13,000
(700) (c ) (900) (d) (300) (e) 7,100
13,000
(170) 6,930
13,000
6,930
6,800
600
10,100
6,400
6,800
600
10,100
170 3,970
7,000 13,400
6,800
600
10,100
3,970
+
+
8,900 (a) 9,600
(700) (900) (300) 6,400
7
8
+
-
+
2.48
7,000 7,000
(f)
Chapter 2: The accounting information system
Key to Retained Earnings column on previous page. (a) (b) (c) (d) (e) (f)
(b)
Service Revenue Dividends Salaries Expense Rent Expense Advertising Expense Electricity Expense
Healthy Paws Ltd Income statement for the Month Ended 30 September 2012 $ Revenues: Service revenue Expenses: Rent expense Salaries expense Advertising expense Electricity expense Total expenses Profit
$ 8,900 900 500 300 170 2,070 $6,830
Healthy Paws Ltd Calculation of Retained earnings for the Month Ended 30 September 2012 $ Retained Earnings 1 September Add: Profit
700 6,830 7,530 (600) $6,930
Less: Dividends Retained Earnings 30 September
2.49
Solutions manual to accompany Accounting: building business skills 4e
Healthy Paws Ltd Statement of financial position as at 30 September 2012 $ Current assets: Cash Accounts receivable Supplies Total current assets Non-current assets: Office equipment Total assets
$
13,400 6,800 600 20,800 10,100 30,900
Current liabilities: Accounts Payable
3,970
Non-current liabilities: Bank loan* Total liabilities Net Assets Equity: Share capital Retained Earnings Total Equity
7,000 10,970 $19,930 13,000 6,930 $19,930
2.50
Chapter 2: The accounting information system
PROBLEM SET B 2.4 Too Much Fun Park Date Apr.
1
4
8
11
12 13
17
20
25
30
30
Account Titles and Explanation Cash Share capital (Issued shares for cash) Land Cash (Purchased land for cash) Advertising Expense Accounts Payable (Incurred advertising expense on account) Salaries Expense Cash (Paid salaries) No entry. Prepaid Insurance Cash (Paid for one-year insurance policy) Dividends Cash (Payment of cash dividend) Cash Admission Revenue (Received cash for services rendered) Cash Revenue received in advance (Received advance for future services) Cash Admission Revenue (Received cash for services provided) Accounts Payable Cash (Paid creditor on account)
2.51
Debit 60,000
Credit 60,000
30,000 30,000 1,800 1,800 1,700 1,700
3,000 3,000 600 600 5,700 5,700 2,500 2,500 7,900 7,900 700 700
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 2.5 (a) Skeptical Accountants Date
Account Titles and Explanation
Ref
May 1 Cash
100 300
Share capital (Issued shares for cash)
Debit $ 52,000
Credit $ 52,000
2 No entry—not a transaction. 3 Supplies Accounts Payable (Purchased supplies on account)
115 200
1,200
7 Rent Expense Cash (Paid office rent)
510 100
900
11 Accounts Receivable Service Revenue (Billed client for services provided)
110 400
1,100
12 Cash
100 210
4,500
100 400
1,200
31 Salaries Expense Cash (Paid salaries)
500 100
1,000
31 Accounts Payable ($1,200 X 40%) Cash (Paid creditor on account)
200 100
480
Revenue received in advance (Received an advance for future services) 17 Cash Service Revenue (Received cash for revenue earned)
2.52
1,200
900
1,100
4,500
1,200
1,000
480
Chapter 2: The accounting information system
(b) Skeptical Accountants’ general ledger
1-May 12-May
Cash 52,000 7-May 4,500 31-May
17-May
1-Jun
Opening balance
1,200 31-May 31 May 57,700 55,320
Service revenue
Accounts Receivable 1,100
110
11-May
Accounts Payable
Supplies 1,200
115
3-May
31-May 31 May
Cash Closing balance
31 May
Closing balance
Accounts Payable 480 3-May 720 1,200 1 June
Rent expense Salaries expense
100 900 1,000
Share capital Revenue received in advance Service revenue
Accounts payable Closing balance
480 55,320 57,700
Supplies
200 1,200
Opening balance
1,200 720
Revenue received in advance 12-May Cash
210 4,500
Share Capital 1-May
300 52,000
Service Revenue 11-May 2300 17-May 2,300 1 June
Cash
Accounts receivable Cash Opening balance
400 1,100 1,200 2,300 2,300
Cash
Salaries Expense 1,000
500
31-May
Cash
Rent Expense 900
510
7-May
2.53
Solutions manual to accompany Accounting: building business skills 4e
(c) Skeptical Accountants Trial balance as at 31 May 2012
(d)
No.
Account Name
100 110 115 200 210 300 400 500 510
Cash Accounts Receivable Supplies Accounts Payable Revenue Received in Advance Share Capital Service Revenue Salaries Expense Rent Expense
Debit $ 53,320 1,100 1,200
Credit $
720 4,500 52,000 2,300 1,000 900 $59,520 $59,520
Skeptical Accountants Income statement for the month ended 31 May 2012 $ Revenues: Service revenue Expenses: Salaries expense Rent expense Total expenses Profit
$ 2,300 1,000 900 1,900 $ 400
2.54
Chapter 2: The accounting information system
Skeptical Accountants Statement of financial position as at 31 May 2012 $ Current assets: Cash Accounts receivable Supplies Total assets
$
55,320 1,100 1,200 57,620
Current liabilities: Accounts Payable Rent revenue received in advance Total liabilities Net Assets Equity: Share capital Retained Earnings Total Equity
2.55
720 4,500 5,220 $52,400 52,000 400 $52,400
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 2.6 Alice Springs Dry Cleaners (a) and (c) 100 1-Jul Opening balance 8-Jul Accounts receivable 11-Jul Dry cleaning revenue
110 1-Jul Opening balance 22-Jul Dry cleaning revenue
120 1-Jul Opening balance 17-Jul Accounts payable
9-Jul Salaries expense 14-Jul Accounts payable 30-Jul Various expenses
2,100 10,750 5,190
31-Jul Dividends 31-Jul Closing balance
500 3,853 22,393
22,393 3,853
1-Aug Opening balance
1-Aug Opening balance
Cash 12,532 4,936 4,925
Accounts Receivable 10,536 8-Jul Cash 4,700 31-Jul Closing balance 15,236 10,300
4,936 10,300 15,236
1-Aug Opening balance
Supplies 4,844 554 31-Jul Closing balance 5,398 5,398
130 1-Jul Opening balance
Equipment 25,950
200 14-Jul Cash 31-Jul Closing balance
Accounts Payable 10,750 1-Jul Opening balance 5,682 17-Jul Supplies 16,432 1-Aug Opening balance
15,878 554 16,432 5,682
Revenue received in advance 1-Jul Opening balance
1,730
210
300
Share Capital 1-Jul Opening balance
310 31-Jul Cash
5,398 5,398
Dividends 500
2.56
36,254
Chapter 2: The accounting information system
400 31-Jul Closing balance
Dry Cleaning Revenue 11-Jul Cash 9,625 22-Jul Accounts receivable 9,625 1-Aug Opening balance
500 30-Jul Cash
Repair Expense 492
510 9-Jul Cash 30-Jul Cash 1-Aug Opening balance
Salaries Expense 2,100 3,114 31-Jul Closing balance 5,214 5,214
520 30-Jul Cash
Electricity Expense 1,584
(b) Date July 8
9
11
Account Titles and Explanation Cash Accounts Receivable (Received cash on account)
Debit 4,936
Salaries Expense Cash (Paid salaries)
2,100
Cash
4,925
17
22
30
31
5,214 5,214
Credit 4,936
2,100
Dry Cleaning Revenue (Received cash for services provided) 14
4,925 4,700 9,625 9,625
Accounts Payable Cash (Paid creditors)
4,925 10,750 10,750
Supplies Accounts Payable (Purchased supplies on account)
554 554
Accounts Receivable Dry Cleaning Revenue (Billed for services provided)
4,700
Salaries Expense Electricity Expense Repair Expense Cash (Paid for various expenses)
3,114 1,584 492
Dividends Cash (Payment of cash dividend)
500
2.57
4,700
5,190
500
Solutions manual to accompany Accounting: building business skills 4e
d) Alice Springs Dry Cleaners Trial Balance as at 31 July, 2012 No. 100 110 120 130 200 210 300 310 400 500 510 520
(e)
Account Name
Debit $
Cash Accounts Receivable Supplies Equipment Accounts Payable Revenue received in advance Share Capital Dividends Dry Cleaning Revenue Repairs Expense Salaries Expense Electricity Expense
Credit $
3,853 10,300 5,398 25,950 5,682 1,730 36,254 500 9,625 492 5,214 1,584 $53,291
$53,291
Alice Springs Dry Cleaners Income statement for the month ended 31 July 2012 $ Revenues: Service revenue Expenses: Salaries expense Repairs expense Electricity expense Total expenses Profit
$ 9,625 5,214 492 1,584 7,290 $2,335
2.58
Chapter 2: The accounting information system
Alice Springs Dry Cleaners Statement of financial position as at 31 July 2012 $ Current assets: Cash Accounts receivable Supplies Total current assets Non-current assets: Equipment Total assets
$
3,853 10,300 5,398 19,551 25,590 45,501
Current liabilities: Accounts Payable Revenue received in advance Total liabilities Net Assets Equity: Share capital Retained Earnings * Total Equity
5,682 1,730 7,412 $38,089 36,254 1,835 $38,089
*retained earnings profit $2,335 less dividend $500= $1,835
2.59
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 2.7 (a) Busy Bookkeepers Pty Ltd Date
Account Titles and Explanation
Ref
Jan 2 Cash
100 300
Share capital (Issued shares for cash)
Debit $ 88,000
88,000
3
No entry—not a transaction.
4
Supplies Accounts Payable (Purchased supplies on account)
115 200
1,600
Rent Expense Cash (Paid office rent)
510 100
2,400
Accounts Receivable Service Revenue (Billed client for services provided)
110 400
3,800
Cash
100 210
3,000
100 400
1,700
Salaries Expense Cash (Paid salaries)
500 100
2000
Accounts Payable ($1,600 X 40%) Cash (Paid creditor on account)
200 100
640
7
11
12
Revenue received in advance (Received an advance for future services) 17
Cash Service Revenue (Received cash for revenue earned)
31
31
2.60
Credit $
1,600
2,400
3,800
3,000
1,700
2,000
640
Chapter 2: The accounting information system
(b) Busy Bookkeepers Pty Ltd
2-Jan 12-Jan
Cash 88,000 7-Jan 3,000 31-Jan
17-Jan
1-Feb
Opening balance
Service revenue
Accounts Receivable 3,800
110
11-Jan
Accounts Payable
Supplies 1,600
115
4-Jan
31-Jan 31 Jan
Cash Closing balance
31 Jan
Closing balance
1,700 31-Jan 31 Jan 92,700 87,660
Accounts Payable 640 4-Jan 960 1,600 1 Feb
Rent expense Salaries expense
100 2,400 2,000
Share capital Revenue received in advance Service revenue
Accounts payable Closing balance
640 87,660 92,700
Supplies
200 1,600
Opening balance
1,600 960
Revenue received in advance 12-Jan Cash
210 3,000
Share Capital 2-Jan
300 88,000
Service Revenue 11-Jan 5,500 17-Jan 5,500 1 Feb
Cash
Accounts receivable Cash Opening balance
400 3,800 1,700 5,500 5,500
Cash
Salaries Expense 2,000
500
31-Jan
Cash
Rent Expense 2,400
510
7-Jan
2.61
Solutions manual to accompany Accounting: building business skills 4e
(c) Busy Bookkeepers Pty Ltd Trial Balance as at 31 January 2013
(d)
No.
Account Name
100 110 115 200 210 300 400 500 510
Cash Accounts Receivable Supplies Accounts Payable Revenue Received in Advance Share Capital Service Revenue Salaries Expense Rent Expense
Debit $ 87,660 3,800 1,600
Credit $
960 3,000 88,000 5,500 2,000 2,400 $97460
$97460
Busy Bookkeepers Pty Ltd Income statement for the month ended 31 January 2013 $ Revenues: Service revenue Expenses: Salaries expense Rent expense Total expenses Profit
$ 5,500 2,000 2,400 4,400 $1,100
2.62
Chapter 2: The accounting information system
Busy Bookkeepers Pty Ltd Statement of financial position as at 31 January 2013 $ Current assets: Cash Accounts receivable Supplies Total assets
$
87,660 3,800 1,600 93,060
Current liabilities: Accounts Payable Revenue received in advance Total liabilities Net Assets Equity: Share capital Retained Earnings Total Equity
960 3,000 3,960 $89,100 88,000 1,100 $89,100
2.63
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 2.8 Lights Out Theatre Ltd (a) and (c) 100 1-Apr Opening balance 9-Apr Admission revenue 25-Apr Admission revenue 30-Apr Candy bar revenue
Opening balance 105 30-Apr Candy bar revenue
107 30-Apr Cash
Cash 6,000 3,800 3,200 85
13,085 6,685
800 1,000 2,000 300 1,600 700 6,685 13,085
Accounts Receivable 85
Prepaid Rent 700
120 1-Apr Opening balance
Land 10,000
130 1-Apr Opening balance
Building 8,000
140 1-Apr Opening balance
Equipment 6,000
200 10-Apr Rent expense 30-Apr Closing balance
210 Mortgage Payable 10-Apr Cash 30-Apr Closing balance
300
2-Apr Rental expense 10-Apr Accounts payable 10-Apr Mortgage payable 12-Apr Advertising expense 29-Apr Salaries expense 30-Apr Prepaid rent Closing balance
Accounts Payable 1,000 1-Apr Opening balance 1,500 20-Apr Rent expense 2,500 1-May Opening balance
2,000 6,000 8,000
2,000 500 2,500 1,500
1-Apr Opening balance
8,000
Opening balance
8,000 6,000
Opening balance
20,000
Share Capital
400 Closing balance
Admission Revenue 9-Apr Cash 7,000 25-Apr Cash 7,000
2.64
3,800 3,200 7,000
Chapter 2: The accounting information system
1-May Opening balance 410
7,000
30-Apr Closing balance
Candy Bar Revenue 30-Apr Cash 170 30-Apr Accounts receivable 170 1-May Opening balance
510 12-Apr Cash
Advertising Expense 300
520 2-Apr Cash 20-Apr Cash
Film Rental Expense 800 500 30-Apr Closing balance 1,300 1,300
1-May Opening balance 530 29-Apr Cash
1,300 1,300
Salaries Expense 1,600
(b) Date Apr.
Account Titles and Explanation 2
Film Rental Expense Cash (Paid film rental)
3
No entry—not a transaction.
9
Cash
Debit
10
Credit
800 800
3,800 Admission Revenue (Received cash for admissions)
Mortgage Payable Accounts Payable Cash (Made payments on mortgage and accounts payable)
11
No entry—not a transaction.
12
Advertising Expense Cash (Paid advertising expenses)
2.65
85 85 170 170
3,800
2,000 1,000 3,000
300 300
Solutions manual to accompany Accounting: building business skills 4e
20
25
Film Rental Expense Accounts Payable (Rented film on account)
500 500
Cash
3,200 Admission Revenue (Received cash for admissions)
29
30
30
3,200
Salaries Expense Cash (Paid salaries expense)
1,600 1,600
Cash Accounts Receivable Candy Bar Revenue (17% X $1,000) (Received cash and balance on account for concession revenue)
85 85
Prepaid Rentals Cash (Paid cash for future film rental)
700
(d)
170
700
Lights Out Theatre Ltd Trial Balance as at 30 April 2013 No. Account Name
Debit
100 Cash ................................................................................... $ 6,685 105 Accounts Receivable .......................................................... 85 107 Prepaid Rentals .................................................................. 700 120 Land ................................................................................... 10,000 130 Buildings ............................................................................. 8,000 140 Equipment .......................................................................... 6,000 200 Accounts Payable ............................................................... 210 Mortgage Payable............................................................... 300 Share Capital ...................................................................... 400 Admission Revenue ............................................................ 410 Candy Bar Revenue ........................................................... 510 Advertising Expense ........................................................... 300 520 Film Rental Expense ........................................................... 1,300 530 Salaries Expense ................................................................ 1,600 $34,670
2.66
Credit
$ 1,500 6,000 20,000 7,000 170
000,000 $34,670
Chapter 2: The accounting information system
(e) Lights Out Theatre Ltd Income statement for the month ended 30 April 2013 Revenues Admission revenue Candy bar revenue Total revenue Expenses Advertising expense Film rental expense Salaries expense Total expenses Profit
7000 170 7170 300 1300 1600 3,200 $3,970
Lights Out Theatre Ltd Statement of financial position as at 30 April 2013 $ $
Assets: Current assets Cash Account receivable Prepaid rentals Total current assets Non-current assets Land Buildings Equipment Total non current assets Total assets Liabilities: Current liabilities Accounts payable Non current liabilities Mortgage payable Total liabilities Net Assets
6,685 85 700 7,470
10,000 8,000 6,000 24,000 31,470
1,500
6,000 7,500 $23,970
Equity Share capital Retained Earnings Total equity
20,000 3,970 $23,970
2.67
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 2.9 New Trial Balance as follows: Theatre Adelaide Ltd Trial Balance as at 31 May 2013 Debit $
Account Names
Cash ($5,850 + $420 – $225) ............................................................. 6,045 Accounts Receivable ($2,750 – $180 – $210) ..................................... 2,360 Prepaid Insurance ($700 + $100) ........................................................ 800 Supplies ($0 + $420) ........................................................................... 420 Equipment ($8,000 – $420) ................................................................. 7,580 Accounts Payable ($4,500 – $100 + $420 – $210) .............................. Rates and Taxes Payable ................................................................... Share Capital ($5,700 + $700) ............................................................ Retained Earnings ............................................................................. Dividends ($0 + $700) ......................................................................... 700 Service Revenue ($6,690 + $270)....................................................... Salaries Expense ($4,200 + $200) ...................................................... 4,400 Advertising Expense ($1,100 + $225) ................................................. 1,325 Rates and Taxes Expense ($800 + $100) ........................................... 900 $24,530
Credit $
4,610 560 6,400 6,000 6,960
000,000 $24,530
The following explanations assume normal balances (i.e. an increase in a debit account = debit the relevant amount): 1 Prepaid insurance, Rates and taxes expense each increase by $100; Accounts payable decreases by $100 2 Accounts receivable decreases by $(2750-2570) = 180; Service revenue increases by $(6960 – 6690) = 270 3 Salaries expense increases by $200 4 Dividends increases by $700, Share capital increases by $700 5 Equipment decreases by $420; Supplies increases by $420; Cash increases by $420; Accounts payable increases by $420 6 Cash decreases by $(250 – 25) = 225; Advertising expense increases by $225 7 Accounts payable decreases by $210; Account receivable decreases by $210 Note also-Accounts receivable, Rates and taxes payable, Service revenue and Advertising expense were listed on the incorrect sides for their normal balances
2.68
Chapter 2: The accounting information system
PROBLEM SET B 2.10 New Trial Balance as follows: Client Services Pty Ltd Trial Balance as at 31 December 2012 Debit $
Account Names Cash ($3,902 -$360) ........................................................................... Accounts Receivable ($5,752 +$360) .................................................. Supplies ($1,820 -$220) ...................................................................... Equipment ($7,780 +$220) .................................................................. Accounts Payable ($5,399 -$490-$409) .............................................. Revenue Received in Advance ........................................................... Share Capital ...................................................................................... Dividends ($600 + $600) ..................................................................... Service Revenue ($9,904 +$576) ........................................................ Salaries Expense ($6,300 +$900-$600) .............................................. Office Expense ....................................................................................
Credit $
3,542 6,112 1,600 8,000 4,500 1,600 9,000 1,200 10,480 6,600 2,410
$29,464
$25,580
Explanation: The first number in the brackets is the balance as per the initial trial balance on page 143. The subsequent numbers are the corrections. Note that Cash should start in the debit and Revenue received in advance should start in the credit. Brief explanation of each error: 1.
$840 – $480 = $360. Need to decrease Accounts Receivable by $360 and increase cash by $360 to correctly record the collection of $480 on account.
2.
Printer should not be included in Supplies so decrease Supplies by $220. Printers should be included in Equipment, so increase Equipment by $2200.
3.
Service Revenue needs to be adjusted upwards by $576 ($640– $64).
4.
Increase Salaries Expenses by $900.
5.
A payment on account should be debit to Accounts Payable. The amount of $490 was incorrectly credited. To correct this entry, the balance of Accounts Payable must be reduced by $490. To correctly record the payment of $409 on account, Accounts Payable is reduced further by $409
6.
Need to reduce Salaries Expense by $600 and increase Dividends by $600.
This problem is incorrect and does not balance by $3,884. There must be other errors not listed.
2.69
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 2.1
FINANCIAL REPORTING PROBLEM
Domino’s Pizza Enterprises Ltd (a) Account
1.
Issued Capital Trade and other Payables (Accounts Payable) Trade and other Receivables (Accounts Receivable) Marketing expenses Prepayments (in Note 11) Property, Plant and Equipment (net) Revenue from Sale of Goods(Note 2)
Increase Side
2.
Decrease Side
3.
Normal Balance
Right Right
Left Left
Credit Credit
Left
Right
Debit
Left Left Left Right
Right Right Right Left
Debit Debit Debit Credit
(b)
1. 2. 3.
Cash is increased. Cash is decreased. Cash is decreased.
(c)
1. 2.
Cash is decreased. Cash is decreased or Bank Loan is increased.
BUILDING BUSINESS SKILLS 2.2 COMPARATIVE ANALYSIS PROBLEM Domino’s Pizza Enterprises Ltd vs. Freedom Nutritional Products Limited (a) Domino’s Pizza Enterprises Ltd 1. 2. 3. 4. 5.
Cash Goodwill Borrowings Retained Earnings : Revenue from Sale of Goods:
Freedom Nutritional Products Limited debit debit credit credit credit
2.70
1. 2. 3. 4. 5.
Inventories: Income Tax Payable Provisions: Issued Capital Administrative Expenses
debit credit credit credit debit
Chapter 2: The accounting information system
(b)
The following other accounts are ordinarily involved: 1.
Increase in accounts receivable: Service Revenue or Sales Revenue is increased (credited).
2.
Bank loan is decreased: Cash is decreased (credited).
3.
Increase in machinery: Bank Loan is increased (credited) or Cash is decreased (credited).
4.
Interest Revenue is increased: Cash or Interest Receivable are increased (debited).
BUILDING BUSINESS SKILLS 2.3
INTERPRETING FINANCIAL STATEMENTS
Nike International Ltd (a)
Possible advantages of long-term debt: ▪ Reebok International could expand operations and earn a greater return for its shareholders. ▪ Long-term debt does not have to be repaid in the short-term which gives the entity time to generate cash to cover interest payments and accumulate the cash needed to repay the loan. ▪ Reebok International does not need to raise funds using a share issue – this offers a number of advantages, e.g. creditors do not share profits (dividends), they only receive interest and principal when it is due. Possible disadvantages of long-term debt: ▪ Reebok International’s financial risk is increased when additional funds are raised via long-term debt than from a new share issue. That is, dividend will only be paid to shareholders if the company is profitable, however, interest payments must be made when they fall due regardless of whether the company is profitable. This makes debt more risky than issuing new shares. ▪ If Reebok International cannot pay the interest payments on the long-term debt when they fall due, it may go into bankruptcy. If the entity is bankrupt, creditors will have to be paid in full before any payments can be made to the shareholders.
(b)
Advantages to Reebok International from having a large cash balance is that cash is available to finance such things as repaying debt when it falls due, purchasing more inventory for sale and investing in new equipment. New opportunities may be seized and expansions may be undertaken at the time most advantageous for the business. A disadvantage is that cash earns little or no interest. A higher rate of return might be generated on excess cash by some other type of investment.
(c)
Accounts payable, as purchases on credit, represent interest-free loans. Business enterprises don’t pay cash unless the supplier requires immediate payment. Nearly all exchange transactions are conducted on 30-day or more credit.
2.71
Solutions manual to accompany Accounting: building business skills 4e
(d)
Reebok International’s main earning activity is the sale of goods to customers – this may explain its large inventory balance. Advantages of holding a large inventory balance include: ▪ Not missing out on sales because the inventory is not available. ▪ Being able to obtain “bulk” buying discounts from suppliers or manufacturing in bulk. Disadvantages of holding a large inventory balance include: ▪ Opportunity cost of using funds to invest in other activities earning a higher return. ▪ Need for storage space which may involve large rental costs.
CRITICAL THINKING BUILDING BUSINESS SKILLS 2.4
GROUP DECISION CASE
Outback Riding School Pty Ltd (a) May
1
Correct.
5
Cash
500 Lesson Revenue
7
Cash
500 1,500
Revenue Received in Advance 9
14
15
20
1,500
Hay and Feed Supplies Accounts Payable
2,500
Office Equipment Cash
1,800
Dividends Cash
3,200
Cash
4,500
2,500
1,800
3,200
Riding Revenue 31
(b)
4,500
Veterinary Expense Accounts Payable
750
750
The error in the entries of May 14 and May 20 would prevent the trial balance from balancing.
2.72
Chapter 2: The accounting information system
(c) Profit as reported Add: May 5 Lesson fees May 9, Hay and Feed Expense May 15, Salaries Expense (Dividends declared and paid) Less: May 7, Boarding Revenue Received in Advance Correct Profit
(d)
Cash as reported ............................................................................ Add: 9/5, Purchase on account ................................... $2,500 .............................................................................. 16,710 Less: 20/5, Transposition error ..................................... (900)
$6,200 $500 2,500 3,200
6,200 12,400 (1,500) $10,900
$14,210
$15,810
BUILDING BUSINESS SKILLS 2.5
COMMUNICATION ACTIVITY
Fancy Flowers Limited To: From: Re:
Assistant Accountant – Fancy Flowers Limited Accounting Student Steps in Recording Process
In the first transaction, invoices totalling $8,500 were sent to customers for services provided. Therefore, the asset Accounts Receivable is increased $8,500 and the revenue Service Revenue is increased $8,500. Debits increase assets and credits increase revenues, so the journal entry is: Accounts Receivable Service Revenue (Invoice customer for services provided)
8,500 8,500
The $8,500 amount is then posted to the debit side of the general ledger account Accounts Receivable and to the credit side of the general ledger account Service Revenue. In the second transaction, $3,200 was paid in salaries to employees. Therefore, the expense Salaries Expense is increased $3,200 and the asset Cash is decreased $3,200. Debits increase expenses and credits decrease assets, so the journal entry is: Salaries Expense Cash (Salaries paid)
3,200 3,200
The $3,200 amount is then posted to the debit side of the general ledger account Salaries Expense and to the credit side of the general ledger account Cash.
2.73
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 2.6
COMMUNICATION ACTIVITY John Jones
To: From: Re:
John Jones Assistant Accountant – ABC Accounting Practice Accounting Student Purposes of a Trial Balance
A trial balance is a list of the accounts in the general ledger and their balances at a given time. The trial balance is usually prepared at the end of an accounting period, for example monthly and the accounts are listed in the order they appear in the general ledger. The debit balances are listed in one column and the credit balances in the other and the totals of the two columns must be equal. The purpose of the trial balance is primarily to check the mathematical equality after the postings have been completed. This is necessary particularly in a manual accounting system. In today’s accounting environment the transactions are often processed with the use of computers so the programs are written as such that the debits will equal the credits. However the use of computers does not ensure the transactions have been processed correctly, nor if the trial balance balances does it ensure the transactions have been processed and posted correctly. The types of errors the trail balance detects is where the debits do not equal the credits such as omitting one side of the posting or transposing a figure when the entry was posted. The trial balance will not specifically identify if the posting was to the correct side of the ledger, say a debit to an assets account when the item should have been expensed, nor will it identify an omitted transaction, a journal entry posted twice, incorrect amounts are posted to both sides or errors where co-incidentally offset one another so the debits still equal the credits. However the listing of the balances would facilitate in the identification of posting errors, where you as the accountant use your knowledge of the expected balances. For example you would not expect Accounts receivable to have a credit balance or the miscellaneous expense account to have a large balance. So despite the limitation the trail balance is a useful screen in identifying recording errors. The trail balance is also useful in providing an overview of the account balances for review and preparation of the financial statements.
2.74
Chapter 2: The accounting information system
BUILDING BUSINESS SKILLS 2.7
ETHICS RESEARCH
(a)
The word ethics comes from the Greek word ethicos meaning related to custom or habit. The second edition of the Macquarie concise dictionary (page 320) defines ethical as ‘1. pertaining to or dealing with morals or the principles of morality; pertaining to right and wrong conduct 2. in accordance with the rules or standards for right conduct or practice, esp. the standards of a profession’.
(b)
The student answer could include: ethical behaviour is acting morally, acting in a way that is right or appropriate, acting in a way that people should behave, acting according to rules or agreed and acceptable ways of behaving, acting for the good or benefit of others rather than harm…etc…
(c)
Criteria that an accountant was behaving ethically could include: acts credibly and honestly – eg Provides credible information/advice and acts honestly abides by the professional rules/standards fair cost for service provided safeguard the interests of clients and the public integrity – honest and sincere approach to their work objectivity – fair and not prejudice or bias – treat all clients equally Reliability – can be relied upon to get the job done
(d)
Personal and financial costs of Unethical behaviour include: feeling of shame, remorse or guilt for acting unethically if caught - being disgraced, discredited if caught - damaged reputation and loss of current and future employment if caught - jail sentence or fine or be excluded from the profession and unable to practice as a professional cause harm to others – eg financial loss
(e)
Students’ own experiences …
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Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 3 – ACCRUAL ACCOUNTING CONCEPTS ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives 1.
Differentiate between the cash basis and the accrual basis of accounting.
2.
Explain criteria for revenue recognition and expense recognition.
3.
Explain why adjusting entries are needed and identify the major types of adjusting entries.
4.
Prepare adjusting entries for prepayments and accruals.
5.
Brief Exercises
Exercises
1
1,9
Problems 7A
2,3,4
2
5,9, 10, 11,13
1A, 2A,10A, 1B,2B.10B
3, 4
5, 6, 7, 8,9, 10,11,12,13
ALL PROBLEMS
Describe the nature and purpose of the adjusted trial balance.
5
9,10,11
ALL PROBLEMS
6.
Explain the purpose of closing entries.
6
12
3A, 4A,5A,6A, 7A,8A, 9A,10A, 3B, 4B, 5B,6B, 7B,8B,9B,10B
7.
Describe the required steps in the accounting cycle.
8.
Describe the purpose and the basic form of a worksheet.
6, 7
3A, 5A,6A,8A, 9A,10A,3B,5B, 6B,8B,9B,10B 13
3.1
9A,10A 7B,9B,10B
Chapter 3: Accrual accounting concepts
CHAPTER 3 – ACCRUAL ACCOUNTING CONCEPTS ANSWERS TO QUESTIONS 1.
2.
(a)
Under the accounting period concept, an accountant is required to determine the impact of each accounting transaction or event in specific accounting periods.
(b)
An accounting time period of one year in length is referred to as a financial year.
The accounting principles and the qualitative characteristics, together with accounting standards, are collectively referred to as Australian generally accepted accounting principles (GAAP). Generally accepted accounting principles that pertain to adjusting the accounts include (choose two): The revenue recognition criteria which states that revenues should be recognised in the time period in which it is probable that any future economic benefits associated with the revenue will flow to the entity and the revenue can be reliably measured; The accounting period concept which states that the life of a business can be divided into artificial periods, such as one month, six month, 12 months, and that useful financial statements give feedback on the profitability of the business; The expense recognition criteria which states that expenses should be recognised when the outflow of future economic benefits associated with the expense is probable and the expense can be measured reliably.
3.
The law firm should recognise the revenue in April. The revenue recognition criterion states that revenue should be recognised in the accounting period in which it is probable that any future economic benefits associated with the revenue will flow to the entity and the revenue can be reliably measured. If the engagement has been completed the amount of revenue would typically be able to be measured reliably.
4.
Expenses of $5500 should be deducted from the revenues in April in order to match the revenue recognised in April.
5.
The financial information in a trial balance may not be up-to-date because:
6.
(1)
Some events are not journalised daily because it is unnecessary and inexpedient to do so.
(2)
The expiration of some costs occurs with the reduction in an asset with the passage of time.
(3)
Some items may be unrecorded because the transaction data are not known.
The two categories of adjusting entries are prepayments and accruals. Prepayments are either revenues received in advance or prepayments of amounts that provide economic benefit for more than one period, e.g. prepaid rent. Accruals consist of revenues and expenses earned or incurred but which have not been recorded through daily transactions.
3.2
Solutions manual to accompany Accounting: building business skills 4e
In a prepaid expense adjusting entry, expenses are debited and assets are credited. In a revenue received in advance adjusting entry liabilities are debited and revenues are credited. 7.
Depreciation expense is an expense account whose normal balance is a debt. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the depreciation that has been recognised from the date of acquisition to the reporting date.
8.
Liability and revenue. The revenue account is debited and liability account (Revenue Received in Advance) is credited. This is the nature of the adjusting entry if the original entry was to record the amount received as revenue.
9.
An asset is debited and an expense is credited by the adjusting entry.
10.
(a)
Prepaid expenses (initially recorded as an expense) or Accrued revenue
11.
(b)
Revenues received in advance.
(c)
Accrued expenses or revenue received in advance (initially recognised as revenue).
(d)
Accrued expenses or prepaid expenses.
(e)
Prepaid expenses.
(f)
Accrued revenues or revenues received in advance.
A worksheet is a multi-columned form. The columns of the worksheet from left to right are two columns each for the trial balance, adjustments, adjusted trial balance, income statement and statement of financial position.
3.3
Chapter 3: Accrual accounting concepts
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3.1 Cash $ -120 0 0 +960 -3,000 0 0
(a) (b) (c) (d) (e) (f) (g)
Retained Earnings $ 0 -60 +1,200 0 0 -1,200 0
BRIEF EXERCISE 3.2 Riko Ltd (1) Type of Adjustment
Item (a)
Prepaid Expense
(b)
Accrued Revenue
(c)
Accrued Expense
(d)
Revenue Received in Advance
(2) Accounts Before Adjustment Asset Overstated Expense Understated Asset Understated Revenue Understated Expense Understated Liability Understated Liability Overstated Revenue Understated.
BRIEF EXERCISE 3.3 Shah Ltd June
30
Depreciation Expense - Equipment Accumulated Depreciation – Equipment (Depreciation for the year )
3 000 3 ,000
Depreciation Expense – Equipment 30/6
Accumulated Depreciation
3 000
Accumulated Depreciation – Equipment 30/6 FINANCIALSTATEMENT PRESENTATION IS NET Equipment Less Accumulated depreciation
3.4
Depreciation Expense 25 000 (3 000)
3 000
Solutions manual to accompany Accounting: building business skills 4e
$22 000 BRIEF EXERCISE 3.4 DeVoe Ltd General Journal Date
(a)
(b)
(c)
Account name(narration) June 30 Interest Expense Interest Payable (Accrual of interest on loan) June 30 Service Revenue Receivable Service Revenue (Accrual of revenue) June 30 Salaries Expense Salaries Payable (Accrual of salaries)
Debit $ 400
G 15 Credit $ 400
1,400 1,400 700 700
BRIEF EXERCISE 3.5 Hoi Ltd Item
(1) Type of Adjustment
Account
(2) Related Account
(a)
Accounts Receivable
Accrued Revenue
Service Revenue
(b)
Prepaid Insurance
Prepaid Expense
Insurance Expense
(c)
Equipment
Depreciation refer item (d)
(d)
Accum. Depreciation – Equipment
Prepaid Expense
(e)
Bank Loan
Accrue interest refer item (f)
(f) (g)
Interest Payable Service Revenue Received in Advance Interest Receivable Wages Payable
Accrued Expense Revenue Received in Advance
Interest Expense Service Revenue
Accrued revenue Accrued expense
Interest Revenue Wages Expense
(h) (i)
Depreciation Expense
BRIEF EXERCISE 3.6 Khanna Ltd Account (a) (b) (c)
Accumulated Depreciation Depreciation Expense Retained Earnings
(d) (e) (f) (g)
Dividends Service Revenue Supplies Accounts Payable
Financial Statement Statement of financial position Income Statement Statement of financial position (and statement of changes in equity) Statement of changes in equity Income Statement Statement of financial position Statement of financial position 3.5
Post Closing Trial Balance Yes No Yes No No Yes Yes
Chapter 3: Accrual accounting concepts
BRIEF EXERCISE 3.7 The proper sequencing of the required steps in the accounting cycle is as follows: 1. 2. 3. 4. 5. 6. 7. 8. 9.
(e) (a) (b) (i) (g) (d) (h) (f) (c)
Analyse business transactions. Journalise the transactions. Post to ledger accounts. Prepare a trial balance. Journalise and post adjusting entries. Prepare an adjusted trial balance. Prepare financial statements. Journalise and post closing entries. Prepare a post-closing balance.
3.6
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO EXERCISES
EXERCISE 3.1 Ng Pty Ltd (a) Cash Basis $ 33,000 20,250 3,250 $9,500
Service Revenue - Operating Expenses - Insurance Expense Profit (b)
Accrual Basis $ 39,000 22,500 $16,500
Both accrual basis and cash basis provide useful information. However, it can be argued that the accrual basis of accounting provides more useful information about performance for decision makers because it recognises the impact of accounting transactions or events on specific accounting periods. The cash basis of accounting only recognises cash transactions. The accrual basis of accounting provides a more comprehensive picture of the business activities in the records. For example, accrued basis profit takes account of all revenues and expenses for a period whether or not cash is received or paid (provided recognition criteria are met). It also takes account of internal events, such as the consumption of supplies or the depreciation of plant assets. However, cash basis accounting is also useful. For example, the statement of cash flows shows how much cash is generated from ordinary operating activities (which will invariably be greater or less than accrual basis profit).
EXERCISE 3.2 (a) (b) (c) (d) (e) (f) (g) (h)
6. 1. 5. 8. 7. 2. 4. 3.
Going concern principle. Accounting entity concept. Full disclosure principle. Monetary principle. Materiality. Accounting period concept. Expense recognition criteria. Cost principle.
EXERCISE 3.3 (a) (b) (c) (d) (e) (f)
Revenue recognition criteria. Accounting period concept. No violation (not a violation of cost as the principle used for inventory is measurement at the lower of cost and net realisable value). Going concern principle. Cost principle. Accounting entity concept.
3.7
Chapter 3: Accrual accounting concepts
EXERCISE 3.4 (a) 9. Materiality. (b) 7. Expense recognition criteria. (c) 3. Monetary principle. (d) 4. Accounting period concept. (e) 8. Cost principle. (f) 1. Accounting entity concept. (g) 5. Full disclosure principle. (h) 6. Revenue recognition criteria.
EXERCISE 3.5 Zimbabwe Ltd
Item
(1) Type of Adjustment
(2) Accounts Before Adjustment
(b) Effect on profit Overstated /(understated) Understated
(a)
Accrued Revenue
Asset Understated Revenue Understated
(b)
Prepaid Expense
Asset Overstated Expense Understated
Overstated
(c)
Accrued Expense
Expense Understated Liabilities Understated
Overstated
(d)
Revenue Received in Advance
Liability Overstated Revenue Understated
Understated
(e)
Accrued Expense
Expense Understated Liability Understated
Overstated
(f)
Prepaid Expense
Asset Overstated Expense Understated
Overstated
3.8
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 3.6 Dirty Laundry Ltd General Journal
Date 1.
2.
3.
4.
5.
Account name(narration)
June 30 Depreciation Expense ($325 x 3) Accumulated Depreciation – Equipment (Depreciation for the year) 30 Revenue Received in Advance Rent Revenue ($12,090 x 1/3) (Rent Revenue April-Jun now revenue) 30 Interest Expense Interest Payable (Accrued interest) 30 Supplies Expense Supplies ($2,800 - $1105) (supplies used) 30 Insurance Expense ($390 x 3) Prepaid Insurance (Interest expense for the 3 months to June)
Post Ref.
$ Debit
420 121
975
210 300
4 030
400 220
650
440 110
1 695
430 100
1 170
$ Credit
975
4 030
650
1 695
1 170
NB. Adjusting entries are made quarterly (i.e. every 3 months). EXERCISE 3.7 James Dunn Dental Practice General Journal
a
b
c
d
e
Date Account name(narration) 2013 Jan 31 Accounts Receivable Service Revenue (Service preformed January) 31 Electricity Expense Electricity Payable (Accrued electricity) 31 Depreciation Expense Accumulated Dep’n – Dental Equipment (Depreciation for the month) 31 Interest Expense Interest Payable (Accrued interest) 31 Insurance Expense Prepaid Insurance (January insurance exp $12000/12) 31 Supplies Expense Supplies ($1600 - $500 (Supplies used January)) 3.9
$ Debit
$ Credit
750 750 520 520 400 400 500 500 1,000 1,000 1 100 1 100
Chapter 3: Accrual accounting concepts
EXERCISE 3.8
Date
1.
2.
3.
4.
5.
6.
7.
Wong Pty Ltd General Journal Account name (narration)
Post ref
2013 Oct. 31 Advertising Supplies Expense Advertising Supplies ($2,500 - $1,600) (Supplies used October ) 31 Insurance Expense Prepaid Insurance (Insurance expense October) 31 Depreciation Expense Accumulated Depreciation – Office Equipment (Depreciation expense October) 31 Service Revenue Received in Advance Service Revenue (Revenue now performed) 31 Accounts Receivable Service Revenue (Accrued revenue) 31 Interest Expense Interest Payable (Accrued interest) 31 Salaries Expense Salaries Payable (Accrued salaries)
$ Credit
505 110
900
515 112
100
520 131
60
213 400
300
104 400
700
518 210
80
500 215
1 300
900
100
60
300
700
80
1 300
EXERCISE 3.9 Wolfmother Ltd Income Statement for the month ended 31 July 2014
Revenues: Service revenue ($5 500 + $800) Expenses: Wages expense ($2 300 + $300) Supplies expense ($1 200 - $400) Electricity expense Insurance expense Depreciation expense Total expenses Profit
$
$ 6 300
2 600 800 600 300 150 4 450 $1 850
3.10
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 3.10 Speedy Carpet Cleaners Pty Ltd Answer (a)
Supplies balance 1/7= $1 200
Calculation/Account Reconstruction Supplies expense
$1425
Add: Supplies (31/7) Less: Supplies purchased Supplies (1/7)
1050 (1275) $1200
1/7*
(b)
(c)
Supplies 1200 1275 31/7 2475
Bal. Purchases
Expense Bal.
Total premium = $7 200
Total premium = Monthly premium x 12; $600 x 12 = $7,200
Purchase date = 31 Jan 2013
Purchase date: On 31 July there are 6 months coverage remaining ($600 x 6). Thus, the purchase date was 6 months earlier on 31 January 2013.
Salaries payable = $2 250
Cash paid Salaries payable (31/7 )
$3750 1200 $4950 2700 $2250
Less: Salaries expense Salaries payable (1/7 or 30/6)
31/7
Salaries paid Bal
Salaries Payable 3 750 1/7 Bal 1 200 4 950
Salaries exp. 31/7 Bal
(d)
1425 1050 2,475
Service revenue = $1 725
Service revenue Amount received for July services Revenue received in Advance now recognised
31/7
Service Revenue Received in Advance Services 600 1/7 Bal. Performed Bal. 1,125 1,725 31/7 Bal
3.11
2 250 2 700 4 950 1 200 $3 000 2 400 600
1,725
1,150 1,125
Chapter 3: Accrual accounting concepts
EXERCISE 3.11 Martin Pty Ltd Answer (a)
Supplies balance 1/3= $800
Calculation/Account Reconstruction Supplies expense Add: Supplies (31/3) Less: Supplies purchased Supplies (1/3)
1/3*
(b)
Total premium = $4 800
$950 700 (850) $800
Supplies 800 850 31/3 1650
Bal. Purchases
Expense Bal.
950 700 1650
Total premium = Monthly premium x 12; $400 x 12 = $4,800 At 31 March the prepaid amount is half the annual premium so policy was purchased six months earlier on 1 October 2013
Purchase date = 31 Oct 2013 (c)
Salaries payable = $1 500
Cash paid Salaries payable (31/3 )
$2,500 800 $3,300 1,800 $1500
Less: Salaries expense Salaries payable (1/3)
31/3
Salaries paid Bal
Salaries Payable 2,500 1/3 Bal 800 3,300
Salaries exp. 31/3 Bal
(d)
Service revenue = $1 ,150
Service revenue Amount received for March services Revenue received in Advance now recognised
31/3
Service Revenue Received in Advance Services 400 1/3 Bal. Performed Bal. 750 1,150 31/3 Bal
3.12
1,500 1,800 3,300 800 $2,000 1,600 400
1,150
1,150 750
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 3.12 Snowmass Ltd General Journal Date (a)
Account name (narration)
July 10 Supplies Cash
$ Debit 200
200
14 Cash
3 000 Service Revenue
3 000
15 Salaries Expense Cash
1 200 1 200
20 Cash
700 Service Revenue Received in Advance
(b)
$ Credit
July 31 Supplies Expense Supplies
700 500 500
31 Salaries Expense Salaries Payable
1 200 1 200
31 Service Revenue Receivable Service Revenue
500
31 Service Revenue Received in Advance Service Revenue
900
3.13
500
900
Chapter 3: Accrual accounting concepts
EXERCISE 3.13
Date
1.
2.
3.
4.
Woks Ltd General Journal Account name (narration)
2013 June 30 Insurance Expense Insurance Payable Calculations: $22200 ÷ 3 yrs = $7 400 per annum, 1.5 yrs remain $6 340 ÷ 2 yrs= 3 170 per annum, 1 year remains $10 570 Prepayment of B4564 at 30/6/13 is $11 100 Prepayment of A2958 at 30/6/09 is 3 170 $14 270 Pre adjustment balance or Prepaid Insurance $24 840 Adjustment required to be recognised as exp $10 570
$ Debit
$ Credit
10 570 10 570
30 Subscription Revenue Received in Advance Subscription Revenue Calculations: Apr 300 x $85 x 3/12 = $6 375 May 400 x $85 x 2/12 = 5 667 Jun 680 x $85 x 1/12 = 4 817 Subscriptions earned and to be recognised as revenue $16 859
16 859
30 Interest Expense Interest Payable Calculation: $85,000 x 9% x 4/12 = $2 550
2 550
30 Salaries Expense Salaries Payable Calculations: 5 x $840 x 3/5 = 3 x $1050 x 3/5 =
4 410
16 859
2 550
4 410 $2 520 1 890 $4 410
(b) Subscriptions are usually paid in advance and for revenue to be recognised it needs to meet the revenue recognition criteria. The revenue is recognised as the work is performed not when the cash is received.
3.14
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A
PROBLEM SET A 3.1 Hans Ltd General Journal (a).
1.
2.
3.
4.
5.
6.
7.
Post Ref.
$ Debit
505 113
3 200
30 Electricity Expense Electricity Payable (Accrued electricity)
530 218
600
30 Insurance Expense Prepaid Insurance (Prepaid insurance expired ($4800 ÷ 12 mth x 2)
515 112
800
30 Service Revenue Received in Advance Service Revenue (Services performed in relation to revenue received in advance)
213 400
1 500
30 Salaries Expense Salaries Payable (Accrued salaries)
500 215
3 200
30 Depreciation Expense Accumulated Depreciation – Office Equipment ($720 x 2 ) (Record depreciation expense)
520 131
1 440
30 Accounts Receivable Service Revenue (Accrued revenue)
104 400
4 000
Date Account Titles (Narration) 2012 June 30 Supplies Expense Supplies ($6 800 - $3 600) (To adjust supplies account to reflect supplies used)
$ Credit
3 200
600
800
1 500
3 200
1 440
4 000
Students need to look and see what has been recorded in the ledgers to work out if one or two months adjustments are required. For insurance and depreciation no expense had been recorded to date.
3.15
Chapter 3: Accrual accounting concepts
(b) Hans Ltd General ledger Cash 30/6
Balance
100
17 280 Accounts Receivable
30/6
Balance
13 020 30/6
30/6
Service Revenue
4 000
104 Balance
17 020 1/7
Opening Balance
17 020
17 020 Prepaid Insurance
30/6
Balance
4 800 30/6 30/6
112 Insurance Expense
800
Closing Balance
4 000
4 800 1/7
Opening Balance
4 800
4 000 Supplies
30/6
Balance
6 800 30/6 30/6
113 Supplies Expense
3 200
Closing Balance
3 600
6 800 1/7
Opening Balance
6 800
3 600 Office Equipment
30/6
Balance
17 020
130
43 200 Accumulated Depreciation – Office Equipment 30/6
Depreciation Expense
Accounts Payable 30/6
131 1 440 200
Balance
9 900
Service Revenue Received in Advance
213
30/6
Service Revenue
30/6
Closing Balance
1 500 30/6
Balance
2 400
900 2 400
2 400 1/7
Salaries Payable 3.16
Opening Balance
900 215
Solutions manual to accompany Accounting: building business skills 4e
30/6
Salaries Expense
Electricity Payable 30/6
218 Electricity Expense
Share Capital 30/6
Closing Balance
Balance
400 Balance
38 300
30/6
Service Rev in Adv
1 500
Accounts Receivable
4 000
43 800
43 800 1/7
Opening Balance
Salaries Expense Balance
11 900
30/6
Salaries Payable
3 200
50 000
30/6 43 800 30/6
30/6
600 300
Service Revenue
30/6
3 200
43 800
500
15 100
Supplies Expense 30/6
Supplies
3 200 Rent Expense
30/6
Balance
Prepaid Insurance
Accumulated Depreciation
Electricity Expense
520
1 440 Electricity Expense
30/6
515
800 Depreciation Expense
30/6
510
3 600 Insurance Expense
30/6
505
600
3.17
530
Chapter 3: Accrual accounting concepts
(c) Hans Ltd Adjusted Trial Balance as at 30 June 2012 No.
Account Name
100 104 112 113 130 131 200 213 215 218 300 400 500 505 510 515 520 530
Cash Accounts Receivable Prepaid Insurance Supplies Office Equipment Accumulated Depreciation – Office Equipment Accounts Payable Service Revenue Received in Advance Salaries Payable Electricity Payable Share Capital Service Revenue Salaries Expense Supplies Expense Rent Expense Insurance Expense Depreciation Expense Electricity Expense
Debit $ 17 280 17 020 4 000 3 600 43 200
Credit $
1 440 9 900 900 3 200 600 50 000 43 800 15 100 3 200 3 600 800 1 440 600 $109 840
$109 840
(d) Profit for the month Revenues $43 800 less expenses ($15100+3200+3600+800+1440+600) = $19 060 (e)
If the cost of the equipment was allocated over the two years then the annual depreciation expense would be $21 600 ($43200/2) instead of $8 640 which means profit in the first 2 years would be $12 960 ($21600-$8640) less than if the depreciation was charged over the useful life and this would mean the profit in year 3 4 and 5 would be $8 640 more as no depreciation would be charged. Note over the 5 years total depreciation is the same is $43 200 either rate used.
3.18
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 3.2 (a) Combined Services Ltd General Journal Date
Account Name (narration)
Post Ref.
$ Debit
$ Credit
2014 1.
June 30
Supplies Expense
505
Supplies
250
113
250
(Supplies used $750-$500) 2.
30
Electricity Expense
530
Electricity Payable
150
218
150
(Accrued expense) 3.
30
Insurance Expense
515
Prepaid Insurance
800
112
800
(Prepaid insurance expired) 4.
5.
30
30
Revenue Received in Advance
213
Service Revenue
400
Salaries Expense
500
Salaries Payable
1 500 1 500 2 300
215
2 300
(Accrued salaries) 6.
30
Depreciation Expense
520
Accumulated Depreciation
2,000
131
2,000
(Depreciation expense) 7.
30
Accounts Receivable
104
Service Revenue
400
(Accrued revenue)
3.19
2 200 2 200
Chapter 3: Accrual accounting concepts
(b) COMBINED SERVICES LTD GENERAL LEDGER Cash 30/6
Opening Balance
100
27 400
Accounts Receivable 30/6
Opening Balance
7 500
30/6
Service Revenue
2 000 30/6
104 Closing Balance
9 700 1/7
Opening Balance
9 700
9 700 Prepaid Insurance
30/6
Opening Balance
112
1 600 30/6
Insurance Expense
800
____ 30/6
Closing Balance
800
1 600 1/7
Opening Balance
1 600
800 Supplies
30/6
Opening Balance
113
750 30/6
Supplies Expense
250
____ 30/6
Closing Balance
500
750 1/7
Opening Balance
750
500 Office Equipment
30/6
Opening Balance
130
15 ,000
Accumulated Depreciation 30/6
Closing Balance
9 700
12 000
131
30/6
Opening Balance
10 000
30/6
Depreciation Expense
2 000
12 000
12 000 1/7
Opening Balance
Accounts Payable 30/6
3.20
12 000 200
Opening Balance
3 700
Solutions manual to accompany Accounting: building business skills 4e
Service Revenue Received in Advance 30/6
Service Revenue
30/6
Closing Balance
1 500 30/6
Opening Balance
213 2 000
500
........
2 000
2 000 1/7
Opening Balance
Salaries Payable 30/6
215 Salaries Expense
Electricity Payable 30/6
500 2 300
218 Electricity Expense
Share Capital
150 300
30/6
Opening Balance
Retained Earnings 30/6
30 000 310
Opening Balance
Service Revenue
3 750 400
30/6
Opening Balance
23 400
30/6
Serv. rev rec’d in advance
1 500
30/6
Accounts Receivable
2 200 27 100
30/6 30/6
30/6
30/6
30/6 30/6
Opening balance Salaries Payable
Supplies
Salaries Expense 17 000 2 300 19 300 Supplies Expense 250
500
505
510
Opening Balance
Rent Expense 1 000
515
Opening Balance Prepaid Insurance
Insurance Expense 600 800 1 400
3.21
Chapter 3: Accrual accounting concepts
30/6
30/6 30/6
Depreciation Expense Accumulated Depreciation 2 000
520
Electricity Expense 2 000 150 2 150
530
Opening balance Electricity Payable
(c) Combined Services Ltd Adjusted Trial Balance as at 30 June 2014 No. 100
Account name Cash
104
Accounts Receivable
9 700
112
Prepaid Insurance
800
113
Supplies
500
130
Office Equipment
131
Accumulated Depreciation
12 000
200
3 700
215
Accounts Payable Service Revenue Received in Advance Salaries Payable
218
Electricity Payable
300
Share Capital
30 000
310
Retained Earnings
3 750
400
Service Revenue
27 100
500
Salaries Expense
19 300
505
Supplies Expense
250
510
Rent Expense
1000
515
Insurance Expense
1 400
520
Depreciation Expense
2 000
530
Electricity Expense
2 150
_______
$79 500
$79 500
213
Debit $ Credit $ 27 400
15 000
500 2 300 150
3.22
Solutions manual to accompany Accounting: building business skills 4e
(d) Profit for the year: $ Service revenue Less Expenses: Salaries expense Supplies expense Rent expense Insurance expense Depreciation expense Electricity expense Profit
19 300 250 1 000 1 400 2 000 2 150
$ 27 100
26 100 $ 100
(e) To report a higher profit the expense adjustments would be avoided therefore adjustment numbers 1, 2, 3, 5, and 6.
3.23
Chapter 3: Accrual accounting concepts
PROBLEM SET A 3.3 (a)
Perth Business Park Ltd General Journal Date Account name (narration) 2013 Sept 30 Rent Expense Prepaid Rent (To record expired rent)
Post Ref
Debit $
510 120
2 250
30 Supplies Expense Supplies (To record supplies consumed)
530 130
225
30 Depreciation Expense – Equipment Accumulated Depreciation – Equipment (To record depreciation expense)
520 151
1 125
30 Accounts Receivable Commission Revenue (To record commission revenue not yet received)
110 400
9 300
30 Interest Expense Interest Payable (To record interest accrued)
550 220
150
30 Rent Revenue Received in Advance Rent Revenue (To record services provided for revenue)
230 410
1 200
30 Salaries Expense Salaries Payable (To record accrued salaries)
500 210
2 100
3.24
Credit $
2 250
225
1 125
9 300
150
1 200
2 100
Solutions manual to accompany Accounting: building business skills 4e
(b) Perth Business Park Ltd Income Statement for the three months ended 30 September 2013 $ Revenues: Rent revenue Commission revenue Total revenues Expenses: Salaries expense Rent expense Depreciation expense Supplies expense Electricity expense Interest expense Total expenses Profit
$ 16 200 11 100 27 300
14 100 9 750 1 125 225 765 150 26 115 $ 1 185
Perth Business Park Ltd Calculation of retained earnings for the three months ended 30 September 2013 Retained earnings, 1 July Add: Profit
$
Less: Dividends Retained earnings, 30 September
3.25
1 185 1 185 (900) $285
Chapter 3: Accrual accounting concepts
Perth Business Park Ltd Statement of financial position as at 30 September 2013 $ Assets Current assets Cash Accounts receivable Supplies Total current assets Non-current assets Equipment Less: Accumulated depreciation – equipment Total assets Liabilities Accounts payable Salaries payable Interest payable Rent revenue received in advance Bank loan* Total liabilities Net Assets Equity: Share capital Retained earnings Total equity
$
2 475 9 900 450 12 825 22 500 (1 125)
21 375 34 200
2 265 2 100 150 900 7 500 12 915 $21 285 21 000 285 $21 285
* bank loan could also be classified as non-current
(c)
The following accounts would be closed: Commission Revenue, Rent Revenue, Salaries Expense, Rent Expense, Depreciation Expense, Supplies Expense, Electricity Expense, Interest Expense, Dividends.
(d)
1 August 2013. Interest of 12% per year equals a monthly rate of 1%; monthly interest is $75 ($7500 x 1%). Since total interest expense is $150, the loan has been outstanding for two months. OR Monthly interest is [$7500 x .12) x 1/12] = $75 Since the total interest expense is $150, the company must have taken out the loan two months ago on 1 August 2013. (Alternatively, 31 July 2013)
3.26
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 3.4 (a) Frog Ltd General Journal Date Account name (narration) 2012 June 30 Accounts Receivable Revenue (To record revenue not yet received)
Post Ref 110 400
900
30 Office Supplies Expense Office Supplies (To record supplies consumed)
510 120
2 400
30 Insurance expense Prepaid Insurance (To record insurance expense)
530 130
2 250
30 Depreciation Expense – Equipment Accumulated Depreciation – Equipment (To record depreciation expense)
540 141
1 800
30 Salaries Expense Salaries Payable (To record accrued salaries)
500 210
1 650
30 Rent Revenue Received in Advance Rent Revenue (To record services provided for revenue)
220 410
1 200
3.27
Debit $
Credit $
900
2 400
2 250
1 800
1 650
1 200
Chapter 3: Accrual accounting concepts
(b) Frog Ltd Income Statement for the year ended 30 June 2012 $ Revenues: Service revenue Rent revenue Total revenues Expenses: Salaries expense Office Supplies expense Rent expense Insurance expense Depreciation expense Total expenses Profit
$ 51 900 17 700 69 600
27 150 2 400 22 000 2 250 1 800 55 600 $14 000
Frog Ltd Calculation of retained earnings for the year ended 30 June 2012 Retained earnings, 1 July Add: Profit
5 600 14 000 19 600 (-) $19 600
Less: Dividends Retained earnings, 30 September
3.28
Solutions manual to accompany Accounting: building business skills 4e
Frog Ltd Statement of financial position as at 30 June 2012 $ Assets Current assets Cash Accounts receivable Office supplies Prepaid insurance Total current assets Non-current assets Equipment Less: Accumulated depreciation – equipment Total non-current assets Total assets Liabilities Accounts payable Salaries payable Rent revenue received in advance Total liabilities Net Assets Equity Share capital Retained earnings Total equity
3.29
$
14 500 14 100 1 050 3 750 33 400 18 000 (5 400) 21 375 46 000 8 700 1 650 1 050 11 400 $34 600 15 000 19 600 $34 600
Chapter 3: Accrual accounting concepts
(c) Frog Ltd General Journal Date Account name (narration) 2012 June 30 Service Revenue Rent revenue Income Summary (To close revenue accounts)
Post Ref
Debit $
400 410 330
51 900 17 700
30 Income Summary Salaries expense Office Supplies expense Rent expense Insurance expense Depreciation expense (To close expense accounts)
330 500 510 520 530 540
55 600
30 Income Summary Retained earnings (To close profit to retained earnings)
330 310
14 000
3.30
Credit $
69 600
27 150 2 400 22 000 2 250 1 800
14 000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 3.5 (a)
Albert Ltd General Journal Date Account name (narration)
Post Ref
2013 Sept 30 Accounts Receivable Sales Revenue (To record Sales revenue)
$ Debit
110 400
2 500
30 Rent Expense Prepaid Rent (To record expired rent )
510 120
2 500
30 Supplies Expense Supplies (To record supplies consumed)
530 130
1 500
30 Depreciation Expense – Equipment Accumulated Depreciation – Equipment (To record depreciation expense)
520 151
2 000
30 Salaries Expense Salaries Payable (To record accrued salaries)
500 210
3 600
30 Interest Expense Interest Payable (To record interest accrued)
550 220
200
30 Comm Revenue Received in Advance Commission Revenue (To record services provided for revenue)
230 410
2 200
3.31
$ Credit
2 500
2 500
1 500
2 000
3 600
200
2 200
Chapter 3: Accrual accounting concepts
(b) Albert Ltd Income Statement for the three months ended 30 September 2013 $ Revenues: Sales revenue Commission revenue Total revenues Expenses: Salaries expense Rent expense Depreciation expense Supplies expense Electricity expense Interest expense Total expenses Profit
$ 28 400 17 200 45 600
21 700 7 500 2 000 1 500 1 750 200 34 650 $10 950
Albert Ltd Calculation of retained earnings for the three months ended 30 September 2013 Retained earnings, 1 July Add: Profit
$ 10 950 10 950 (1 000) $9 950
Less: Dividends Retained earnings, 30 September
3.32
Solutions manual to accompany Accounting: building business skills 4e
Albert Ltd Statement of financial position as at 30 September 2013 $ Assets Current assets Cash Accounts receivable Prepaid Rent Supplies Total current assets Non-current assets Equipment Less: Accumulated depreciation – equipment Total assets Liabilities Accounts payable Salaries payable Interest payable Commission revenue received in advance Bank loan* Total liabilities Net Assets Equity Share capital Retained earnings Total equity
$
38 150 4 300 5 000 1 500 48 950 40 000 (2 000)
38 000 86 950
6 400 3 600 200 1 800 30 000 42 000 $44 950 35 000 9 950 $44 950
* bank loan could also be classified as non-current
(c)
The following accounts would be closed: Sales Revenue, Commission Revenue, Salaries Expense, Rent Expense, Depreciation Expense, Supplies Expense, Electricity Expense, Interest Expense, Dividends.
(d)
1 September 2013. Interest of 8% per year on loan $30 000 = $2,400. Monthly interest is $200 ($2400/12) Since total interest expense is $200, the loan has been outstanding for one month.
(e)
Useful live-need to calculate the depreciation rate. Three months depreciation was $2 000 or $8 000 annually. Useful life = cost/annual depreciation = $40 000/$8 000= Five years
3.33
Chapter 3: Accrual accounting concepts
PROBLEM SET A 3.6 (a)
Characters Ltd General Journal Date Account name (narration) 2014 June 30 Insurance Expense Prepaid Insurance (To record expired insurance)
Post Ref
Debit $
505 120
950
30 Supplies Expense Supplies (To record supplies consumed)
530 130
3 800
30 Depreciation Expense – Equipment Accumulated Depreciation – Equipment (To record depreciation expense)
520 151
7 840
30 Accounts Receivable Revenue (To record commission revenue not yet received)
110 400
1 680
30 Interest Expense Interest Payable (To record interest accrued)
510 220
120
30 Revenue Received in Advance Revenue (To record services provided for revenue)
230 400
1 570
30 Salaries Expense Salaries Payable (To record accrued salaries)
500 240
1 400
3.34
Credit $
950
3 800
7 840
1 680
120
1 570
1 400
Solutions manual to accompany Accounting: building business skills 4e
(b) Characters Ltd Income Statement for the year ended 30 June 2014 $ : Revenue Expenses: Salaries expense Insurance expense Interest expense Depreciation expense Supplies expense Rent expense Total expenses Profit
$ 68 880
12 600 950 720 7 840 3 800 4 880 30 390 $38 490
Characters Ltd Calculation of retained earnings for the year ended 30 June 2014 Retained earnings, 1 July 2013 Add: Profit
$6 160 38 490 44 650 (13 440) $31 210
Less: Dividends Retained earnings, 30 June 2014
3.35
Chapter 3: Accrual accounting concepts
Characters Ltd Statement of financial position as at 30 June 2014 $ Assets Current assets Cash Accounts receivable Supplies Prepaid Insurance Total current assets Non-current assets Equipment Less: Accumulated depreciation Total non-current assets Total assets Liabilities Current liabilities Accounts payable Salaries payable Interest payable Revenue received in advance Total current liabilities Non-current liabilities Bank loan Total liabilities Net Assets Equity Share capital Retained earnings Total equity
$
24 520 24 080 5 600 2 800 57 000 67 200 (39 200) 28 000 85 000
5 600 1 400 120 6 270 13 390 18 000 31 390 $53 610 22 400 31 210 $53 610
(c)
The following accounts would be closed: Revenue, Salaries Exp, Insurance Exp, Interest Exp, Depreciation Exp, Supplies Exp, Rent Exp, and Dividends.
(d)
The total interest expense for the six months is $720. So annually the interest is $1440. Rate is $1 440 ÷ $18 000 = 8%.
(e)
O/B? + exp$12 600 –Paid $13 400 = C/B $1 400 Opening balance 30 June 2013 = $2 200
(f)
The effect on profit was to reduce profit by $10 860 ( $950+3800+7840 - 1680 +120 – 1570 + 1400).
3.36
Solutions manual to accompany Accounting: building business skills 4e
(g)
Information concerning the future forecast for the next year. What has been budgeted for sales and expenses? Any new markets for the business? Who are the major competitors? and what are the general economic conditions?
3.37
Chapter 3: Accrual accounting concepts
PROBLEM SET A 3.7 Showroom Rentals Ltd Worksheet as at 30 June 2014 (a) Trial Balance No. 100 112 113 120 122 123 130 131 200 212 214 215 220 300 400 505 506 510 512 515 525 530
Account names Cash Prepaid Insurance Supplies Land Building Acc’d Depn – Building Furniture Acc’d Depn –Furniture Accounts Payable Rent Rev Rec’d in Adv Salaries Payable Interest Payable Mortgage Payable Share Capital Rent Revenue Advertising Expense Depreciation Expense Electricity Expense Insurance Expense Interest Expense Salaries Expense Supplies Expense
Dr $ 5 000 3 600 3 800 30 000 140 000
Cr $
Adjustments Dr $
Cr $ 900 1 400
1 2
1 800
3
1 500
3
600 2 100
5 6 4
3 000
5
33 600 9 400 7 200
3 000
70 000 120 000 18 400 1 000 3 300
3
900 2 100 600 1 400 $11 300
1 4 6 2
2 000
6 000 $225 000
$225 000
$11 300
Profit
Adjusted Trial Balance. Dr $ C $r 5 000 2 700 2 400 30 000 140 000 1 800 33 600 1 500 9 400 4 200 600 2 100 70 000 120 000 21 400 1 000 3 300 2 000 900 2 100 6 600 1 400 $231 000 $231 000
Income statement Dr $ Cr $
21 400 1 000 3 300 2 000 900 2 100 6 600 1 400 4 100 $21 400
3.38
Statement of financial position Dr $ Cr $ 5 000 2 700 2 400 30 000 140 000 1 800 33 600 1 500 9 400 4 200 600 2 100 70 000 120 000
$21 400
$213 700
4 100 $213 700
Solutions manual to accompany Accounting: building business skills 4e
(b)
Showroom Rentals Ltd General Journal
1
2
3
4
5
6
Date Account name (narration) 2014 June 30 Insurance expense Prepaid Insurance (To record expired insurance)
Post Ref
Debit $
512 112
900
30 Supplies Expense Supplies (To record supplies consumed)
530 113
1 400
30 Depreciation Expense Accumulated Depreciation – Building Accumulated Depreciation – Furniture (To record depreciation expense for 3 months)
506 123 131
3 300
30 Interest Expense Interest Payable (To record interest accrued ($70,000 x12%)x3/12)
513 215
2 100
30 Rent Revenue Received in Advance Rent Revenue (To record June rent)
212 400
3 000
30 Salaries Expense Salaries Payable (To record accrued salaries)
525 214
600
3.39
Credit $
900
1 400
1 800 1 500
2 100
3 000
600
Chapter 3: Accrual accounting concepts
(c) 30/6
Showroom Rentals Ltd General Ledger Cash Balance
5 000 Prepaid Insurance
30/6
Balance
3 600 30/6 30/6
112 Insurance Expense
900
Closing Balance
2 700
3 600 1/7
Opening Balance
3 600
2 700 Supplies
30/6
Balance
3 800 30/6 30/6
113 Supplies Expense
1 400
Closing Balance
2 400
3 800 1/7
Opening Balance
3 800
2 400 Land
30/6
Balance
120
30000 Building
30/6
Balance
122
140 000 Accumulated Depreciation – Building 30/6
Depreciation Expense
Furniture 30/6
Balance
100
123 1 800 130
33 600 Accumulated Depreciation – Furniture 30/6
Depreciation Expense
Accounts Payable 30/6
131 1 500 200
Balance
9 400
Rent Revenue Received in Advance
212
30/6
Rent Revenue
3 000 30/6
30/6
Closing Balance
4 200 7 200 3.40
Balance
7 200 7 200
Solutions manual to accompany Accounting: building business skills 4e
1/7
Opening Balance
Salaries Payable 30/6
214 Salaries Expense
Interest Payable 30/6
Interest Expense
2 100 220
Balance
Share Capital 30/6
600 215
Mortgage Payable 30/6
4 200
70 000 300
Balance
Rent Revenue
120 000 400
30/6
Balance
18 400
30/6
Rent Revenue in Advance
3 000 21 400
Advertising Expense 30/6
Balance
1 000 Depreciation Expense
30/6
Accumulated Depreciation Balance Prepaid Insurance
510
2 000 Insurance Expense
30/6
506
3 300 Electricity Expense
30/6
505
512
900 515 Interest Expense
30/6
Interest Payable
2 100 Salaries Expense
30/6
Balance
30/6
Salaries Payable
525
6 000 600 6 600 Supplies Expense
30/6
Supplies
1 400
3.41
530
Chapter 3: Accrual accounting concepts
(d)
No. 100 112 113 120 122 123 130 131 200 212 214 215 220 300 400 505 506 510 512 515 525 530
Showroom Rentals Ltd Adjusted Trial Balance as at 30 June 2014 Account names Debit $ Cash 5 000 Prepaid Insurance 2 700 Supplies 2 400 Land 30 000 Building 140 000 Accumulated Depreciation – Building Furniture 33 600 Accumulated Depreciation – Furniture Accounts Payable Rent Revenue Received in Advance Salaries Payable Interest Payable Mortgage Payable Share Capital Rent Revenue Advertising Expense 1 000 Depreciation Expense 3 300 Electricity Expense 2 000 Insurance Expense 900 Interest Expense 2 100 Salaries Expense 6 600 Supplies 1 400 $231 000
3.42
Credit $
1 800 1 500 9 400 4 200 600 2 100 70 000 120 000 21 400
$231 000
Solutions manual to accompany Accounting: building business skills 4e
(e) Showroom Rentals Ltd Income Statement for the three months ended 30 June 2014 $ Revenues: Rent revenue Expenses: Advertising expense Depreciation expense Electricity expense Insurance expense Interest expense Salaries expense Supplies expense Total expenses Profit
$ 21 400 1 000 3 300 2 000 900 2 100 6 600 1 400 17 300 $ 4 100
Showroom Rentals Ltd Calculation of retained earnings for the three months ended 30 June 2014 Retained earnings, 1 April Add: Profit Retained earnings, 30 June 2014
$
4 100 $4 100
3.43
Chapter 3: Accrual accounting concepts
Showroom Rentals Ltd Statement of financial position as at 30 June 2014 $ Assets Current Assets Cash Prepaid Insurance Supplies Total current assets Non-current assets Land Building Less: Accumulated depreciation Furniture Less: Accumulated depreciation Total non-current assets Total assets
5 000 2 700 2 400 10 100 30 000 140 000 (1 800) 33 600 (1 500)
138 200 32 100 200 300 210 400
Liabilities Current Liabilities Accounts payable Rent revenue received in advance Salaries payable Interest payable Total current liabilities Non-current Liabilities Mortgage Payable Total liabilities Net Assets Equity Share capital Retained earnings Total equity
(f)
$
9 400 4 200 600 2 100 16 300 70 000 86 300 $124 100 120 000 4 100 $124 100
The following accounts would be closed: Rent Revenue, Advertising expense, Depreciation Expense, Electricity Expense, Insurance Expense, Interest Expense, Salaries Expense, Supplies Expense.
3.44
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 3.8 (a)
O’Brien Cleaning Ltd General Journal Account name (narration)
Date 2013 July 1
Post Ref
Debit $
100 300
20 000
170 100 200
16 000
Cleaning Supplies Accounts Payable (Purchased cleaning supplies)
120 200
1 200
Prepaid Insurance Cash (Paid insurance annual policy July 1)
130 100
4 800
Accounts Receivable Service Revenue (Invoiced customers)
110 400
5 240
Accounts Payable Cash (Paid accounts payable)
200 100
3 800
Salaries Expense Cash (Paid salaries)
540 100
3 200
Cash
100 110
4 000
110 400
3 600
500 100
400
315 100
750
Cash Share Capital (Issued shares for cash)
1
Truck Cash Accounts Payable (Purchased truck)
3
5
12
18
20
21
Accounts Receivable (Collected cash from customers on account) 25
31
31
Accounts Receivable Service Revenue (Invoiced customers) Petrol & Oil Expense Cash (Paid for petrol and oil) Dividends Cash (Paid cash dividend)
3.45
Credit $
20 000
5 000 11 000
1 200
4 800
5 240
3 800
3 200
4 000
3 600
400
750
Chapter 3: Accrual accounting concepts
(b), (e) & (h)
1/7 21/7
Share Capital Accounts Receivable
Cash 20 000 1/7 4 000 5/7 18/7 20/7 31/7 31/7 31/7
1/8
Opening Balance
Motor Vehicles Prepaid Insurance Accounts Payable Salaries Expense Petrol & Oil Expense Dividends Closing Balance
24 000 6 050
Accounts Receivable 12/7 Service Revenue 5 240 21/7 Cash 25/7 Service Revenue 3 600 31/7 Service Revenue* 2 000 31/7 Closing Balance 10 840 1/8 Opening Balance 6 840 * (e) adjusting entry, balance was $4840 dr before adjusting entry Cleaning Supplies 3/7 Accounts Payable 1 200 31/7 Cleaning Supplies Expense* 31/7 Closing Balance 800 1/8 Opening Balance 400 * (e) adjusting entry, balance was $1200 dr before adjusting entry Prepaid Insurance 5/7 Cash 4 800 31/7 Insurance Expense* 31/7 Closing Balance 4 400 1/8 Opening Balance 4 400 * (e) adjusting entry, balance was $4 800 dr before adjusting entry
1/7
Cash/Accounts Payable
Truck 16 000
Accumulated Depreciation – Trucks 31/7 Depreciation Expense* * (e) adjusting entry, nil balance before adjusting entry
3.46
100 5 000 4 800 3 800 3 200 400 750 6 050 24 000
110 4 000 6 840 10840
120 800 400 800
130 400 4 400 4 400
170
171 250
Solutions manual to accompany Accounting: building business skills 4e
18/7 31/7
Cash Closing Balance
Accounts Payable 3 800 1/7 8 400 3/7 12 200 1/8 Salaries Payable 31/7
Opening Balance
200 11 000 1 200 12 200 8 400
Salaries Expense*
210 300
Motor Vehicles Cleaning Supplies
* (e) adjusting entry, nil balance before adjusting entry Share Capital 1/7
31/7 31/7
31/7
Dividends Closing Balance
Cash
Retained Earnings 750 31/7 4 740 5 490 1/8 Dividends 750 31/7
Cash
300 20 000
Income Summary
310 5 490
Opening Balance
5 490 4 740
Retained Earnings
315 750
Income Summary 320 31/7 Expenses 5 350 31/7 Revenue 10 840 31/7 Retained Earnings 5 490 5,000 5,000 Entries to this account are closing entries. It has a nil balance before and after closing entries because the balance, profit, is closed to retained earnings, Service Revenue 400 31/7 Income Summary 10 840 12/7 Accounts Receivable 5 240 25/7 Accounts Receivable 3 600 31/7 Accounts Rec’ble* 2 000 10 840 10 840 * (e) Adjusting entry,$8840 cr balance before adjusting entry, $10 840 cr after adjustment, before closing
31/7
Cash
Petrol & Oil Expense 400 31/7 Income Summary
3.47
500 400
Chapter 3: Accrual accounting concepts
31/7
Cleaning Supplies*
Cleaning Supplies Expense 800 31/7 Income Summary
510 800
* (e) Adjusting entry, nil balance before adjusting entry, $200 dr after adjustment, before closing
31/7
Depreciation Expense Accumulated Depreciation* 250 31/7 Income Summary
520 250
* (e) adjusting entry, nil balance before adjusting entry
31/7
Prepaid Insurance*
Insurance Expense 400 31/7 Income Summary
530 400
* (e) Adjusting entry, nil balance before adjusting entry, $200 dr after adjustment, before closing Salaries Expense 540 20/7 Cash 3 200 31/7 Income Summary 3 500 31/7 Salaries Payable* 300 3 500 3 500 * (e) adjusting entry, $3200 dr balance before adjusting entry, $3 500 dr after adjusting entry before closing.
3.48
Solutions manual to accompany Accounting: building business skills 4e
(c) & (f)
O’Brien Cleaning Ltd Trial Balance as at 31 July 2013 (c) Unadjusted
No.
Account name
100 110 120 130 170 171 200 210 300 310 400 500 510 520 530 540
Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Trucks Accumulated Depreciation – Trucks Accounts Payable Salaries Payable Share Capital Dividends Service Revenue Petrol & Oil Expense Cleaning Supplies Expense Depreciation Expense Insurance Expense Salaries Expense
(d) Date 1.
Debit $
(f) Adjusted
Credit $
6 050 4 840 1 200 4 800 16 000
Debit $ 6 050 6 840 400 4 400 16 000
250 8 400 300 20 000
8 400 20 000 750
750 8 840
400
3 200 $37 240
O’Brien Cleaning Ltd General Journal Account name (narration) July 31 Accounts Receivable Service Revenue
Credit $
$37 240
10 840 400 800 250 400 3 500 $39 790
Post Ref. 110
$39 790
Debit $ 2 000
400
Credit $ 2 000
(Accrued revenue) 2.
31
Depreciation Expense
520
Accumulated Depreciation
250
172
250
(Depreciation expense) 3.
31
Insurance Expense
530
Prepaid Insurance
400
130
400
(Prepaid insurance expired) 4.
31
Cleaning Supplies Expense Cleaning Supplies
510
800
120
800
(Supplies used) 5.
31
Salaries Expense
540
Salaries Payable
210
(Accrued salaries)
3.49
300 300
Chapter 3: Accrual accounting concepts
(g)
O’Brien Cleaning Ltd Income Statement for the month ended 31 July 2013 $
Revenues: Service revenue Expenses: Salaries expense Cleaning supplies expense Depreciation expense Petrol & Oil expense Insurance expense Total expenses Profit
$ 10 840 3 500 800 250 400 400 5 350 $5 490
O’Brien Cleaning Ltd Calculation of retained earnings for the month ended 31 July 2013
Retained earnings 1 July Add: Profit
$ 5 490 5 490 (750) $4 740
Less: Dividends Retained earnings 31 July
3.50
Solutions manual to accompany Accounting: building business skills 4e
O’Brien Cleaning Ltd Statement of financial position as at 31 July 2013 $ ASSETS Current assets Cash Accounts receivable Cleaning supplies Prepaid insurance Total current assets Non-current assets Property, plant and equipment: Motor Vehicles Less: Accumulated depreciation Total non-current assets Total assets LIABILITIES Current liabilities Accounts payable Salaries payable Total liabilities NET ASSETS EQUITY Share capital Retained earnings TOTAL EQUITY
$
6 050 6 840 400 4 400 17 690
16 000 (250) 15 750 33 440
8 400 300 8 700 $24 740 20 000 4 740 $24 740
3.51
Chapter 3: Accrual accounting concepts
O’Brien Cleaning Ltd General Journal
(h)
Date
Post
Account name (narration)
Debit $
Credit $
Ref
July 31
Service Revenue
400
Income Summary
10 840
320
10 840
(Close revenue accounts) 31
Income Summary
320
5 350
Petrol & Oil Expense
500
400
Cleaning Supplies Expense
510
800
Depreciation Expense
520
250
Insurance Expense
530
400
Salaries Expense
540
3 500
(Close expense accounts) 31
Income Summary
320
Retained Earnings
5 490
310
5 490
(Close Income summary account) 31
Retained Earnings
310
Dividends
315
750 750
(Close dividends account) (i)
O’Brien Cleaning Ltd Post-Closing Trial Balance as at 31 July 2013 No. 100 110 120 130 170 171 200 210 300 310
Account name Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Trucks Accumulated Depreciation – Trucks Accounts Payable Salaries Payable Share Capital Retained Earnings
Debit $ 6 050 6 840 400 4 400 16 000
$33 690
3.52
Credit $
250 8 400 300 20 000 4 740 $33 690
Solutions manual to accompany Accounting: building business skills 4e
(j)
Today’s society is aware of their social responsibility and as such business’s can only operate successfully if they meet society’s expectations and as such are willing to take actions which is socially responsible. This means using environmentally friendly resources even though it may not be the cheapest. Triple bottom line reporting means measuring success not only the economic return but also the environment and the social dimensions.
PROBLEM SET A 3.9 (a) Chart of accounts: students may have different account numbers as long as they are grouped to sections of the ledger 100 110 120 130 150 151 200 210 215 300 310 400 510 515 520 525
Cash Accounts receivable Supplies Prepaid rent Store equipment Accumulated Depreciation Accounts Payable Service Revenue Received in Advance Salaries Payable Share Capital Retained earnings Service Revenue Depreciation Expense Supplies Expense Salaries Expense Rent Expense
(b), (d) and (f) Bulwara Ltd General Ledger Cash
100
1/7
Opening Balance
5 000 8/7
Salaries Expense/Payable
10/7
Accounts Receivable
2 000 24/7 Accounts Payable
12/7
Service Revenue
27/7
Revenue Rec’d in Advance
800 24/7 Rent Expense/prepaid
Opening Balance
2 000 800
1 300 25/7 Salaries Expense
3 000
31/7 Closing Balance
300
9 100 1/8
3 000
9 100
300 Accounts Receivable
110
1/7
Opening Balance
5 600 10/7
Cash
2 000
27/7
Service Revenue
2 300 31/7
Closing Balance
5 900
7 900 1/8
Opening Balance
5 900 3.53
7 900
Chapter 3: Accrual accounting concepts
Supplies
120
1/7
Opening Balance
2 000 31/7
Supplies Expense
2 200
17/7
Accounts Payable
3 400 31/7
Closing Balance
3 200
5 400 1/8
Opening Balance
5 400
3 200
Balance before adjusting entry $2000 + $3400 = $5400 Prepaid rent 24/7
Cash
130
400 Store Equipment
1/7
Opening Balance
20 000 31/7
15/7
Accounts Payable
8 000
150 Closing Balance
28 000 1/8
Opening Balance
28 000
28 000
Accumulated Depreciation – Store Equipment 31/7
28 000
Closing Balance
1/7
Opening Balance
31/7
Depreciation Expense
1 240
151 1 000 240 1 240
1/8
Opening Balance
1 240
Balance before adjusting entry $1000 Accounts Payable 24/7 31/7
Cash Closing Balance
200
2 000 1/7
Opening Balance
4 200
15/7
Store Equipment
8 000
Supplies
3 400
13 600 17/7 15 600
15 600 1/8
Opening Balance
Service Revenue Received in Advance 31/7
Service Revenue
600 1/7
31/7
Closing Balance
1 500 27/7
Opening Balance Cash
3 100
13 600 210 800 1 300 3 100
1/8 Balance before adjusting entry $800 + $1300 = $2100
3.54
Opening Balance
1 500
Solutions manual to accompany Accounting: building business skills 4e
Salaries Payable
215
8/7
Cash
1 000 1/7
Opening Balance
1 000
31/7
Closing Balance
1 000 31/7
Salaries Expense
1 000
1 000
1 000 1/8
Opening Balance
1 000
Balance before adjusting entry, $1000 - $100 = $0 Share Capital 1/7
300 Opening Balance
Retained Earnings 1/7
20 000 310
Opening Balance
Service Revenue
5 600 400
12/7
Cash
27/7
Accounts Receivable
31/7
Service Revenue in Advance
800 2 300 600 3 700
Balance before adjusting entry $800+ $2300 = $3100 Depreciation Expense 31/7
Accumulated Depreciation
510
240
Nil balance before adjusting entry Supplies Expense 31/7
Supplies
515
2 200
Nil balance before adjusting entry Salaries Expense 8/7
Cash
2 000
25/7
Cash
3 000
31/7
Salaries Payable
1 000
520
6 000 Balance before adjusting entry $2000 + $3000 = $5000 Rent Expense 24/7
Cash
400
3.55
525
Chapter 3: Accrual accounting concepts
(c)
Bulwara Ltd General Journal
Date
Post Ref
Debit $
Salaries Payable Salaries Expense Cash (Payment of salaries for June and July)
215 520 100
1 000 2 000
Cash
100 110
2 000
100 400
800
Store Equipment Accounts Payable (Purchased store equipment on account)
150
8 000
Supplies Accounts Payable (Purchased supplies on account)
120 200
3 400
Accounts Payable Cash (Paid creditors on account)
200 100
2 000
Rent Expense Prepaid rent Cash (Paid July/August rent)
525 130 100
400 400
Salaries Expense Cash (Paid salaries)
520 100
3 000
Accounts Receivable Service Revenue (To record service revenue)
110 400
2 300
Cash
100 210
1 300
Account name (narration)
2013 July 8
10
Accounts Receivable (Cash received from customers on account) 12
Cash Service Revenue (To record service revenue)
15
17
24
24
25
July 27
27
Service Revenue Received in Advance (Received cash from customers in advance) 3.56
Credit $
3 000
2 000
800
8 000
3 400
2 000
800
3 000
2 300
1 300
Solutions manual to accompany Accounting: building business skills 4e
(e) and (g) Bulwara Ltd Trial Balance as at 31 July 2013
No 100 110 120 130 150 151 200 210 215 300 310 400 510 515 520 525
Account names Cash Accounts Receivable Supplies Prepaid Rent Store Equipment Accumulated Depreciation Accounts Payable Service Revenue Received in Advance Salaries Payable Share Capital Retained Earnings Service Revenue Depreciation Expense Supplies Expense Salaries Expense Rent Expense
3.57
Unadjusted Debit $ Credit $ 300 5 900 5 400 400 28 000 1 000 13 600 2 100 20 000 5 600 3 100
5 000 400 $45 400
$45 400
Adjusted Debit $ Credit4 300 5 900 3 200 400 28 000 1240 13 600 1 500 1 000 20 000 5 600 3 100 240 2 00 6 000 400 $46 640 $46 640
Chapter 3: Accrual accounting concepts
(f)
Bulwara Ltd General Journal Date
1.
2.
3.
4.
Account names (narration)
Post Ref
Debit $
July 31 Supplies Expense Store Supplies ($5400 - $3200) (To record supplies used)
515 120
2 200
31 Salaries Expense Salaries Payable (To record accrued salaries)
520 215
1 000
31 Depreciation Expense Accumulated Depr. – Store Equipment (To record one month’s depreciation expense)
510 151
240
30 Service Revenue Received in Advance Service Revenue (To record revenue)
210 400
600
2 200
1 000
240
600
(h) Bulwara Ltd Income statement for the month ended 31 July 2013 Revenues: Service revenue Expenses: Salaries expense Supplies expense Rent expense Depreciation expense Total expenses Loss
$
$ 3 700 6 000 2 200 400 240 8 840 ($5 140)
Bulwara Ltd Calculation of retained earnings for the month ended 31 July 2013 $ 5 600 (5140) $ 460
Retained earnings 1 July Less: Loss Retained earnings 31 July
3.58
Credit $
Solutions manual to accompany Accounting: building business skills 4e
Bulwara Ltd Statement of financial position as at 31 July 2013 $ ASSETS Current Assets Cash Accounts receivable Supplies Prepaid Rent Total current assets Non-current assets Store equipment Less: Accumulated depreciation Total non-current assets Total assets
$
300 5 900 3 200 400 9 800 28000 (1 240) 26 760 36 560
LIABILITIES Accounts payable Salaries payable Service revenue received in advance Total liabilities
13 600 1 000 1 500 16 100
NET ASSETS EQUITY Share capital Retained earnings
$20 460 20 000 460
TOTAL EQUITY
$20 460
3.59
Chapter 3: Accrual accounting concepts
PROBLEM SET A 3.9 (i) Bulwara Ltd Worksheet as at 31 July 2013 .
No. 100 110 120 130 150 151 200 210 215 300 310 400 510 515 520 525
Account names Cash Accounts receivable Supplies Prepaid rent Store equipment Accumulated Depreciation Accounts Payable Service Rev Rec’d in Advance Salaries Payable Share Capital Retained earnings Service Revenue Depreciation Exp Supplies Expense Salaries Expense Rent Expense
Trial Balance
Adjustments
Dr $
Dr $
Cr $
Cr $
300 5 900 5 400 400 28 000
2 200
1 000 13 600 2 100
240
Adjusted Trial Balance. Dr $ Cr $ 300 5 900 3 200 400 28 000 1 240
600 1 000
20 000 5 600 3 100
600 240 2 200 1 000
5 000 400
Income Statement Dr $ Cr $
13 600 1 500
13 600 1 500
1 000 20 000 5 600 3 700
1 000 20 000 5 600 3 700
240 2 200 6 000 400
Loss Totals
_______ $45 400
_______ $45 400
_______ $4 040
Statement of Financial Position Dr $ Cr $ 300 5 900 3 200 400 28 000 1 240
_______ $4 040
_______ $46 640
3.60
_______ $46 640
______ $8 840
5 140 ______ $8 840
5 140 _______ $42 940
______ $42 940
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 3.10 (a) Cortex Cleaning Ltd General Journal Date
Post Ref.
Debit $
100 300
75 000
Motor Vehicles Cash Accounts Payable (Purchased truck)
171 100 200
45 000
Cleaning Supplies Accounts Payable (Purchased cleaning supplies)
120 200
9 750
Prepaid Insurance Cash (Paid insurance annual policy July 1)
130 100
11 640
Accounts Receivable Service Revenue (Invoiced customers)
110 400
13 700
Accounts Payable Cash (Paid accounts payable)
200 100
24 250
Salaries Expense Cash (Paid salaries)
540 100
6 800
Cash
100 110
5 500
Accounts Receivable Service Revenue (Invoiced customers)
110 400
11 950
Petrol & Oil Expense Cash (Paid for petrol and oil) Dividends Cash (Paid cash dividend)
500 100
864
315 100
1 200
Account name (narration)
2014 April 1
Cash Share Capital (Issued shares for cash)
1
5
7
14
21
21
23
Accounts Receivable (Collected cash from customers on account) 25
30
30
3.61
Credit $
75 000
25 000 20 000
9 750
11 640
13 700
24 250
6 800
5 500
11 950
864
1 200
Chapter 3: Accrual accounting concepts
(b), (e) & (h) Cortex Cleaning Ltd General Ledger
1/4 23/4
Share Capital Accounts Receivable
1/5
Opening Balance
Cash 75 000 1/4 5 500 7/4 21/4 21/4 30/4 30/4 30/4 80 000 10 746
Motor Vehicles Prepaid Insurance Accounts Payable Salaries Expense Petrol & Oil Exp Dividends Closing Balance
Accounts Receivable 14/4 Service Revenue 13 700 23/4 Cash 25/4 Service Revenue 11 950 30/4 Service Revenue* 2 300 30/4 Closing Balance 27 950 1/8 Opening Balance 22 450 * (e) adjusting entry, balance was $20 150 dr before adjusting entry
100 25 000 11 640 24 250 6 800 864 1 200 10 746 24 000
110 5 500 22 450 27 950
Cleaning Supplies 5/4 Accounts Payable 9 750 30/4 Cleaning Supplies Exp* 30/4 Closing Balance 9 750 1/8 Opening Balance 1 500 * (e) adjusting entry, balance was $9 750 dr before adjusting entry
120 8 250 1 500 9 750
Prepaid Insurance 7/4 Cash 11 640 30/4 Insurance Expense* 30/4 Closing Balance 11 640 1/8 Opening Balance 10 670 * (e) adjusting entry, balance was $11 640 dr before adjusting entry
130 970 10 670 11 640
1/4
Cash/Accounts Payable
Motor vehicle 45 000
Accumulated Depreciation – Trucks 30/4 Depreciation Expense* * (e) adjusting entry, nil balance before adjusting entry
3.62
171
172 750
Solutions manual to accompany Accounting: building business skills 4e
21/4 30/4
Cash Closing Balance
Accounts Payable 24 250 1/4 5 500 5/4 29750 1/8 Salaries Payable 30/4
Opening Balance
200 20 000 9 750 29 750 5 500
Salaries Expense*
210 2 400
Motor Vehicles Cleaning Supplies
* (e) adjusting entry, nil balance before adjusting entry Share Capital 1/4
30/4 30/4
30/4
Dividends Closing Balance
Cash
Retained Earnings 1 200 30/4 6 716 7 916 1/8 Dividends 1 200 30/4
Cash
300 75 000
Income Summary
310 7 916
Opening Balance
7 916 6 716
Retained Earnings
315 1 200
Income Summary 320 30/4 Expenses 20 034 30/4 Revenue 27 950 30/4 Retained Earnings 7 916 27 950 27 950 Entries to this account are closing entries. It has a nil balance before and after closing entries because the balance, profit, is closed to retained earnings, Service Revenue 400 30/4 Income Summary 27 950 14/4 Accounts Receivable 13 700 25/4 Accounts Receivable 11 950 30/4 Accounts Rec’ble* 2 300 27 950 27 950 * (e) Adjusting entry,$25 650 cr balance before adjusting entry, $27 950 cr after adjustment, before closing
30/4
Cash
Petrol & Oil Expense 864 30/4 Income Summary
3.63
500 864
Chapter 3: Accrual accounting concepts
30/4
Cleaning Supplies*
Cleaning Supplies Expense 8 250 30/4 Income Summary
510 8 250
* (e) Adjusting entry, nil balance before adjusting entry, $8 250 dr after adjustment, before closing
30/4
Depreciation Expense Accumulated Depreciation* 750 30/4 Income Summary
520 750
* (e) adjusting entry, nil balance before adjusting entry
30/4
Prepaid Insurance*
Insurance Expense 970 30/4 Income Summary
530 970
* (e) Adjusting entry, nil balance before adjusting entry, $200 dr after adjustment, before closing Salaries Expense 540 21/4 Cash 6 800 30/4 Income Summary 9 200 30/4 Salaries Payable* 2400 9 200 9 200 * (e) adjusting entry, $6800 dr balance before adjusting entry, $9200 dr after adjusting entry before closing.
3.64
Solutions manual to accompany Accounting: building business skills 4e
(c) & (f) Cortex Cleaning Ltd Trial Balance as at 30 April 2014 (c) Unadjusted No.
Account name
100 110 120 130 171 172
Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Motor Vehicles Accumulated Depreciation – Motor vehicles Accounts Payable Salaries Payable Share Capital Dividends Service Revenue Petrol & Oil Expense Cleaning Supplies Expense Depreciation Expense Insurance Expense Salaries Expense
200 210 300 310 400 500 510 520 530 540
(d) Date 1.
Debit $
(f) Adjusted
Credit $
Debit $
10 746 20 150 9 750 11 640 45 000
Credit $
10 746 22 450 1 500 10 670 45 000 750 5 500
5 500 2 400 75 000
75 000 1 200
1 200 25 650
864
6 800 $106 150
Cortex Cleaning Ltd General Journal Account name (narration) April 30 Accounts Receivable Service Revenue
$106 150
27 950 864 8 250 750 970 9 200 $111 600
Post ref. 110
$111 600
Debit $ 2 300
400
Credit $ 2 300
(Accrued revenue) 2.
30
Depreciation Expense
520
Accumulated Depreciation
750
172
750
(Depreciation expense) 3.
30
Insurance Expense
530
Prepaid Insurance
970
130
970
(Prepaid insurance expired) 4.
30
Cleaning Supplies Expense Cleaning Supplies
510
8 250
120
8 250
(Supplies used) 5.
30
Salaries Expense
540
Salaries Payable
210
(Accrued salaries) 3.65
2 400 2 400
Chapter 3: Accrual accounting concepts
(g) Cortex Cleaning Ltd Income Statement for the month ended 30 April 2014 $ Revenues: Service revenue Expenses: Salaries expense Cleaning supplies expense Depreciation expense Petrol & Oil expense Insurance expense Total expenses Profit
$ 27 950 9 200 8 250 750 864 970 20 034 $7 916
Cortex Cleaning Ltd Calculation of retained earnings for the month ended 30 April 2014
Retained earnings 1 April Add: Profit
$
7 916 7 916 ( 1 200) $6 716
Less: Dividends Retained earnings 30 April
3.66
Solutions manual to accompany Accounting: building business skills 4e
Cortex Cleaning Ltd Statement of financial position as at 30 April 2014 $ ASSETS Current assets Cash Accounts receivable Cleaning supplies Prepaid insurance Total current assets Non-current assets Motor Vehicles Less: Accumulated depreciation Total non-current assets Total assets LIABILITIES Current liabilities Accounts payable Salaries payable Total liabilities NET ASSETS EQUITY Share capital Retained earnings TOTAL EQUITY
$
10 746 22 450 1 500 10 670 45 366 45 000 (750) 44 250 89 616
5 500 2 400 7 900 $81 716 75 000 6 716 $81 716
3.67
Chapter 3: Accrual accounting concepts
(h)
Cortex Cleaning Ltd General Journal
Date
Post Ref 400
Account name (narration)
July 31
Service Revenue Income Summary
Debit $
Credit $
27 950
320
27 950
(Close revenue accounts) 31
Income Summary
320
20 034
Petrol & Oil Expense
500
864
Cleaning Supplies Expense
510
8 250
Depreciation Expense
520
750
Insurance Expense
530
970
Salaries Expense
540
9 200
(Close expense accounts) 31
Income Summary
320
Retained Earnings
7 916
310
7 916
(Close Income summary account) 31
Retained Earnings
310
Dividends
315
1 200 1 200
(Close dividends account) (i) Cortex Cleaning Ltd Post-Closing Trial Balance as at 30 April 2014 No. 100 110 120 130 171 172 200 210 300 310
Account name Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Motor vehicles Accumulated Depreciation – MV Accounts Payable Salaries Payable Share Capital Retained Earnings
Debit $ 10 746 22 450 1 500 10 670 45 000
$90 366
3.68
Credit $
750 5 500 2 400 75000 6 716 $90 366
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 3.10 (j) Cortex Cleaning Ltd Worksheet as at 30 April 2014 Prepare +adjusting entries and adjusted trial balance using a worksheet.
No. 100 110 120 130 171 172 200 210 300 310 315 320 400 500 510 520 530 540
Account names Cash Accounts receivable Cleaning Supplies Prepaid insurance Motor vehicles Accumulated Depreciation Accounts Payable Salaries Payable Share Capital Retained earnings Dividends Income Summary Service Revenue Petrol & oil expense Cleaning Supplies Expense Depreciation Expense Insurance Expense Salaries Expense
Trial Balance
Adjustments
Dr $ Cr $ 10 746 20 150 9 750 11 640 45 000
Dr $
Cr $
2 300 8 250 970 750
5 500 2 400 75 000
Adjusted Income Trial Balance. Statement Dr $ Cr $ Dr $ Cr $ 10 746 22 450 1 500 10 670 45 000 750 5 500 2 400 75 000
1 200
1 200 25 650
2 300
864 8 250 750 970 2 400
6 800
27 950 864 8 250 750 970 9 200
27 950 864 8 250 750 970 9 200
Profit Totals
Statement of Financial Position Dr $ Cr $ 10 746 22 450 1 500 10 670 45 000 750 5 500 2 400 75 000
7 916 $106 150
$106 150
$14 670
$14 670
3.69
$111 600
$111 600
$27 950
7 916 $27 950
$91 566
$91 566
Chapter 3: Accrual accounting concepts
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 3.1 (a). Solo Ltd General Journal
1.
2.
3.
4.
5.
6.
7.
Post Ref.
$ Debit
505 113
700
30 Electricity Expense Electricity Payable (Accrued electricity)
530 218
150
30 Insurance Expense Prepaid Insurance (Prepaid insurance ($2400 ÷ 12 months)
515 112
200
30 Service Revenue Received in Advance Service Revenue (Services performed in relation to revenue received in advance)
213 400
2 500
30 Salaries Expense Salaries Payable (Accrued salaries)
500 215
1 500
30 Depreciation Expense Accumulated Depreciation – Office Equipment ($15,000 ÷ 60 months) (Record depreciation expense for month)
520 131
250
30 Service revenue Receivable Service Revenue (Accrued revenue)
104 400
3 000
Date Account name (narration) 2013 June 30 Supplies Expense Supplies ($2000 - $1300) (To adjust supplies account to reflect supplies used)
3.70
$ Credit
700
150
200
2 500
1 500
250
3 000
Solutions manual to accompany Accounting: building business skills 4e
(b) General Ledger Solo Ltd Cash 30/6
Balance
100
7 750 Accounts Receivable
30/6
Balance
6 000 30/6
30/6
Service Revenue
3 000
104 Balance
9 000 1/7
Opening Balance
9 000
9 000 Prepaid Insurance
30/6
Balance
2 400 30/6 30/6
112 Insurance Expense
200
Closing Balance
2 200
2 400 1/7
Opening Balance
2 400
2 200 Supplies
30/6
Balance
2 000 30/6 30/6
113 Supplies Expense
700
Closing Balance
1 300
2 000 1/7
Opening Balance
2 000
1 300 Office Equipment
30/6
Balance
9 000
130
15 000 Accumulated Depreciation – Office Equipment 30/6
Depreciation Expense
Accounts Payable 30/6
131 250 200
Balance
4 500
Service Revenue Received in Advance
213
30/6
Service Revenue
2 500 30/6
30/6
Closing Balance
1 500
Balance
4 000
4 000 4 000
1/7
Opening Balance
Salaries Payable 30/6
3.71
1 500 215
Salaries Expense
1 500
Chapter 3: Accrual accounting concepts
Electricity Payable 30/6
218 Electricity Expense
Share Capital 30/6
150 300
Balance
Service Revenue
21 750 400
30/6 Balance
7 900
30/6 Accounts Receivable
3 000
30/6 Service Revenue in Advance
2 500 13 400
Salaries Expense 30/6
Balance
4 000
30/6
Salaries Payable
1 500
500
5 500 Supplies Expense 30/6
Supplies
700 Rent Expense
30/6
Balance
Prepaid Insurance
Accumulated Depreciation
Electricity Expense
520
250
Electricity Expense 30/6
515
200 Depreciation Expense
30/6
510
1 000 Insurance Expense
30/6
505
150
3.72
530
Solutions manual to accompany Accounting: building business skills 4e
(c) Solo Ltd Adjusted Trial Balance as at 30 June 2013 No.
Account name
100 104 112 113 130 131 200 213 215 218 300 400 500 505 510 515 520 530
Cash Accounts Receivable Prepaid Insurance Supplies Office Equipment Accumulated Depreciation – Office Equipment Accounts Payable Service Revenue Received in Advance Salaries Payable Electricity Payable Share Capital Service Revenue Salaries Expense Supplies Expense Rent Expense Insurance Expense Depreciation Expense Electricity Expense
Debit $ 7 750 9 000 2 200 1 300 15 000
Credit $
250 4 500 1 500 1 500 150 21 750 13 400 5 500 700 1 000 200 250 150 $43 050
$43 050
(d)
Profit for the month Revenues $13 400 less expenses ($5500 +$700 +$10500+ $200+ $250 + $150) = $5 600
(e)
If the cost of the equipment was allocated over the two years then the annual depreciation expense would be $7 500 ($15000/2) instead of $3 000 which means profit in the first 2 years would be $4 500 ($7500-$3000 ) less than if the depreciation was charged over the useful life and this would mean the profit in year 3 4 and 5 would be $4 500 more as no depreciation would be charged. Note over the 5 years total depreciation is the same is $15 000 either rate used.
3.73
Chapter 3: Accrual accounting concepts
PROBLEM SET B 3.2 (a). Coen Ltd General Journal
1.
2.
3.
4.
5.
6.
7.
Post Ref.
$ Debit
505 113
3 720
30 Electricity Expense Electricity Payable (Accrued electricity)
530 218
220
30 Insurance Expense Prepaid Insurance (Prepaid insurance( ($5040 ÷ 12 months)x 5 months))
515 112
2 100
30 Service Revenue Received in Advance Service Revenue (Services performed in relation to revenue received in advance)
213 400
1 600
30 Salaries Expense Salaries Payable (Accrued salaries)
500 215
1 540
30 Depreciation Expense Accumulated Depreciation – Office Equipment ($45,000 ÷ 60 months x 5) (Record depreciation expense)
520 131
3 750
30 Accounts Receivable Service Revenue (Accrued revenue)
104 400
3 000
Date Account name (narration) 2013 June 30 Supplies Expense Supplies ($4700 - $980) (To adjust supplies account to reflect supplies used)
3.74
$ Credit
3 720
220
2 100
1 600
1 540
3 750
3 000
Solutions manual to accompany Accounting: building business skills 4e
(b) 30/6
Coen Ltd General Ledger Cash Balance
100
18 960 Accounts Receivable
30/6
Balance
6 300 30/6
30/6
Service Revenue
3 000
104 Balance
9 300 1/7
Opening Balance
9 300
9 300 Prepaid Insurance
30/6
Balance
5 040 30/6 30/6
112 Insurance Expense
2 100
Closing Balance
2 940
5 040 1/7
Opening Balance
5 040
2 940 Supplies
30/6
Balance
4 700 30/6 30/6
113 Supplies Expense
3 720
Closing Balance
980
4 700 1/7
Opening Balance
4 700
980 Office Equipment
30/6
Balance
9 300
130
45 000 Accumulated Depreciation – Office Equipment 30/6
Depreciation Expense
Accounts Payable 30/6
131 3 750 200
Balance
3 100
Service Revenue Received in Advance
213
30/6
Service Revenue
1 600 30/6
30/6
Closing Balance
1 400
Balance
3 000
3 000 3 000
1/7
Opening Balance
Salaries Payable 30/6
3.75
1 400 215
Salaries Expense
1 540
Chapter 3: Accrual accounting concepts
Electricity Payable 30/6
218 Electricity Expense
Share Capital 30/6
220 300
Balance
Service Revenue
40 000 400
30/6
Balance
50 990
30/6
Accounts Receivable
3 000
30/6
Service Revenue in Advance
1 600 55 590
Salaries Expense 30/6
Balance
6 590
30/6
Salaries Payable
1 540
500
8 130 Supplies Expense 30/6
Supplies
3 720 Rent Expense
30/6
Balance
Prepaid Insurance
Accumulated Depreciation
Electricity Expense
520
3 750
Electricity Expense 30/6
515
2 100 Depreciation Expense
30/6
510
10 500 Insurance Expense
30/6
505
220
3.76
530
Solutions manual to accompany Accounting: building business skills 4e
(c) Coen Ltd Adjusted Trial Balance as at 30 June 2013
(d)
No.
Account name
100 104 112 113 130 131 200 213 215 218 300 400 500 505 510 515 520 530
Cash Accounts Receivable Prepaid Insurance Supplies Office Equipment Accumulated Depreciation – Office Equipment Accounts Payable Service Revenue Received in Advance Salaries Payable Electricity Payable Share Capital Service Revenue Salaries Expense Supplies Expense Rent Expense Insurance Expense Depreciation Expense Electricity Expense
Debit $ 18 960 9 300 2 940 980 45 000
Credit $
3 750 3 100 1 400 1 540 220 40 000 55 590 8 130 3 720 10 500 2 100 3 750 220 $105 600
$105 600
To report the higher profit the adjustments to accrue expense and not write down assets would be avoided hence depreciation, writing down supplies and the prepaid insurance, recognising salaries and electricity expense. The shareholders old and potential new shareholders and the creditors would be affected as they would make incorrect assumptions about the profitability and liquidity of the business
3.77
Chapter 3: Accrual accounting concepts
PROBLEM SET B 3.3 (a) Matrix Ltd General Journal Date
Account name (narration)
Post Ref.
Debit $
2013 Sept. 30 Commission Receivable Commission Revenue (To record accrued commission revenue)
110 400
780
30 Rent Expense Prepaid Rent (To record expired prepaid rent)
510 120
780
30 Supplies Expense Supplies (To record supplies used)
530 130
260
30 Depreciation Expense Accumulated Depreciation – Equipment (To record depreciation expense)
520 151
455
30 Salaries Expense Salaries Payable (To record accrued salaries)
500 210
520
30 Interest Expense Interest Payable (To record accrued interest)
550 220
65
30 Rent Revenue Received in Advance Rent Revenue (To record revenue)
230 410
390
3.78
Credit $
780
780
260
455
520
65
390
Solutions manual to accompany Accounting: building business skills 4e
(b) Matrix Ltd Income Statement for the quarter ended 30 September 2013 $ Revenues: Commission revenue Rent revenue Total revenues Expenses: Salaries expense Rent expense Depreciation expense Supplies expense Electricity expense Interest expense Total expenses Profit
$ 18 980 910 19,890
12 220 1 950 455 260 663 65 15 613 $4 277
Matrix Ltd Calculation of retained earnings for the quarter ended 30 September 2013 $ Retained earnings 1 July Add: Profit
0 4 277 4 277 (780) $3 497
Less: Dividends Retained earnings 30 September
3.79
Chapter 3: Accrual accounting concepts
Matrix Ltd Statement of financial position as at 30 September 2013 $ ASSETS Current assets Cash Accounts receivable Prepaid rent Supplies Total Current assets Non-current assets Equipment Less: Accumulated depreciation – equipment Total assets LIABILITIES Liabilities: Accounts payable Salaries payable Interest payable Rent revenue received in advance Bank loan Total liabilities NET ASSETS EQUITY Share capital Retained earnings TOTAL EQUITY
$
8 710 1 300 1 170 1 00 12 80 19 500 (455)
19 045 31 525
1 963 520 65 780 6 500 9 828 $21 697
18 200 3 497 $21 697
*bank loan could also be classified as non-current (c)
The following accounts would be closed: Commission Revenue, Rent Revenue, Salaries Expense, Rent Expense, Depreciation Expense, Supplies Expense, Electricity Expense, Interest Expense, Dividends.
(d)
31 August 2013. Interest of 12% per year equals a monthly rate of 1%; monthly interest is $65 ($6,500 x 1%). Since total interest expense is $65, the loan has been outstanding one month. OR Monthly interest is [$6,500 x .12) x 1/12] = $65 Since the total interest expense is $65, the company must have taken out the loan one month ago on 31 August 2013. (Alternatively, 1 September 2013)
3.80
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 3.4 (a)
Date
Digital Ltd General Journal Account name (narration)
June 30 Accounts Receivable Service Revenue (To accrue revenue) 30 Office Supplies Expense Office Supplies (Record use of supplies) 30 Insurance Expense Prepaid Insurance (to write down prepaid insurance) 30 Depreciation Expense Accumulated Depreciation – Office Equipment ( To record depreciation) 30 Salaries Expense Salaries Payable (to accrue salaries) 30 Rent Revenue Received in Advance Rent Revenue (to record rent revenue now earned) (b) Digital Ltd Income Statement for the year ended June 30 2014
Ref #
$ Debit
110 400
600
510 120
1600
530 130
1 500
540 141
1 200
500 210
1 100
220 410
800
$ Revenues: Service revenue Rent revenue Total revenue
$ Credit
600
1600
1 500
1200
1 100
800
$ 34 600 11 800 46 400
Expenses: Salaries expense Office supplies expense Rent expense Insurance expense Depreciation expense Total expenses Profit
18 100 1 600 15 000 1 500 1,200 37 400 $9 000
3.81
Chapter 3: Accrual accounting concepts
Digital Ltd Calculation of Retained Earnings for the year ended June 30 2014 $ 5 600 9 000 $14 600
Retained earnings, 1 July 2013 Add: Profit Retained earnings, 30 June 2014
Digital Ltd Statement of financial position as at 30 June 2014 $ ASSETS Current Assets Cash Service revenue receivable Office supplies Prepaid insurance Total current assets Non-Current Assets Office equipment Less: Accumulated depreciation – office equipment Total assets LIABILITIES Accounts payable Salaries payable Rent received in advance Total liabilities NET ASSETS
$
10 400 9 400 700 2 500 23 000 14 000 (4 800)
9 200 32 200
5 800 1 100 700 7 600 $24 600
EQUITY Share capital Retained earnings TOTAL EQUITY
10 000 14 600 $24 600
3.82
Solutions manual to accompany Accounting: building business skills 4e (c )
Date
Digital Ltd General Journal Account name (narration)
June 30 Service Revenue Rent Revenue Income Summary (Closing entry) 30 Income Summary Salaries Expense Office Supplies Expense Rent Expense Insurance Expense Depreciation Expense (Closing entry ) 30 Income Summary Retained Earnings (Closing Entry)
Ref #
Debit $
Credit $
34 600 11 800 46 400 37 400 18 100 1 600 15 000 1 500 1 200 9 000 9 000
3.83
Chapter 3: Accrual accounting concepts
PROBLEM SET B 3.5 (a) McPherson Ltd General Journal Date Account name (narration) 2012 Mar 31 Accounts Receivable Sales Revenue (Accrues revenue) 31 Supplies Expense Supplies (Supplies used) 31 Rent Expense Prepaid Rent (Rent now expensed) 31 Depreciation Expense Acc’d Depreciation - Equipment (to record depreciation) 31 Interest Expense Interest Payable (Interest accrued) 31 Rent Revenue Received in Advance Rent Revenue (Rent revenue now earned) 31 Salaries Expense Salaries Payable (Accrued salaries)
Post Ref
Debit
110 400
5 500
530
900
Credit
5 500
4,760 510 120
2 000
520 151
1 750
550 220
250
230 410
500
500 210
1 800
2 000
1 750
250
1,960
1 800
(b) McPherson Ltd Income Statement for the 3 months ended 31 March 2012 $ Revenues: Sales revenue Rent revenue
$ 18 600 12 000 30 600
Expenses: Salaries expense Rent expense Depreciation expense Supplies expense Electricity expense Interest expense Total expenses Profit
11 340 6 000 1 750 900 750 250 20 990 $ 9 610
3.84
Solutions manual to accompany Accounting: building business skills 4e
McPherson Ltd Calculation of Retained Earnings for the 3 months ended 31 March 2012 Retained earnings, 1 January Add: Profit
$ 9 610 9 610 (600) $9 010
Less: Dividends Retained earnings, 31 December
McPherson Ltd Statement of financial position as at 31 March 2012 $ ASSETS Current Assets Cash Accounts receivable Supplies Total Current Assets
$
15 750 6 800 600 23 150
Non-Current Assets Equipment Less: Accumulated Depreciation Total Non-Current Assets Total Assets LIABILITIES Current Liabilities Accounts Payable Interest Payable Salaries Payable Rent Revenue Received in Advance Total Current Liabilities
32 000 (1 750) 30 250 53 400
1 840 250 1 800 500 4 390
Non-Current Liabilities Bank Loan Total Non-Current Liabilities Total Liabilities NET ASSETS
15 000 15 000 19 390 $34 010
EQUITY Share Capital Retained Earnings TOTAL EQUITY
25 000 9 010 $34 010
3.85
Chapter 3: Accrual accounting concepts
(c)
Accounts to be closed: Sales Revenue and Rent Revenue, Salaries Expense, Rent Expense, Depreciation Expense, Supplies Expense, Electricity Expense, Interest Expense,
(d)
Loan was taken out 31 January 2012 or 1 February 2012. Bank loan $15 000 x 10%= $1,500 annually or $125 monthly. Interest expense is $250 so the loan was taken out 2 months before reporting date.
3.86
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 3.6 (a) Pete’s Advertising Agency Pty Ltd General Journal Date Account name (narration) 2014 Dec 31 Accounts Receivable Advertising Revenue (accrue revenue) 31 Art Supplies Expense Art Supplies (supplies used) 31 Insurance Expense Prepaid Insurance (insurance expired) 31 Depreciation Expense Acc’d Depreciation - Equipment (depreciation for year) 31 Interest Expense Interest Payable (Interest expense accrued) 31 Advertising Revenue Received in Advance Advertising Revenue (Revenue now earned) 31 Salaries Expense Salaries Payable (Salaries accrued)
Post Ref
Debit $
110 400
2 100
530 130
4 760
505 140
1 190
520 151
9 800
510 220
210
230 400
1 960
500 240
1 820
Credit $
2 100
4 760
1 190
9 800
210
1 960
1 820
(b) Pete’s Advertising Agency Pty Ltd Income Statement for the year ended 31 December 2014 $ Revenues: Advertising revenue Expenses: Salaries expense Depreciation expense Rent expense Art supplies expense Insurance expense Interest expense Total expenses Profit
$ 86 100
15 820 9 800 5 600 4 760 1 190 700 37 870 $48 230
3.87
Chapter 3: Accrual accounting concepts
Pete’s Advertising Agency Pty Ltd Calculation of Retained Earnings for the year ended 31 December 2014 Retained earnings, 1 January Add: Profit
$ 7 700 48 230 55 930 (16 00) $39 130
Less: Dividends Retained earnings, 31 December
Pete’s Advertising Agency Pty Ltd Statement of financial position as at 31 December 2014 ASSETS Current Assets Cash Accounts receivable Art supplies Prepaid Insurance Total Current Assets
$
$
$
15 400 30 100 7 000 3 500 56 000
Non-Current Assets Printing Equipment Less: Accumulated Depreciation Total Non-Current Assets Total Assets LIABILITIES Current Liabilities Accounts Payable Interest Payable Salaries Payable Advertising Revenue Received in Advance Total Current Liabilities Non-Current Liabilities Bank Loan Total Non-Current Liabilities Total Liabilities NET ASSETS
$84 000 (49 000) 35 000 91 000
7 000 210 1 820 7 840 16 870
7 000 7 000 23 870 $67 130
EQUITY Share Capital Retained Earnings TOTAL EQUITY
$28 000 39 130 $67 130
3.88
Solutions manual to accompany Accounting: building business skills 4e
(c)
Accounts to be closed: Advertising Revenue, Salaries Expense, Depreciation Expense, Rent Expense, Art Supplies Expense, Insurance Expense, Interest Expense, Dividends
(d)
Annual Interest Rate on Bank Loan: Interest Expense for 6 months Interest Expense for 12 months Interest Rate Interest Rate
(e)
= $700 = $1,400 = 1,400 ÷ 7,000 = 20%
Salaries Payable on 31 December 2013: Salaries paid in 2011 Salaries Payable 31 December 2014
$15 600 1 820 17,420 (15 20) $1 ,600
Salaries Expense for 2011 Salaries Payable 31 December 2013 (f)
The effect of profit from the adjustments is a net decrease of $ 13 720.
3.89
Chapter 3: Accrual accounting concepts
Problem SET B 3.7 (a)
Palpatine Hotel Ltd Worksheet for month ended 31 May 2013 No. 100 112 113 120 122 123 130 131 200 212 214 215 220 300 400 505 506 510 512 515 525 530
Account names Cash Prepaid Insurance Supplies Land Building Acc’d Depn – Building Furniture Acc’d Depn –Furniture Accounts Payable Rent Rev Rec’d in Adv Salaries Payable Interest Payable Mortgage Payable Share Capital Rent Revenue Advertising Expense Depreciation Expense Electricity Expense Insurance Expense Interest Expense Salaries Expense Supplies Expense
Trial Balance
Adjustments
Dr $ 4 500 2 520 2 660 21 000 98 000
Dr $
Cr $
Cr $ 210 980
1 2
420
3
350
3
420 500
5 6 4
2 100
5
23 520 6 580 5 040
2 100
50 000 84 000 12 880 700 770
3
210 500 420 980 $4 980
1 4 6 2
1 400
4 200 $158 500
$158 500
$4 980
Profit
Adjusted Trial Balance. Dr $ C $r 4 500 2 310 1 680 21 000 98 000 420 23 520 350 6 580 2 940 420 500 50 000 84 000 14 980 700 770 1 400 210 500 4 620 980 $160 190 $160 190
Income statement Dr $ Cr $
14 980 700 770 1 400 210 500 4 620 980 5 800 $14 980
3.90
Statement of financial position Dr $ Cr $ 4 500 2 310 1 680 21 000 98 000 420 23 520 350 6 580 2 940 420 500 50 000 84 000
$14 980
$151 010
5 800 $151 010
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 3.7 CONTINUED (b)
The Palpatine Hotel Ltd General Journal Account Name (narration)
Date
1.
2.
3.
4.
5.
6.
Post ref
Debit $
512 112
210
31 Supplies Expense Supplies (To record supplies consumed)
530 113
980
31 Depreciation Expense Accumulated Depreciation – Building Accumulated Depreciation –Furniture (To record monthly depreciation expense)
506 123 131
770
31 Interest Expense Interest Payable [($50,000 x 12%) x 1/12] (To record interest accrued)
515 215
500
31 Rent Revenue Received in Advance Rent Revenue (To record services provided for revenue)
212 400
2 100
31 Salaries Expense Salaries Payable (To record accrued salaries)
525 214
420
2013 May 31 Insurance Expense Prepaid Insurance (To record expired insurance)
Credit $
210
980
420 350
500
2 100
420
(c) General ledger Cash 31/5
Balance
100
4 500 Prepaid Insurance
31/5
Balance
2 520 31/5 31/5 2,520
1/6
Opening Balance
2 310
3.91
112 Insurance Expense
210
Closing Balance
2 310 2 520
Chapter 3: Accrual accounting concepts
Supplies 31/5
Balance
2 660 31/5 31/5
113 Supplies Expense
980
Closing Balance
1 680
2 660 1/6
Opening Balance
2 660
1 680 Land
31/5
Balance
120
21 000 Building
31/5
Balance
122
98 000 Accumulated Depreciation – Building 31/5
Depreciation Expense
Furniture 31/5
Balance
123 420 130
23 520 Accumulated Depreciation – Furniture 31/5
Depreciation Expense
Accounts Payable 31/5
131 350 200
Balance
6 580
Rent Revenue Received in Advance
212
31/5
Rent Revenue
2 100 31/5
31/5
Closing Balance
2 940
Balance
5 040
5 040 5 040
1/6
Opening Balance
Salaries Payable 31/5
214 Salaries Expense
Interest Payable 31/5
3.92
420 215
Interest Expense
Mortgage Payable 31/5
2 940
500 220
Balance
50 000
Solutions manual to accompany Accounting: building business skills 4e
Share Capital 31/5
300 Balance
Rent Revenue
84 000 400
31/5
Balance
12 880
31/5
Rent Revenue in Advance
2 100 14 980
Advertising Expense 31/5
Balance
700 Depreciation Expense
31/5
Accumulated Depreciation
Balance
Prepaid Insurance
Interest Payable
Balance
31/5
Salaries Payable
515
500 Salaries Expense
31/5
512
210 Interest Expense
31/5
510
1 400 Insurance Expense
31/5
506
770
Electricity Expense 31/5
505
525
4,200 420 4 620 Supplies Expense
31/5
Supplies
980
3.93
530
Chapter 3: Accrual accounting concepts
(d) The Palpatine Hotel Ltd Adjusted Trial Balance as at 31 May 2013 No.
Account name
100 112 113 120 122 123 130 131 200 212 214 215 220 300 400 505 506 510 512 515 525 530
Cash Prepaid Insurance Supplies Land Building Accumulated Depreciation – Building Furniture Accumulated Depreciation – Furniture Accounts Payable Rent Revenue Received in Advance Salaries Payable Interest Payable Mortgage Payable Share Capital Rent Revenue Advertising Expense Depreciation Expense Electricity Expense Insurance Expense Interest Expense Salaries Expense Supplies Expense
3.94
Debit $ $ 4 500 2 310 1 680 21 000 98 000
Credit $ $
420 23 520 350 6 580 2 940 420 500 50 000 84 000 14 980 700 770 1 400 210 500 4 620 980 $160 190
$160 180
Solutions manual to accompany Accounting: building business skills 4e
(e) The Palpatine Hotel Ltd Income Statement for the month ended 31 May 2013 $ Revenues: Rent revenue Expenses: Salaries expense Electricity expense Supplies expense Advertising expense Interest expense Insurance expense Depreciation expense Total expenses Profit
$ $14 980
4 620 1 400 980 700 500 210 770 9 180 $5 800
The Palpatine Hotel Ltd Calculation of retained earnings for the month ended 31 May 2013 $ Retained earnings, 1 May 2013 Add: Profit Retained earnings, 31 May 2013
0 5 800 $5 800
3.95
Chapter 3: Accrual accounting concepts
The Palpatine Hotel Ltd Statement of financial position as at 31 May 2013 $ ASSETS Current assets Cash Prepaid insurance Supplies Total current assets Non-current assets Land Buildings Less: Accumulated depreciation – building Furniture Less: Accumulated depreciation – furniture Total non-current Total assets LIABILITIES Current Liabilities Accounts payable Rent revenue received in advance Salaries payable Interest payable Total current liabilities Non-current liabilities Mortgage payable Total liabilities NET ASSETS EQUITY Share capital Retained earnings TOTAL EQUITY
(f)
$
3 500 2 310 1 680 8 490 21 000 98 000 (420) 23 520 (350)
97 580 23 170 141 750 150 240
6,580 2,940 420 500 10 440 50 000
50 000 60 440 $89 800 84 000 5 800 $89,800
The following accounts would be closed: Rent Revenue, Salaries Expense, Electricity Expense, Advertising Expense, Interest Expense, Insurance Expense, Supplies Expense, Depreciation Expense
3.96
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 3.8 (a) Corellian Windows Ltd General Journal Account name (narration)
Date 2012 July 1
Post Ref.
$ Debit
100 300
13 500
Motor Vehicles Cash Accounts Payable (Purchased truck)
171 100 200
9 000
Cleaning Supplies Accounts Payable (Purchased cleaning supplies)
120 200
1 350
Prepaid Insurance Cash (Paid insurance)
130 100
1 800
Accounts Receivable Service Revenue (Invoiced customers)
110 400
3 750
Accounts Payable Cash (Paid accounts payable)
200 100
2 250
Salaries Expense Cash (Paid salaries)
540 100
1 800
Cash
100 110
2 100
Accounts Receivable Service Revenue (Invoiced customers)
110 400
3 000
Petrol & Oil Expense Cash (Paid for petrol and oil)
500 100
300
Dividends Cash (Paid cash dividend)
315 100
900
Cash Share Capital (Issued shares for cash)
1
3
5
12
18
20
21
Accounts Receivable (Collected cash from customers on account) 25
31
31
3.97
$ Credit
13 500
4 500 4 500
1 350
1 800
3 750
2 250
1 800
2 100
3 000
300
900
Chapter 3: Accrual accounting concepts
(b), (e) & (h)
1/7 21/7
Share Capital Accounts Receivable
Cash 13,500 1/7 2,100 5/7 18/7 20/7 31/7 31/7 31/7
1/8
Opening Balance
Motor Vehicles Prepaid Insurance Accounts Payable Salaries Expense Petrol & Oil Expense Dividends Closing Balance
15,600 4,050
100 4,500 1,800 2,250 1,800 300 900 4,050 15,600
Accounts Receivable 12/7 Service Revenue 3,750 21/7 Cash 25/7 Service Revenue 3,000 31/7 Service Revenue* 1,650 31/7 Closing Balance 8,400 1/8 Opening Balance 6,300 * (e) adjusting entry, balance was $4,650 dr before adjusting entry
110 2,100
Cleaning Supplies 3/7 Accounts Payable 1,350 31/7 Cleaning Supplies Expense* 31/7 Closing Balance 1,350 1/8 Opening Balance 900 * (e) adjusting entry, balance was $1,350 dr before adjusting entry
120 450 900 1,350
Prepaid Insurance 5/7 Cash 1,800 31/7 Insurance Expense* 31/7 Closing Balance 1,800 1/8 Opening Balance 1,650 * (e) adjusting entry, balance was $1,800 dr before adjusting entry
130 150 1,650 1,800
1/7
Cash/Accounts Payable
Motor Vehicles 9,000
Accumulated Depreciation – Motor Vehicles 31/7 Depreciation Expense* * (e) adjusting entry, nil balance before adjusting entry
3.98
6,300 8,400
171
172 300
Solutions manual to accompany Accounting: building business skills 4e
18/7 31/7
Cash Closing Balance
Accounts Payable 2,250 1/7 3,600 3/7 5,850 1/8 Salaries Payable 31/7
Opening Balance
200 4,500 1,350 5,850 3,600
Salaries Expense*
210 600
Motor Vehicles Cleaning Supplies
* (e) adjusting entry, nil balance before adjusting entry Share Capital 1/7
31/7 31/7
31/7
Dividends Closing Balance
Cash
Retained Earnings 900 31/7 3,900 4,800 1/8 Dividends 900 31/7
Cash
300 13,500
Income Summary
310 4,800
Opening Balance
4,800 3,900
Retained Earnings
315 900
Income Summary 320 31/7 Expenses 3,600 31/7 Revenue 8,400 31/7 Retained Earnings 4,800 8,400 8,400 Entries to this account are closing entries. It has a nil balance before and after closing entries because the balance, profit, is closed to retained earnings, 31/7
P & L Summary
Service Revenue 8,400 12/7 25/7 31/7
Accounts Receivable Accounts Receivable Accounts Receivable*
400 3,750 3,000 1,650
8,400 8,400 * (e) Adjusting entry,$6,750 cr balance before adjusting entry, $8,400 cr after adjustment, before closing
31/7
Cash
Petrol & Oil Expense 300 31/7 P & L Summary
3.99
500 300
Chapter 3: Accrual accounting concepts
31/7
Cleaning Supplies Expense Cleaning Supplies* 450 31/7 P & L Summary
510 450
* (e) Adjusting entry, nil balance before adjusting entry, $450 dr after adjustment, before closing
31/7
Accumulated Depreciation*
Depreciation Expense 300 31/7 P & L Summary
520 300
* (e) adjusting entry, nil balance before adjusting entry 31/7
Prepaid Insurance*
Insurance Expense 150 31/7 P & L Summary
530 150
* (e) Adjusting entry, nil balance before adjusting entry, $150 dr after adjustment, before closing Salaries Expense 540 20/7 Cash 1,800 31/7 P & L Summary 2,400 31/7 Salaries Payable* 600 2,400 2,400 * (e) adjusting entry $1800 dr balance before adjusting entry, $2400 dr after adjusting entry before closing (c) & (f) Corellian Windows Ltd Trial Balance as at 31 July 2012
No. 100 110 120 130 171 172 200 210 300 310 400 500 510 520 530 540
Account name Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Motor Vehicles Acc’ed Depreciation – M. Vehicles Accounts Payable Salaries Payable Share Capital Dividends Service Revenue Petrol & Oil Expense Cleaning Supplies Expense Depreciation Expense Insurance Expense Salaries Expense
(c) Unadjusted Debit $ Credit $ 4 050 4 650 1 350 1 800 9 000 3 600 13 500 900 6 750 300
1 800 $23 850
3.100
$23 850
(f) Adjusted Debit $ Credit $ 4 050 6 300 900 1 650 9 000 300 3 600 600 13 500 900 8 400 300 450 300 150 2 400 $26 400 $26 400
Solutions manual to accompany Accounting: building business skills 4e
(d) General Journal Corellian Windows Ltd Account name (narration)
Date 1.
2.
3.
4.
5.
July 31
31
31
31
31
Post Ref. 110 400
Debit
Depreciation Expense Accumulated Depreciation (Depreciation expense)
520 172
300
Insurance Expense Prepaid Insurance (Prepaid insurance expired)
530 130
150
Cleaning Supplies Expense Cleaning Supplies (Supplies used)
510 120
450
Salaries Expense Salaries Payable (Accrued salaries)
540 210
600
Accounts Receivable Service Revenue (Accrued revenue)
Credit
1 650 1 650
300
150
450
600
(g) Corellian Windows Ltd Income Statement for the month ended 31 July 2012 $ Revenues: Service revenue Expenses: Salaries expense Cleaning supplies expense Depreciation expense Petrol & Oil expense Insurance expense Total expenses Profit
$ 8 400
2 ,400 450 300 300 150 3 600 $4 800
Corellian Windows Ltd Calculation of retained earnings for the month ended 31 July 2012 Retained earnings 1 July Add: Profit
$4 800 4 800 (900) $3 900
Less: Dividends Retained earnings 31 July
3.101
Chapter 3: Accrual accounting concepts
Corellian Windows Ltd Statement of financial position as at 31 July 2012 $
$
ASSETS Current assets Cash Accounts receivable Cleaning supplies Prepaid insurance Total current assets Non-current assets: Motor Vehicles Less: Accumulated depreciation Total non-current assets Total assets LIABILITIES Current liabilities: Accounts payable Salaries payable Total current liabilities NET ASSETS
9 000 (300)
EQUITY: Share capital Retained earnings TOTAL EQUITY
13 500 3 900
4 050 6 300 900 1 650 12 900
8 700 21 600
3 600 600 4 200 $17 400
$17 400
3.102
Solutions manual to accompany Accounting: building business skills 4e
(h) Corellian Windows Ltd General Journal closing entries Date
Account name (narration)
July 31
31
31
31
Post Ref 400 320
Debit
Income Summary Petrol & Oil Expense Cleaning Supplies Expense Depreciation Expense Insurance Expense Salaries Expense (Close expense accounts)
320 500 510 520 530 540
3 600
Income Summary Retained Earnings (Close Income summary account)
320 310
4 800
Retained Earnings Dividends (Close dividends account)
310 315
900
Debit $
Credit $
Service Revenue Income Summary (Close revenue accounts)
Credit
8 400 8 400
300 450 300 150 2 400
4 800
900
(i) Corellian Windows Ltd Post-Closing Trial Balance as at 31 July 2012
(j)
No.
Account name
100 110 120 130 150 151 200 210 300 310
Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Motor Vehicles Accumulated Depreciation – Motor Vehicles Accounts Payable Salaries Payable Share Capital Retained Earnings
After the adjusting entries reported profit increased by $ 150
3.103
4 050 6 300 900 1 650 9 000 300 3 600 600 13 500 3 900 $21 900 $21 900
Chapter 3: Accrual accounting concepts
PROBLEM SET B 3.9 (a) Chart of accounts: students may have different account numbers as long as they are grouped to sections of the ledger 100 110 120 150 151 200 210 215 300 310 400 510 515 520 525
Cash Accounts receivable Supplies Store equipment Accumulated Depreciation Accounts Payable Service Revenue Received in Advance Salaries Payable Share Capital Retained earnings Service Revenue Depreciation Expense Supplies Expense Salaries Expense Rent Expense
3.104
Solutions manual to accompany Accounting: building business skills 4e
Naboo Equipment Ltd General Ledger (b), (d) and (f) Cash 1/11
Opening Balance
100
3 348 8/11
Salaries Expense/Payable
10/11 Accounts Receivable
1 440 20/11 Accounts Payable
12/11 Service Revenue
1 680 22/11 Rent Expense
29/11 Revenue Advance
Rec’d
in
Opening Balance
Opening Balance
27/11 Service Revenue 1/12
Opening Balance
30/11 Closing Balance
1 248 7,128
1 248 110
3 012 10/11 Cash
1 440
1 080 30/11 Closing Balance
2 652
4,092
4 092
2 652 Supplies
1/11
Opening Balance
17/11 Accounts Payable 1/12
Opening Balance
120
1 200 30/11 Supplies Expense
1 080
1 800 30/11 Closing Balance
1 920
3 000
3 000
1 920 Store Equipment
1/11
Opening Balance
15/11 Accounts Payable
150
12 000 30/11 Closing Balance
Opening Balance
15 600
15 600 Accumulated Depreciation
30/11 Closing Balance
744 1/11
600
30/11 Depreciation Expense
144 744
1/12
Opening Balance
Accounts Payable
30/11 Closing Balance
151
Opening Balance
744
20/11 Cash
15 600
3 600 15 600
1/12
360 1 00
Accounts Receivable 1/11
3 000
660 25/11 Salaries Expense
7,128 1/12
1 320
3 000 1/11
744 200
Opening Balance
2 520
15/11 Store Equipment
3 00
4 920 17/11 Supplies
1 800
7 920
7 920 1/12
3.105
Opening Balance
4 920
Chapter 3: Accrual accounting concepts
Service Revenue Received in Advance 30/11 Service Revenue
360 1/11
30/11 Closing Balance
780 29/11 Cash
210
Opening Balance
480 660
1 140
1 140 1/12
Opening Balance
780
Salaries Payable 8/11
Cash
215
600 1/11
30/11 Closing Balance
Opening Balance
600
600 30/11 Salaries Expense
600
1,200
1,200 1/12
Opening Balance
600
Share Capital 1/11
300 Opening Balance
12 000
Retained Earnings 1/11
310 Opening Balance
3 360
Service Revenue
400
12/11 Cash
1 680
27/11 Accounts Receivable
1 080
30/11 Service Advance*
Revenue
in
360 3 120
•
Adjusting entry balance before adjusting entry $ 2 760 Depreciation Expense
30/11 Accumulated Depreciation
144
Supplies Expense 30/11 Supplies
515
1 080 Salaries Expense
8/11
510
Cash
720
25/11 Cash
1 200
30/11 Salaries Payable
520
600 2 520
*balance before adjusting entry $ 1 920 Rent Expense
3.106
525
Solutions manual to accompany Accounting: building business skills 4e
22/11 Cash
360
(c) Naboo Equipment Ltd General Journal Date
Post ref
Account name (narration)
Debit $
Credit $
2012 Nov 8
10
Salaries Payable Salaries Expense Cash (Payment of salaries for October & November)
215 520 100
600 720
Cash
100 110
1 440
100 400
1 680
Store Equipment Accounts Payable (Purchased store equipment on account) Supplies Accounts Payable (Purchased supplies on account)
150 200
3 600
120 200
1 800
Accounts Payable Cash (Paid creditors on account)
200 100
3 000
Rent Expense Cash (Paid November rent)
525 100
360
Salaries Expense Cash (Paid salaries)
520 100
1 200
Accounts Receivable Service Revenue (To record service revenue)
110 400
1 080
Cash
100 210
660
Accounts Receivable (Cash received from customers on account) 12
Cash Service Revenue (To record service revenue)
15
17
20
22
25
27
29
Service Revenue Rec’d in Advance (Received cash from customers for future services)
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1 320
1 440
1 680
3 600
1 00
3 000
360
1 00
1 080
660
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(e) & (g Naboo Equipment Ltd Trial Balance as at 30 November 2012
Account name s Cash Accounts Receivable Supplies Store Equipment Accumulated Depreciation Accounts Payable Service Revenue Received in Advance Salaries Payable Share Capital Retained Earnings Service Revenue Depreciation Expense Supplies Expense Salaries Expense Rent Expense
Unadjusted Debit Credit
Adjusted Debit Credit
$1 248 2 652 3 000 15 600
$1 248 2 652 1 920 15 600 $ 600 4 920 1 140
$ 744 4 920 780 600 12 000 3 360 3 120
12,000 3 360 2 760
1 920 360 $24 780
$24 780
144 1 080 2 520 360 $25 524
$25 524
(f) Naboo Equipment Ltd General Journal Date
Account name (narration) 2012 1. Nov. 30 Supplies Expense Supplies ($3,000 - $1,920) (To record supplies used) 2.
3.
4.
Post ref
Debit $
515 120
1 080
30 Salaries Expense Salaries Payable (To record accrued salaries)
520 215
600
30 Depreciation Expense Accum Depreciation. (To record one month’s depreciation expense)
510 151
144
30 Service Revenue Received in Advance Service Revenue (To record revenue)
210 400
360
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Credit $
1 080
600
144
360
Solutions manual to accompany Accounting: building business skills 4e
(g) Naboo Equipment Ltd Income Statement for the month ended 30 November 2012 Revenues: Service revenue Expenses: Salaries expense Supplies expense Rent expense Depreciation expense Total expenses Loss
$3 120 $2 520 1 080 360 144 4 104 ($ 984)
Naboo Equipment Ltd Calculation of retained earnings For the month ended 30 November 2012 Retained earnings 1 November Less: Loss Retained earnings 30 November
$3 360 (984) $2 376
Naboo Equipment Ltd Statement of financial position as at 30 November 2012 ASSETS Current Assets Cash Accounts receivable Supplies Total Current assets Non-current assets Store equipment Less: Accumulated depreciation Total assets
$
$ 1 248 2 652 1 920 5 820
15 600 (744)
LIABILITIES Accounts payable Salaries payable Service revenue received in advance Total liabilities NET ASSETS EQUITY Share capital Retained earnings TOTAL EQUITY
14 856 20 676
4 920 600 780 6 300 $14 376
12 000 2 376 $14 376
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PROBLEM SET B 3.9 (i) Naboo Equipment Ltd Worksheet as at 30 November 2012 Trial Balance
No. 100 110 120 150 151 200 210 215 300 310 400 510 515 520 525
Adjustments
Adjusted Trial Balance.
Income Statement
Account names Dr $ Cr $ Dr $ Cr $ Dr $ Cr $ Dr $ Cr $ Cash 1 248 1 248 Accounts receivable 2 652 2 652 Supplies 3000 1 080 1 920 Store equipment 15 600 15 600 Acc’d Depreciation 600 144 744 Accounts Payable 4 920 4 920 Service revenue rec’d in 1 140 360 780 advance Salaries Payable 600 600 Share Capital 12 000 12 000 Retained earnings 3 360 3 360 Service Revenue 2 760 360 3 120 3 120 Depreciation Expense 144 144 144 Supplies Expense 1 080 750 750 Salaries Expense 1 920 600 2 520 2 520 Rent Expense 360 9 200 9 200 Loss Totals
$24 780
$24 780
$2 184
$2 184
3.110
$25 524
$25 524
$4 104
Statement of Financial Position Dr $ Cr $ 1 248 2 652 1 920 15 600 744 4 920 780 600 12 000 3 360
984
984
$4 104
$22 404
$22 404
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 3.10 Spick and Span Services Ltd General Journal Account name (narration)
Date 2012 Sept 1
Post Ref.
Debit $
100 300
50 000
Motor Vehicles Cash Accounts Payable (Purchased truck)
171 100 200
30 000
Cleaning Supplies Accounts Payable (Purchased cleaning supplies)
120 200
6 200
Prepaid Insurance Cash (Paid insurance annual policy Sept1)
130 100
9 000
Accounts Receivable Service Revenue (Invoiced customers)
110 400
8 900
Accounts Payable Cash (Paid accounts payable)
200 100
18 500
Salaries Expense Cash (Paid salaries)
540 100
5 100
Cash
100 110
6 000
Accounts Receivable Service Revenue (Invoiced customers)
110 400
9 500
Petrol & Oil Expense Cash (Paid for petrol and oil) Dividends Cash (Paid cash dividend)
500 100
660
315 100
300
Cash Share Capital (Issued shares for cash)
1
5
7
14
21
21
23
Accounts Receivable (Collected cash from customers on account) 25
30
30
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Credit $
50 000
15 000 15 000
6 200
9 000
8 900
18 500
5 100
6 000
9 500
660
300
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(b), (e) & (h) Spick and Span Services Ltd General Ledger
1/9 23/9
Share Capital Accounts Receivable
1/10
Opening Balance
Cash 50 000 1/9 6 000 7/9 21/9 21/9 30/9 30/9 30/9 56 000 7 440
Motor Vehicles Prepaid Insurance Accounts Payable Salaries Expense Petrol & Oil Exp Dividends Closing Balance
Accounts Receivable 14/9 Service Revenue 8 900 23/9 Cash 25/9 Service Revenue 9 500 30/9 Service Revenue* 1 800 30/9 Closing Balance 20 200 1/10 Opening Balance 14 200 * (e) adjusting entry, balance was $12400 dr before adjusting entry
100 15 000 9 000 18 500 5 100 660 300 7 440 56 000
110 6 000 14 200 20 200
Cleaning Supplies 5/9 Accounts Payable 6 200 30/9 Cleaning Supplies Exp* 30/9 Closing Balance 6 200 1/8 Opening Balance 1 200 * (e) adjusting entry, balance was $6 200 dr before adjusting entry
120 5 000 1 200 6 200
Prepaid Insurance 7/9 Cash 9 000 30/9 Insurance Expense* 30/9 Closing Balance 9 000 1/8 Opening Balance 8 250 * (e) adjusting entry, balance was $9000 dr before adjusting entry
130 750 8 250 9 000
1/9
Cash/Accounts Payable
Motor vehicle 30 000
Accumulated Depreciation – Trucks 30/9 Depreciation Expense* * (e) adjusting entry, nil balance before adjusting entry
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171
172 500
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21/9 30/9
Cash Closing Balance
Accounts Payable 18 500 1/9 2 700 5/9 24 000 1/10 Salaries Payable 30/9
Opening Balance
200 15 000 6 200 21 200 2 700
Salaries Expense*
210 1 800
Motor Vehicles Cleaning Supplies
* (e) adjusting entry, nil balance before adjusting entry Share Capital 1/9
30/9 30/9
Dividends Closing Balance
Retained Earnings 300 30/9
Cash
310 Income Summary
5 490
5 490 1/10
30/9
30/9 30/9
Cash
Expenses Retained Earnings
300 50 000
Dividends 300 30/9
Income Summary 30/9
Opening Balance
Retained Earnings
Revenue
315 300
320 20 200
5,000 5,000 Entries to this account are closing entries. It has a nil balance before and after closing entries because the balance, profit, is closed to retained earnings, Service Revenue 400 30/9 Income Summary 20 200 14/9 Accounts Receivable 8 900 25/9 Accounts Receivable 9 500 30/9 Accounts Rec’ble* 1 800 20 200 20 200 * (e) Adjusting entry,$18400 cr balance before adjusting entry, $20200 cr after adjustment, before closing
30/9
Cash
Petrol & Oil Expense 660 30/9 Income Summary
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30/9
Cleaning Supplies*
Cleaning Supplies Expense 5 000 30/9 Income Summary
510 5 000
* (e) Adjusting entry, nil balance before adjusting entry, $5000 dr after adjustment, before closing
30/9
Depreciation Expense Accumulated Depreciation* 500 30/9 Income Summary
520 500
* (e) adjusting entry, nil balance before adjusting entry
30/9
Prepaid Insurance*
Insurance Expense 750 30/9 Income Summary
530 750
* (e) Adjusting entry, nil balance before adjusting entry, $750 dr after adjustment, before closing Salaries Expense 540 21/9 Cash 5 100 30/9 Income Summary 6 900 30/9 Salaries Payable* 1 800 6 900 6 900 * (e) adjusting entry, $5100 dr balance before adjusting entry, $6900 dr after adjusting entry before closing.
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(c) & (f) Spick and Span Services Ltd Trial Balance as at 30 September 2012 (c) Unadjusted No.
Account name
100 110 120 130 171 172
Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Motor Vehicles Accumulated Depreciation – Motor vehicles Accounts Payable Salaries Payable Share Capital Dividends Service Revenue Petrol & Oil Expense Cleaning Supplies Expense Depreciation Expense Insurance Expense Salaries Expense
200 210 300 310 400 500 510 520 530 540
(d) Date 1.
Debit $
Debit $
7 440 12 400 6 200 9 000 30 000
Credit $
7 440 14 200 1 200 8 250 30 000 500 2 700
2 700 1 800 50 000
50 000 300
300 18 400
660
5 100 $71 100
General Journal Account name (narration) Sept 30
Credit $
(f) Adjusted
Accounts Receivable
$71 100
20 200 660 5 000 500 750 6 900 $75 200
Post Ref. 110
Service Revenue
$75 200
$ Debit 1 800
400
$ Credit 1 800
(Accrued revenue) 2.
30
Depreciation Expense
520
Accumulated Depreciation
500
172
500
(Depreciation expense) 3.
30
Insurance Expense
530
Prepaid Insurance
750
130
750
(Prepaid insurance expired) 4.
30
Cleaning Supplies Expense Cleaning Supplies
510
5 000
120
5 000
(Supplies used) 5.
30
Salaries Expense
540
Salaries Payable
210
(Accrued salaries)
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(g) Spick and Span Services Ltd Income Statement for the month ended 30 September 2012 $ Revenues: Service revenue Expenses: Salaries expense Cleaning supplies expense Depreciation expense Petrol & Oil expense Insurance expense Total expenses Profit
$ 20 200 6 900 5 000 500 660 750 13 810 $6 390
Spick and Span Services Ltd Calculation of retained earnings for the month ended 30 September 2012
Retained earnings 1 September Add: Profit
$6 390 6 390 ( 300) $6 090
Less: Dividends Retained earnings 30 September
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Spick and Span Services Ltd Statement of financial position as at 30 September 2012 $ ASSETS Current assets: Cash Accounts receivable Cleaning supplies Prepaid insurance Total current assets Non-current assets: Motor Vehicles Less: Accumulated depreciation Total non-current assets Total assets LIABILITIES Current liabilities: Accounts payable Salaries payable Total liabilities NET ASSETS EQUITY Share capital Retained earnings TOTAL EQUITY
$
7 440 14 200 1 200 8 250 31 090 30 000 (500) 29 500 60 590
2 700 1 800 4 500 $56 090 50 000 6 090 $56 090
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(h)
Spick and Span Services Ltd General Journal Account name (narration)
Date
Post
Debit
Credit
Ref
July 31
Service Revenue
400
Income Summary
20 200
320
20 200
(Close revenue accounts) 31
Income Summary
320
13 810
Petrol & Oil Expense
500
660
Cleaning Supplies Expense
510
5 000
Depreciation Expense
520
500
Insurance Expense
530
750
Salaries Expense
540
6 900
(Close expense accounts) 31
Income Summary
320
Retained Earnings
6 390
310
6 390
(Close Income summary account) 31
Retained Earnings
310
Dividends
315
300 300
(Close dividends account) (i) Spick and Span Services Ltd Post-Closing Trial Balance as at 30 September 2012 No. 100 110 120 130 171 172 200 210 300 310
Account name Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Motor vehicles Accumulated Depreciation – MV Accounts Payable Salaries Payable Share Capital Retained Earnings
Debit $ 7 440 14 200 1 200 8 250 30 000
$61 090
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Credit $
500 2 700 1 800 50 000 6 090 $61 090
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 3.10 (j)
No. 100 110 120 130 171 172 200 210 300 310 315 320 400 500 510 520 530 540
Account names Cash Accounts receivable Cleaning Supplies Prepaid insurance Motor vehicles Accumulated Depreciation Accounts Payable Salaries Payable Share Capital Retained earnings Dividends Income Summary Service Revenue Petrol & oil expense Cleaning Supplies Exp Depreciation Expense Insurance Expense Salaries Expense
Spick and Span Services Ltd Worksheet as at 30 September 2012 Trial Balance Adjustments Adjusted Income Statement Trial Balance. Dr $ Cr $ Dr $ Cr $ Dr $ Cr $ Dr $ Cr $ 7 440 7 440 12 400 1 800 14 200 6 200 5 000 1 200 9 000 750 8 250 30 000 30 000 500 500 2 700
2 700 1 800 50 000
1 800 50 000 300
2 700 1 800 50 000
300 25 650
1 800
660
5 100
300 20 200
660 5 000 500 750 6 900
5 000 500 750 1 800
Statement of Financial Position Dr $ Cr $ 7 440 14 200 1 200 8 250 30 000 500
20 200 660 5 000 500 750 6 900
Profit
6 390 Totals
$71 100
$71 100
$75 200
$75 200
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$75 200
$75 200
$20 200
6 390 $2 200
$61 390
$61 390
Chapter 3: Accrual accounting concepts
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 3.1
FINANCIAL REPORTING PROBLEM
Domino’s Pizza Enterprises Ltd (a)
Items that may have resulted in adjusting entries for accruals are: ▪ ▪ ▪ ▪ ▪ ▪ ▪
Franchise income (accrued, note 3.8.2) Royalties (accrued, note 3.8.4) Interest revenue (accrued, note 3.8.5) Income tax expense (accrued note 3.10 but explanation is somewhat obscure for introductory students) Borrowing costs (accrued note 3.16) Employee benefits(Wages, salaries and annual leave) (accrued, note 3.21) Provisions (accrued, note 3.22)
(b)
The employee benefits provision was $2,323,000. The split between current and noncurrent is unclear .Other provisions of $324,000 are included and of total provisions $2,647,000 ($2,323,000 +$324,000) -- $2,171,000 is classified as current and $476,000 as non-current. There is also a note stating that $1,953,000 of the current employee benefit provisions relates to annual leave and long service leave which is not expected to be paid out within the next twelve months ( that is it is technically current but Dominos do not expect all employees to claim their leave entitlements within the next year.).
(c)
The statement of cash flows reports income taxes paid in 2010 of $3 720 000. The income statement reports income tax expense of $5 908 000.
BUILDING BUSINESS SKILLS 3.2
FINANCIAL REPORTING PROBLEM
Domino’s Pizza Enterprises Ltd (a)
The different forms of revenue recorded by Domino’s are: Extract from Note 3.8 Revenue recognition of the 2010 Domino’s financial report “3.8 REVENUE RECOGNITION Revenue is measured at the fair value of the consideration received or receivable. 3.8.1 Sale of goods Revenue from the sale of goods is recognised when the Consolidated entity has transferred to the buyer the significant risks and rewards of ownership of the goods. 3.8.2 Franchise income Franchise income is recognised on an accrual basis in accordance with the substance of the relevant agreement. 3.8.3 Rendering of services
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Service revenue relates primarily to store building services and is recognised by reference to the stage of completion of the contract. 3.8.4 Royalties Royalty revenue is recognised on an accrual basis in accordance with the substance of the relevant agreement (provided that it is probable that the economic benefits will flow to the Consolidated entity and the amount of revenue can be measured reliably). Royalties determined on a time basis are recognised on a straight-line basis over the period of the agreement. Royalty arrangements that are based on sales and other measures are recognised by reference to the underlying arrangement. 3.8.5 Dividend and interest revenue Dividend revenue from investments is recognised when the shareholder’s right to receive payment has been established (provided that it is probable that the economic benefits will flow to the Consolidated entity and the amount of revenue can be reliably measured). Interest revenue is recognised when it is probable that the economic benefits will flow to the Consolidated entity and the amount of revenue can be measured reliably. Interest revenue is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount on initial recognition.” (b)
The recognition of revenue for the sale of goods is consistent with the principles of recognition discussed in the chapter. As stated in the chapter, AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a)
the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b)
the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods;
(c)
the amount of revenue can be recognised reliably;
(d)
it is probable that the economic benefits of the revenue will flow to the entity; and
(e)
the associated costs can be measured reliably.
Students should notice that the wording in the Dominos accounts are similar to the accounting standard (c)
The distinction between revenue and other income flows from the source. Page 142 of the textbook explains the definition from the conceptual Framework. Income encompasses both revenue and other gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including
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sales, fees, interest, dividends, royalties and rent. You examined the definition and recognition criteria for these items in your answer to part (a)
Gains represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary activities of an entity. Gains represent increases in economic benefits and as such are no different in nature from revenue. Hence, they are not regarded as constituting a separate element in this Framework. Gains include, for example, those arising on the disposal of non-current assets. See Note 8 of the Domino’s a financial statement.
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BUILDING BUSINESS SKILLS 3.3 INTERPRETING FINANCIAL STATEMENTS Chip Ltd General Journal (a)
(Amounts in millions) Account name (narration)
1.
2.
3.
4.
5.
6.
(b)
Depreciation Expense Accumulated Depreciation (Depreciation for the year) Office Supplies Expense Office Supplies (To record office supplies used) Administrative Salaries Expense R&D salaries Expense Salaries Payable (To accrue salaries) Insurance Expense Prepaid Insurance (balance of Prepaid Insurance now expired))
Debit $ $M 30
Rent Expense Prepaid Rent (Prepaid rent now expensed) Interest Expense Interest Payable (To accrue interest expense)
Credit $ $M 30
1 1 7.5 7.5 15 2.5 2.5
7 7 10 10
The accounts are considered in the order of the journal entries:
General Ledger Account
Income Statement Item
Depreciation Expense Accumulated Depreciation Office Supplies Expense Office Supplies Administrative Salaries Expense R&D Salaries Expense Salaries Payable Insurance Expense Prepaid Insurance Rent Expense Prepaid Rent Interest Expense Interest Payable
Selling general and administrative N/A (statement of financial position) Selling, general and administrative N/A (statement of financial position) Selling, general and administrative Research and development N/A (statement of financial position) Selling, general and administrative N/A (statement of financial position) Selling, general and administrative N/A (statement of financial position) Interest expense N/A (statement of financial position) 3.123
Increased (Decreased) Increased Increased Increased Increased Increased Increased Increased
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(c)
Chip Ltd Income statement (partial) For the year ended 30June 2013
Revenues: Net sales Interest revenue and other
$5,738.0 279.0 6,017.0
Expenses: Cost of sales Selling, general and administrative Research and development Interest expense
4,700.0 795.0 (1) 231.5 (2) 250.0 (3) 5,976.5
Profit before income tax
$40.5
(1) Original figure $747 million + 30, depreciation, + 1, office supplies, + 7.5, salaries, +2.5, insurance expense, + 7, rent expense, = $795 million. (2)
Original figure $224 million + $7.5, salaries, = $231.5 million
(3)
Original figure $240 million + $10 million not recorded = $250 million.
BUILDING BUSINESS SKILLS 3.4
FINANCIAL ANALYSIS ON THE WEB
Telecom New Zealand This solution is based on the 2011 Annual Report of Telecom See p84 part note 1 to the financial statements (a) General policy -Telecom recognises revenues as it provides services or delivers products to customers. Then you have specific services_ • Billings for telecommunications services (including fixed line, mobile, broadband and internet access billings) are made on a monthly basis. Unbilled revenues from the billing cycle date to the end of each month are recognised as revenue during the month the service is provided. Revenue is deferred in respect of the portion of fixed monthly charges that have been billed in advance. (this will help with response to part b) • sale of prepaid mobile units is initially deferred, with recognition occurring when the prepaid units are used by the customer. • installations and connections are recognised upon completion of the installation or connection. • equipment sales is recognised upon delivery of equipment to the customer.
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•
Revenue from contractual arrangements, including contracts to design and build ICT solutions, is recognised by reference to the stage of completion method, when the outcome of the arrangement can be estimated reliably. Telecom uses appropriate measures of the stage of completion, such as services performed to date, as a percentage of total services to be performed or the proportion that costs incurred to date bear to the estimated total costs of the transaction. When the outcome of a transaction, or achievement of milestones, cannot be estimated reliably, and it is not probable that the costs incurred will be recovered, revenue is not recognised and the costs incurred are recognised as an expense.
•
For long-term IT services contracts that equate to the provision of an indeterminate number of acts over a specified period of time for an agreed price, revenue is recognised on a straight-line basis over the term of the arrangement. Where the contract allows for billing as services are delivered then revenue is recognised as those services or materials are delivered.
•
interconnect fees is recognised at the time the services are performed. In some instances, management may be required to estimate levels of traffic flows between networks in order to determine amounts receivable or payable for interconnection.
Where multiple products or services are bundled together on sale, revenue is allocated to each element in proportion to its fair value and recognised as appropriate for that element. Revenue is recognised to the extent that it is not contingent on the provision or delivery of a future service. (b)
Accrual adjustments are required for the unbilled services such as calls made between the last billing date and reporting date. Accrual adjustments are required for fixed charges because revenue is received in advance and only recognised when the period to which it relates lapses. The revenue on prepaid cellular time requires accrual adjustment for minutes used by the customer. Any revenue received in advance for connections, installations or other services billed in advance, would require accrual adjustment when the connection or installation is completed, or as the service has been performed.
(c)
Yes. The revenue becomes probable and able to be measured reliably when the service is provided. AASB 118 and NZ IAS 18 ‘Revenue’ prescribe tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably. Telecom’s policies can be summarised as accruing revenue for calls made by customers that have not been billed, and deferring revenue for services (prepaid time, installations and connections) until the time lapses or the service is performed. Accruing revenue when calls have been made is consistent because costs and revenue can be measured reliably (as they know how many calls were made), the stage of completion is known (100% as the call has been made) and it is probable that benefits will flow because a valid claim exists against the customer. Deferral of revenue until time services, installation or connection is complete is consistent. The relevant tests are (b) and (d) above. The provision of the service, passage of time or completion of installation or 3.125
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connection gives rise to an enforceable claim as it would then be too late for the customer to cancel. Further, in some instances, such as installation, Telecom may be unable to measure the cost (e.g. resources spent on installation) until completion.
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CRITICAL THINKING BUILDING BUSINESS SKILLS 3.5
GROUP DECISION CASE
(a) Holiday Travel Australasia Income Statement for the year ended 31 March 2014 $ Revenues: Service revenue ($150000 - $16000) Expenses: Advertising expense (8700 +15000 – 5200+3200)
134 000
Wages expense ($56400 + $300) Electricity expense ($4600 + $320) Depreciation expense Repair expense ($4000 + $2000) Insurance expense ($21000 x 9/12) Interest expense ($20000 x 10%x 3/12) Total expenses Profit
(b)
$
18 800 56 700 4 920 1 200 6 000 15 750 500 115 670 $19 330
Accrual accounting was not followed with respect to several items of revenue and expense. Revenue recognition criteria had not been followed as revenue of $16,000 had been recognised for services not yet performed. Similarly, expense recognition principles were not followed. Expenses were not recorded even though a decrease in economic benefits had occurred (consumption of supplies, expiry of insurance) and they could be measured reliably. Likewise not recording the advertising, electricity and repair expenses (and corresponding liabilities), was inconsistent with the expense and recognition criteria; it is probable that an outflow will occur because the parties who have invoiced Holiday Travel Australasia have a valid and enforceable claim, and the amount can be recognised reliably as the invoice has been received. Similarly, the expense recognition criteria were not followed with respect to wages expense and interest expense. While these amounts were not invoiced they could be measured reliably by calculating the unpaid wages and interest.
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BUILDING BUSINESS SKILLS 3.6
COMMUNICATION ACTIVITY Sam Portafello
(a) – (d) Report on Comparison of Cash-Based and Accrual Accounting Executive Summary This report examines two alternative forms of accounting: cash-based and accrual accounting. Adoption of accrual accounting is recommended because it provides more information about the financial position of the business, in particular, assets and liabilities, and results in a more inclusive measure of profit that reflects increases and decreases in all assets and liabilities, and not only movements in cash. Detailed Report Accrual accounting records the events in the periods in which the events occur, rather than in the periods in which the entity receives or pays cash. This report presents an argument in favour of the use of accrual accounting for business reporting. Cash-based accounting records transactions when cash is paid or received. Thus some items that may be relevant to assessing how the business has performed during the period may be omitted because the resulting cash is received or paid in a different period. For example, wages and other expenses, such as telephone and electricity expenses, are omitted to the extent that they are unpaid at the end of the period. Further, revenues for which the customer has not yet paid are omitted by cash-based accounting. Some items are included as revenues and expenses under cash-based accounting that would be separately identified as assets and liabilities under accrual accounting. For example, a receipt for rent revenue in advance is accounted for as revenue under cash-based accounting. Under accrual accounting only that portion of the rental receipt that pertains to the current reporting period is recognised as revenue; and the amount of the rental payment received for a rental period that has not expired at the reporting date, is recognised as a liability (rent received in advance). Examples of omitted assets include prepaid insurance and prepaid rent. Under cash-based accounting, all insurance premiums and rental paid are treated as expenses even though the periods covered by the premiums and rentals may not have expired. Another omitted item under cash-based accounting is depreciation. Accrual accounting allocates the cost of long-lived assets over their useful life. Under cash-based accounting the asset is expensed in the period in which it is paid for. Depreciation spreads the cost of the asset over the periods in which the economic benefits are consumed. In doing so, it provides better performance measurement because the consumption of economic benefits is spread over the periods in which the benefits are realised through using the asset. The differences between accrual accounting and cash-based accounting are more pronounced when non-current assets are involved. Non-current assets involve large payments and benefits which extend over more reporting periods than other forms of prepayments (such as insurance premiums). Accordingly, the acquisition of non-current assets causes greater distortion of profit 3.128
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in a single period, thus making the use of accrual accounting more appropriate for the measurement of profitability. Information presented on an accrual basis is useful because it reveals relationships that are likely to be important in predicting future results. Conversely, under cash basis accounting, revenue is recorded only when cash is received, and an expense is recognised only when cash is paid. This results in the omission of assets and liabilities. As a result, the cash basis of accounting often leads to misleading financial statements. Accordingly, accrual accounting is recommended for your business to provide more comprehensive information about its financial position and financial performance to assist decision makers.
BUILDING BUSINESS SKILLS 3.7
ETHICS CASE
Wellcovered Insurance Ltd (a)
The stakeholders in this situation include anyone who relies on the press release.
(b)
Ed’s application of the timeliness constraint is inappropriate. The constraint refers to situations where delaying the reporting of information until all aspects of a transaction or event are known may cause loss of relevance. Thus it may be necessary to report information before all aspects of a transaction are known. In the case of Wellcovered Insurance, Ed Honcho is suggesting that the information be reported before ANY aspects of the relevant transactions are known.
(c)
Ed’s actions are inconsistent with reliability, which is one of the principal qualitative characteristics identified in the Framework for the Preparation and Presentation of Financial Statements. One aspect of reliability is that the information is free of material error. Ed and Ben are unable to determine the reliability of the information due to the effects of the computer virus. Accordingly the estimated numbers may be very misleading,
(d)
It would be unethical to report the financial results without full disclosure that they are estimates, and that actual figures are unavailable due to the computer virus. Users relying on the information should be aware of its inherent uncertainty and the associated risks.
(e) A significant overestimation of profit is likely to increase the share price. However, this would be a temporary gain because the share price would fall when the actual information is disclosed. Shareholders who sold while the price was high would make a gain at the expense of those who purchased them. More long-term damage to the company (in the form of share price and reputation) may occur when shareholders and investors observe that the company disclosed information that was subsequently found to be materially in error; they may have less confidence in information provided by the company in future.
3.129
Chapter 3: Accrual accounting concepts
BUILDING BUSINESS SKILLS 3.8
COMMUNICATION ACTIVITY
Woolworths Limited sustainability report Note to instructor the response will depend on which sustainability report the student accesses. Below is the link to Woolworths the sustainability report may be on the front page if not click on our responsibilities tab Woolworths http://www.woolworthslimited.com.au/ Students were asked to outline Woolworths approach and then summarise the achievements in community and the environment. It would be expected that the students after outlining the general approach would then list the goal and how it was measured and how the achievement in that area was measured.
3.130
CHAPTER 4 – INVENTORIES ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1.
Identify the differences between a service business and a merchandising business.
2.
Explain the recording of purchases under a perpetual inventory system.
2
2,4,5,6
1A,2A,4A, 7A 1B, 2B,4B, 7B
3.
Explain the recording of sales revenue under a perpetual inventory system.
2,3
1,2,3,4
1A, 2A, 4A, 7A, 1B, 2B, 4B, 7B
4.
Prepare a fully classified statement of financial performance.
1,4,5
7,8,9,10
1A, 3A, 4A, 5A, 6A, 7A 1B, 3B, 4B, 5B, 6B, 7B
5.
Use ratios to analyse profitability.
6
7,8,9
1A, 3A, 7A 1B, 3B, 7B
6.
Understand the basic process and main features of the goods and services tax (GST).
7.
Complete journal entries to record GST.
7,8
11,12,13
8A, 8B
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 4 – INVENTORIES ANSWERS TO QUESTIONS 1.
2.
(a)
Disagree. The steps in the accounting cycle are the same for both a merchandising company and a service enterprise. See Chapter 3, Figure 3-26 page 179 Required Steps in the Accounting Cycle.
(b)
The measurement of profit is conceptually the same. In both types of companies, profit (or loss) is determined by subtracting expenses from revenues.
(a)
The profit measurement process is as follows:
Sales Revenue
(b)
Cost of Sales
Less
Equals
Gross Profit
Less
Operating Expenses
Equals
Net Profit
Profit measurement in a merchandising business differs from a service business as follows: (i)
sales are the primary source of revenue; and
(ii)
expenses are divided into two main categories: •
cost of sales, and
•
operating expenses
3. Net sales revenues Cost of sales Gross profit
$110,000 77,000 $33,000
4.
Agree. In accordance with the revenue recognition principle, sales revenues are generally recognised when the goods are transferred from the seller to the buyer. Recognition of revenue is not dependent on the cash collection of credit sales.
5.
(a)
The primary source documents are: (1)
cash sales – cash register tapes, and
(2)
credit sales – sales invoices.
4.2
(b)
The entries for the perpetual method of accounting for inventories are: Debit Cash sales -
Credit sales -
Cash
xx
Sales Cost of sales Inventory
xx
Accounts Receivable Sales Cost of sales Inventory
Credit
xx xx xx xx xx xx
6. 24 July
Accounts Payable ($4,480 - 280) Discount Received ($4,200 x 2%) Cash ($4,200- $84)
4,200 84 4,116
7. Gross profit Less: Profit before tax Operating expenses 8.
$696,000 (360,000) $336,000
(a)
Businesses most likely to use a perpetual inventory system would include those selling products which have a high unit-value such as automobile dealerships, equipment supply companies. With computerisation, perpetual systems are becoming increasingly cost-effective, for example, the use of optical scan cash registers in supermarkets means that a perpetual system can be employed for high turnover low unit cost items.
(b)
Owners of small businesses such as cafes, restaurants and greengrocers are more likely to use periodic inventory systems because for them, the costs of using perpetual inventory systems may outweigh the benefits.
9.
Factors affecting a company’s gross profit rate include selling products with a higher (or lower) ‘mark-up’, increased competition that results in lower selling prices and price increases from suppliers.
10.
(a)
False. GST may be paid on taxable supplies at each stage in the commercial chain, however, it is the final consumer, not the first purchaser, who bears the cost of the GST.
(b)
True. The GST is a value-added tax, which means that tax is levied on the value added by a business at each stage in the production and distribution chain. The GST is not a tax on business income.
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4.1 Zetro Ltd (a)
Sales
=
$235,950 ($93,470 + $142,480)
(b)
Cost of sales
=
$40,950 ($97,500 - $56,550)
(c)
Gross profit
=
$55,900 ($140,400 - $84,500)
(d)
Operating expenses
=
$42,510 ($56,550 - $14,040)
(e)
Operating expenses
=
$17,550 ($55,900 - $38,350)
(f)
Profit
=
$91,130 ($142,480 - $51,350)
BRIEF EXERCISE 4.2 Keo Ltd Inventory Accounts Payable
900 900 Mayo Ltd
Accounts Receivable Sales Cost of sales Inventory
900 900 600 600
BRIEF EXERCISE 4.3 Hunt Ltd (a)
(b)
(c)
2 Mar
6 Mar
8 Mar
Accounts Receivable Sales Cost of sales Inventory
900,000
Sales Returns and Allowances Accounts Receivable Inventory Cost of sales
130,000
Cash ($770,000 - $15,400) Discount Allowed ($770,000x 2%) Accounts Receivable ($900,000 - $130,000)
754,600 15,400
900,000 600,000 600,000
4.4
130,000 80,000 80,000
770,000
BRIEF EXERCISE 4.4 Li An Lim Ltd Income Statement (Partial) for the month ended 31 October 2012
Sales Revenues: Sales ($330,000 + $110,000) Less: Sales returns and allowances Net sales
$440,000 (22,000) $418,000
BRIEF EXERCISE 4.5 These items and where they would appear in a fully classified income statement are listed below: Item Interest revenue Cost of sales Depreciation expense
Sales returns and allowances Purchase returns and allowances
Discount received Discount allowed
Section Revenue or other income (below gross profit) it depends on the type of business Cost of sales Operating expenses. Depreciation expenses could be further classified either as an administrative expense (e.g. depreciation of office equipment) or a selling expense (e.g. depreciation of store or warehouse equipment). Sales revenue. Under the periodic inventory system, purchase returns and allowances appears in the income statement in the calculation of cost of sales as part of the determination of gross profit. Under the perpetual inventory system, purchase returns and allowances are recorded as a decrease in inventory and therefore do not appear on the income statement Other income Financial expenses
BRIEF EXERCISE 4.6 Paisley Pty Ltd (a)
Return on assets
=
$80,000
($500,000 + $600,000 ) 2
= 14.5%
(b)
Profit margin
= 80,000 ÷ $250,000 = 32.0%
(c)
Gross profit rate
= ($250,000 - $100,000) ÷ $250,000 = 60.0%
(d)
Operating expenses to sales ratio
= $50,000 ÷ $250,000 = 20.0%
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 4.7 Maori Jewellery Cash collected = NZ$28,750 ($25,000 + 15% x $25,000) Revenue earned = NZ$25,000
BRIEF EXERCISE 4.8 These journal entries record the payment of GST to the taxation authority. Sellers Limited has collected $100 GST on sales during the reporting period, and the amount of GST paid on purchases is $90; the remaining balance is the amount of cash paid to the tax authority.
4.6
SOLUTIONS TO EXERCISES EXERCISE 4.1 Sailing Boats Ltd (a)
(1)
7 Dec
Accounts Receivable
720,000
Sales Cost of sales
720,000 480,000
Inventory (2)
8 Dec
Sales Returns and Allowances
480,000 30,000
Accounts Receivable (3)
13 Dec
30,000
Cash ($690,000 - $13,800)
676,200
Discount Allowed [($720,000 - $30,000) x 2%]
13,800
Accounts Receivable ($720,000 - $30,000) (b)
2 Jan
Cash
690,000 Accounts Receivable ($720,000 - $30,000)
(c)
690,000
690,000
The advantages associated with granting a discount for early payment are that the purchaser saves money and the seller is able to shorten the operating cycle thereby improving cash flow by converting accounts receivable to cash earlier. The disadvantage to the seller is that there is a cost associated with offering a discount.
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 4.2 (a)
1 Jul
TARINGA PTY LTD
Inventory
10,000
Accounts Payable 10 Jul
Accounts Payable
10,000 10,000
Cash
9,700
Discount Received (b)
1 Jul
Inventory
300 10,000
Accounts Payable 10 Jul
Accounts Payable
10,000 10,000
Cash
9,700
Inventory (c)
300
In part (a), profit and assets will initially be $300 higher than in part (b). As inventory is transferred to cost of sales, cost of sales will be higher in part (a) than part (b). By the time all the inventory is sold the total profit and assets in part (a) and (b) will be the same.
EXERCISE 4.3 SPRINGFIELD PTY LTD
(a)
1 Jul
Accounts Receivable
10,000
Sales
10,000
Cost of sales
6,000
Inventory (b)
10 Jul
6,000
Cash
9,700
Discount Allowed
300
Accounts Receivable
4.8
10,000
EXERCISE 4.4 University Office Supplies 6 Sept.
Inventory (80 x $20) Cash
9 Sept. 10 Sept. 12 Sept.
14 Sept.
20 Sept.
1,600 1,600
Freight In Cash
80
Accounts Receivable Inventory
40
Accounts Receivable (26 x $30) Sales Cost of sales (26 x $20) Inventory
780
Sales Returns and Allowances Accounts Receivable
30
Inventory Cost of sales
20
Accounts Receivable (30 x $30) Sales Cost of sales (30 x $20) Inventory
900
80 40 780 520 520 30 20 900 600 600
EXERCISE 4.5 Hans Olaf Pty Ltd (a)
(1)
(2)
(3)
(4)
(5)
(b)
5 April
6 April
7 April
8 April
11 April
4 May
Inventory Accounts Payable Freight In Cash
18,000 18,000 900 900
Equipment Accounts Payable
26,000
Accounts Payable Inventory
3,000
Accounts Payable ($18,000 - $3,000) Discount Received [($18,000 - $3,000) x 2%] Cash ($15,000 - $300)
15,000
Accounts Payable ($18,000 - $3,000) Cash
15,000
26,000
3,000
300 14,700
15,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 4.6 Ice Box Ltd (a)
10 June
11 June
12 June
17 June
Inventory Accounts Payable (Terms 2/7, n/30)
$10,800 $10,800
Freight In Cash
$540
Accounts Payable Inventory
$540
$540
$540
Accounts Payable ($10,800 - $540) Discount Received ($10,260 x 2%) Cash ($10,260 - $205*)
$10,260 $205 $10,055
* to the nearest dollar (b)
Hell Freezes Over Ltd 10 June
Accounts Receivable Sales
10,800
Cost of sales Inventory
5,400
10,800
5,400
11 June
No entry (freight paid by the purchasing company)
12 June
Sales Returns and Allowances Accounts Receivable
540
Inventory Cost of sales
270
19 June
540
270
Cash ($10,260 - $205*) Discount Allowed ($10,260 x 2%) Accounts Receivable($10,800 - $540)
10,055 205 10,260
* to the nearest dollar (c)
Freight-in refers to freight costs paid by the purchaser. Freight-in forms part of the cost of inventory but because of the difficulty of allocating freight costs to individual inventory items when several items are delivered at the same time, a freight-in account is often kept and the amount of freight-in is incorporated into cost of sales in the income statement. Freight-out refers to freight costs paid by the seller. These costs appear under operating expenses (selling and distribution expenses) on the income statement. Customers may be charged an additional amount to cover freight-out expenses.
4.10
EXERCISE 4.7 (a) Gonzales Ltd Income Statement for the month ended 31 January 2012
INCOME Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales GROSS PROFIT
$350,000 (13,000) $337,000 (208,000) 129,000
Other income: Discount received Rent revenue
EXPENSES Selling expenses: Freight out Rent expense – store space Administrative expenses: Insurance expense Office salaries expense Financial expenses: Discount allowed Bank charges Total operating expenses
7,000 1,000
7,000 20,000
27,000
12,000 61,000
73,000
8,000 50
8,050
8,000 137,000
108,050
PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT
28,950 (8,385) $20,565
(b) Profit margin =
20,565 = 6.1% 337,000
Gross profit rate =
129,000 = 38.3% 337,000
Operating expenses to sales ratio =
(c)
108,050 = 32.1% 337,000
It is often more useful to be able to compare financial ratios than to compare the actual financial results. For example, knowing the gross profit rate gives a better indicator of an entity’s profitability than knowing the dollar amount of the gross profit. Just knowing the operating expenses is less useful than knowing the operating expenses to sales ratio. Furthermore, ratios allow for meaningful comparisons than just using dollars. For example, the gross profit ratio relates gross profit to sales and provides an indication of mark-up on cost. Finally, using ratios enables analysts to compare the profitability of entities of different sizes because ratios control for size whereas a dollar value does not.
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 4.8 Young Ltd & Rice Ltd (a) Young Ltd
Rice Ltd
Sales Sales returns Net sales
$90,000 *(9,000) $81,000
*$100,000 (5,000) $95,000
Net sales Cost of sales Gross profit
$81,000 (56,000) *$25,000
$95,000 *57,000 $38,000
Gross profit Operating expenses Profit
$25,000 (15,000) *$10,000
$38,000 *(23,000) $15,000
*Indicates missing amount. (b) Young Ltd
Rice Ltd
Profit margin
$10,000 ÷ $81,000 = 12.3%
$15,000 ÷ $95,000 = 15.8%
Gross profit rate
$25,000 ÷ $81,000 = 30.9%
$38,000 ÷ $95,000 = 40%
Operating expenses to sales ratio
$15,000 ÷ $81,000 = 18.5%
$23,000 ÷ $95,000 = 24.2%
4.12
EXERCISE 4.9 (a) Music Box Ltd Income Statement for the year ended 30 June 2013
OPERATING REVENUE Net sales revenue: Less: Cost of sales
$2,820,000 (1,186,800) $1,633,200
GROSS PROFIT Other operating revenue
54,000 1,687,200
OPERATING EXPENSES Selling expenses
828,000
Administrative expenses
522,000
Financial expenses Total operating expenses
84,000
PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
1,434,000 253,200 (75,960) $177,240
(b) Profit margin =
Profit after tax Net sales
177,240 =6.3% 2,820,000
Gross profit rate =
Gross Profit Net Sales
1,633,200 = 57.9% 2,820,000
Operating expenses to sales ratio =
Operating Expenses Net Sales
1,434,000 = 50.9% 2,820,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 4.10 Cinderfella Pty Ltd Income Statement (Partial) for the year ended 30 June 2012
Sales revenue: Sales Less: Sales returns and allowances Net sales
$1,170,000 (18,200) $1,151,800
Note: Freight-out is a selling expense. Discount allowed is a financial expense.
EXERCISE 4.11 Peters Pottery Ltd (a)
(b)
Dr Cash/Accounts Receivable Cr GST Collected (liability) Cr Sales
$6,600
Dr Inventory Dr GST Paid (asset) Cr Cash/Accounts Payable
$1,100 110
$600 $6,000
$1,210
Dr GST Collected Cr GST Paid Cr Cash
$600 $110 $490
Alternatively a single GST cleaning account can be used instead of GST Collected and GST Paid accounts.
4.14
EXERCISE 4.12 Rock Shop Ltd (a)
May 3
May 10
Dr Inventory Dr GST Paid Cr Cash/Accounts payable
400 40
Dr Cash/Accounts receivable Cr Sales Cr GST collected
550
Dr GST Collected Cr GST Paid Cr Cash
50
440
500 50
40 10
EXERCISE 4.13 Peters Pottery Ltd (a)
(b)
Dr Cash/Accounts Receivable Cr GST Clearing Cr Sales
6,600
Dr Inventory Dr GST Clearing Cr Cash/Accounts Payable
1,100 110
Dr GST Clearing Cr Cash
600 6,000
1,210 490 490
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 4.1 (a) Smart Stationary Ltd General Journal
Date May
2
3
5
9
10
11
12
15
May
Post Ref.
Particulars
20
21
24
Debit
Accounts Receivable Sales Cost of Sales Inventory
110 400 505 120
6,300
Inventory Accounts Payable
120 200
8,400
Accounts Payable Inventory
200 120
280
Cash ($6,300 - $126) Discount Allowed ($6,300 x 2%) Accounts Receivable
100 500 110
6,174 126
Accounts Payable ($8,400 - $280) Discount Received ($8,120 x 2%) Cash
200 410
8,120
Supplies Cash
130 100
1,260
Inventory Cash
120 100
3,360
Cash
100 120
322
Inventory Inventory Accounts Payable
120 200
2,660
Freight Inwards Cash
510 100
350
Cash
100 400 505 120
8,680
120 200
1,400
Sales Cost of Sales Inventory 25 Inventory Accounts Payable
4.16
Credit
6,300 4,200 4,200
8,400
280
6,300
162
100
7,958
1,260
3,360
322
2,660
350
8,680 6,076 6,076
1,400
Date
Particulars 27
29
31
Post Ref.
Debit
Accounts Payable Discount Received ($2,660 x 2%) Cash
200 410
Sales Returns and Allowances Cash Inventory Cost of Sales
405 100 120 505
140
Accounts Receivable Sales Cost of Sales Inventory
110 400 505 120
2,240
Credit
2,660 53
100
2,607
140 98 98
2,240 1,568 1,568
(b) May
June
1 9 15 24
Opening Bal. Accounts Receivable Inventory Sales
1
Opening. Bal.
May
2 31
Sales Sales
June
1
Opening Bal.
Cash 7,000 May 6,174 322 8,680
10 11
Accounts. Payable Supplies
12 21 27 29 31
Inventory Freight Inwards Accounts Payable Sales Returns Closing Bal.
22,176 6,501
Accounts Receivable 6,300 May 9 2,240 31 8,540 2,240
May
3 12 20 25 29
Accounts Payable Cash Accounts Payable Accounts Payable Cost of Sales
Inventory 8,400 May 3,360 2,660 1,400 98
June
1
Opening Bal.
15,918 3,472
2 5 15 24 31 31
100 7,958 1,260 3,360 350 2,607 140 6,501 22,176
Cash & Discount Closing Bal.
110 6,300 2,240 8,540
Cost of Sales Accounts Payable Cash Cost of Sales Cost of Sales Closing Bal.
120 4,200 280 322 6,076 1,568 3,472 15,918
Solutions manual to accompany Accounting: building business skills 4e
May
11 Cash
May
5 10 27 31
Supplies 1,260
Inventory Cash & Discount Cash & Discount Closing Bal.
130
Accounts Payable 280 May 3 8,120 20 2,660 25 1,400 12,460 June 1
Share Capital May 1
May
31 Closing Bal.
Sales 17,220 May
2 24 31
Inventory Inventory Inventory
200 8,400 2,660 1,400
Opening Bal.
12,460 1,400
Bal.
300 7,000
Accounts Receivable Cash Accounts Receivable
17,220
May
29 Cash
Sales Returns and Allowances 140
405
Discount Received 215 May 10 27 215
410 162 53 215
May
21 Closing Bal.
May
9
May
2 Inventory 24 Inventory 31 Inventory
May
Accounts Receivable
21 Cash
400 6,300 8,680 2,240 17,220
Accounts Payable Accounts Payable
Discount Allowed 126
Cost of Sales 4,200 May 29 6,076 1,568 31 11,844 Freight Inwards 350
4.18
500
Inventory Closing Bal.
505 98 11,746 11,844 510
(c) Smart Stationary Ltd Income statement (Partial) for the month ended 31 May 2012
OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales Freight inwards GROSS PROFIT
17,220 (140) 17,080 11,746 350
(12,096) $4,984
(d) Profit margin ratio =
Gross profit rate =
Profit after tax Net sales
$4,984 (Gross P) - $1,960 (Op. Exp.*) - $266 (Tax Exp.) + $215 (Dis. Rec’d) =
Gross Profit Net Sales
* Note: Discount allowed included in operating expenses.
2,973 = 17.4% 17,080 4,984 = 29.2% 17,080
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 4.2 The Reading Warehouse General Journal June
2
3
6
9
15
Inventory (130 x $6) Accounts Payable (Terms 1/7, n/30) Freight In Cash
780 780 60 60
Accounts Receivable (140 x $12) Sales (Terms 2/7, n/30) Cost of Sales (140 x $6) Inventory
1,680 1,680 840 840
Accounts Payable Inventory
60
Accounts Payable ($780 - $60) Discount Received ($720 x 1%*) Cash
720
60
Cash
7 713 1,680
Accounts Receivable
17
20
24
26
28
30
1,680
Accounts Receivable (120 x $12) Sales (Term 2/7, n/30) Cost of Sales (120 x $6) Inventory Inventory (120 x $6) Accounts Payable (Term 2/7, n/30)
1,440 1,440 720 720 720 720
Cash Discount Allowed ($1,440 x 2%*) Accounts Receivable Accounts Payable Discount Received ($720 x 2%*) Cash Accounts Receivable (110 x $12) Sales
1,411 29 1,440 720 14 706 1,320 1,320
Cost of Sales (110 x $6) Inventory
660
Sales Returns and Allowances Accounts Receivable
180
Inventory Cost of Sales
90
660
180
90
(*to the nearest dollar) 4.20
(b)
The advantages for The Reading Warehouse of using a perpetual inventory system as opposed to a periodic inventory system are: • Inventory is constantly updated every time a purchase or sale is made. This means that The Reading Warehouse will be aware of when to reorder items of inventory. • Cost of sales is updated every time a sale is made so interim financial statements can be prepared without having to conduct an inventory count. • When The Reading Warehouse does conduct an inventory count (which should be at least annually), any inventory losses can be accurately determined. • Using a perpetual inventory system would be a disadvantage for The Reading Warehouse if the business does not have a suitable computer system to maintain inventory records.
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 4.3 (a)
Dave Jonos Department Store Pty Ltd Income Statement for the year ended 30 June 2012
OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales
$1,183,00 0 (13,000) $1,170,000 (823,186) $346,814
GROSS PROFIT Other operating revenue: Discount received Interest revenue
OPERATING EXPENSES Selling expenses: Dep’n expense – store equipment Freight out Rent expense – store space Sales commissions expense Sales salaries expense
1,300 5,200
6,500 353,314
12,350 10,660 11,700 18,200 91,000
143,910
Dep’n expense – office equipment Electricity expense Insurance expense Office salaries expense Rent expense – office space Rates and taxes expense
5,200 13,780 11,700 52,000 26,000 4,550
113,230
Interest expense Total operating expenses
10,400
Administrative expenses:
Financial expenses:
PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
10,400 267,540 85,774 (25,740) 60,034
Dave Jonos Department Store Pty Ltd Statement of Changes in Equity for the year ended 30 June 2012 Retained Earnings, 1 July 2011 Add: Profit
$18,460 60,034 78,494 (15,600)
Less: Dividends 4.22
Retained Earnings, 30 June 2012
62,894
Dave Jonos Department Store Pty Ltd Statement of Financial Position as at 30 June 2012 ASSETS Current Assets: Cash Accounts receivable Inventory Prepaid Insurance Total Current Assets
Non-Current Assets: Property, plant and equipment Store equipment Less: Accum. dep’n – store equipment Office equipment Less: Accum. Dep’n – office equipment Total Non-Current Assets TOTAL ASSETS LIABILITIES AND EQUITY Current Liabilities: Accounts payable Income tax payable Rates and taxes payable Sales commissions payable Total Current Liabilities Non-Current Liabilities: Bank loan Total Liabilities Equity Share capital Retained Earnings Total Equity TOTAL LIABILITIES AND EQUITY
$10,400 15,301 47,060 5,850 $78,611
162,500 (54,340) 74,100 (25,584)
108,160 48,516 156,676 $235,287
35,503 25,740 4,550 7,800 73,593 59,800 133,393 39,000 62,894 101,894 $235,287
Solutions manual to accompany Accounting: building business skills 4e
(b) Return on assets =
60,034 Profit after tax = 27.1% = Av total assets 221,644
Average total assets = (208,000 + 235,287) /2 = 221,644
(c)
Profit margin =
Profit after tax Net sales
Gross profit rate =
Gross Profit = Net Sales
Operating expenses to sales ratio =
267,540 Operating Expenses = 22.9% = 1,170,000 Net Sales
=
60,034 = 5.1% 1,170,000
346,814 = 29 .6% 1,170,000
A fully classified income statement provides more information than a summary-type statement. For instance, readers of the statement can ascertain how many sales were returned, discounts allowed on sales, and discounts received on purchases. Useful ratios such as the gross profit ratio and operating expenses to sales ratio can also be calculated. If the operating expense ratio is high, a further breakdown of expenses into categories can give insight as to which particular expenses were excessive.
4.24
PROBLEM SET A 4.4 (a) Tiger’s Tennis Pro Shop Pty Ltd General Journal
Date April
7
Particulars
Post Ref
Inventory Accounts Payable
115 200
2,040
505 100
96
Accounts Payable Inventory
200 115
240
Accounts Receivable Sales
105 400
1,080
Cost of Sales Inventory
500 115
756
Inventory Accounts Payable
115 200
792
Accounts Payable ($2,040 – $240) Discount Received ($1,800 x 2%) Cash
200 410 100
1,800
Accounts Payable Inventory
200 115
72
Accounts Receivable Sales
105 400
840
Cost of Sales Inventory
500 115
588
Accounts Payable ($792 - $72) Discount Received ($720 x 1%) Cash
200 410 100
720
Sales Returns and Allowances Accounts Receivable
405 105
72
Cash
100 105
1,320
8 Freight Inwards Cash 9
10
14
17
20
21
27
30
Accounts Receivable
Debit
Credit
2,040
96
240
1,080
756
792
36 1,764
72
840
588
7 713
72
1,320
Solutions manual to accompany Accounting: building business skills 4e
(b) April 1
Opening Bal
30
Accounts Receivable
Cash 3,000 April 8 April 14 1,320 21 30
May 1
Opening Bal.
April 10
Sales
20
Sales
Accounts Receivable 1080 April 27 Sales Returns & Allowances 840 30 Cash 1,920 30 Closing Bal.
Opening Bal.
April 1 7 14
Opening Bal. Accounts Payable Accounts Payable
May 1
Opening Bal.
April 9 14 17 21
Inventory Cash & Discount Inventory Cash & Discount
1,747 4,320
105 72 1,320 528 1,920
528 Inventory 4,200 April 9 2,040 10 792 17 20 30 7,032 5,376
Accounts Payable Cost of sales Accounts Payable Cost of sales Closing Bal.
Accounts Payable 240 April 7 Inventory 1,800 14 Inventory 72 720 2,832
Share Capital April 1
Sales April 10 20
Accounts Receivable
Closing Bal.
4,320 1,747
May 1
April 27
Freight Inwards Accounts Payable
100 96 1,764 713
Opening Bal.
Accounts Receivable Accounts Receivable
Sales Returns and Allowances 72
Discount Received April 14 Accounts Payable 21 Accounts Payable
4.26
115 240 756 72 588 5,376 7,032
200 2,040 792
2,832
300 7,200
400 1080 840 1,920
405
410 36 7 43
May
10 Inventory 20 Inventory
April
8
Cash
Cost of Sales 756 588 1,344
500
Freight Inwards 96
505
(c) Tiger’s Tennis Pro Shop Pty Ltd Trial Balance as at April 30, 2013 Debit Cash Accounts Receivable Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Discount Received Cost of Sales Freight Inwards
Credit $1,747 528 5,376 $7,200 1,920 72 43 1,344 96 $9,163
$9,163
(d) Tiger’s Tennis Pro Shop Pty Ltd Income Statement (Partial) for the month ended 30 April 2013
Sales revenues Sales Less: Sales returns and allowances Net sales Less: Cost of sales Freight inwards Gross Profit
$1,920 (72) $1,848 1,344 96
1440 $ 408
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 4.5 Seaview Pty Ltd Income Statement for the year ended 30 June 2012
OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales GROSS PROFIT
$990,000 (33,000) $957,000 (610,500) $346,500
Other operating revenue: Discount received Rent revenue Total operating revenue
17,600 8,800
OPERATING EXPENSES Selling expenses: Advertising 11,000 Freight out 33,000 Sales commissions expense (6600 + 4400) 11,000 Sales salaries expense 88,000
143,000
Administrative expenses: Dep’n expense – office equipment 8,800 Office salaries expense 40,700 Rent expense – office space (26400 – 6600)19,800 Electricity expense 13,200
82,500
Financial expenses: Discount allowed Interest expense Bank charges Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
8,800 2,200 1,100
26,400 372,900
12,100 237,600 135,300 (40,590) $94,710
4.28
PROBLEM SET A 4.6 Diamantina Ltd (a)
Dec.
31
31
31
31
Depreciation Expense – Buildings Accumulated Dep’n - Buildings
10,000
Depreciation Expense – Equipment Accumulated Dep’n – Equipment
9,000
Interest Expense Interest Payable
7,000
Income Tax Expense Income Tax Payable
24,840
10,000
9,000
7,000
24,840
Note: The figure used for the income tax expense entry was derived after the Income Statement in (d) was prepared.
(b) Accumulated Depreciation – Buildings Dec. 31 Balance 31 Depreciation Exp.
Accumulated Depreciation - Equipment Dec. 31 Balance 31 Depreciation Exp.
Dec.
Depreciation Expense – Buildings 31 Accum. Depr. 10,000
Dec.
Depreciation Expense – Equipment 31 Accum. Depr. 9,000
Dec.
31 Interest Payable
57,000 10,000 67,000
42,400 9,000 51,400
Interest Expense 7,000
Interest Payable Dec. 31
Interest Expense
7,000
Solutions manual to accompany Accounting: building business skills 4e
(c) Diamantina Ltd Adjusted Trial Balance As at 30 June 2013 Debit Cash Accounts Receivable Inventory Land Buildings Accumulated Depreciation – Buildings Equipment Accumulated Depreciation – Equipment Accounts Payable Income Tax Payable Interest Payable Bank Loan Share Capital Retained Profits Interest Revenue Dividends Sales Sales Returns and Allowances Discount Allowed Cost of Sales Salaries Expense (Office) Salaries Expense (Sales) Utilities Expense Repair Expense Petrol & Oil Expense Insurance Expense Depreciation Expense – Buildings Depreciation Expense – Equipment Income Tax Expense Interest Expense Interest Payable Totals
4.30
$33,400 37,600 110,000 92,000 197,000
Credit
$67,000
83,500 51,400 37,500 24,480 7,000 50,000 200,000 67,800 1,000 10,000 921,100 1,000 3,600 709,900 55,000 14,800 9,400 8,900 7,200 3,500 10,000 9,000 24,840 7,000 $1,427,640
$1,427,640
(d) Diamantina Ltd Statement of Financial Performance for the Year Ended 30 June 2013
OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales GROSS PROFIT
$921,100 (1,000) $920,100 (709,900) $210,200
Other operating revenue: Interest revenue
1,000 1,000 211,200
Total operating revenue OPERATING EXPENSES Selling expenses: Dep’n expense – store equipment Sales salaries expense
9,000 14,800
23,800
Administrative expenses: Dep’n expense – buildings Insurance expense Office salaries expense Petrol and oil expense Repair expense – computers Utilities expense
10,000 3,500 55,000 7,200 8,900 9,400
94,000
3,600 7,000
10,600
Financial expenses: Discount allowed Interest expense Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense NET PROFIT AFTER INCOME TAX
128,400 82,800 (24,840) $57,960
Diamantina Ltd Statement of Changes in Equity for the year ended 30 June 2013 Retained Profits, 1 January Add: Net Profit Less: Dividends Retained Profits, 31 December
$67,800 57,960 125,760 (10,000) $115,760
Solutions manual to accompany Accounting: building business skills 4e
Diamantina Ltd Statement of Financial Position As at 30 June 2013 ASSETS Current Assets: Cash Accounts receivable Inventory Total Current Assets
$33,400 37,600 110,000 $181,000
Non-Current Assets: Property, plant and equipment Land Buildings Less: Accum. dep’n – buildings Store equipment Less: Accum. Dep’n – store equipment Total Non-Current Assets TOTAL ASSETS LIABILITIES AND OWNER’S EQUITY Current Liabilities: Bank loan (portion due in 2014) Accounts payable Interest payable Income tax payable Total Current Liabilities Non-Current Liabilities: Bank loan Total Liabilities Owners’ Equity Share capital Retained profits Total Owners’ Equity TOTAL LIABILITIES AND OWNERS’ EQUITY
$92,000 $197,000 67,000 83,500 51,400
130,000 32,100 254,100 $435,100
15,000 37,500 7,000 24,840 84,340 35,000 119,340 200,000 115,760 315,760 $435,100
(e) The income statement is prepared for a period of time because it summarises income and expenses for that period. The profit or loss then is used to update equity at the end of that period. The statement of financial position shows the financial position, i.e., the balances of assets, liabilities, and equity on the date the statement of financial position is prepared.
4.32
PROBLEM SET A 4.7 Funky Fashion Distributing Pty Ltd General Journal (a) April
4
6
7
11
13
14
16
Inventory Accounts Payable
6,490
Accounts Receivable Sales
5,500
Cost of Sales Inventory
4,400
Accounts Payable Inventory
330
Freight Out Cash
220
6,490
5,500
4,400
330
220
Accounts Payable ($6,490 - $330) Discount Received ($6,160 x 2%) Cash
6,160
Cash Discount Allowed ($5,500 x 2%) Accounts Receivable
5,390 110
Inventory Cash
4,840
Cash
123 6,037
5,500
4,840 550
Inventory 21
22
23
Inventory Accounts Payable Freight In Cash Cash
550 6,300 6,300 110 110 8,140
Sales
26
27
29
30
8,140
Cost of Sales Inventory
6,732
Inventory Cash
2,530
Accounts Payable Discount Received ($6,300 x 2%) Cash
6,300
6,732
2,530
126 6,174
Sales Returns and Allowances Cash
99
Inventory Cost of Sales
77
Accounts Receivable Sales
4,070
Cost of Sales Inventory
3,300
99
77
4,070
3,300
Solutions manual to accompany Accounting: building business skills 4e
(b) April1 13 16 23
Opening Bal. Accounts Receivable Inventory Sales
May 1
Opening Bal.
April6 30
Sales Sales
May 1
Opening Bal.
Cash 9,900 April7 5,390 11 550 8,140
220 6,037
Inventory Freight In Inventory Accounts Payable Sales Returns Closing Bal.
4,840 110 2,530 6,174 99 3,970 $23,980
$23,980 3,970
Accounts Receivable 5,500 April13 Cash & Discount 4,070 30 Closing Bal. 9,570 4,070
April4 14 21 26 29
Accounts Payable Cash Accounts Payable Cash Cost of sales
May 1
Opening Bal.
April6 11 27
14 22 26 27 29 30
Freight Out Accounts Payable
Inventory Cash & Discount Cash & Discount
Inventory 6,490 April6 4,840 6 6,300 16 2,530 23 77 30 30 20,237 4,925
Cost of sales Accounts Payable Cash Cost of sales Cost of sales Closing Bal.
Accounts Payable 330 April4 Inventory 6,160 21 Inventory 6,300 12,790
Share Capital April1
Opening Bal.
Sales April6 Accounts Receivable 23 Cash 30 Accounts Receivable
April29
Cash
Sales Returns and Allowances 99
4.34
5,500 4,070 9,570
4,400 330 550 6,732 3,300 4,925 20,237
6,490 6,300 12,790
9,900
5,500 8,140 4,070 17,710
Discount Received April11 Accounts Payable 27 Accounts Payable
April13
April22
April7
123 126 249
Discount Allowed 110
Accounts Receivable
Cash
Freight In 110
Cash
Freight Out 220
April 6 23 30
Inventory Inventory Inventory
May 1
Opening Bal.
Cost of Sales 4,400 April29 6,732 30 3,300 14,432 14,355
Inventory Closing Bal.
77 14,355 14,432
(c) Funky Fashion Distributing Pty Ltd Income Statement (Partial) for the month ended 30 April 2012
OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales Freight in GROSS PROFIT
$17,710 (99) $17,611 (14,355) (110)
(14,465) $3,146
(d) Profit margin ratio = Profit Net sales Gross profit ratio =
Gross Profit Net Sales
GP 3,146 – 990 oper. Expen* + disc. rec’d $249
2,405 = 13.7% 17,611
3,146 = 17.9% 17,611
Solutions manual to accompany Accounting: building business skills 4e
*Note: It is assumed that discounts allowed and freight out are included in operating expenses.
4.36
PROBLEM SET A 4.8 Kids + Kites Ltd (a) Cash/Accounts Receivable GST Collected ($70,700/11) Sales (To record sales revenue and GST collected)
70,700
Sales Returns and Allowances GST Collected ($1,400/11) Accounts Receivable
1,273 127
Inventory GST Paid ($28,560/11) Accounts Payable (To record inventory purchase and GST paid)
25,964 2,596
Accounts Payable GST Paid ($3,360/11) Inventory (To record purchase return and GST recovered)
3,360
GST Collected GST Paid Cash (To record payment of GST to tax authority)
6,300
Cash/Accounts Receivable GST Clearing Sales (To record sales revenue and GST collected)
70,700
Sales Returns and Allowances GST Clearing Accounts Receivable (To record sales returns and GST refunded)
1,273 127
Inventory GST Clearing Accounts Payable (To record inventory purchase and GST paid)
25,964 2,596
Accounts Payable GST Clearing Inventory (To record purchase return and GST recovered)
3,360
GST Clearing Cash (To record payment of GST to tax authority)
4,009
6,427 64,273
1,400
28,560
305 3,055
2,291 4,009
(b)
6,427 64,273
1,400
28,560
305 3,055
4,009
Solutions manual to accompany Accounting: building business skills 4e
(c) Cash/Accounts Receivable GST Collected ($28,560/11) Sales (To record sales revenue and GST collected)
28,560
Inventory GST Paid ($70,700/11) Accounts Payable (To record inventory purchase and GST paid)
64,273 6,427
Cash GST Collected GST Paid (To record refund of GST from tax authority)
3,831 2,596
Cash/Accounts Receivable GST Clearing Sales (To record sales and GST collected)
28,560
Inventory GST Clearing Accounts Payable (To record inventory purchase and GST paid)
64,273 6,427
Cash
3,831
2,596 25,964
70,700
6,427
(d) 2,596 25,964
GST Clearing (To record GST refund from tax authority)
4.38
70,700
3,831
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 4.1 Finger Lickin’ Distributing Company General Journal April
4
6
7
8
11
13
14
16
Inventory Accounts Payable
5,900
Accounts Receivable Sales
5,000
Cost of Sales Inventory
4,000
5,900
5,000
4,000
Freight-out Cash
200
Accounts Payable Inventory
300
200
300
Accounts Payable ($5,900 - $300) Discount Received ($5,600 x 2%) Cash
5,600
Cash Discount Allowed ($5,000 x 2%) Accounts Receivable
4,900 100
Inventory Cash
4,400
Cash
112 5,488
5,000
4,400 500
Inventory 21
22
23
Inventory Accounts Payable Freight-In Cash Cash
500 4,200 4,200 100 100 7,400
Sales
26
27
29
7,400
Cost of Sales Inventory
6,120
Inventory Cash
2,300
Accounts Payable Discount Received ($4,200 x 2%) Cash
4,200
6,120
2,300
84 4,116
Sales Returns and Allowances Cash
90
Inventory Cost of Sales
70
90
70
Solutions manual to accompany Accounting: building business skills 4e 30
Accounts Receivable Sales
3,700
Cost of Sales Inventory
3,000
3,700
3,000
(b)
April1 13 16 23
May 1
Opening Bal. Accounts Receivable Inventory Sales
Opening Bal.
April6 30
Sales Sales
May 1
Opening Bal.
April4 14 21 26 29
Accounts Payable Cash Accounts Payable Cash Cost of Sales
May 1
Opening Bal.
April8 11 27
Inventory Cash & Discount Cash & Discount
Cash 9,000 April7 4,900 11 500 7,400
14 22 26 27 29 30
Freight-Out Accounts Payable
200 5,488
Inventory Freight-In Inventory Accounts Payable Sales Returns Closing Bal.
4,400 100 2,300 4,116 90 5,106 $21,800
$21,800 5,106
Accounts Receivable 5,000 April13 Cash & Discount 3,700 30 Closing Bal. 8,700 3,700
Inventory 5,900 April6 4,400 8 4,200 16 2,300 23 70 30 30 16,870 2,950
Cost of Sales Accounts Payable Cash Cost of Sales Cost of Sales Closing Bal.
Accounts Payable 300 April4 Inventory 5,600 21 Inventory 4,200 10,100
Share Capital April1
4.40
Opening Bal.
5,000 3,700 8,700
4,000 300 500 6,120 3,000 2,950 16,870
5,900 4,200 10,100
9,000
Sales April6 23 30
April29
Cash
Accounts Receivable Cash Accounts Receivable
Sales Returns and Allowances 90
Discount Received April11 Accounts Payable 27 Accounts Payable
April13
Accounts Receivable
112 84 196
Discount Allowed 100
Cash
Freight-In 100
April7
Cash
Freight-Out 200
April 6 23 30
Inventory Inventory Inventory
April22
5,000 7,400 3,700 16,100
Cost of Sales 4,000 April29 6,120 30 3,000 13,120
Inventory Closing Bal.
70 13,050 13,120
(c) Finger Lickin’ Distributing Company Income Statement (Partial) for the month ended 30 April 2013
OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales Freight in GROSS PROFIT
$16,100 (90) $16,010 (13,050) (100)
(13,150) $2,860
(d) Profit margin = Profit net sales Gross profit rate =
Gross Profit 2,860 – 900 oper. expen. + disc. rec’d $196
2,156 = 13.5% 16,010
2,860 = 17.9% 16,010 Note: It is assumed that freight-out and discounts allowed are included in operating expenses. PROBLEM SET B 4.2 Gross Profit Net Sales
Solutions manual to accompany Accounting: building business skills 4e
July
1
3
6
9
17
18
20
21
22
22
Modern Art Warehouse Inventory (50 X $15) Accounts Payable
750 750
Accounts Receivable (40 X $25) Sales
1,000
Cost of Sales (40 X $15) Inventory
600
Accounts Payable Discount received ($750 X 0.01) Cash
750
Cash Discounts allowed (1,000 x .01) Accounts Receivable
990 10
Accounts Receivable (30 X $25) Sales
750
Cost of Sales (30 X $15) Inventory
450
Inventory (60 X $15) Accounts Payable
900
1,000
600
8 742
1,000
750
450
900
Freight-In Cash
100
Accounts Payable Inventory
150
100
150
Cash Discounts allowed ($750 X .01) Accounts Receivable
742 8
Accounts Receivable (40 X $25) Sales
1,000
Cost of Sales (40 X $15) Inventory
600
750
1,000
600
4.42
30
31
Accounts Payable ($900 – $150) Cash
750 750
Sales Returns and Allowances Accounts Receivable
125
Inventory Cost of Sales
75
125
75
(b) The advantages for Modern Art Warehouse of using a perpetual inventory system as opposed to a periodic inventory system are: •
Inventory is constantly updated every time a purchase or sale is made. This means that Modern Art Warehouse will be aware of when to reorder items of inventory.
•
Cost of sales is updated every time a sale is made so interim financial statements can be prepared without having to conduct an inventory count.
•
When Modern Art Warehouse does conduct an inventory count (which should be at least annually), any inventory losses can be accurately determined.
•
Using a perpetual inventory system would be a disadvantage for Modern Art Warehouse if the business does not have a suitable computer system to maintain inventory records.
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 4.3
(a)
AL FALFA DEPARTMENT STORE Income Statement for the Year Ended 30 June 2012
Operating revenue Sales revenues Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of sales Gross profit Other operating revenue: Interest revenue
$628,000 8,000 620,000 412,700 207,300 4,000 4,000 211,300
Operating expenses Selling expenses: Sales commissions expense Sales salaries expense
14,500 76,000
90,500
Administrative expenses Depreciation expense—equipment Depreciation expense—building Electricity expense Insurance expense Office salaries expense Property taxes expense
13,300 10,400 11,000 7,200 32,000 4,800
78,700
11,000
11,000
Financial expenses: Interest expense Total operating expenses Profit before income tax
180,200 31,100
AL FALFA DEPARTMENT STORE Statement of Changes in Equity for the Year Ended 30 June 2012 Retained Earnings, 1 July 2011 Add: Profit
$26,600 31,100 57,700 28,000 $29,700
Less: Dividends Retained Earnings, 30 June 2011 4.44
AL FALFA DEPARTMENT STORE Statement of Financial Position as at 30 June, 2012 Assets Current assets Cash Accounts receivable Inventory Prepaid insurance Total current assets Non-current assets Property, plant, and equipment Building Less: Accumulated depreciation— building Equipment Less: Accumulated depreciation— equipment Total assets
$ 33,000 50,300 75,000 2,400 160,700
$190,000 52,500 100,000
$137,500
42,900
57,100
Liabilities and Equity Current liabilities Accounts payable Mortgage payable Rates and taxes payable Sales commissions payable Interest payable Total current liabilities Non-current liabilities Mortgage payable – long term (due after 2013) Total liabilities Equity Share capital Retained Earnings Total equity Total liabilities and equity
194,600 $355,300
$ 79,300 20,000 4,800 3,500 8,000 115,600 60,000 175,600 150,000 29,700 179,700 $355,300
(b) Return on assets = profit after tax/average total assets = 31,100/337,650 = 9.2% Note: average total assets = (320,000+355,300)/2 = 337,650 Profit margin = profit after tax/net sales = 31,300/620,000 = 5.0% Gross profit rate = gross profit / net sales = 207,300/620,000 = 33.4% Operating expenses to sales ratio = operating exp./net sales = 180,200/620,000 = 29.1%
Solutions manual to accompany Accounting: building business skills 4e
(c) A fully classified income statement provides more information than a summary-type statement. For instance, readers of the statement can ascertain how many sales were returned, discounts allowed on sales, and discounts received on purchases. Useful ratios such as the gross profit ratio and operating expenses to sales ratio can also be calculated. If the operating expense ratio is high, a further breakdown of expenses into categories can give insight as to which particular expenses were excessive.
4.46
PROBLEM SET B 4.4
STAR-STRUCK TENNIS SHOP General Journal
(a) Date Apr. 6 7
Account Titles Inventory Accounts Payable
Debit 840
840
Freight-In Cash
40
Accounts Receivable Sales
900
Cost of Sales Inventory
600
Accounts Payable Inventory
40
Inventory Cash
300
Accounts Payable ($840 – $40) Discount received ($800 X 3%) Cash
800
Inventory Accounts Payable
500
15
Cash
50
17
Inventory Freight-In Cash
30
8
10 11 13
14
18
20 21
27 30
40 900 600 40 300 24 776 500 50 30
Accounts Receivable Sales
900
Cost of Sales Inventory Cash Accounts Receivable
530
Accounts Payable Discount received ($500 X 2%) Cash
500
Sales Returns and Allowances Accounts Receivable
30
Cash
500 Accounts Receivable
Credit
900 530 500 500 10 490 30 500
Solutions manual to accompany Accounting: building business skills 4e
(b)
Opening balance 15-Apr Inventory 20-Apr Accounts receivable
Cash 2,500 50 500
30-Apr Accounts receivable
500
7-Apr Freight-In 11-Apr Inventory 13-Apr Accounts payable
40 300 776
17-Apr Freight-In 21-Apr Accounts payable
30 490
Closing balance 1-May Opening balance
8-Apr Sales 18-Apr Sales
1-May Opening balance
Opening balance 6-Apr Accounts payable 11-Apr Cash 14-Apr Accounts payable
1-May Opening balance
10-Apr Inventory 13-Apr Discount and cash 21-Apr Discount and cash 30-Apr Closing balance
3,550 1,914
Accounts Receivable 900 20-Apr Cash 900 27-Apr Sales returns 30-Apr Cash Closing balance 1,800 770
Inventory 1,700 8-Apr COGS 840 10-Apr Accounts payable 300 15-Apr Cash 500 18-Apr COGS Closing balance 3,340 2,120
Accounts Payable 40 6-Apr Inventory 800 14-Apr Inventory 500 0 1,340 1-May Opening balance
1,914 3,550
500 30 500 770 1,800
600 40 50 530 2,120 3,340
840 500
1,340 0
Share Capital Opening balance
4,200
Sales 8-Apr Accounts receivable 18-Apr Accounts receivable
4.48
900 900 1,800
27-Apr Accounts receivable
Sales Returns and Allowances 30
Discount Received 13-Apr Accounts payable 21-Apr Accounts payable
8-Apr Inventory 18-Apr Inventory
7-Apr Cash 17-Apr Cash
Cost of Sales 600 530 1,130 Freight-In 40 30 70
(c) STAR-STRUCK TENNIS SHOP Trial Balance As at 30 April, 2013
Cash Accounts receivable Inventory Accounts payable Share capital Sales Sales returns and allowances Cost of sales Freight-In Discount received
Debit 1,914 770 2,120
Credit
4,200 1,800 30 1,130 70 6,034
34 6,034
(d) STAR-STRUCK TENNIS SHOP Income Statement (Partial) for the Month Ended 30 April, 2013 Sales revenues Sales ................................................................................................. $1,800 Less: Sales returns and allowances .................................................. 30 Net sales............................................................................................ $1,770 Cost of sales (Cost of sales + Freight-In)..................................................... 1,200 Gross profit.................................................................................................. $ 570
24 10 34
Solutions manual to accompany Accounting: building business skills 4e
(e)
The chart of accounts lists all the accounts in the general ledger and serves as an index of accounts. Each ledger account has a title and unique number. The chart of accounts is helpful for recording transactions because it identifies which accounts should be used.
4.50
PROBLEM SET B 4.5 Sima Nan Ltd Income Statement for the year ending 30 June 2013 OPERATING REVENUE Sales revenue: Gross sales revenue (702 000-10 000) Less: Sales returns and allowances Net sales revenue Less: Cost of Sales
$692,000 0 $692,000 (470,000) $222,000
GROSS PROFIT Other operating revenue: Interest revenue
5,300
5,300 227,300
OPERATING EXPENSES Selling expenses: Advertising Depreciation expense - store equip Freight out Sales commissions expense Sales salaries expense Administrative expenses: Insurance expense (7 000-1 200) Office salaries expense Rent expense – office space Electricity expense
10,000 7,500 10,000 6,500 76,000
110,000
5,800 19,000 16,000 8,000 48,800
Financial expenses: Discount allowed Interest expense Bank charges Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
11300 4000 1,000
16,300 175,100 52,200 (15,660) 36,540
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 4.6 (a)
June. 30 30
30
30
Shakira Fashion Centre Store Supplies Expense Store Supplies Depr. Expense—Store Equipment Accumulated Depreciation— Store Equipment Depr. Expense—Office Equipment Accumulated Depreciation— Office Equipment Interest Expense Interest Payable
2,000 2,000 9,000 9,000 7,000 7,000 11,000 11,000
(b) Store Supplies 30/6 Bal. 30/6 Bal.
5,500 3,500
30/6 Supplies expense 2,000
Accumulated Depreciation— Store Equipment 30/6 30/6 30/6
Bal. 38,000 Deprec exp – SE 9,000 Bal. 47,000
Accumulated Depreciation— Office Equipment 30/6 Bal. 30/6 Deprec exp – SE 30/6 Bal.
6,000 7,000 13,000
Store Supplies Expense 30/6
Supplies 2,000 Depreciation Expense—Store Equipment
30/6 Accu. Deprn store equipment
9,000
Depreciation Expense— Office Equipment 30/6 Accu. Deprn office equip 7,000 Interest Expense 30/6 Interest payable
11,000 Interest Payable 30/6 Interest expense 11,000 30/6 Bal. 11,000
(c) 4.52
SHAKIRA FASHION CENTRE Adjusted Trial Balance 30 June 2014 Debit Cash Accounts Receivable Inventory Store Supplies Store Equipment Accumulated Depreciation—Store Equipment Office Equipment Accumulated Depreciation—Office Equipment Notes Payable Accounts Payable Share Capital Retained Earnings Dividends Sales Sales Returns and Allowances Cost of Sales Salaries Expense Administrative Staff Sales Staff Advertising Expense Electricity Expense Repair Expense Freight Out Rent Expense Store Supplies Expense Depreciation Expense—Store Equipment Depreciation Expense—Office Equipment Interest Expense Interest Payable Totals
$
Credit
36,700 33,700 45,000 3,500 85,000 $
47,000
38,000 13,000 41,000 48,500 80,000 30,000 12,000 747,200 4,200 507,400 100,000 30,000 26,400 14,000 12,100 16,700 24,000 2,000 9,000 7,000 00,0011,000 $1,017,700
11,000 $1,017,700
Solutions manual to accompany Accounting: building business skills 4e
(d) SHAKIRA FASHION CENTRE Income Statement for the Year Ended 30 June 2014 OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Less: Cost of Sales
$747,200 (4,200) $743,000 (507,400) $235,600
GROSS PROFIT Other operating revenue:
0 235,600
OPERATING EXPENSES Selling expenses: Advertising Depreciation expense - store equip Freight out Store supplies expense Sales salaries expense Administrative expenses: Depreciation exp - office equipment Office salaries expense Repair expense Rent expense - office space Electricity expense
26,400 9,000 16,700 2,000 30,000
84,100
7,000 100,000 12,100 24,000 14,000 157,100
Financial expenses: Interest
11000
11,000
Total operating expenses
252,200
PROFIT(LOSS) BEFORE INCOME TAX (Ignore income tax)
(16,600)
SHAKIRA FASHION CENTRE Statement of Changes in Equity for the Year Ended 30 June 2014 Retained Earnings, July 1, 2013 Less: Loss Dividends Retained Earnings, June 30, 2014
$30,000) $16,600 12,000
4.54
( 28,600)) $ 1,400)
SHAKIRA FASHION CENTRE Statement of Financial Position as at 30 June 2014 Assets Current assets: Cash Accounts receivable Inventory Store supplies Total current assets Non-current assets: Property, plant, and equipment Store equipment Accumulated depreciation— store equipment Office equipment Accumulated depreciation— Office equipment Total assets Liabilities and Equity Current liabilities: Notes payable due in 2015 Accounts payable Interest payable Total current liabilities Long-term liabilities Notes payable due after 2015 Total liabilities Equity Share capital Retained Earnings Total equity Total liabilities and equity
(e)
$ 36,700 33,700 45,000 3,500 118,900
$85,000 47,000 38,000
$38,000
13,000
25,000
63,000 $181,900
$ 30,000 48,500 11,000 89,500 11,000 100,500 80,000 1,400 81,400 $181,900
The income statement is prepared for a period of time because it summarises income and expenses for that period. The profit or loss then is used to update equity at the end of that period. The statement of financial position shows the financial position, i.e., the balances of assets, liabilities, and equity on the date the statement of financial position is prepared.
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 4.7 (a) Hummingbird Hardware Pty Ltd Date
Details
May 2
Accounts Receivable Sales Cost of Sales Inventory
Post Ref 110 400 505 120
Inventory Accounts Payable
120 200
6,000
Accounts Payable Inventory
200 120
200
Cash Discount Allowed Accounts Receivable
100 500 110
4,410 90
Accounts Payable Cash Discount Received
200 100
5,800
Supplies Cash
130 100
900
Inventory Cash
120 100
2,400
Cash Inventory
100 120
230
Inventory Accounts Payable
120 200
1,900
Freight Inwards Cash
510 100
250
May 3
May 5
May 9
May 10
May 11
May 12
May 15
May 20
May 21
May 24
May 25
May 27
May 29
Debit 4,500
4,500 3,000 3,000
6,000
200
4,500
5,684 116
900
2,400
230
1,900
250
Cash Sales Cost of Sales Inventory
100 400 505 120
6,200
Inventory Accounts Payable
120 200
1,000
Accounts Payable Cash Discount Received
200 100 410
1,900
Sales Returns and Allowance Cash Inventory Cost of Sales
405 100 120 505
100
4.56
Credit
6,200 4,340 4,340
1,000
1,862 38
100 70 70
May 31
Accounts Receivable Sales Cost of Sales Inventory
110 400 505 120
1,600 1,600 1,120 1,120
(b)
May 1 9 15 24
Jun 1
May 1 2 31 Jun 1
Opening Balance Accounts Receivable Inventory Sales
Opening Balance
Cash 5,000 May 10 4,410 11 230 6,200
12 21 27 29
______ 15,840
31
Accounts Payable Supplies Inventory Freight Inwards Accounts Payable Sales Returns and Allowances Closing Balance
100 5,684 900 2,400 250 1,862 100 4,644 15,840
4,644
Accounts Receivable Opening Balance 0 May 9 Cash and Discount Allowed Sales 4,500 31 Closing Balance Sales 1,600 6,100 Opening Balance 1600
110 4,500
Inventory 6,000 May 2 2,400 5 1,900 15 1,000 24 70 31 11,370 31
Cost of Sales Accounts Payable Cash Cost of Sales Cost of Sales Closing Balance
120 3,000 200 230 4,340 1,120 2,480 11,370
Closing Balance
130 900 900
May 3 12 20 25 29
Accounts Payable Cash Accounts Payable Accounts Payable Cost of Sales
Jun 1
Opening Balance
May 11
Cash
Jun 1
Opening Balance
1,600 6,100
2,480
Supplies 900 May 31 900 900
Solutions manual to accompany Accounting: building business skills 4e
May 5 10 27 31
Accounts Payable Inventory 200 May 1 Cash and Discount 5,800 3 Received Cash and Discount 1,900 20 Received Closing Balance 1,000 25 8,900 Jun 1
Share Capital May 1
Sales May 2 24 31
May 29
Cash
May 9
Accounts Receivable
May 2 24 31
Inventory Inventory Inventory
Opening Balance Inventory
200 0 6,000
Inventory
1,900
Inventory Opening Balance
1,000 8,900 1,000
Opening Balance
300 5,000
Accounts Receivable Cash Accounts Receivable
Sales Returns and Allowances 100
May 21
Cash
Jun 1
Opening Balance
400 4,500 6,200 1,600 12,300
405
Discount Received May 10 Accounts Payable 27 Accounts Payable
410 116 38 154
Discount Allowed 90
500
Cost of Sales 3,000 May 29 4,340 1,120 8,390
Freight Inwards 250 May 31 250 250
4.58
Inventory
Closing Balance
505 70
510 250 250
Solutions manual to accompany Accounting: building business skills 4e
(c) Hummingbird Hardware Pty Ltd Income Statement (Partial) For the month ended May 31
Operating Revenue Sales Revenue Gross Sales Revenue Less: Sales Returns and Allowances Net Sales Revenue Less: Cost of Sales Gross Profit
12,300 (100) 12,200 (8,390) 3,810
(d)
Profit margin =
Profit/Net Sales
Gross profit ratio =
Gross Profit/Net Sales
Profit: 3,810 Gross Profit + (116 + 38) Discount Received – 1,400 Operating Expense – 190 Tax Expense = 2,374
2,374/12,200 = 19.46%
3,810/12,200 = 31.23%
PROBLEM SET B 4.8 Lam Electronics Ltd (a) Cash/Accounts Receivable GST Collected ($50,500/11) Sales (To record sales revenue and GST collected)
50,500
Sales Returns and Allowances GST Collected ($1,000/11) Accounts Receivable (To record sales revenue and GST returned)
909 91
Inventory GST Paid ($20,400/11) Accounts Payable (To record inventory purchase and GST paid)
18,546 1,854
Accounts Payable GST Paid ($2,400/11) Inventory (To record purchase return and GST recovered)
2,400
GST Collected GST Paid Cash (To record payment of GST to tax authority)
4,500
4.60
4,591 45,909
1,000
20,400
218 2,182
1,636 2,864
(b) Cash/Accounts Receivable GST Clearing Sales (To record sales revenue and GST collected)
50,500
Sales Returns and Allowances GST Clearing Accounts Receivable (To record sales returns and GST refunded)
909 91
Inventory/Purchases GST Clearing Accounts Payable (To record inventory purchase and GST paid)
18,546 1,854
Accounts Payable GST Clearing Inventory (To record purchase return and GST recovered)
2,400
GST Clearing Cash (To record payment of GST to tax authority)
2,864
Cash/Accounts Receivable GST Collected ($20,400/11) Sales (To record sales revenue and GST collected)
20,400
Inventory GST Paid ($50,500/11) Accounts Payable (To record inventory purchase and GST paid)
45,909 4,591
Cash GST Collected GST Paid (To record refund of GST from tax authority)
2,737 1,854
Cash/Accounts Receivable GST Clearing Sales (To record sales and GST collected)
20,400
Inventory GST Clearing Accounts Payable (To record inventory purchase and GST paid)
45,909 4,591
Cash
2,737
4,591 45,909
1,000
20,400
218 2,182
2,864
(c) 1,854 18,546
50,500
4,591
(d)
GST Clearing (To record GST refund from tax authority)
1,854 18,546
50,500
2,737
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 4.1 FINANCIAL REPORTING PROBLEM Domino’s Pizza Enterprises Limited (a)
Percentage change in revenue from sale of goods: 2009 to 2010 ($156,105,000 - $160,055,000) ÷ $160,055,000= -2.5% Percentage change in profit after tax: 2009 to 2010 ($17,814,000 – $15,353,000) ÷ $15,353,000 = 16% There has been a 16% increase in profit from 2009 to 2010
(b)
Operating expenses to sales ratio: 2009 2010
$138,498,000 ÷ $160,055,000 = 86.5% $138,980,000 ÷ $156,105,000 = 89%
The operating expenses to sales ratio has increased marginally between 2009 and 2010, which indicates that expenses have risen in a slightly larger proportion than sales. Note: Analysis of trend typically involves a longer period. Trend analysis is covered in Chapter 12.
4.62
BUILDING BUSINESS SKILLS 4.2
COMPARATIVE ANALYSIS PROBLEM
Nike vs. Adidas Group The analysis is based on the 2010 reports (a) Nike ($’000,000) (1)
Profit margin
Adidas ($’000,000)
$1,907 $19,014 = 10%
$568 $11,990
= 4.7%
(2)
Gross profit (000’s)
$8,800 ($19,014-$10,214)
$5,730 ($11,990–$6,260)
(3)
Gross profit rate
$8,800 $19,014
$5,730 = 47.8% $11,990
= 46.3%
(4)
Profit after tax
$1,907
$568
(5)
Percent change in Profit after tax
$1,907-$1,487 = 28.2% $1,487
$568–$245 = 132% $245
(6)
Operating expenses to sales ratio
$6,284 $19,014= 33%
$5,159** = 43% $11,990
**($5,046 + $113)
(b)
Nike’s higher profit margin suggests that it was better at turning sales dollars into profit. The gross profit rate is slightly better for Adidas, suggesting that Adidas can command a slightly higher mark-up on its goods and/or lower product costs. Alternatively, the difference could reflect different accounting policies between the two companies. Adidas’s operating profit increased substantially between 2009 and 2010. Although Nike has a slightly lower gross profit margin, it achieved a higher profit margin because it had a lower operating expense to sales ratio ie: better control of its operating expenses. However, we should be careful not to read too much into a comparison based on only one year’s data.
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 4.3
RESEARCH CASE
The article by Eleanor Mason and Mike Dobbie entitled ‘If the GST knocks, who answers?’ can be obtained from the course management system that accompanies the text. (a)
GST journal entries for Timber Merchant, Furniture Manufacturer and Furniture Retailer. Timber Merchant General Journal Account
Debit
Credit
Timber merchant sells timber to the Furniture manufacturer: Cash/Accounts Receivable 220 GST Collected Sales
20 200
Timber merchant remits GST to the Taxation Authority: GST Collected Cash
20
20
Furniture Manufacturer General Journal Account
Debit
Credit
Furniture manufacturer buys timber from the Timber merchant: Inventory 200 GST Paid 20 Cash/Accounts Payable
220
Furniture manufacturer sells table to the Furniture retailer: Cash/Accounts Receivable GST Collected Sales
40 400
Furniture manufacturer remits GST to Taxation Authority: GST Collected GST Paid Cash
4.64
440
40 20 20
Furniture Retailer General Journal Account
Debit
Credit
Furniture retailer buys table from the Furniture manufacturer: Inventory 400 GST Paid 40 Cash/Accounts Payable
440
Furniture retailer sells table to the Consumer: Cash/Accounts Receivable GST Collected Sales
50 500
Furniture retailer remits GST to Taxation Authority: GST Collected GST Paid Cash
550
50 40 10
Residential property landlords will bear the cost of GST in the short term as they cannot pass the GST on to the consumer even though they pay GST on many items (e.g. management fees, repairs and insurance), they cannot recover GST costs from the taxation authority.
(b)
‘Sticking’ means that the business cannot pass the GST on to the consumer so the business is left ‘stuck’ with having paid the GST on the goods and services they bought and are unable to receive an input tax credit from the tax office. For example, banks incur numerous GST liable input costs (e.g. purchasing of office supplies or furniture and equipment) but cannot recover GST costs from the taxation authority. Residential property landlords also pay GST on management fees, repairs and insurance, yet they cannot recover GST costs from the taxation authority.
(c)
The GST is essentially a 10% tax imposed on most goods and services. The tax is paid at each stage in the production and supply chain, but it is the final consumer who bears the cost. Businesses that supply goods and services are generally eligible for a credit from the taxation authority on the tax paid. Suppliers essentially act as tax collectors for the taxation authority. The difference between how much GST a business has collected and paid determines whether the business has a GST liability to pay to the taxation office or will receive a refund from the taxation authority. Note: This answer is from the text and the author. Students should use their own words as required in the question.
(d)
Answers to part e from the ATO web site. Extract from page accessed 29/08/2011 http://www.ato.gov.au/businesses/content.asp?doc=/content/20724.htm&pc=001/003 /022/002/014&mnu=60&mfp=001&st=&cy=1
Solutions manual to accompany Accounting: building business skills 4e
GST sales, purchases and credits (1) & (2) The words ‘sale’ and ‘purchase’ describe the GST terms ‘supply’ and ‘acquisition’. For GST, a sale includes a sale of goods or services, lease of premises, hire of equipment, giving of advice, export of goods and the supply of other things. A purchase includes an acquisition of goods or services such as trading stock, a lease, consumables and other things (including importations). We use the term GST credit to describe the GST term ‘input tax credit’. A GST credit is what you claim to get back the GST included in the price you pay for most goods and services you purchase for your business. (3)
You don’t include GST in the price of GST-free sales that you make, but you are entitled to GST credits for things you have purchased or imported for use in your business. Some examples of GST-free sales include basic food, exports, sewerage and water, the sale of a business as a going concern, non-commercial activities of charities, and most education and health services.
BUILDING BUSINESS SKILLS 4.4
COMMUNITY AND SOCIAL PERSPECTIVE
a) Some of the benefits to businesses that make donations of excess inventory include: • • • • •
Freeing up storage space from excess, overstocked, obsolete or outdated inventory; The business can claim a tax deduction for the market value of merchandise donated; Enhance the business’ corporate image by donating excess items to a good cause, rather than dumping or liquidating the items; Avoid sending the wrong message to customers that a liquidation sales may bring; Avoid disrupting the business’ distribution or sales channels with excessive inventory that are becoming obsolete.
b) The procedures for making donations of excess inventory with Charity Link Australia are: • The donor company completes a Product Donation Agreement which contains relevant information about the products being donated, including description, quantity, configuration, timing, inventory location and fair market value of the inventory. • The charity organisation will confirm receipt of the Product Donation Agreement and collect or arrange transfer of the donated inventory. • Charity Link Australia will warehouse the donations until requested by welfare organisations that are qualified and meet the registration criteria. Where possible, the requested donations will be delivered directly to the welfare organisations or the families in need. • Charity Link Australia will provide tax documentation to the donor company in accordance with the Australian Taxation Office requirements and valuations.
4.66
BUILDING BUSINESS SKILLS 4.5
A GLOBAL FOCUS
Woolworths vs. Wal-Mart (a) Woolworths AUS$ (in millions)
Wal-Mart US$ (in millions)
Gross profit rate
12,723 =25.65% 49,595
100,389 =24.78% 405,046
Operating expense sales
10,291 =20.75% 49,595
81,491 =20.12% 405,046
Based on these ratios and assuming consistent accounting policies, it would appear that Woolworths is able to command a higher mark-up than Wal-Mart, but that Wal-Mart is slightly better at controlling its operating costs. It is possible, however, that some of this difference is due to a difference between the two companies in the way that they report expenses, e.g. what one company includes in cost of sales, the other company reports as an operating expense.
(b) Woolworths AUS$ (in millions)
Wal-Mart US$ (in millions)
Return on assets
1,860 =11.36% 16,379
14,848 =8.89% 167,068
Profit margin
1,860 =3.75% 49,595
14,848 = 3.67% 405,046
Woolworths’ return on assets is greater than that of Wal-Mart which indicates it is more efficient in generating profit from its assets. Also, from the data we observe that both companies are comparable in their ability to generate profit from each dollar of sales. (c) Woolworths AUS$ (in millions)
Wal-Mart US$ (in millions)
Current ratio
4,859 =0.76 : 1 6,415
48,331 =0.87 : 1 55,561
Debt to total assets ratio
10,028 =58.7% 17,085
97,777 = 57.28% 170,706
Solutions manual to accompany Accounting: building business skills 4e
Both companies report low current ratios. Both are less than 1. This is not surprising since it is the retail industry which has a quick turnaround of inventory and mostly cash sales, limiting the amount of current assets that they hold. However, further investigation as to the cause would be worthwhile. The debt to total assets ratio of both companies are comparable in the range of 57 – 59%. (d)
Ratios improve our ability to compare these two companies that report financial information using different currencies. However, other factors can still reduce our ability to compare them. As noted in part (a), the two companies might classify items quite differently. Also, different accounting standards in the two countries might result in dramatically different results under the same circumstances. Besides, differences in laws, such as insolvency laws, can affect the results. For example, if Australian insolvency laws favour shareholders more than US insolvency laws, then Australian companies may rely more on debt financing than US companies. Finally, the data for comparison is just one year. It would be more useful to compare the trend over a number of years. (Note to lecturer: Trend analysis is covered in Chapter 12 of the textbook.)
BUILDING BUSINESS SKILLS 4.6
FINANCIAL ANALYSIS ON THE WEB
Answers will vary depending on the company and article chosen by student.
4.68
CRITICAL THINKING BUILDING BUSINESS SKILLS 4.7 GROUP DECISION CASE (a)
(1) Groove Music Store Projected Income Statement for the year ended 30 June 2014
Net sales [$700,000 + ($700,000 x 6%)] Cost of sales ($742,000 x 75%)* Gross profit ($742,000 x 25%)** Operating expenses: Selling expenses Administrative expenses Finance expenses Total operating expenses Profit
$742,000 556,500 185,500
$100,000 20,000 5,000 125,000 $60,500
*75% = ($546,000/700,000) –3%; Alternatively: Net sales $742,000 – gross profit, $185,500 **25% = ($154,000 ÷ $700,000) + 3%
(a)
(2)
Groove Music Store Projected Income Statement for the year ended 30 June 2014
Net sales Cost of sales Gross profit Operating expenses: Selling expenses* Administrative expenses Finance expenses Profit
$700,000 546,000 154,000
$72,000 20,000 5,000
*$100,000 - $30,000 – ($30,000 x 40%) + ($700,000 x 2%) = $72,000
97,000 $57,000
Solutions manual to accompany Accounting: building business skills 4e
(b)
Kathy’s proposed changes will increase profit by $31,500. John’s proposed changes will reduce operating expenses by $28,000 and result in a corresponding increase in profit. Thus, if the choice is between Kathy’s plan and John’s plan, Kathy’s plan should be adopted. While John’s plan will increase profit, it may also have an adverse effect on sales personnel. Under John’s plan, sales personnel will be taking a cut of $16,000 in compensation {$60,000 – ($30,000 + $14,000)}. In some circumstances, a commission may be expected to motivate staff to try to make more sales, although this has been assumed not to be the case for the Groove Music Store.
(c) Groove Music Store Projected Income Statement for the year ended 30 June 2014
Net sales Cost of sales Gross profit
$742,000 556,500 185,500
Operating expenses: Selling expenses* Administrative expenses Finance expenses Profit
$72,840 20,000 5,000
97,840 $87,660
*$72,000 + 2% x ($742,000 - $700,000) = $72,840. If both plans are implemented, profit will be $58,660 ($87,660 - $29,000) higher than the 2012 results. This is an increase of over 200%. (d)
A variety of factors might be presented by the student. For example, increasing the quantity of inventory purchased will increase warehousing and other costs of inventory. It will also increase the risk of holding obsolete or out-of-fashion inventory. Reduced store deliveries may anger customers, especially if competitors provide more frequent service. Staff morale may be affected by the lower salaries which are not fully offset by commissions. Given the size of the increase, John’s plan to compensate sales personnel might be modified so that they would not have to take a pay cut. For example, if sales commissions were 3%, the compensation cut would be reduced to $7,740 [$60,000 – ($30,000 - $742,000 x 3%)]. Cutting salespersons’ salaries and making them more dependent on commissions might actually be viewed favourably by the sales staff if they have the potential to increase their total compensation.
4.70
BUILDING BUSINESS SKILLS 4.8
ETHICS CASE Fine Foods
(a)
Rita Roma, as a new employee, is placed in a position of responsibility and is pressured by her supervisor to continue an unethical practice previously performed by him. The unethical practice is taking undeserved cash discounts. Her dilemma is either follow her boss’ unethical instructions or offend her boss and maybe lose the job she just assumed.
(b)
The stakeholders (affected parties) are: Rita Roma, the assistant accountant Jamie Caterino, the accountant Fine Foods, the company Creditors of Fine Foods (suppliers) Mail room employees (those assigned the blame) The Post Office (also assigned blame).
(c)
Rita’s alternatives: 1.
Tell the accountant (her boss) that she will attempt to take every allowable cash discount by preparing and mailing cheques within the discount period – the ethical thing to do. This will offend her boss and may jeopardise her continued employment.
2.
Join the team and continue the unethical practice of taking undeserved settlement discounts.
3.
Go over her boss’s head and take the chance of receiving just and reasonable treatment from an officer superior to Jamie. The company may not condone this practice. Rita definitely has a choice, but probably not without consequence. To continue the practice is definitely unethical. If Rita submits to this request, she may be asked to perform other unethical tasks. If Rita stands her ground and refuses to participate in this unethical practice, she probably won’t be asked to do other unethical things – if she isn’t fired. Maybe nobody has ever challenged Jamie’s unethical behaviour and his reaction may be one of respect rather than anger and retribution. Being ethically compromised is no way to start a new job.
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 5 – REPORTING AND ANALYSING INVENTORY ASSIGNMENT CLASSIFICATION TABLE
Brief Exercises
Learning Objectives
Exercises
Problems
1.
Record purchases and sales of inventory under a periodic inventory system.
1
1
1A, 7A, 1B, 7B
2.
Determine cost of sales under a periodic inventory system.
2
2, 3
1A, 2A, 7A, 8A, 1B,2B, 7B, 8B
3.
Describe the steps in determining inventory quantities
4
4.
Identify the unique features of the income statement for a merchandising business under a periodic inventory system.
5
1A, 2A, 7A, 8A, 1B, 2B, 7B, 8B
5.
Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system.
6, 7
3A, 4A, 9A, 3B, 4B, 9B
6.
Explain the financial statement effects of each of the inventory cost flow methods
7.
Explain the lower of cost and net realizable value basis of accounting for inventories
4
8
8.
Calculate and interpret inventory turnover.
5
9
9.
Apply the inventory cost flow methods to perpetual inventory records.
6
10
10.
Indicate the effect of inventory errors on the financial statements
7
11
11.
Record the closing entries for merchandising entities
1, 3
3A, 4A, 9A, 3B, 4B, 9B
12, 13
5.2
5A, 10A, 5B, 10B 6A, 12A, 6B, 12B
11A, 11B
Chapter 5: Reporting and analysing inventory
CHAPTER 5 – REPORTING AND ANALYSIS INVENTORY ANSWERS TO QUESTIONS 1. July 24
Accounts Payable ($1,600 - $100) Discount Received ($1,500 x 2%) Cash ($1,500 – $30)
2.
3.
(a)
x = Purchase returns and allowances.
(b)
x = Cost of goods purchased.
(c)
x = Ending inventory.
(a)
(b)
1,500 30 1,470
(1)
The goods will be included in Janine Ltd’s inventory if the terms of sale are FOB destination.
(2)
They will be included in Laura Ltd’s inventory if the terms of sale are FOB shipping point.
Janine Ltd should include goods shipped to a consignee in its inventory. Goods held by Janine Ltd on consignment should not be included in inventory.
4.
The primary basis of accounting for inventories is cost in accordance with the cost principle. The major objective for inventories is the proper determination of profit in accordance with the matching principle.
5.
No. Selection of an inventory costing method is a management decision. However, once a method has been chosen, it should be consistently applied.
6.
(a)
FIFO
(b)
Average cost
(c)
LIFO.
7.
Diva Ltd is using the FIFO method of inventory costing and Dover Ltd is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Diva Ltd will have the lower gross profit because cost of goods will include a higher proportion of goods purchased at earlier (higher) costs.
8.
Lucy should know the following: (a)
A departure from the cost basis of accounting for inventories is justified when the value of the goods is no longer as great as its cost. The write-down to market value should be recognised in the period in which the price decline occurs.
5.1
Solutions manual to accompany Accounting: building business skills 4e
(b)
AASB 102 defines net realisable value as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale (i.e. marketing, selling and distributing to customers).
9.
Disagree. The results under the FIFO method are the same but the results under the LIFO method are different. The reason is that the pool of inventoriable costs (costs of goods available for sale) is not the same. Under a periodic system, the pool of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale.
10.
(a)
Mila Ltd’s 2013 profit will be understated $5,000;
(b)
2014 profit will be overstated $5,000; and
(c)
the combined profit for the two years will be correct.
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5.1
a) Perpetual system, specific identification b) Perpetual system, average cost c) Periodic system, specific identification d) Perpetual system, FIFO e) Periodic system, specific identification BRIEF EXERCISE 5.2 Bass Ltd OPERATING REVENUE Sales revenue: Gross sales revenue
945,000
Less: Sales returns and allowances
-
Net sales revenue
945,000
Cost of sales: Beginning inventory
90,000
Purchases
600,000
Less: Purchase returns and allowances
(28,500)
Net purchases
571,000
Freight-in
24,000
Cost of goods purchased
595,500
Cost of goods available for sale
685,500
Less: Ending inventory
(135,000)
Add:
Cost of sales
550,500
GROSS PROFIT
394500
5.2
Chapter 5: Reporting and analysing inventory
BRIEF EXERCISE 5.3 Quilt Ltd (a)
The ending inventory under FIFO consists of 400 units at $9 for a total allocation of $3,600.
(b)
The ending inventory under LIFO consists of 300 units at $6 + 100 units at $7 for a total allocation of $2,500 ($1,800 + $700).
BRIEF EXERCISE 5.4 Sweet Pea Garden Centre Inventory Categories
Cost
NRV
LCNRV
Native trees Potting mix Garden statues Total valuation
$16,800 12,600 19,600 $49,000
$14,280 13,300 17,920 $45,500
$14,280 12,600 17,920 $44,800
The lower of cost and net realisable value (LCNRV) is $44,800
BRIEF EXERCISE 5.5 Raybando Ltd Inventory turnover ratio:
$86,134 $86,134 = = 2.79 ($26,200 + $35,548 ) 2 $30,874
Days in inventory:
365 = 130 .8 days 2.79
BRIEF EXERCISE 5.6 Spain Department Store 1.
FIFO
June 1 sale: Aug. 27 sale:
30 units @ $10 = 20 units @ $10 = 13 units @ $15 =
5.3
Cost of Sales $300 $200 195
395 $695
Solutions manual to accompany Accounting: building business skills 4e
2.
LIFO June 1 sale: Aug. 27 sale:
3.
30 units @ $10 = 30 units @ $15 = 3 units @ $10 =
Cost of Sales $300 $450 30
480 $780
AVERAGE COST June 1 sale: Aug. 27 sale: *
30 units @ $10 = 33units @ $13* =
Cost of Sales $300 429 $729
[(50 − 30 ) $10] + (30 $15 ) 50 units
BRIEF EXERCISE 5.7 The understatement of ending inventory caused cost of sales to be overstated by $7,000 and gross profit to be understated by $7,000. The correct profit for 2012 is $97,000 ($90,000 + $7,000). Total assets in the balance sheet will be understated by the amount that ending inventory is understated, $7,000.
SOLUTIONS TO EXERCISES EXERCISE 5.1 (a) Hans Ltd (a)
(1)
(2)
(3)
(4)
(5)
(b)
5 April
6 April
7 April
8 April
9 April
4 May
Purchases Accounts Payable Freight-in Cash
18,000 18,000 900 900
Equipment Accounts Payable
26,000
Accounts Payable Purchase Returns and Allowances
3,000
Accounts Payable ($18,000 - $3,000) Discount Received [($18,000 - $3,000) x 2%] Cash ($15,000 - $300)
15,000
Accounts Payable ($18,000 - $3,000) Cash
15,000
5.4
26,000
3,000
300 14,700
15,000
Chapter 5: Reporting and analysing inventory
EXERCISE 5.2 McAlpine Pty Ltd Income Statement (partial) for the year ended 30 June 2013
Beginning inventory 1 July 2012 Purchases Less: Purchase returns and allowances Net purchases Cost of goods available for sale Ending inventory 30 June 2013 Cost of sales
$37,840 $313,280 4,400 308,880 346,720 57,200 $289,520
EXERCISE 5.3 (a) (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (b)
$1,460 $1,570 $1,510 $50 $200 $120 $7,500 $730 $8,940 $5,200 $1,500 $44,330
($1,500 - $40) ($1,460 + $110) ($1,820 - $310) ($1,080 - $1,030) ($1,230 - $1,030) ($1,350 - $1,230) ($290 + $7,210) ($7,940 - $7,210) ($1,000 + $7,940) ($49,530 - $44,330 from (l)) ($43,590 - $42,090) ($42,090 + $2,240)
The purpose of this exercise is to develop the skill to determine the relationship between each component in the calculation of cost of sales.
5.5
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 5.4 Novotna Ltd (a) Ending inventory – physical count 1. No effect – title passes to purchaser upon shipment when terms are FOB shipping point 2.
3.
4.
-
No effect – title does not transfer to Novotna Ltd until goods are received
-
Add to inventory: Title passed to Novotna Ltd when goods were shipped
25,000
Add to inventory: Title remains with Novotna Ltd until purchaser received goods
40,000
5
The goods did not arrive prior to year-end. The goods, therefore, cannot be included in the inventory
6.
The goods should have been written-off under AASB102 by application of the LCNRV rule.
Correct inventory
(b)
$295,000
(44,000)
(50,000) $266,000
It is important for the Bank of Milton to determine the correct amount for inventory before granting a loan to Novotna Ltd because this will help the Bank determine the accuracy of the financial statements. The Bank’s main interest in the financial statements is trying to determine whether Novotna Ltd has the ability to repay the loan. The year end inventory balance of $295,000 is overstated by $29,000. Therefore assets in the statement of financial position are overstated. Cost of sales in the income statement would be understated so the profit would also be overstated.
5.6
Chapter 5: Reporting and analysing inventory
EXERCISE 5.5 Bozic Ltd Income Statement for the month ended 31 January 2013
INCOME Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 January Purchases Less: Purchase returns and allowances Net purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Less: Ending Inventory 31 January Cost of sales GROSS PROFIT
$405,600 16,900 $388,700
54,600 $260,000 11,700 248,300 13,000 261,300 315,900 81,900 234,000 154,700
OPERATING EXPENSES Selling expenses: Freight-out Rent expense – store space Sales salaries expense
9,100 13,000 27,300
49,400
Administrative expenses: Insurance expense Office salaries expense Rent expense – office space
15,600 52,000 13,000
80,600
10,400
10,400
Financial expenses: Discount allowed Total operating expenses PROFIT
140,400 $14,300
5.7
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 5.6 Powder Ltd (a) FIFO Beginning inventory (26 x $97) Purchases: 12 May (45 x $102) 19 May (28 x $104) 22 May (40 x $105) Cost of goods available for sale Less: Ending inventory (*15 x $105) Cost of sales * 15 = 139 – 124
$2,522 $4,590 2,912 4,200
11,702 14,224 1,575 $12,649
PROOF Date 1/5 12/5 19/5 22/5
Units
Unit Cost
Total Cost
26 45 28 25 124
$97 102 104 105
$2,522 4,590 2,912 2,625 $12,649
LIFO Cost of goods available for sale Less: Ending inventory (15 x $97) Cost of sales
$14,224 1,455 $12,769
PROOF Date 26/5 19/5 12/5 1/5
Units
Unit Cost
Total Cost
40 28 45 11 124
$105 104 102 97
$4,200 2,912 4,590 1,067 $12,769
5.8
Chapter 5: Reporting and analysing inventory
(b)
FIFO $1,575 (ending inventory) + $12,649 (Cost of sales) = $14,224 = Cost of goods available for sale. LIFO $1,455 (ending inventory) + $12,769 (Cost of sales) = $14,224 = Cost of goods available for sale. Under both methods, the sum of the ending inventory and Cost of sales equals the same amount, $14,224, which is the cost of goods available for sale.
EXERCISE 5.7 Dakota Pty Ltd (a) 1.
FIFO Beginning inventory (200 x $5) Purchases: 12 June (300 x $6) 23 June (500 x $7) Cost of goods available for sale Less: Ending inventory (180 x $7) Cost of sales
2.
$1,000 $1,800 3,500
5,300 6,300 1,260 $5,040
LIFO Cost of gods available for sale Less: Ending inventory (180 x $5) Cost of sales
3.
$6,300 900 $5,400
AVERAGE COST Cost of Goods Available for Sale $6,300
÷
Total Units Available for Sale 1,000
=
Weighted Average Unit Cost $6.30
Ending inventory (180 x $6.30) $1,134 Cost of sales (820 x $6.30) $5,166 or $6,300 - $1,134 = $5,166
(b)
The FIFO method will produce the highest ending inventory because costs have been rising. Under this method, the earliest costs are assigned to Cost of Sales, and the latest costs remain in ending inventory. The LIFO method will produce the highest Cost of Sales for Dakota Pty Ltd. Under LIFO the most recent costs are charged to Cost of Sales and the earliest costs are included in the ending inventory.
5.9
Solutions manual to accompany Accounting: building business skills 4e
(c)
The average cost ending inventory ($1,134) is higher then LIFO ($900) but lower than FIFO ($1,260). For Cost of Sales, average cost ($5,166) is higher than FIFO ($5,040) but lower than LIFO ($5,400).
(d)
The simple average would be ($5 + $6 + $7)/3 = $6. However, the average cost method uses a weighted average unit cost, not a simple average of unit costs.
EXERCISE 5.8
(a) Ribbons Elite Hair Accessories Pty Ltd Inventory Categories
Cost
NRV
Silk ribbons Gold-plated hair clips Crystal hair jewels Total valuation
$25,200 18,900 29,400 $73,500
$21,420 19,950 26,880 $68,250
The lower of cost and net realisable value is.
$67,200
(b)
LCNRV $21,420 18,900 26,880 $67,200
It is important to account for inventory using the LCNRV basis as this is required by AASB102. No asset should be valued at an amount greater than the economic benefits expected to be received from that asset.
EXERCISE 5.9 CocoColo Ltd 2012 Inventory turnover ratio
2013
2014
$8,452 ($1,051 + $853) 2
$8,525 ($853 + $732) 2
$9,330 ($732 + $1,016) 2
=8.88
=10.76
=10.68
Days in inventory
365 = 41 days 8 .9
365 = 33.8 days 10.8
365 = 34.1 days 10.7
Gross profit ratio
$20,337 − $8,452
= 0.58
$20,917 − $8,525
= 0.59
$22,348 − $9,330
= 0.58 $20,917 $20,337 $22,348 (b) The inventory turnover ratio increased by approximately 20% from 2012 to 2014, while the days in inventory decreased by almost 17% over the same time period. Both of these changes would be considered positive in nature. CocoColo’s gross profit ratio remained relatively unchanged from 2012 to 2014.
5.10
Chapter 5: Reporting and analysing inventory
EXERCISE 5.10 Powder Ltd (a)
FIFO
Date 1/5 5/5 12/5
Purchases
Sales
(12 @ $97) $1,164 (45 @ $102)
$4,590
16/5
(14 @ $97) (36 @ $102) $5,030
19/5
(28 @ $104)
$2,912
26/5
(40 @ $105)
$4,200
29/5
Balance (26 @ $97) $2,522 (14 @ $97) $1,358 (14 @ $97) (45 @ $102) $5,948 (9 @ $102) $918 (9 @ $102) (28 @ $104) $3,830 (9 @ $102) (28 @ $104) (40 @ $105) $8,030
(9 @ $102) (28 @ $104) (25 @ $105) $6,455
(15 @ $105) $1,575
Sales
Balance
LIFO Date 1/5 5/5 12/5
Purchases
(12 @ $97) $1,164 (45 @ $102)
$4,590
16/5
(5 @ $97) (45 @ $102) $5,075
19/5
(28 @ $104)
$2,912
26/5
(40 @ $105)
$4,200
29/5
(22 @ $104) (40 @ $105) $6,488
5.11
(26 @ $97) $2,522 (14 @ $97) $1,358 (14 @ $97) (45 @ $102) $5,948 (9 @ $97) $873 (9 @ $97) (28 @ $104) $3,785 (9 @ $97) (28 @ $104) (40 @ $105) $7,985 (9 @ $97) (6 @ $104) $1,497
Solutions manual to accompany Accounting: building business skills 4e
AVERAGE COST Date 1/5 5/5 12/5 16/5 19/5 22/5 29/5
Purchases
(45 @ $102) (28 @ $104) (40 @ $105)
Sales
Balance
(12 @ $97)
$1,164
(50 @ $100.81)
$5,041*
(62 @ $104.14)
$6,457*
$4,590 $2,912 $4,200
(26 @ $97) (14 @ $97) (59 @ $100.81)a (9 @ $100.81) (37 @ $103.22)b (77 @ $104.14)c (15 @ $104.14)
$2,522 $1,358 $5,948 $907 $3,819 $8,019 $1,562
* Rounded a 5948 ÷ 59 = 100.81 b 3819 ÷ 37 = 103.22 c 8019 ÷ 77 = 104.14 (b) Ending Inventory FIFO Ending Inventory LIFO (c)
Periodic $1,575 $1,455
Perpetual $1,575 $1,497
FIFO yields the same ending inventory value under both periodic and perpetual inventory systems LIFO yields different ending inventory values when using either a periodic or perpetual inventory system.
EXERCISE 5.11 Aruba Pty Ltd (a) 2012 Sales Cost of sales: Beginning inventory Cost of goods purchased Cost of goods available for sale Ending inventory ($40,000 - $6,000) Cost of sales Gross profit
(b)
2013
$210,000 $250,000 32,000 173,000 205,000 34,000 171,000 $39,000
34,000 202,000 236,000 52,000 184,000 $66,000
The cumulative effect on total gross profit for the two years is nil as shown below: Incorrect gross profits: Correct gross profits: Difference:
$45,000 + $60,000 = $39,000 + $66,000 =
5.12
$105,000 105,000 $ -
Chapter 5: Reporting and analysing inventory
(c)
Dear Sir/Madam Because your ending inventory of 30 June 2012 was overstated by $6,000, your gross profit and profit for 2012 was overstated by $6,000 and your gross profit and profit for 2013 was understated by $6,000. In a periodic system, the Cost of Sales is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if ending inventory is overstated as it was in June 2012, the Cost of Sales is understated and therefore profit will be overstated by that amount. This overstated ending inventory figure goes on to become the next period’s beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse. Because the errors over the two year period cancel each other out, at the end of the second year (20113) inventory and retained earnings are correct. Thank you for allowing me to bring this to your attention. If you have any question, please contact me at your convenience. Sincerely,
EXERCISE 5.12 Closing debit and credit accounts to income summary Aruba Pty Ltd General Journal Date 30-6-13
Accounts Sales Ending Inventory Income summary (Closing credit accounts summary) Income summary Beginning Inventory Purchases (Closing debit accounts summary)
Debit Credit 250,000 52,000 302,000 to
income
242,000 40,000 202,000 to
income
EXERCISE 5.13 Aruba Pty Ltd 30 June 2012
Inventory Sales Purchases
Adjusted Trial Balance DR CR 32,000 210,000 173,000
5.13
Closing Entries DR CR 40,000 32,000 210,000 173,000
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 5.1 THE GOLF HOUSE PTY LTD (a) Date
Particulars
Debit
Oct. 5 Purchases Accounts Payable
Credit
3,640 3,640
7 Freight-in Cash
112
9 Accounts Payable Purchase Returns and Allowances
140
112
10 Accounts Receivable Sales
140 1,680 1,680
12 Purchases Accounts Payable
924 924
12 Accounts Payable ($3,640 - $140) Discount Received ($3,500 x 2%) Cash ($3,500 - $70)
3,500
17 Accounts Payable Purchase Returns and Allowances
84
18 Accounts Payable ($924 - $84) Discount Received Cash ($840 - $8)
840
20 Accounts Receivable Sales
70 3,430
84
8 832 1,260 1,260
27 Sales Returns and Allowances Accounts Receivable
42
30 Cash
840
42
Sales
840
30 Cash
1,540 Accounts Receivable
5.14
1,540
Chapter 5: Reporting and analysing inventory
(b) Cash 1/10
Opening Balance
31/10
Sales
30/10
Accounts receivable
3,500 7/10
Freight in
840 12/10
Accounts payable
3,430
1,540 21/10
Accounts payable
832
31/10
Closing Balance
1,506
5,880 1/11
Opening Balance
112
5,880
1,506 Accounts Receivable
10/10
Sales
1,680 27/10
Sales returns
20/10
Sales
1,260 30/10
Cash
42 1,540 1,358
2,940 1/11
Opening Balance
2,940
1,358 Inventory
1/10
Opening Balance
4,900 Accounts Payable
9/10
Purchase returns
140 5/10
Purchases
3,640
12/10
Discounts and cash
3,500 12/10
Purchases
924
17/10
Purchase returns
84
18/10
Discounts and cash
840 4,564
4,564 1/11
Opening Balance
$-
1/10
Opening Balance
8,400
10/10
Accounts Receivable
1,680
20/10
Accounts Receivable
1,260
30/10
Cash
Share Capital
Sales
840 3,780
5.15
Solutions manual to accompany Accounting: building business skills 4e
Sales Returns and Allowances 27/10
Accounts receivable
42 Purchases
5/10
Accounts payable
3,640
12/10
Accounts payable
924 4,564
Purchase Returns and Allowances 9/10
Accounts payable
140
17/10
Accounts payable
84 224
Discount Received 12/10
Accounts payable
70
18/10
Accounts payable
8 78
Freight-in 7/10
Cash
112
(c) The Golf House Pty Ltd Trial Balance as at 31 October 2012 Debit Cash Accounts Receivable Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Purchases Purchase Returns and Allowances Discount Received Freight-in
Credit
$1,506 1,358 4,900 8,400 3,780 42 4,564 224 78 112 $12,482
5.16
$12,482
Chapter 5: Reporting and analysing inventory
(d) Date
Particulars
Debit
Oct 31 Income summary
Credit 9,618
Beginning inventory Sales returns and allowances Purchases Freight inwards (To close various debits amounts to the Income Summary)
Oct 31
Ending inventory Sales Purchases returns and allowances Discount received Income summary (To close various credit accounts to income summary)
(e)
4,900 42 4,564 112
5,880 3,780 224 78 9,962
The Golf House Pty Ltd Income Statement (partial) for the month ended 31 October 2012
Sales revenues: Sales Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 October Purchases Less: Purchase returns and allowances Net purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory 31 October Cost of sales Gross profit
5.17
$3,780 (42) 3,738 4,900 $4,564 (224) 4,340 112 4,452 9,352 (5,880) (3,472) $266
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 5.2 Kiwi Fruit Ltd Income Statement for the year ended 30 November 2013 OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue
1,056,000 11,000 1,045,000
Cost of sales: Beginning inventory 1 December 2012 Purchases Less: Purchase returns and allowances Net Purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Less: Ending inventory 30 November 2013 Cost of sales GROSS PROFIT
39,820 693,000 (3,300) 689,700 5,566 695,266 735,086 (37,796) 697,290 347,710
Other operating revenue: Discount received
7,700
OPERATING EXPENSES Selling expenses: Depreciation expense – store equipment Freight-out Sales commissions expense
10,450 9,020 13,200
32,670
Administrative expenses: Depreciation expense – office equipment Insurance expense Office salaries expense Rates and taxes expense Rent expense – office space Electricity expense
4,400 9,900 154,000 3,850 20,900 22,660
215,710
1,100
1,100
Financial expenses: Bank charges Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
7,700 355,410
249,480 105,930 (31,779) $74,151
5.18
Chapter 5: Reporting and analysing inventory
PROBLEM SET A 5.3 Zoom Around Town Ltd (a)
Cost of Goods available for Sale
Date
Explanation
March 1 5 13 21 26
Beginning inventory Purchase Purchase Purchase Purchase Total
(b)
Units 90 210 330 240 90 960
Unit Cost $70 80 90 100 110
FIFO (1) Date
Ending Inventory Units
March 26 21
Unit Cost
90 60 *150
$110 100
Total Cost $9,900 6,000 $15,900
*960 – 810
(2)
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
$86,700 (15,900) $70,800
Proof of Cost of sales Date March 1 5 13 21
Units
Unit Cost 90 210 330 180 810
$70 80 90 100
5.19
Total Cost $6,300 16,800 29,700 18,000 70,800
Total Cost $6,300 16,800 29,700 24,000 9,900 $86,700
Solutions manual to accompany Accounting: building business skills 4e
LIFO (1) Date
Ending Inventory Units Unit Cost
March 1 5
(2)
90 60 150
$70 80
$6,300 4,800 $11,100
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
Date
Total Cost
$86,700 (11,100) $75,600
Proof of Cost of sales Units Unit Cost
March 26 21 13 5
90 240 330 150 810
$110 100 90 80
Total Cost $9,900 24,000 29,700 12,000 75,600
AVERAGE COST (1)
Ending Inventory
$86,700 ÷ 960 = $90.3 Units Unit Cost 150
(2)
$90.3
(1) (2)
$13,545
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
(c)
Total Cost
$86,700 (13,545) $73,155
As shown in (b) above, FIFO produces the highest inventory amount, $15,900. As shown in (b) above, LIFO produces the highest Cost of sales, $75,600.
5.20
Chapter 5: Reporting and analysing inventory
PROBLEM SET A 5.4 (a)
STAR WEST LTD Comparative Income Statements for the Year Ended 31 December 2013
Sales Cost of sales Beginning inventory Cost of goods purchased Cost of goods available for sale Ending inventory Cost of sales Gross profit Operating expenses Profit before income tax Income tax expense (30%) Profit
FIFO $665,000
LIFO $665,000
35,000 502,000 537,000 153,000a 384,000 281,000 120,000 161,000 48,300 $112,700
35,000 502,000 537,000 135,000b 402,000 263,000 120,000 143,000 42,900 $100,100
a
20,000 x $4.5 + 15,000 x $4.2 = $153,000. $35,000 + (25,000 x $4) = $140,000.
b
(b)
(1)
The FIFO method produces the most meaningful inventory amount for the statement of financial position because the units are costed at the most recent purchases. It can also be argued that FIFO best represents the physical flow of goods for most companies, resulting in an ending inventory figure that is a more faithful representation of reality.
(2)
It is argued that LIFO produces the most meaningful profit because the Cost of Sales is measured with the most recent purchases. Some argue that because LIFO does not approximate physical flow for most companies, Cost of Sales is not a faithful representation of reality, and that this “unreliable” figure cannot be meaningful.
(3)
The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimise spoilage and obsolescence.
(4)
There will be $5,400 additional cash available under LIFO because income taxes are $42,900 under LIFO and $48,300 under FIFO.
(5)
Gross profit under the average cost method will be (a) lower than FIFO and (b) higher than LIFO.
5.21
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 5.5
(a) World Building Products Ltd 2012 Inventory turnover ratio
$306,729.8 0 ($31,465.2 0+$31,738.20 )2
= 9.7 Days in inventory
365 = 37.6 days 9.7
Current ratio
$115,343.8 0 =0.93 : 1 $124,295.6 0
(b)
The inventory turnover ratio indicates the number of times on average that inventory is sold during the period. The average days in inventory indicates the average number of days it takes to sell the inventory.
(c)
Generally it is considered to be better to have a higher inventory turnover or lower number of days in inventory as this means that inventory is selling faster. This is beneficial to the entity as it will have less cash tied up in inventory and there is less chance that the inventory will become obsolete. If the inventory turnover ratio is too high, it may be an indication that the entity may not have enough inventory and may lose customers. Businesses which sell perishable items will generally have higher inventory turnover ratios than businesses which sell non-perishable items.
5.22
Chapter 5: Reporting and analysing inventory
PROBLEM SET A 5.6 Ski Lifts Ltd (a) (1) FIFO Date Purchases 1/7 (5 @ $95) $475 6/7 11/7 (4 @ $106) $424
Sales
14/7 21/7
(3 @ $112)
(3 @ $95)
$285
(2 @ $95)} (1 @ $106)}
$296
$336
27/7
(3 @ $106)} (1 @ $112) $430
Balance (5 @ $95) $475 (2 @ $95) $190 (2 @ $95) (4 @ $106) $614 (3 @ $106) (3 @ $106)} (3 @ $112)}
$318
($2 @ $112)
$224
$654
Ending inventory=$224 (2) AVERAGE COST Date Purchases 1/7 (5 @ $95) $475 6/7 11/7 (4 @ $106) $424 14/7 21/7 (3 @ $112) $336 27/7
Sales (3 @ $95)
$285
(3 @ $102.3) $308 (4 @ $107)
$428
Balance (5 @ $95) $475 (2 @ $95) $190 (6 @ $102)* $614 (3 @ $102) $306 (6 @ $107)** $642 (2 @ $107) $214
*$614 ÷ 6 = $102.3 **$642 ÷ 6 = $107 Ending inventory = $214 (3) LIFO Date Purchases 1/7 (5 @ $95) $475 6/7 11/7 (4 @ $106) $424 14/7 21/7
27/7
(b)
Sales (3 @ $95)
(3 @ $106) (3 @ $112)
$336
(3 @ $112)} (1 @ $106)} Ending inventory=$190
Balance (5 @ $95) $475 $285 (2 @ $95) $190 (2 @ $95)} (4 @ $106)} $614 $318 (2 @ $95)} (1 @ $106)} $296 (2 @ $95)} (1 @ $106)} (3 @ $112)} $632 $442 (2 @ $95)
The highest ending inventory is $224 under the FIFO method.
5.23
$190
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 5.7 Cricket Balls Ltd General Journal (a)
Date
Particulars
Debit
Oct. 4 Purchases Accounts Payable
Credit
1,316 1,316
6 Freight-in Cash
56 56
8 Accounts Receivable Sales
1,260 1,260
10 Accounts Payable Purchase Returns and Allowances
56
11 Purchases Cash
840
56
840
11 Accounts Payable ($1,316 - $56) Discount Received ($1,260 x 3%) Cash ($1,260 - $38)
1,260 38 1,222
14 Purchases Accounts Payable
700
15 Cash
70
700
Purchase Returns and Allowances 17 Freight-in Cash
70 42 42
18 Accounts Receivable Sales
1,120 1,120
20 Cash
700 Accounts Receivable
20 Accounts Payable Discount Received ($700 x 2%) Cash
5.24
700 700 14 686
Chapter 5: Reporting and analysing inventory
Date
Particulars
Debit
27 Sales Returns and Allowances Accounts Receivable
Credit
42 42
30 Accounts Receivable Sales
1,260 1,260
30 Cash
700 Accounts Receivable
700
(b) Cash 1/10
Opening Balance
3,500 6/10
Freight-in
56
15/10
Purchase returns
70 11/10
Purchases
840
20/10
Accounts receivable
700 11/10
Accounts payable
30/10
Accounts receivable
700 17/10
Freight-in
42
20/10
Accounts payable
686
31/10
Closing Balance
2,124
4,970 1/11
Opening Balance
1,222
4,970
2,124
Accounts Receivable 8/10
Sales
1,260 20/10
Cash
700
18/10
Sales
1,120 27/10
Sales returns
42
30/10
Sales
1,260 30/10
Cash
700
31/10
Closing Balance
3,640 1/11
Opening Balance
2,198 3,640
2,198 Inventory
1/10
Opening Balance
2,380 Accounts Payable
10/10
Returns and allowances
11/10
Discounts and cash
20/10
Discounts and cash
56 4/10
Purchases
1,316
1,260 14/10
Purchases
700
700 2,016
5.25
2,016
Solutions manual to accompany Accounting: building business skills 4e
Share Capital 1/10
Opening Balance
5,880
8/10
Accounts receivable
1,260
18/10
Accounts receivable
1,120
30/10
Accounts receivable
1,260
Sales
3,640 Sales Returns and Allowances 27/10
Accounts Receivable
42 Purchases
4/10
Account Payables
1,316
11/10
Cash
840
14/10
Accounts Payable
700 2,856
Purchase Returns and Allowances 10/10
Accounts Payable
56
15/10
Cash
70 126
Discount Received 11/10
Accounts Payable
38
20/10
Accounts Payable
14 52
Freight-in 6/10
Cash
56
17/10
Cash
42 98
5.26
Chapter 5: Reporting and analysing inventory
(c) Cricket Balls Pty Ltd Trial Balance as at 31 October 2013 Debit Cash Accounts Receivable Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Purchases Purchase Returns and Allowances Discount Received Freight-in
Credit
$2,124 2,198 2,380 $5,880 3,640 42 2,856 126 52 98 $9,698
$9,698
(d) Closing entries: Income summary
$5,376 Beginning inventory Sales returns and allowances
Purchases Freight-in (To close various debits amounts to the Income Summary)
Ending inventory $2,520 Sales 3,640 Purchases returns and allowances 126 Discount received 52 Income summary (To close various credit accounts to income summary)
5.27
$2,380 42 2,856 98
$6,338
Solutions manual to accompany Accounting: building business skills 4e
(e) Cricket Balls Pty Ltd Partial Income Statement for the month ended 31 October 2013
Sales revenues: Sales Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 October Purchases Less: Purchase returns and allowances Net purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory 31 October Cost of sales Gross profit
5.28
$3,640 (42) 3,598 2,380 $2,856 (126) 2,730 98 2,828 5,208 2,520 2,688 $910
Chapter 5: Reporting and analysing inventory
PROBLEM SET A 5.8 (a) The Fashion Shop Ltd Income Statement for the year ended 30 June 2014 OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory Purchases Less: Purchase returns and allowances Net Purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Less: Ending inventory Cost of sales GROSS PROFIT
$933,400 10,400 $923,000
97,500 $574,600 (8,320) 566,280 7,280 573,560 671,060 (52,650) 618,410 304,590
Other operating revenue: Discount received
15,600
OPERATING EXPENSES Selling expenses: Sales commissions expense Sales salaries expense Administrative expenses: Depreciation expense – equipment Depreciation expense – building Office salaries expense Rates and taxes expense Insurance expense Electricity expense Financial expenses: Interest expense Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
18,850 98,800
117,650
17,290 13,520 41,600 8,840 9,360 14,300
104,910
2,600
2,600
15,600 320,190
225,160 95,030 (28,509) $66,521
5.29
Solutions manual to accompany Accounting: building business skills 4e
The Fashion Shop Ltd has “purchases” and “purchases returns and allowances” accounts in the adjusted trial balance. These accounts are used by entities that account for inventory using the periodic inventory system. If an entity uses the perpetual inventory system to account for inventory, there will be a “Cost of Sales” ledger account in the trial balance and no “purchases” or “purchase returns and allowances” accounts.
(b)
PROBLEM SET A 5.9 Old Time Show Time Ltd (a)
Cost of Goods available for Sale
Date Oct 1 3 9 19 25
(b)
Explanation
Units
Unit Cost
Beginning inventory Purchase Purchase Purchase Purchase Total
1,100 3,850 4,400 3,300 2,200 14,850
Total Cost
$5 6 7 8 9
$5,500 23,100 30,800 26,400 19,800 $105,600
FIFO (1)
Ending Inventory
Date
Units
Oct. 25 19
Unit Cost
2,200 550 *2,750
Total Cost
$9 8
$19,800 4,400 $24,200
*14,850 – 12,100 (Units available for sale less units sold)
(2)
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
5.30
$105,600 (24,200) $81,400
Chapter 5: Reporting and analysing inventory
Proof of Cost of sales Date
Units Oct. 1 3 9 25
Unit Cost
1,100 3,850 4,400 2,750 12,100
$5 6 7 8
Total Cost $5,500 23,100 30,800 22,000 $81,400
LIFO (1) Ending Inventory Date Units Oct. 1 3
(2)
Unit Cost
1,100 1,650 2,750
$5 6
Total Cost $5,500 9,900 $15,400
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
Proof of Cost of sales Date Units Oct. 25 19 9 3
$105,600 (15,400) $90,200
Unit Cost
2,200 3,300 4,400 2,200 12,100
$9 8 7 6
Total Cost $19,800 26,400 30,800 13,200 90,200
AVERAGE COST (1)
Ending Inventory
$105,600÷ 14,850 = $7.11 Units Unit Cost 2,750
5.31
$7.11
Total Cost $19,553
Solutions manual to accompany Accounting: building business skills 4e
(2)
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
(c)
$105,600 (19,553) $86,047
(1)
FIFO results in the highest inventory amount for the statement of financial position ($24,200).
(2)
LIFO results in the highest Cost of Sales for the income statement ($90,200).
PROBLEM SET A 5.10 Cookie House Ltd 2012 Inventory turnover ratio
$328,942.6 0 ($139,851. 60+$142,257.4 0)2
= 2.3 Days in inventory
365 = 158 .7 days 2.3
Current ratio
$187,663 = 2.32 : 1 $81,019.4
(b) Of the two companies, Cookie House Ltd has the better current ratio: 2.32:1 versus 0.75:1; however, Cookie House’s stronger current ratio is offset by its much lower inventory turnover and days in inventory. Obviously, I would like more information as to why one company has a much lower current ratio and the other a much lower inventory turnover. I would also like to compare these figures to the industry averages.
5.32
Chapter 5: Reporting and analysing inventory
PROBLEM SET A 5.11 (a)
Lee Ltd Perceptual Inventory Method Sales Revenue
$140,250 Income Summary
$140,250
(To close various credit accounts to income summary)
Income Summary
$103,290 Cost of sales Sales returns and allowances
$95,040 8,250
(To close various debit amounts to the Income Summary)
Income Summary
$36,960 Retained Earnings
$36,960
(To close Income Summary to Retained Earnings )
OR one net entry Sales Revenue
$140,250 Cost of sales Sales returns and allowances
$95,040 8,250
Income Summary
36,960
(To close various debit and credit amounts to the Income Summary)
Fung Ltd Periodic Inventory Method Income summary
$131,340 Beginning inventory Sales returns and allowances
$23,100 8,250
Purchases Freight inwards
99,000 990
(To close various debit amounts to the Income Summary)
Ending inventory Sales Purchases returns and allowances Income summary
$26,400 140,250 1,650 $168,300
(To close various credit accounts to income summary)
Income Summary Retained Earnings
$36,960 $36,960
(To close Income Summary to Retained Earnings )
5.33
Solutions manual to accompany Accounting: building business skills 4e
(b) General ledgers Perpetual method Cost of sales, etc. Retained Earnings
Income Summary 103,290 Sales revenue 36,960
140250
$140,250
$140,250
Income Summary 131340 Ending Inventory etc
168,300
Periodic method Beginning Inventory, etc. Retained Earnings
36,960
$168,300
$168,300
5.34
Chapter 5: Reporting and analysing inventory
PROBLEM SET A 5.12 University Office Supplies 6 Sept.
9 Sept.
10 Sept.
12 Sept.
14 Sept.
20 Sept.
Inventory (80 x $20) GST Paid Cash (Purchase 80 calculators @ $22)
1 600 160 1 760
Freight Inwards/Inventory GST Paid Cash (Paid freight )
80 8
Accounts Receivable (2 x $22) Inventory (2 x $20) GST Paid (Returned 2 calculators - credit given)
44
Accounts Receivable (26 x $33) Sales GST Collected Cost of Sales (26 x $20) Inventory (Sold 26 calculators)
858
Sales Returns and Allowances GST Collected Accounts Receivable Inventory Cost of Sales (1 calculator was returned into stock)
30 3
Accounts Receivable (30 x $33) Sales GST Collected Cost of Sales [(5 x $20) + (25 x $20)] * Inventory (Sold 30 calculators to Mega Ltd)
990
88
40 4
780 78 520 520
33 20 20
900 90 600
*Note: University Office Supplies uses the FIFO inventory cost flow assumption, which means that inventory purchased earlier will be sold first. On 1st September, University Office Supplies had 30 calculators on stock @ $20 each. The first 26 calculators were sold to Reader Book Store on 12th September, so there were only 4 calculators left @ $20. But 1 Calculator was returned from Reader Book Store on 14 September. So when University Office Supplies sold 30 calculators to Mega Ltd on 20th September, 5 calculators from old stock @ $20 each were sold first, and the remaining 25 calculators were taken from the new stock purchased on 6th September also @ $20 each.
5.35
600
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 5.1 Murdoch’s Pro Shop Pty Ltd (a) Date
Particulars
Debit
Oct. 5 Purchases Accounts Payable
Credit
2,600 2,600
7 Freight-in Cash
80
9 Accounts Payable Purchase Returns and Allowances
100
80
10 Accounts Receivable Sales
100 1,200 1,200
12 Purchases Accounts Payable
660 660
12 Accounts Payable ($2,600 - $100) Discount Received ($2,500 x 2%) Cash ($2,500 - $50)
2,500
17 Accounts Payable Purchase Returns and Allowances
60
18 Accounts Payable ($660 - $60) Discount Received Cash ($600 - $6)
600
20 Accounts Receivable Sales
900
27 Sales Returns and Allowances Accounts Receivable
30
30
600
50 2,450 60
6 594
900
Cash
30
Sales
600
30 Cash
1,100 Accounts Receivable
1,100
5.36
Chapter 5: Reporting and analysing inventory
(b) Cash 1/10
Opening Balance
2,500 7/10
310/10
Sales
30/10
Accounts Receivable
Freight-in
600 14/10
Accounts Payable
2,450
1,100 18/10
Accounts Payable
594
Closing Balance
1,076
31/10 4,200 1/11
Opening Balance
80
4,200
1,076 Accounts Receivable
10/10
Sales
1,200 27/10
20/10
Sales
900 30/10 31/10
Sales Return Sales Closing Balance
2,100 1/11
Opening Balance
30 1,100 970 2,100
970 Inventory
1/10
Opening Balance
3,500 Accounts Payable
9/10
Purchase returns
100 5/10
Purchases
2,600
12/10
Discounts and cash
2,500 12/10
Purchase
660
17/10
Purchase returns
60
18/10
Discounts and cash
600 3,260
3,260 1/11
Opening Balance
$-
1/10
Opening Balance
6,000
10/10
Accounts Receivable
1,200
20/10
Accounts Receivable
900
30/10
Cash
600
Share Capital
Sales
2,700 Sales Returns and Allowances 27/10
Accounts Receivable
30
5.37
Solutions manual to accompany Accounting: building business skills 4e
Purchases 5/10
Accounts Payable
2,600
12/10
Accounts Payable
660 3,260
Purchase Returns and Allowances 9/10
Accounts Payable
100
17/10
Accounts Payable
60 160
Discount Received 12/10
Accounts Payable
50
18/10
Accounts Payable
6 56
Freight-in 7/10
Cash
80
5.38
Chapter 5: Reporting and analysing inventory
(c) Murdoch’s Pro Shop Pty Ltd Trial Balance as at 31 October 2012 Debit Cash Accounts Receivable Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Purchases Purchase Returns and Allowances Discount Received Freight-in
(d)
Credit
$1,076 970 3,500 $6,000 2,700 30 3,260 160 56 80 $8,916
$8,916
Murdoch’s Pro Shop Pty Ltd Income Statement for the month ended 31 October 2012
Sales revenues: Sales Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 October Purchases Less: Purchase returns and allowances Net purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory 31 October Cost of sales Gross profit
5.39
$2,700 (30) $2,670 3,500 $3,260 (160) 3,100 80 3,180 6,680 4,200 2,480 $190
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 5.2 Best Buy Department Store Income Statement for the year ended 30 November 2013 $ OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 December 2009 Purchases Less: Purchase returns and allowances Net Purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Less: Ending inventory 30 November 2010 Cost of sales GROSS PROFIT
$
960,000 10,000 950,000 34,360 630,000 (3,000) 627,000 5,060 632,060 666,420 (36,200) 630,220 319,780
Other operating revenue: Discount received
7,000
OPERATING EXPENSES Selling expenses: Depreciation expense – store equipment Freight-out Sales commissions expense
9,500 8,200 12,000
29,700
Administrative expenses: Depreciation expense – office equipment Insurance expense Office salaries expense Rates and taxes expense Rent expense – office space Electricity expense
4,000 9,000 140,000 3,500 19,000 20,600
196,100
1,000
1,000
Financial expenses: Bank charges Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
$
7,000 326,780
226,800 99,980 (29,994) $69,986
5.40
Chapter 5: Reporting and analysing inventory
PROBLEM SET B 5.3 Perfect Sail (a)
Cost of Goods available for Sale
Date
Explanation
March 1 5 13 21 26
Beginning inventory Purchase Purchase Purchase Purchase Total
(b)
Units
Unit Cost
150 350 550 400 150 1,600
Total Cost
$70 80 90 100 110
$10,500 28,000 49,500 40,000 16,500 $144,500
FIFO (1)
Ending Inventory
Date
Units
March 26 21
Unit Cost
150 100 *250
$110 100
Total Cost $16,500 10,000 $26,500
*1,600 – 1,350
(2)
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
$144,500 (26,500) $118,000
Proof of Cost of sales Date March 1 5 13 21
Units
Unit Cost
150 350 550 300 1350
5.41
$70 80 90 100
Total Cost $10,500 28,000 49,500 30,000 $118,000
Solutions manual to accompany Accounting: building business skills 4e
LIFO (1) Ending Inventory Date Units March 1 5
(2)
Unit Cost
150 100 250
$70 80
Total Cost $10,500 8,000 $18,500
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
Proof of Cost of sales Date Units March 26 21 13 5
$144,500 (18,500) $126,000
Unit Cost
150 400 550 250 1,350
$110 100 90 80
Total Cost $16,500 40,000 49,500 20,000 $126,000
Average Cost (1)
Ending Inventory
$144,500 ÷ 1,600 = $90.3 Units Unit Cost 250
(2)
(1) (2)
$22,575
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
(c)
$90.3
Total Cost
$144,500 (22,575) $121,925
As shown in (b) above, FIFO produces the highest inventory amount, $26,500. As shown in (b) above, LIFO produces the highest Cost of sales, $126,000.
5.42
Chapter 5: Reporting and analysing inventory
PROBLEM SET B 5.4 (a)
REAL NOVELTY LTD Comparative Income Statements for the Year Ended 31 December 2013
Sales Cost of sales Beginning inventory Cost of goods purchased Cost of goods available for sale Ending inventory Cost of sales Gross profit Operating expenses Profit before income tax Income tax expense (32%) Profit
FIFO $865,000
LIFO $865,000
34,000 578,500 612,500 53,000a 559,500 305,500 147,000 158,500 50,720 $107,780
34,000 578,500 612,500 45,500b 567,000 298,000 147,000 151,000 48,320 $102,680
a
20,000 x $2.65 = $53,000. $34,000 + ($5,000 x $2.30) = $45,500.
b
(b)
(1)
The FIFO method produces the most meaningful inventory amount for the statement of financial position because the units are costed at the most recent purchases. It can also be argued that FIFO best represents the physical flow of goods for most companies, resulting in an ending inventory figure that is a more faithful representation of reality.
(2)
It is argued that LIFO produces the most meaningful profit because the Cost of Sales is measured with the most recent purchases. Some argue that because LIFO does not approximate physical flow for most companies, Cost of Sales is not a faithful representation of reality, and that this “unreliable” figure cannot be meaningful.
(3)
The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimise spoilage and obsolescence.
(4)
There will be $2,400 additional cash available under LIFO because income taxes are $48,320 under LIFO and $50,720 under FIFO.
(5)
Gross profit under the average cost method will be (a) lower than FIFO and (b) higher than LIFO.
5.43
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 5.5 (a) Pacific Motors Ltd 2012 Inventory turnover ratio
$353,919 ($36,306 +$36,621) 2
$353,919 =9.7 $36,463.50
(b)
Days in inventory
365 = 37.6 days 9.7
Current ratio
$133,089 =0.93 : 1 $143,418
A low inventory turnover or high days in inventory is not ideal for shareholders. If there is a low inventory turnover, it generally indicates that sales are slow. It may indicate that too much cash is being tied up in inventory. Nevertheless, inventory turnover needs to be compared with ratios for businesses in a similar industry or with industry averages. Some industries have lower inventory turnover ratios than others due to the nature of the business.
PROBLEM SET B 5.6 Save-Mart Centre (a) (1) FIFO Date Purchases 1/7 (5 @ $90) $450 6/7 11/7 (4 @ $99) $396 14/7 21/7
(3 @ $106)
Sales (3 @ $90)
$270
(2 @ $90)} (1 @ $99)}
$279
$318
27/7
(3 @ $99)} (1 @ $106)} Ending inventory=$212
5.44
$403
Balance (5 @ $90) $450 (2 @ $90) $180 (2 @ $90) (4 @ $99) $576 (3 @ $99) (3 @ $99)} (3 @ $106)}
$297
$2 @ $106)
$212
$615
Chapter 5: Reporting and analysing inventory
(2) AVERAGE COST Date Purchases 1/7 $5 @ $90) $450 6/7 11/7 (4 @ $99) $396 14/7 21/7 (3 @ $106) $318 27/7
Sales (3 @ $90)
$270
(3 @ $96)
$288
(4 @ $101)
$404
Balance (5 @ $90) $450 (2 @ $90) $180 (6 @ $96)* $576 (3 @ $96) $288 (6 @ $101)** $606 (2 @ $101) $202
*$576 ÷ 6 = $96 **$606 ÷ 6 = $101 Ending inventory=$202
(3) LIFO Date Purchases Sales 1/7 (5 @ $90) $450 6/7 (3 @ $90) 11/7 (4 @ $99) $396 14/7 21/7
(3 @ $99) (3 @ $106)
$270
$297
$318
27/7
(3 @ $106)} (1 @ $99)}
$417
Balance (5 @ $90) (2 @ $90) (2 @ $90)} (4 @ $99)} (2 @ $90)} (1 @ $99)} (2 @ $90)} (1 @ $99)} (3 @ $106)} (2 @ $90)
Ending inventory=$180 (b)
The highest ending inventory is $212 under the FIFO method.
5.45
$450 $180 $576 $279
$597 $180
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 5.7 Kicked-Back Tennis Shop Pty Ltd General Journal (a) Date
Particulars
Debit
Oct. 4 Purchases Accounts Payable (Terms 3/7, n/30)
Credit
940 940
6 Freight-in Cash
40 40
8 Accounts Receivable Sales
900
10 Accounts Payable Purchase Returns and Allowances
40
11 Purchases Cash
600
11 Accounts Payable ($940 - $40) Discount Received ($900 x 3%) Cash ($900 - $27)
900
14 Purchases Accounts Payable (Terms 2/7, n/60)
500
15 Cash
50
900
40
600
27 873
500
Purchase Returns and Allowances
50
17 Freight-in Cash
30
18 Accounts Receivable Sales
800
20 Cash
500
30
800
Accounts Receivable
500
20 Accounts Payable Discount Received ($500 x 2%) Cash
5.46
500 10 490
Chapter 5: Reporting and analysing inventory
27 Sales Returns and Allowances Accounts Receivable
30
30 Accounts Receivable Sales
900
30 Cash
500
30
900
Accounts Receivable
500
(b) Cash 1/10
Opening Balance
2,500 6/10
Freight-in
40
15/10
Purchase returns
50 11/10
Purchases
600
20/10
Accounts Receivable
500 11/10
Accounts Payable
873
30/10
Accounts Receivable
500 17/10
Freight-in
30
20/10
Accounts Payable
490
31/10
Closing Balance
1,517
3,550 1/11
Opening Balance
3,550
1,517 Accounts Receivable
8/10
Sales
900 20/10
Cash
500
18/10
Sales
800 27/10
Sales Returns
30
30/10
Sales
900 30/10
Cash
500
Closing Balance
1,570
31/10 2,600 1/11
Opening Balance
2,600
1,570 Inventory
1/10
Opening Balance
1,700 Accounts Payable
10/10
Purchase Returns
40 4/10
Purchases
940
11/10
Discounts Received & Cash
900 14/10
Purchases
500
20/10
Discounts Received & Cash
500 1,440
1,440
5.47
Solutions manual to accompany Accounting: building business skills 4e
Share Capital 1/10
Opening Balance
4,200
8/10
Accounts Receivable
900
18/10
Accounts Receivable
800
30/10
Accounts Receivable
900
Sales
2,600 Sales Returns and Allowances 27/10
Accounts Receivable
30
Purchases 4/10
Accounts Payable
940
11/10
Cash
600
14/10
Accounts Payable
500 2,040
Purchase Returns and Allowances 10/10
Accounts Payable
40
15/10
Cash
50 90
Discount Received 11/10
Accounts Payable
27
20/10
Accounts Payable
10 37
Freight-in 6/10
Cash
40
17/10
Cash
30 70
5.48
Chapter 5: Reporting and analysing inventory
(c) Kicked-Back Tennis Shop Pty Ltd Trial Balance as at 31 October 2013 Debit Cash Accounts Receivable Inventory Accounts Payable Share Capital Sales Sales Returns and Allowances Purchases Purchase Returns and Allowances Discount Received Freight-in
Credit
$1,517 1,570 1,700 $4,200 2,600 30 2,040 90 37 70 $6,927
$6,927
(d) Closing entries: Income summary
3,840 Beginning inventory Sales returns and allowances
Purchases Freight inwards (To close various debits amounts to the Income Summary) Ending inventory 1,800 Sales 2,600 Purchases returns and allowances 90 Discount received 37 Income summary (To close various credit accounts to income summary)
5.49
1,700 30 2,040 70
4,527
Solutions manual to accompany Accounting: building business skills 4e
(e) Kicked-Back Tennis Shop Pty Ltd Partial Income Statement for the month ended 31 October 2013
Sales revenues: Sales Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 October Purchases Less: Purchase returns and allowances Net purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory 31 October Cost of sales Gross profit
5.50
$2,600 (30) $2,570 1,700 $2,040 (90) 1,950 70 2,020 3,720 1,800 1,920 $650
Chapter 5: Reporting and analysing inventory
PROBLEM SET B 5.8 High-Point Ltd Income Statement for the year ended 30 June 2014 $ OPERATING REVENUE Sales revenue: Gross sales revenue Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory 1 July 2013 Purchases Less: Purchase returns and allowances Net Purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale Less: Ending inventory 30 June 2014 Cost of sales GROSS PROFIT
$
718,000 (8,000) 710,000
40,500 442,000 (6,400) 435,600 5,600 441,200 481,700 (75,000) 406,700 303,300
Other operating revenue: Discount received
12,000
OPERATING EXPENSES Selling expenses: Sales salaries expense Sales commissions expense Administrative expenses: Depreciation expense – equipment Depreciation expense – building Office salaries expense Rates and taxes expense Insurance expense Electricity expense Financial expenses: Interest expense Total operating expenses PROFIT BEFORE INCOME TAX Less: Income tax expense PROFIT AFTER INCOME TAX
$
76,000 14,500
90,500
13,300 10,400 32,000 6,800 7,200 11,000
80,700
2,000
2,000
12,000 315,300
173,200 142,100 (42,630) $99,470
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PROBLEM SET B 5.9 Downunder Distribution (a)
Cost of Goods available for Sale
Date
Explanation
Oct 1 3 9 19 25
(b)
Units
Beginning inventory Purchase Purchase Purchase Purchase Total
1,000 3,500 4,000 3,000 2,000 13,500
Unit Cost
Total Cost
$5 6 7 8 9
$5,000 21,000 28,000 24,000 18,000 $96,000
FIFO (1)
Ending Inventory
Date
Units
Oct. 25 19
Unit Cost
2,000 500 *2,500
$9 8
Total Cost $18,000 4,000 $22,000
*13,500 – 11,000
(2)
Cost of Sales
Cost of goods available for sale Less: Ending inventory Cost of sales
$96,000 (22,000) $74,000
Proof of Cost of Sales Date
Units Oct. 1 3 9 25
Unit Cost
1,000 3,500 4,000 2,500 11,000
5.52
$5 6 7 8
Total Cost $5,000 21,000 28,000 20,000 $74,000
Chapter 5: Reporting and analysing inventory
LIFO (1) Ending Inventory Date Units Oct. 1 3
(2)
Unit Cost
1,000 1,500 2,500
$5 6
Total Cost $5,000 9,000 $14,000
Cost of Sales
Cost of goods available for sale Less: Ending inventory Cost of sales
$96,000 (14,000) $82,000
Proof of Cost of Sales Date
Units
Oct. 25 19 9 3
Unit Cost
2,000 3,000 4,000 2,000 11,000
$9 8 7 6
Total Cost $18,000 24,000 28,000 12,000 $82,000
AVERAGE COST (1)
Ending Inventory
$96,000÷ 13,500 = $7.11 Units Unit Cost 2,500
(2)
(1) (2)
$17,775
Cost of sales
Cost of goods available for sale Less: Ending inventory Cost of sales
(c)
$7.11
Total Cost
$96,000 (17,775) $78,225
FIFO results in the highest inventory amount for the statement of financial performance, $22,000. LIFO results in the highest Cost of sales, $82,000.
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PROBLEM SET B 5.10 (a) Make-it-Grow Ltd 2012 Inventory turnover ratio
$234,959 ($99,894 + $101,751) 2
$234,959 = 2.3 $100,822 .5
(b)
Days in inventory
365 = 158 .7 days 2.3
Current ratio
$134,045 = 2.32 : 1 $57,871
Of the two companies, Make-it-Grow has the better current ratio: 2.32:1 versus 0.8:1; however, Make-it-Grow’s stronger current ratio is offset by its much lower inventory turnover and days in inventory. Obviously, I would like more information as to why one company has a much lower current ratio and the other a much lower inventory turnover. I would also like to compare these figures to the industry averages.
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Chapter 5: Reporting and analysing inventory
PROBLEM SET B 5.11 (a)
Jones Ltd Perceptual Inventory Method Sales Revenue
93,500 Income Summary
93,500
(To close various credit accounts to income summary)
Income Summary
68,860 Cost Of Sales Sales Returns and Allowances
63,360 5,500
(To close various debit amounts to the Income Summary)
Income Summary
24,640 Retained Earnings
24,640
(To close Income Summary to Retained Earnings )
OR one net entry Sales Revenue
93,500 Cost Of Sales Sales Returns and Allowances
63,360 5,500
Income Summary
24,640
(To close various debit and credit amounts to the Income Summary)
Brown Ltd Periodic Inventory Method Income summary
87,560 Beginning inventory Sales returns and allowances
15,400 5,500
Purchases Freight inwards
66,000 660
(To close various debit amounts to the Income Summary)
Ending inventory Sales Purchases returns and allowances Income summary
17,600 93,500 1,100 112,200
(To close various credit accounts to income summary)
Income Summary Retained Earnings
24,640 24,640
(To close Income Summary to Retained Earnings )
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(b) General ledgers Perpetual method Cost of Sales, etc. Retained Earnings
Income Summary 68,860 Sales revenue 24,640
93,500
93,500
93,500
Periodic method Income Summary Beginning Inventory, etc. 87,560 Ending Inventory etc Retained Earnings
112,200
24,640
112,200
112,200
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Chapter 5: Reporting and analysing inventory
PROBLEM SET B 5.12
Thompson Office Supplies 6 Sept.
9 Sept.
10 Sept.
12 Sept.
14 Sept.
20 Sept.
Inventory (120 x $29*) GST Paid (120 x $3) Cash (Purchase 120 USB @ $32)
$3 480 360
Freight Inwards/Inventory GST Paid Cash (Paid freight )
120 12
Accounts Receivable (2 x $32) Inventory (2 x $29) GST Paid (Returned 2 USB - credit given)
64
Accounts Receivable (39 x $43) Sales GST Collected Cost of Sales (39 x $30) Inventory (Sold 39 USB)
1 677
Sales Returns and Allowances GST Collected Accounts Receivable Inventory Cost of Sales (1 USB was returned into stock)
39 4
Accounts Receivable (45 x $43) Sales GST Collected Cost of Sales [(7 x $30) + (38 x $29)] * Inventory (Sold 45 USB)
$3 840
132
58 6
1 521 156 1 170 1 170
43 30 30 1 935 1 755 180 1 312
*Rounding to the nearest dollar **Note: Thompson Office Supplies uses the FIFO inventory cost flow assumption, which means that inventory purchased earlier will be sold first. On 1st September, Thompson Office Supplies had 45 USB on stock @ $30 each. The first 39 USB were sold to Sunny Store on 12th September, so there were 6 USB left @ $20. But 1 USB was returned from Sunny Store on 14th September. When Thompson Office Supplies sold 45 USB to Martins Ltd on 20th September, 7 USB from old stock @ $30 each were sold first, and the remaining 38 were taken from the new stock purchased on 6th September @ $29 each.
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BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 5.1
FINANCIAL REPORTING PROBLEM
Domino Pizza Enterprises Ltd (Note: All dollar amounts are in thousands) (a)
Inventories were $3,537 as at 4 July 2010.
(b)
Inventories decreased $61 in 2010. Using 2009 as the base year, the decrease was approximately 1.7%. In 2010, inventories were 7.2% of current assets ($3,537 ÷ $48,959).
BUILDING BUSINESS SKILLS 5.2
COMPARATIVE ANALYSIS PROBLEM
Coca-Cola Amatil Ltd vs. Pepsio (a) Coca-Cola Amatil Ltd (A$ in millions) 1.
Inventory turnover
Pepsio (US$ in millions)
$2,419 ($413 +$387) 2
$20,099 ($1,125 +$1,179) 2
= 6.05 times
=17.45times
365 =60 days 6.05
365 =21 days 17.45
2.
Days in inventory
(b)
Pepsico turns over its inventory at approximately three times the rate of CocaCola Amatil. Generally companies that are able to keep their inventory at lower levels and higher turnovers and still satisfy customer needs are the most successful. Note: In figure 5.18 the inventory ratios for Fantastic Holdings and Nick Scali are somewhat lower that Coca-Cola Amatil and Pepsico. Coca-Cola Amatil and Pepsico sell short shelf life items – beverages – so the turnover would be expected to be higher.
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Chapter 5: Reporting and analysing inventory
BUILDING BUSINESS SKILLS 5.3
A GLOBAL FOCUS AND INTERPRETING FINANCIAL STATEMENTS
Nike & Adidas (a)
Both companies have international sales: thus, they must move their goods around the world. Styles/fashions are often cultural so what sells in one country may not in another. Because trends/fashion in their industry change quickly, both must manage inventory carefully. If a trend/fashion is really popular, a company must make sure it has enough inventory before people’s interest in the product fades. But it doesn’t want to “get stuck” with a lot of excess inventory. The best approach is to have very efficient inventory production and distribution systems that allow a company to respond to changes in demand very quickly.
(b)
Nike’s inventories are stated at lower of cost or market and valued using FIFO or moving average cost basis. Adidas’ merchandise and finished goods are valued at the lower of cost or net realisable value. Costs are determined using a standard valuation method which is the average cost method.
(c)
The format used by Adidas is the approach used by manufacturers. It allows the financial statement reader to see how much inventory is in each stage of production of inventory. This can be useful. For example, if the company is planning to increase production, we would expect to see raw materials increase, or if it is planning a slow-down, we would expect to see raw materials decline. Both Nike and Adidas use other companies to do much of their production (as evidenced by the minor amounts of raw materials and work-in-progress reported by Nike and by the fact that Adidas reports that ‘substantially all’ of its inventory is finished goods. Thus, in this case, it is not surprising that Adidas did not provide this information, and it probably was not necessary that Nike did.
(d) Nike
Adidas
$10,213.6/(($2,357 + $2,040.8) ÷ 2) = 4.64 times 365 ÷ 4.64 = 79 days
$6,260/(($1,471 + $2,119) ÷ 2) = 3.49 times 365 ÷ 3.49= 105 days
Adidas’s inventory turnover is lower (and days in inventory is higher) than that of Nike, suggesting that Nike is slightly more efficient in its use of inventory.
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BUILDING BUSINESS SKILLS 5.4
FINANCIAL ANALYSIS ON THE WEB
JB Hi-Fi’s Ltd (Note: All dollar amounts are in thousands) The following responses are based on the 2010 Consolidated figures in the annual report. (a)
Inventories: $334,754 as at 30 June 2010. Cost of sales for the year: $2,137,146.
(b)
Inventories are stated at the lower of cost and net realisable value. Net realisable value represents the estimated selling price less all estimated costs necessary to make the sale.
(c)
Inventories to total assets ratio: $334,754/$714,322 = 46.86%
(d)
Inventory turnover ratio: 2,137,146/((334,754+324,519/2) = 6.48 times Days in inventory = 365 / 6.48 = 56 days JB Hi-Fi’s inventory turnover is much higher than that of Fantastic Holdings and Nick Scali, suggesting that JB Hi-Fi’s is able to manage its inventory more efficiently than Fantastic Holdings and Nick Scali.
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Chapter 5: Reporting and analysing inventory
CRITICAL THINKING BUILDING BUSINESS SKILLS 5.5
GROUP DECISION CASE
ChemCo International Ltd (a)
The items owned by ChemCo on 30 June would be those purchased and to whom ownership had already passed, as well as those items sold but from which ownership had not yet passed. These would include items described in parts 1, 5 and 7. For item 8, it is not possible to determine ownership as the shipping date is not given in the question and this information is critical.
(b)
The transactions that involve ChemCo’s inventory account on or before 30 June 2013 would be items described in 3 and 5. The transactions that involve ChemCo’s inventory account after 30 June 2013 would be items described in 2 and 7. Note: Items that are inventory would be those items related to ChemCo’s final products (chemicals, airbags and salt). The receipt of office supplies or steel for building are therefore not inventory.
BUILDING BUSINESS SKILLS 5.6
COMMUNICATION ACTIVITY
City Jeans Ltd To:
Su Lee, Managing Director
From:
Accountant
Subject:
2012 Ending Inventory Error
As you know, the 2012 ending inventory figure was overstated by $1 million. This error will cause the 2012 profit figure to be incorrect because the ending inventory is used to calculate the 2012 Cost of Sales. Since the ending inventory is subtracted in the calculation of Cost of Sales, an overstatement of ending inventory results in an understatement of Cost of Sales and therefore an overstatement of profit. Unfortunately, unless corrected, this error will also affect 2013 profit. The 2012 ending inventory is also the 2013 beginning inventory. Therefore, 2013 beginning inventory is also overstated, which causes an overstatement of Cost of Sales and an understatement of 2013 profit.
5.61
CHAPTER 6– INVENTORIES ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1.
Identify the differences between a service business and a merchandising business.
2.
Explain the recording of purchases under a perpetual inventory system.
2
2,4,5,6
1A,2A,4A, 7A 1B, 2B,4B, 7B
3.
Explain the recording of sales revenue under a perpetual inventory system.
2,3
1,2,3,4
1A, 2A, 4A, 7A, 1B, 2B, 4B, 7B
4.
Prepare a fully classified statement of financial performance.
1,4,5
7,8,9,10
1A, 3A, 4A, 5A, 6A, 7A 1B, 3B, 4B, 5B, 6B, 7B
5.
Use ratios to analyse profitability.
6
7,8,9
1A, 3A, 7A 1B, 3B, 7B
6.
Understand the basic process and main features of the goods and services tax (GST).
7.
Complete journal entries to record GST.
7,8
11,12,13
8A, 8B
CHAPTER 6 – ACCOUNTING SUBSYSTEMS ANSWERS TO QUESTIONS 1.
2.
(a)
An accounting information system involves collecting and processing data and disseminating financial information.
(b)
Disagree. An accounting information system applies regardless of whether manual or computerised procedures are used to process the transaction data.
There are four phases when developing an accounting information system: Analysis First determine the information needs of internal and external users. Then a system analyst identifies the sources of the required information and the records and procedures for collecting and reporting the data (if an existing system is being analysed - its strengths and weaknesses must be identified). Design In this phase forms and documents designed, methods and procedures selected, job descriptions prepared, controls integrated, reports formatted and equipment selected. (Redesigning an existing system may require minor modification or a major overhaul). Implementation Requires that documents, procedures and processing equipment be installed and made operational. Personnel must be trained in the start up period. Follow-up Once the system is up and running it must be monitored for weaknesses or breakdowns. Effectiveness should be compared with design and organisational objectives. Changes in design or implementation may be necessary.
3.
A subsidiary ledger is a group of accounts with a common characteristic. The accounts are assembled to facilitate the accounting process by freeing the general ledger from details concerning individual balances. The advantages of using subsidiary ledgers are that they: ▪
▪
▪ ▪
Permit transactions affecting a single customer or single creditor to be shown in a single account, thus providing necessary up-to-date information on specific account balances. Free the general ledger of excessive details relating to inventory, accounts receivable and accounts payable. As a result, a trial balance of the general ledger does not contain potentially thousands of individual account balances. Assist in locating errors in individual accounts by reducing the number of accounts combined in one ledger and by using control accounts. Permit a division of labour in posting by having one employee post to the general ledger and a different employee(s) post to the subsidiary ledgers.
4.
(a)
(1)
Individual transactions are generally posted daily to the subsidiary ledger.
(2) (b)
5.
In contrast, postings to the control accounts are usually made in total at the end of the month.
A control account is a general ledger account that summarises subsidiary ledger data. Subsidiary ledger accounts keep track of specific account activity (i.e. specific debtors or creditors). A subsidiary ledger is outside the general ledger and is not used in the trial balance. The control account provides the same information as the subsidiary ledger – only in summary.
Sales journal: Cash receipts journal: Purchases journal: Cash payments journal:
Records entries for all sales of inventory on account. Records entries for all cash received by the business. Records entries for all purchases of inventory on account. Records entries for all cash paid.
Some advantages of each journal are given below: Sales Journal (1) Since the sales journal employs only one column to record an Accounts Receivable debit and a Sales credit, its use reduces recording time; (2) The credit to Sales is only posted once an accounting period; and (3) The journal’s use allows for dividing responsibilities between employees. Cash Receipts Journal (1) Its use aids in the posting process since the totals for Cash, Discount Allowed, Accounts Receivable, and Sales are all recorded in the general ledger only at the end of the month; and (2) It allows all accounts receivable credits to be posted to the appropriate subsidiary ledger accounts daily. Purchases Journal The advantages are similar to those of the sales journal except that items involved are Inventory debits and Accounts Payable credits. Cash Payments Journal Similar advantages to cash receipts journal except the columns involved are different. In general, special journals: (1) Allow greater division of labour because various individuals can record entries in different journals at the same time; and (2) Reduce posting time of journals because only column totals are posted to the general ledger. 6.
At the end of the month, after all posting to both the general ledger and the subsidiary ledger accounts have been made, a total of a subsidiary ledger account balances should equal the balance of the control account in the general ledger. In this case, the control account balance will be $450 larger than the total of the subsidiary accounts. The difference would be investigated by checking the postings made to the control account and subsidiary ledger accounts and the error would be discovered.
7.
(a)
(b)
No, the customers’ ledger (accounts receivable subsidiary ledger) will not agree with the Accounts Receivable control account. The customers’ ledger will be posted correctly, but the Accounts Receivable control account will be incorrect. The trial balance totals will be agreed and the trial balance will balance. However, the balance in the Cash and Accounts Receivable control accounts will be incorrect due to the addition error.
8.
(a) (b) (c)
General journal General journal Cash receipts journal
(d) (e) (f)
Sales journal Cash receipts journal General journal
9.
One such example is a purchase return. Here the accounts payable control and subsidiary ledger account must be debited for the same amount. The debit/credit equality is unaffected since the trial balance is prepared using general ledger (control) accounts only. The total of the subsidiary ledger accounts should be equal to the related control account balance.
10.
The general journal may be used to record such transactions as the granting of credit to a customer for a sales return or allowance or the receipt of credit from a supplier for purchases returned. In addition, all correcting, adjusting and closing entries should be made in the general journal.
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6.1 (a) (b) (c)
True False True
BRIEF EXERCISE 6.2 (a) (b) (c) (d)
Analysis Follow-up Design Implementation
BRIEF EXERCISE 6.3 (a) (b) (c) (d)
General ledger Subsidiary ledger General ledger Subsidiary ledger
BRIEF EXERCISE 6.4 (a) (b) (c) (d) (e) (f)
Cash receipts journal Cash payments journal Cash payments journal Sales journal Purchases journal Cash receipts journal
BRIEF EXERCISE 6.5 (a) (b) (c) (d)
No Yes Yes No
BRIEF EXERCISE 6.6 (a) (b) (c) (d)
Both in total and daily In total In total Only daily (Note: They can also be individually posted at the end of the month.)
BRIEF EXERCISE 6.7 (a) (b) (c) (d) (e)
Cash receipts journal Cash receipts journal Cash receipts journal Sales journal or cash receipts journal Purchases journal or cash payments journal.
SOLUTIONS TO EXERCISES EXERCISE 6.1 Sabino Ltd (a)
$523,300. Beginning balance of $400,000 plus $250,300 debit from sales journal less $127,000 credit from cash receipts journal.
(b)
$96,860. Beginning balance of $90,000 plus $54,360 credit from purchases journal less $47,500 debit from cash payments journal.
(c)
The column total of $250,300 in the sales journal would be posted to the credit side of the Sales account and the debit side of the Accounts Receivable account in the general ledger.
(d)
The accounts receivable column total of $127,000 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger.
EXERCISE 6.2 Nikolic Ltd (a) & (b) General Ledger Accounts Receivable Control Date Explanation Sept. 1 30 30 30
Balance Credit sales Cash Sales Allowance
Ref.
S1 CR1 G1
Debit
Credit
4,280 7,060 220
Balance 11,960 16,240 9,180 8,960
Accounts Receivable Subsidiary Ledger Edmonds Date Explanation Sept. 1 Balance 30 Credit sales 30 Cash
Lee Date
Explanation
Sept. 1 Balance 30 Cash
Roemer Date Explanation Sept. 1 Balance 30 Credit sales 30 Cash
Schulz Date
Explanation
Sept. 1 30 30 30
Balance Credit sales Cash Sales Allowance
Henry
Ref.
S1 CR1
Ref.
Debit
1,350 1,240
Debit
CR1
Ref.
S1 CR1
Ref.
S1 CR1 G1
Credit
Credit
1,800
Debit
Credit
1,100 1,310
Debit
Credit
800 2,300 220
Balance 2,440 3,790 2,550
Balance 2,640 840
Balance 2,060 3,160 1,850
Balance 4,820 5,620 3,320 3,100
Date
Explanation
Sept. 30 Credit sales 30 Cash
Ref.
Debit
S1 CR1
Credit
1,030 410
Balance 1,030 620
Note: Henry is a new customer so another subsidiary ledger account has been added. (c) Nikolic Ltd Schedule of Accounts Receivable as at 30 September 2013
(d)
Edmonds Lee Roemer Schulz Henry Total
$2,550 840 1,850 3,100 620 $8,960
Accounts Receivable control account balance 30/9/10
$8,960
The subsidiary ledger accounts contain the detail of the totals posted to the control account; therefore the totals of subsidiary ledger and the control accounts must agree. If the balance of the control account and the schedule do not agree, then this indicates that an error has be made which must be corrected before proceeding any further with the accounting process.
EXERCISE 6.3 Kidman Ltd (a) & (b) Sales Journal
Date Account Debited 2005 Sept. 2 R Crow 21 Buffy Ltd
Invoice No.
Ref.
101 102
√ √
Accounts Receivable Dr. Sales Cr.
Cost of Sales Dr. Inventory Cr.
480 800 1,280
300 480 780
Kidman Ltd Purchases Journal
Date Account Credited 2005 Sept. 10 L Dayne 25 F Sage
Terms
Ref.
2/7, n/30 n/30
√ √
P1 Inventory Dr. Accounts Payable Cr. 600 900 1,500
(c) A multicolumn purchases journal enables purchases on credit other than inventory to be recorded in the purchases journal rather than the general journal.
EXERCISE 6.4 Pena Pipes (a) & (b) Cash Receipts Journal CR1 Date
Account Credited
2013 May 1 R Pena, Cap. 2 22 R Dusto
Cash Dr Ref
Discount Allowed Dr
Accounts Receivable Cr
Sales Cr
Other Accounts Cr
60,000
√
6,000 9,000 75,000
Cost of Sales Dr Inventory Cr
60,000 6,000 9,000 9,000
6,000
4,200 60,000
4,200
Pena Pipes Cash Payments Journal CP1 Account
Other
Accounts
Discount
Cash
Date
Ch. No.
2013 May 3 14
101 102
Debited
Inventory Salary Expense
Ref.
Accounts Dr
Payable Dr
Received Cr
Cr
9,000 700
9,000 700
9,700
9,700
EXERCISE 6.5 Abbott Hardware
1. 2.
(a) Journal Cash Payments Cash Receipts
3. 4.
Cash Payments Cash Payments
5. 6. 7. 8. 9. 10.
Cash Receipts Cash Payments Cash Payments Cash Receipts Cash Payments Cash Receipts
(b) Columns in the journal Other Accounts (Dr); Cash (Cr). Cash (Dr); Discount Allowed (Dr); and Accounts Receivable (Cr). Inventory (Dr); Cash (Cr). Accounts Payable (Dr); Cash (Cr); and Discount Received (Cr). Cash (Dr); Accounts Receivable (Cr)’ Other Accounts (Dr); Cash (Cr). Other Accounts (Dr); Cash (Cr). Cash (Dr); Other Accounts (Cr). Other Accounts (Dr); Cash (Cr). Cash (Dr); Sales (Cr); Cost of Sales (Dr); and Inventory (Cr)
EXERCISE 6.6 Opera House Ltd (a) Date Account Titles and Explanation Mar. 2 Equipment Accounts Payable – Harbour Ltd (Purchased equipment on account)
Debit 6,000
6,000
5 Accounts Payable – Boat & Co. Inventory (Received a credit note for inventory damaged in shipment)
300
7 Sales Returns and Allowances Accounts Receivable – Luna Ltd
400
Inventory Cost of Sales (Issued a credit note for inventory returned)
(b)
Credit
300
400 260 260
Memorandum
To:
Managing Director
From:
Accountant
Subject:
Posting to Control Accounts and Subsidiary Ledger Accounts
The posting to control and subsidiary ledger accounts varies with the journals used for recording the transactions. Single column sales and purchases journals – the total for the month is posted to the accounts receivable and accounts payable control accounts respectively. The individual entries are posted daily to the subsidiary accounts. Multicolumn cash receipts and cash payments journals – the total of the control account column for the month is posted to the control account. The individual amounts in the column are posted daily to the subsidiary accounts. General journal – the individual debit and credit entries are posted daily or at the end of the month. Each entry that pertains to a control and a subsidiary account is dual-posted. That is, it is posted to both the control account and the subsidiary ledger account. I hope this memo answers your questions about posting.
EXERCISE 6.7 Poullos Printworks 1. 2. 3. 4. 5. 6. 7.
Cash Payments Journal General Journal Cash Receipts Journal Cash Receipts Journal Sales Journal Cash Receipts Journal General Journal
8. 9. 10. 11. 12. 13.
Cash Receipts Journal Cash Payments Journal General Journal General Journal Cash Payments Journal Purchases Journal
EXERCISE 6.8 Williams Ltd (a)
The debit posting reference on 28 February should be from the cash payments journal (CP) to record the payments made during the month. The missing general ledger debit amount should be $29,500 to balance. Wang’s ending balance must be $3,240. (Accounts Payable control balance of $9,840 less Sealy, $4,600, and Gates, $2,000.)
(b)
All amounts posted in total to the control account are also posted in detail in the accounts payable subsidiary ledger account. This system ensures that the total of the subsidiary ledger accounts will equal the total in the corresponding control account.
EXERCISE 6.9 Lappa Ltd
(a) Purchases Journal
Date July 3 12 14 17 20 21 29
Account Credited
Ref
Benton Ltd Emerick Ltd Dunlap Ltd Comerica Materials Benton Ltd Emerick Ltd Comerica Materials
√ √ √ √ √ √ √
P10 Inventory Dr Accounts Payable Cr 2,000 500 1,100 1,400 700 600 2,100 8,400 120/201
(b) General Journal Date
(c)
Account Titles and Explanations
Ref.
Debit
July 1 Store Equipment Accounts Payable – Alou Equipment Ltd (Purchase of store equipment on account)
153 201/√
3,600
15 Inventory Accounts Payable – Galant Transit (Correction of an error in recording an inventory purchase on credit)
120 201/√
400
18 Accounts Payable – Comerica Materials Inventory (Received a credit note for inventory returned)
201/√ 120
100
25 Accounts Payable – Dunlap Pty Ltd Inventory (Received a credit note for inventory returned)
201/√ 120
200
Credit
3,600
400
100
200
An advantage of using specialised journals is that transactions of a similar nature are grouped together, eliminating the necessity for narrations. Time is also saved because much of the posting will be limited to posting column totals at the end of the month. The circumstances under which it would not be better to use specialise journals would be if there are very few transactions in each accounting period.
EXERCISE 6.10 London Hi Fi Ltd $1,194 ($240 + $348 + $174 + $228 + $204). All of the debit postings to the subsidiary ledger accounts should be from the sales journal. The total of all these debits should therefore be the total credit sales for the month which would be the same amount as the end-of-month debit posting from the sales journal to Accounts Receivable control account.
EXERCISE 6.11 Aleskia Ltd (a)
$261,650. Beginning balance of $200,000 plus $125,150 debit from sales journal less $63,500 credit from cash receipts journal.
(b)
$48,430. Beginning balance of $45,000 plus $27,180 credit from purchases journal less $23,750 debit from cash payments journal.
(c)
The column total of $125,150 in the sales journal would be posted to the credit side of the Sales account and the debit side of the Accounts Receivable account in the general ledger.
(d)
The accounts receivable column total of $63,500 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger.
(e)
Preparing a schedule of Accounts Receivable allows the subsidiary ledger total to be agreed to the total Accounts Receivable Control in the General Ledger.
EXERCISE 6.12 Sing Ltd (a)
The debit posting reference on 28 February should be from the sales journal (SJ) to record some of the credit sales during the month. The missing general ledger debit amount should be $5,000 to balance. Ring’s ending balance must be $5,762. (Accounts Receivable control balance of $33,022 less Ding, $15,060, and King, $12,200.)
(b)
All amounts posted in total to the control account are also posted in detail in the accounts receivable subsidiary ledger account. This system ensures that the total of the subsidiary ledger accounts will equal the total in the corresponding control account.
EXERCISE 6.13 Building Blocks Pty Ltd (a).$1,194 ($240 + $348 + $174 + $228 + $204). All of the credit postings to the subsidiary ledger accounts should be from the purchases journal. The total of all these credits should therefore be the total credit purchases for the month which would be the same amount as the end-of-month credit posting from the purchases journal to Accounts Payable control account. (b). No. Because details in the Accounts Payable subsidiary ledger would be exactly the same as in the general ledger control account.
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 6.1 Hair Flair Supplies Ltd (a) Cash Receipts Journal
CR4 Date
Account Credited
Ref
Cash Dr
Apr. 1 4 5 8 10 11 23 29
S Wigg, Capital Hair for U Cutting Edge Ltd Cash Sales Hair Barn Inventory Cutting Edge Moses
301 √ √
9,000 2,499 930 10,868 1,200 825 2,250 1,800 29,372 (101)
√ 120 √ √
Discount Allowed Dr
Accounts Receivable Cr
Sales Cr
Other Accounts Cr
Cost of Sales Dr Inventory Cr
9,000 51
2,550 930 10,868
6,520
1,200 825 2,250 1,800 8,730 (112)
51 (414)
10,868 (401)
9,825 (x)
6,520 (505)/(120)
Cross-footing Totals $35,934 Dr Total = $35,934 ($29,372 + $51 + $6,520) Cr Total = $35,934 ($8,730 + $10,868 + $9,825 + $6,520)
(b) General Ledger Accounts Receivable Date Explanation Apr. 1 Balance 30
Ref.
Debit
CR4
Credit
8,730
No. 112 Balance 11,025 2,295
Accounts Receivable Subsidiary Ledger Hair Barn Date Explanation Apr. 1 Balance 10
Moses Ltd
Ref.
CR4
Debit
Credit
1,200
Balance 2,325 1,125
Date
Explanation
Ref.
Apr. 1 Balance 29
CR4
Cutting Edge Ltd Date Explanation
Ref.
Apr. 1 Balance 5 23
CR4 CR4
Hair for U Ltd Date Explanation
Ref.
Apr. 1 Balance 4
CR4
(c)
Debit
Credit
Balance
1,800
Debit
Credit
Balance
930 2,250
Debit
Credit
$2,295
Accounts Receivable subsidiary account balances: Hair Barn Cutting Edge Ltd Total
$1,125 1,170
4,350 3,420 1,170
Balance
2,550
Accounts receivable balance
1,800 0
2,550 0
$2,295
PROBLEM SET A 6.2 Jewel House Pty Ltd (a) Cash Payments Journal
Date
Ch. No.
Oct. 1 3 5
63 64 65
10 15 16
66 67 68
19
69
29
70
Account Debited Inventory Equipment Diamond Factory Ltd Inventory Ruby R Us Ltd Amy Amethyst, Drawing Precious Stones Ltd Angus and Bandicoot
Ref
Other Accounts Dr
Accounts Payable Dr
Inventory Dr
CP10 Discount Received Cash Cr Cr
770 157 √
880 1,870
37 2,475
√ 306
2,475 1,540 440
1,540 440
√
1,540
√
2,860 1,320 (x)
7,810 (201)
Cross-footing Totals = $12 375 Total Debits = $12 375 ($1,320 + $7,810 + 3245) Total Credits = $12 375 ($68 + $12,307)
770 880 1,833
31
1,509 2,860
3,245 (120)
68 (405)
12,307 (101)
(b) General Ledger Accounts Payable Date Explanation
Ref.
Oct. 1 Balance 31
CP10
Debit
Credit
No. 201 Balance 11,710 3,900
7,810
Accounts Payable Subsidiary Ledger Diamond Factory Date Explanation
Ref.
Oct. 1 Balance 5
CP10
Precious Stones Ltd Date Explanation
Ref.
Oct. 1 Balance 19
CP10
Ruby R Us Ltd Date Explanation
Ref.
Oct. 1 Balance 15
CP10
Angus and Bandicoot Date Explanation
Ref.
Oct. 1 Balance 29
CP10
I
Debit
Credit
1,870 -
1,870
Debit
Credit
Credit
Balance 1,540 0
1,540
Debit
Balance 2,750 1,210
1,540
Debit
Balance
Credit
2,860
Accounts payable balance
$3,900
Accounts payable subsidiary account balances: Precious Stones Ltd Angus and Bandicoot Total
$1,210 2,690 $3,900
Balance 5,550 2,690
(d) Social Implications Corporate social responsibility (CSR) is ‘social responsibility’ applied in a business environment and involves businesses acting with regard to social principles and acting ethically. Basically, it is about business people’s obligation to act responsibly for the benefit society when carrying on business activities. Amy has an obligation to be socially responsible so given she knows the
goods are stolen it is not socially responsible to sell them to her customers. Financial implications Choosing not to sell stolen goods may impact Jewel House Limited’s profits for the period if they cannot obtain sufficient supplies to meet the demand.
PROBLEM SET A 6.3 Racquet Cave Ltd (a) Purchases Journal P1 Date
July 1 2 5 13 15 15 18 24 26 28
Account Credited (Debited)
Post Ref
Tennis Australia Ltd Johnson Shipping Grant and Sons Racquet Supplies Tennis Australia Lepa Ltd Dennisen Advertisements Grant and Sons Racquet Supplies (Equipment) Johnson Shipping
√ 510/√ √ 126√ √ √ 610/√ √ 157/√ 510/√
Other Accounts Dr
Inventory Dr
8,000 500 5,000 900 3,600 2,900 540 3,600 300 420 2,660 (x)
23,100 (120)
Accounts Payable Cr
8,000 500 5,000 900 3,600 2,900 540 3,600 300 420 25,760 (201)
Helpful Hint: This is a multicolumn purchases journal so purchases of items other than inventory can be recorded. Note in the case of a multicolumn purchases journal, separate columns are needed for Inventory and Accounts Payable. Furthermore, a Freight Inwards account must be added to the Chart of Accounts. Freight Inwards is account number 510.
Sales Journal S1 Date
July 3 3 16 16 21 21 30
Account Debited Squash Club Ltd Teeny Tennis Ltd Martin Ltd Teeny Tennis Ltd Squash Club Ltd Randee Ltd Martin Ltd
Post Ref √ √ √ √ √ √ √
Accounts Receivable Dr Sales Cr 1,800 2,000 3,450 1,370 310 2,800 3,900 15,630 (112)/(401)
Cost of Sales Dr. Inventory Cr 1,260 1,400 2,415 959 217 1,960 2,730 10,941 (505)/(120)
General Journal G1 Date
Account Titles and Explanations
Ref
July 8 Accounts Payable – Grant and Sons Inventory (Received a credit note on inventory returned)
201/√ 120
500
412 112/√
50
22 Sales Returns and Allowances Accounts Receivable – Squash Club Ltd (Granted an allowance for inventory damaged in shipment)
Debit
Credit
500
50
(b) General Ledger Accounts Receivable Date Explanation July 31
Inventory Date Explanation July 31 31
Ref S1 G1
Ref. P1 G1 S1
Supplies Date Explanation
Ref.
July 31
P1
Equipment Date Explanation
Ref.
July 31
P1
Accounts Payable Date Explanation
Ref.
July 31
P1 G1
Debit
Credit
No. 112 Balance
15,630 50
Debit
No. 120 Credit Balance
23,100 500 10,941
Debit
Credit
900
Credit
No. 157 Balance
300
Debit
300
Credit
No. 201 Balance
25,760 500
23,100 22,600 11,659
No. 126 Balance
900
Debit
15,630 15,580
25,760 25,260
Sales Date Explanation
Ref.
July 31
S1
Sales Returns and Allowances Date Explanation
Ref.
Debit
Ref.
July 31
S1
Freight In Date Explanation
Ref.
July 31 31
P1 P1
Advertising Expense Date Explanation
Ref.
July 31
P1
No. 401 Balance
15,630
Debit
G1
Cost of Sales Date Explanation
Credit
Credit
No. 412 Balance
50
50
No. 505 Debit Credit
Balance
10,941
Debit
10,941
Credit
No. 510 Balance
500 420
Debit
15,630
500 920
Credit
No. 610 Balance
540
540
Helpful Hint: When posting the individual amounts from the ‘Other Accounts’ column in the Purchases Journal (at the end of the month), the 31 July date can be used or the actual date of the transaction. Both are acceptable. Accounts Receivable Subsidiary Ledger Teeny Tennis Ltd Date Explanation July 3 16
Squash Club Ltd Date Explanation July 3 21 22
Ref. S1 S1
Ref. S1 S1 G1
Debit
Credit
2,000 1,370
Debit
Balance 2,000 3,370
Credit
1,800 310 50
Balance 1,800 2,110 2,060
Martin Ltd Date Explanation
Ref.
July 16 30
S1 S1
Randee Ltd Date Explanation
Ref.
July 21
S1
Debit
Credit
3,450 3,900
Debit
Balance 3,450 7,350
Credit
2,800
Balance 2,800
Accounts Payable Subsidiary Ledger Racquet Supplies Date Explanation
Ref
July 13 26
P1 P1
Tennis Australia Ltd Date Explanation July 1 15
Ref P1 P1
Grant and Sons Date Explanation July 5 24 8
Johnson Shipping Date Explanation July 2 28
Lepa Ltd Date Explanation July 15
Debit
Credit
Balance
900 300
900 1,200
Debit
Credit 8,000 3,600
Balance 8,000 11,600
Ref P1 P1 G1
Debit
Credit 5,000 3,600
Balance 5,000 8,600 8,100
Ref
Debit
Credit
Balance
500
P1 P1
Ref P1
Debit
500 420
500 920
Credit 2,900
Balance 2,900
Dennisen Advertisements Date Explanation July 18
Ref P1
Debit
Credit 540
Accounts Receivable Control Balance Subsidiary account balances: Teeny Tennis Ltd Squash Club Ltd Martin Ltd Randee Ltd Total
$15,580
$3,370 2,060 7,350 2,800 $15,580
Accounts Payable Control Balance Subsidiary account balances: Racquet Supplies Tennis Australia Ltd Grant and Sons Johnson Shipping Lepa Ltd Dennison Advertisements Total
Balance 540
$25,260
$1,200 11,600 8,100 920 2,900 540 $25,260
PROBLEM SET A 6.4 Bouncing Balls Ltd (a), (b) & (c) Sales Journal
Date
Account Debited
Jan. 4 9 17 31
Toys 4 U Mays Ltd Kid Time Ltd Toys 4 U
Invoice No.
Post Ref
371 372 373 374
√ √ √ √
S17 Cost of Sales Dr Inventory Cr
Accounts Receivable Dr Sales Cr 10,875 8,700 1,800 13,995 35,370 (112)/(401)
6,525 5,220 1,080 8,397 21,222 (505)/(120)
Purchases Journal
Date
Account Credited
Ref
Jan. 3 8 11 23 24
Ball Supplies Ltd Balls Ltd Hoble Ball Supplies Ltd Levine
√ √ √ √ √
P13 Inventory Dr Accounts Payable Cr 15,000 6,750 5,550 11,700 7,035 46,035 (120)/(201)
General Journal Date
Account Titles and Explanation
Jan. 5 Accounts Payable – Ball supplies. Inventory (Returned damaged goods purchased previously on credit) 19 Equipment Sundry Accounts Payable – Johnson Ltd (Purchased equipment on account)
Ref.
Debit
201/√ 120
450
157 202/√
8,250
G14 Credit
450
8,250
Cash Receipts Journal CR15
Date
Account Credited
Jan. 6 13 14 Mays Ltd 17 Toys 4 U 20 27 30 Kids Time Ltd
Ref
√ √
√
Cash Dr
4,725 8,010 8,613 10,875 4,800 5,595 1,800 44,418 (101)
Discount Allowed Dr
87
Accounts Receivable Cr
Sales Cr
Other Accounts Cr
Cost of Sales Dr Inventory Cr
4,725 8,010
2,835 4,806
4,800 5,595
2,880 3,357
8,700 10,875
1,800 87 (716)
21,375 (112)
23,130 (401)
0 (x)
13,878 (505)/(120)
Cross-footing Totals $58,383 Dr Total = $58,383 ($44,418 + $87 + $13,878) Cr Total = $58,383 ($21,375 + $23,130 + $13,878) Cash Payments Journal CP15
Date
Account Debited
Ref
Jan. 4 13 15 20 31
Supplies Ball Supplies Ltd Salaries Expense Balls Ltd Salaries Expense
126 √ 726 √ 726
Other Accounts Dr
Accounts Payable Dr
Inventory Dr
Discount Received Cr
120 14,550
291
6,750
135
21,450 19,800 41,370 (x)
21,300 (201)
0 (x)
426 (416)
Cash Cr
120 *14,259 21,450 6,615 19,800 62,244 (101)
Cross-footing Totals = $62,670 Dr Total = $62,670 ($41,370 + $21,300) Cr Total = $62,670 ($426 + $62,244)
*Helpful Hint: Purchased $15,000 from Ball supplies on 3 Jan. 5 Jan returned $450 damaged goods. Balance paid is $14,550 less 2% discount. (d)
Cross-footing the special journals prior to posting the totals to the ledger accounts ensures that the total dollar debits equals the total dollar credits.
PROBLEM SET A 6.5 Byron Bay Bikes (a), (d) & (g) General Ledger Cash Date Explanation July 31 31
Ref CR16 CP16
Debit 117,918
Accounts Receivable Date Explanation July 31 31
Ref S15 CR16
Debit 21,480
Inventory Date Explanation July 31 29 31 31 Store Supplies Date Explanation July 4 31 Adjusting entry
Ref P14 CR16 S15 CR16
Ref CP16 G5
Debit 50,784
No. 101 Credit Balance 117,918 46,166 71,752
No. 112 Balance 21,480 16,680 4,800
Credit
No. 120 Credit Balance 50,784 540 50,244 13,962 36,282 3,120 33,162
Debit 720
No. 127 Credit Balance 720 552 168
No. 131 Credit Balance 7,200 600 6,600
Prepaid Rent Date Explanation July 11 31 Adjusting entry
Ref CP16 G5
Debit 7,200
Accounts Payable Date Explanation July 31 31
Ref P14 CP16
Debit
Collins, Capital Date Explanation July 1
Ref CR16
Debit
35,520
No. 201 Credit Balance 50,784 50,784 15,264
No. 301 Credit Balance 96,000 96,000
Collins, Drawings Date Explanation July 19
Ref CP16
Debit 3,000
Sales Date Explanation July 31 31
Ref S15 CR16
Debit
Discount Received Date Explanation July 31
Ref CP16
Cost of Sales Date Explanation July 31 31
Ref S15 CR16
Credit
No. 306 Balance 3,000
No. 401 Credit Balance 21,480 21,480 4,800 26,280
No. 405 Credit Balance 274 274
Debit
Debit 13,962 3,120
No. 505 Credit
Balance 13,962 17,082
Discount Allowed Date Explanation July 31
Ref CR16
Debit 102
Credit
No. 614 Balance 102
Supplies Expense Date Explanation July 31 Adjusting entry
Ref G5
Debit 552
Credit
No. 631 Balance 552
Rent Expense Date Explanation July 31 Adjusting entry
Ref G5
Debit 600
Credit
No. 729 Balance 600
Sales Journal
(b)
Date
Account Debited
July 6 Toy World Co. 8 Biker Ltd 10 L Lemansky 21 S Kane
Post Ref
Accounts Receivable Dr Sales Cr
√
6,480
√ √ √
4,320 5,880 4,800 21,480 (112)/(401)
S15 Cost of Sales Dr Inventory Cr
4,212 2,808 3,822 3,120 13,962 (505)/(120)
Cash Receipts Journal CR16
Account Credited
Date July 1 Williams, Capital 7 13 Biker Limited 16 L Lemansky 20 Toy World 29 Inventory
Cash Dr Ref 301
√ √ √ 120
Discount Allowed Dr
Accounts Receivable Cr
Sales Cr
96,000 4,800 4,277 5,821 6,480 540 117,918 (101)
Other Accounts Cr
Cost of Sales Dr Inventory Cr
96,000 4,800 43 59
102 (614)
3,120
4,320 5,880 6,480 16,680 (112)
Cross-footing Totals $121,140 Dr Total = $121,140 ($117,918 + $102 + $3,120) Cr Total = $121,140 ($16,680 + $4,800 + $95,540 + $3,120)
4,800 (401)
540 96,540 (x)
3,120 (505)/(120)
Accounts Payable Subsidiary Ledger Dixon’s Bikes Date Explanation July 4 15
Ref P14 CP16
Debit
Bike Supplies Date Explanation July 5 10
Ref P14 CP16
Debit
R Gamble Date Explanation July 11
Ref P14
M Hill Date Explanation July 13 21
D Jacob Date Explanation July 20
Credit 8,160
Balance 6,800 0
Credit 9,000
Balance 7,500 0
Debit
Credit 4,704
Balance 4,704
Ref P14 CP16
Debit
Credit 18,360
Balance 18,360 0
Ref P14
Debit
Credit 10,560
Balance 10,560
Credit
Balance 5,400 0
8,160
9,000
18,360
Accounts Receivable Subsidiary Ledger Toy World Co. Date Explanation July 6 20
Ref S15 CR16
Debit 6,480
S Kane Date Explanation July 21
Ref S15
Debit 4,800
Credit
Balance 4,800
L Lemansky Date Explanation July 10 16
Ref S15 CR16
Debit 5,880
Credit
Balance 5,880 0
6,480
5,880
Biker Ltd Date Explanation July 8 13
Ref S15 CR16
Debit 4,320
Credit 4,320
Balance 4,320 0
(e) Byron Bay Bikes Unadjusted Trial Balance as at 31 July 2014 Debit 101 112 120 127 131 201 301 306 401 405 505 614
Cash Accounts Receivable Inventory Store Supplies Prepaid Rent Accounts Payable Williams, Capital Williams, Drawings Sales Discount Received Cost of Sales Discount Allowed
Credit
$71,752 4,800 33,162 720 7,200 $15,264 96,000 3,000 26280 274 17,082 102 $137,818
$137,818
(f) Accounts Payable Control Balance Schedule of Accounts Payable 31/7/11: D Jacob R Gamble
$15,264
$10,560 4,704 $15,264
Accounts Receivable Control Balance
$4,800
Schedule of Accounts Receivable 31/7/11: S Kane
$4,800
(b) & (g) General Journal Date
Account Titles and Explanation
Ref
July 31 Supplies Expense Store Supplies (Adjusting entry to record supplies used)
631 127
552
729 131
600
31 Rent Expense Prepaid Rent (Adjusting entry to recognise July rent expense)
Debit
G5 Credit
552
600
(h) Byron Bay Bikes Adjusted Trial Balance as at 31 July 2014 Debit 101 112 120 127 131 201 301 306 401 405 505 614 631 729
(i)
Cash Accounts Receivable Inventory Store Supplies Prepaid Rent Accounts Payable Williams, Capital Williams, Drawings Sales Discount Received Cost of Sales Discount Allowed Supplies Expense Rent Expense
Credit
$71,752 4,800 33,162 168 6600 $15,264 96,000 3,000 26280 274 17,082 102 552 600 $137,818
$137,818
If the trial balance doesn’t balance: • Re-add the columns • Check if all accounts have normal balances. • Check that all balances have been accurately transferred from the general ledger • If the difference between the total of the debit and credit columns is divisible by 2, it may indicate an amount that was posted to the same side twice instead of once as a debit and once as a credit. • If the difference is divisible by 9, a transposition error may have been made i.e., the order of the digits in a number may have been reversed, or the error may be a slide i.e., the decimal place may have been incorrectly placed in one of the postings.
PROBLEM SET A 6.6 Balloon Shop Ltd (b) & (c) Cash Receipts Journal CR1
Account Credited
Date Jan. 7 S Devine 12 W. Wong 23 29 Commission Receivable
Ref √ √
115
Cash Dr 3,500 5,390 10,000 46,500 65,390 (101)
Discount Allowed Dr
Accounts Receivable Cr
110
3,500 5,500
Sales Cr
Other Accounts Cr
Cost of Sales Dr Inventory Cr
10,000
110 (714)
9,000 (112)
6,500
10,000 (401)
46,500 46,500 (x)
Inventory Cr
Discount Received Cr
6,500 (505)/(120)
Cross-footing Totals $72,000 Dr Total = $72,000 ($65,390 + $110 + $6,500) Cr Total = $72,000 ($9,000 + $10,000 + $46,500 + $6,500) Cash Payments Journal CP1
Date
Account Debited
Jan. 11 12 15 18
Freight Inwards Rent Expense D Harms Sales Salaries Expense 18 Office Salaries Expense 20 R Grilson 27 S Warren
Ref
Other Accounts Dr
Accounts Payable Dr
Cash Cr
506 729 √ 726
500 2,000 2,500
500 2,000 15,000 2,500
727
1,000
1,000
15,500
√ √ 6,000 (x)
Cross-footing Totals = $40,950 Dr Total = $40,950 ($6,000 + $34,950) Cr Total = $40,950 ($500 + $40,450)
18,500 950 34,950 (201)
500
0 (x)
500 (415)
18,500 950 40,450 (101)
Sales Journal Account Debited
Date
Post Ref
Jan 5 W Wong 24 Celebrations Ltd
S1 Cost of Sales Dr Inventory Cr
Accounts Receivable Dr Sales Cr
√ √
5,500 7,700
3,575 5,005
13,200 (112)/(401)
8,580 (505)/(120)
Purchases Journal
Date
Account Credited
Jan. 5 S Warren 17 D Lapeska
Terms
Ref
2/7, n/30 2/7, n/30
√ √
Inventory Dr Accounts Payable Cr 3,000 1,500 4,500 (120)/(201)
General Journal Date
Account Titles and Explanation
Ref
Jan. 14 Sales Returns and Allowances Accounts Receivable – Party Time Inventory Write Down Expense ($700 x .65) Cost of Sales (Issued a credit for return of damaged inventory. The inventory is considered unsaleable.) 30 Accounts Payable – D Lapeska Inventory (Returned inventory to supplier)
Debit
412 √/112
700
750 505
455
√/201 120
500
G1 Credit
700
455
500
(a) & (c) General Ledger Cash Date Explanation Jan. 1 Balance 31 31
Ref CR1 CP1
Debit 65,390
No. 101 Credit Balance 43,000 108,390 40,450 67,940
Accounts Receivable Date Explanation Jan. 1 Balance 14 31 31
Commissions Receivable Date Explanation Jan. 1 Balance 29
Inventory Date Explanation Jan. 1 Balance 30 31 31 31
Equipment Date Explanation Jan. 1 Balance
Accumulated Depreciation – Equipment Date Explanation Jan. 1 Balance
Accounts Payable Date Explanation Jan. 1 Balance 30 31 31
B Beatle, Capital Date Explanation Jan. 1 Balance
Ref G1 CR1 S1
Ref
Debit
13,200
Debit
CR1
Ref G1 P1 CR1 S1
Ref
Ref
Ref G1 P1 CP1
Ref
Debit
4,500
Debit
Debit
Debit 500 34,950
Debit
No. 112 Credit Balance 16,500 700 15,800 9,000 6,800 20,000
No. 115 Balance 46,500 46,500 0
Credit
No. 120 Credit Balance 24,500 500 24,000 28,500 6,500 22,000 8,580 13,420
Credit
No. 157 Balance 7,950
Credit
No. 158 Balance 4,500
No. 201 Credit Balance 44,500 44,000 4,500 48,500 13,550
Credit
No. 301 Balance 89,450
Sales Date Explanation Jan. 31 31
Commissions Revenue Date Explanation Jan. 31
Sales Returns and Allowances Date Explanation Jan. 14
Discount Received Date Explanation Jan. 31
Ref CR1 S1
Ref
Ref G1
Ref CP1
Debit
Debit
Debit 700
No. 401 Credit Balance 10,000 10,000 13,200 23,200
Credit
No. 405 Balance 0
Credit
No. 412 Balance 700
Debit
No. 415 Credit Balance 500 500
No. 505 Credit Balance 6,500 15,080 455 14,625
Cost of Sales Date Explanation Jan. 31 31 14
Ref CR1 S1 G1
Debit 6,500 8,580
Freight In Date Explanation Jan. 11
Ref CP1
Debit 500
Credit
No. 506 Balance 500
Discount Allowed Date Explanation Jan. 31
Ref CR1
Debit 110
Credit
No. 714 Balance 110
Sales Salaries Expense Date Explanation Jan. 18
Ref CP1
Debit 2,500
Credit
No. 726 Balance 2,500
Office Salaries Expense Date Explanation Jan. 18
Ref CP1
Debit 1,000
Credit
No. 727 Balance 1,000
Rent Expense Date Explanation Jan. 12
Ref CP1
Debit 2,000
Credit
No. 729 Balance 2,000
Inventory Write Down Expense Date Explanation Jan. 14
Ref G1
Debit 455
Credit
No. 750 Balance 455
Accounts Receivable Subsidiary Ledger Party Time Ltd Date Explanation Jan. 1 Balance 14
Celebrations Date Explanation Jan. 1 Balance 24
Ref
Debit
G1
Ref S1
S Devine Date Explanation Jan. 1 Balance 7
CR1
W Wong Date Explanation Jan. 5 12
Ref S1 CR1
Ref
Credit 700
Debit
Credit
Balance 8,000 15,700
Credit
Balance 5,500 2,000
7,700
Debit
3,500
Debit 5,500
Balance 3,000 2,300
Credit 5,500
Balance 5,500 0
Accounts Payable Subsidiary Ledger Toys 4 U Date Explanation Jan. 1 Balance
R Grilson Date Explanation Jan. 1 Balance 20
Ref
Debit
Credit
Balance 10,500
Ref
Debit
Credit
Balance 18,500 0
CP1
18,500
D Harms Date Explanation Jan. 1 Balance 15
CP1
D Lapeska Date Explanation Jan. 17 30
Ref P1 G1
Debit
S Warren Date Explanation Jan. 5 27
Ref P1 CP1
Debit
Ref
Debit
Credit
Balance 15,500 0
Credit 1,500
Balance 1,500 1,000
Credit 3,000
Balance 3,000 2,050
15,500
500
950
(d) Balloon Shop Ltd Trial Balance as at 31 January 2014 Debit 101 112 115 120 157 158 201 301 401 412 415 505 506 714 726 727 729 750
Cash Accounts Receivable Commissions Receivable Inventory Equipment Accumulated Depreciation – Equipment Accounts Payable B Beatle, Capital Sales Sales Returns and Allowances Discount Received Cost of Sales Freight In Discount Allowed Sales Salaries Expense Office Salaries Expense Rent Expense Inventory Write Down Expense
Credit
$67,940 20,000 13,420 7,950 $4,500 13,550 89,450 23,200 700 500 14,625 500 110 2,500 1,000 2,000 455 $131,200
$131,200
(e) Accounts Receivable Subsidiary Ledger: Party Time Celebrations S Devine
Accounts Receivable Control Accounts Payable Subsidiary Ledger: Toys 4 U D Lapeska S Warren
Accounts Payable Control
$2,300 15,700 2,000 $20,000 $20,000
$10,500 1,000 2,050 $13,550 $13,550
PROBLEM SET A 6.7 Kimball Sports (a) Cash Receipts Journal CR1
Date
Account Credited
June J Kimball, 1 Capital 3 Mastin Pty Ltd 6 Field Ltd 7 9 Block & Son 11 Inventory 15 20 Green Bros.
Discount Allowed Dr
Accounts Receivable Cr
Ref
Cash Dr
301
10,000
√
980
20
1,000
√
1,862 6,135 3,430
38
1,900
70
3,500
√ 120 √
Other Accounts Cr
Cost of Sales Dr Inventory Cr
10,000
6,135
200 5,250 1,600 29,457 (101)
Sales Cr
4,090
200 5,250
3,500
1,600 128 (614)
8,000 (112)
11,385 (401)
Cross-footing Totals $37,175 Dr Total = $37,175 ($29,457 + $128 + $7,590) Cr Total = $37,175 ($8,000 + $11,385 + $10,200 + $7,590)
10,200 (x)
7,590 (505)/(120)
(b) General Ledger Accounts Receivable Date Explanation Jan. 1 Balance 31
Ref.
Debit
CR1
No. 112 Credit Balance 8,000 8,000 0
Accounts Receivable Subsidiary Ledger Block & Son Date Explanation June 1 Balance 9
Field Ltd Date Explanation June 1 Balance 6
Green Bros. Date Explanation June 1 Balance 20
Mastin Pty Ltd Date Explanation June 1 Balance 3
(c)
Accounts receivable control balance Sum of all subsidiary accounts
Ref.
Debit
CR1
Credit 3,500
Ref.
Debit
CR1
Credit 1,900
Ref.
Debit
CR1
Credit 1,600
Ref.
Debit
CR1
Credit 1,000
=0 =0
Balance 3,500 0
Balance 1,900 0
Balance 1,600 0
Balance 1,000 0
PROBLEM SET A 6.8 Toko Futons (b) Purchases Journal P1
Date Account Credited Feb. 6 S Healy 9 L Held
Terms 1/7, n/30 1/10, n/30 2/7, n/30 1/7, n/30
16 R Landly 21 J Able
Inventory Dr Accounts Payable Cr 4,000 30,000
Ref. √ √ √ √
2,400 6,500 42,900 (120)/(201)
Cash Payments Journal CP1
Date
Feb. 9 12 15 17 20 28
Account Debited
Supplies S Healy Equipment L Held J Toko, Drawings R Landly
Ref.
126 √ 157 √ 306 √
Other Accounts Dr.
Accounts Payable Dr.
Inventor y Dr
Discount Received Cr.
1,000 4,000
40
30,000
300
8,000 1,100 10,100 (x)
2,400 36,400 (201)
0
340 (405)
(a), (d) & (g) Note: Corrected post references for Sales Journal and Cash Receipts Journal are S1 and CR1 respectively as illustrated in the solution below. General Ledger Cash Date Explanation Feb. 28 28
Ref. CR1 CP1
Debit 48,595
Credit 46,160
No. 101 Balance 48,595 2,435
Cash Cr.
1,000 3,960 8,000 29,700 1,100 2,400 46,160 (101)
Accounts Receivable Date Explanation Feb 28 28
Inventory Date Explanation Feb. 28 18 28 28
Supplies Date Explanation Feb. 9 28 Adjusting entry
Equipment Date Explanation Feb. 15
Accumulated Depreciation - Equipment Date Explanation Feb. 28 Adjusting entry
Ref. S1 CR1
Ref. P1 CR1 S1 CR1
Ref. CP1 G1
Ref. CP1
Ref. G1
Debit 26,000
Debit 42,900
No. 112 Credit Balance 26,000 12,000 14,000
Credit 150 17,160 4,290
Debit 1,000
Credit 700
Debit 8,000
Debit
Credit
Credit 200
Accounts Payable Date Explanation Feb. 28 28
Ref. P1 CP1
Debit
J Toko, Capital Date Explanation Feb. 1
Ref. CR1
Debit
Credit 30,000
J Toko, Drawings Date Explanation Feb. 20
Ref. CP1
Debit 1,100
Credit
Sales Date Explanation Feb. 28 28
Ref. S1 CR1
Debit
Credit 26,000 6,500
Credit 42,900
36,400
No. 120 Balance 42,900 42,750 25,590 21,300
No. 126 Balance 1,000 300
No. 157 Balance 8,000
No. 158 Balance 200
No. 201 Balance 42,900 6,500
No. 301 Balance 30,000
No. 306 Balance 1,100
No. 401 Balance 26,000 32,500
Discount Received Date Explanation Feb. 28
Ref. CP1
Debit
Cost of Sales Date Explanation Feb. 28 28
Ref. S1 CR1
Debit 17,160 4,290
Credit 340
Discount Allowed Date Explanation Feb. 28
Ref. CR1
Debit
Supplies Expense Date Explanation Feb. 28 Adjusting entry
Ref. G1
Debit 700
Depreciation Expense Date Explanation Feb. 28 Adjusting entry
Ref. G1
Debit 200
No. 405 Balance 340
No. 505 Credit Balance 17,160 21,450
Credit
No. 614 Balance 55
Credit
No. 631 Balance 700
55
No. 711 Credit Balance 200
(c) Accounts Receivable Subsidiary Ledger D Adams Date Explanation Feb. 3 13
Ref. S1 CR1
Debit 5,500
P Babcock Date Explanation Feb. 9 26
Ref. S1 CR1
Debit 6,500
D Chambers Date Explanation Feb. 12
Ref. S1
Debit 8,000
Credit 5,500
Credit 6,500
Credit
Balance 5,500 0
Balance 6,500 0
Balance 8,000
K Dawson Date Explanation Feb. 26
Ref. S1
Debit 6,000
Credit
Balance 6,000
Accounts Payable Subsidiary Ledger J Able Date Explanation Feb. 21
Ref. P1
Debit
Credit 6,500
Balance 6,500
S Healy Date Explanation Feb. 6 12
Ref. P1 CP1
Debit
Credit 4,000
Balance 4,000 0
L Held Date Explanation Feb. 9 17
Ref. P1 CP1
Debit
R Landly Date Explanation Feb. 16 28
Ref. P1 CP1
Debit
4,000
Credit 30,000
Balance 30,000 0
Credit 2,400
Balance 2,400 0
30,000
2,400
(e) Toko Futons Trial Balance as at 28 February 2013 Debit 101 112 120 126 157 201 301 306 401 405 505 614
Cash Accounts Receivable Inventory Supplies Equipment Accounts Payable J Toko, Capital J Toko, Drawings Sales Discount Received Cost of Sales Discount Allowed
Credit
$2,435 14,000 21,300 1,000 8,000 $6,500 30,000 1,100 32,500 340 21,450 55 $69,340
$69,340
(f) Accounts Receivable Control Account
$14,000
Accounts Receivable Subsidiary Accounts: D Chambers K Dawson
$8,000 6,000
$14,000
Accounts Payable Control Account
$6,500
Accounts Payable Subsidiary Account: J Able
$6,500
(g) General Journal Date
Account Titles and Explanation
Feb. 28 Supplies Expense Supplies (Record supplies used) 28 Depreciation Expense Accumulated Depreciation – Equipment (Record depreciation expense)
Ref.
Debit
631 126
700
711 158
200
G1 Credit
700
200
(h) Toko Futons Adjusted Trial Balance as at 28 February 2013 Debit 101 112 120 126 157 158 201 301 306 401 405 505 631 614 711
Cash Accounts Receivable Inventory Supplies Equipment Accumulated Depreciation – Equipment Accounts Payable J Toko, Capital J Toko, Drawings Sales Discount Received Cost of Sales Supplies Expense Discount Allowed Depreciation Expense
Credit
$2,435 14,000 21,300 300 8,000 $200 6,500 30,000 1,100 32,500 340 21,450 700 55 200 $69,540
$69,540
PROBLEM SET A 6.9 Pinky Nail Supplies (a) Cash Payments Journal
Ch. No.
Account Debited
Nov. 1 3 5 11 15 16 19
11
Inventory
12 13 14 15 16 17
25 30
18 19
Equipment Creams & Oils R Us Inventory Plastic Nails Pty Ltd V. Creek, Drawing Nail Polish Professionals Prepaid Insurance Cotton Balls Ltd
Date
Ref
157 √
Other Accounts Dr
Accounts Payable Dr
Inventory Dr
CP10 Discount Received Cash Cr Cr
1,800
1,800
3,400
2,000
60
2,600
52
3,400 3,762 4,000 1,940 1,000 2,548
150 (405)
6,000 5,000 29,450 (101)
3,800
38 4,000
√ 306 √ 130 √
1,000
6,000 10,400 (x)
5,000 13,400 (201)
5,800 (120)
Cross-footing Totals = $29,600 Total Debits = $29,600 ($10,400 + $13,400 + 5,800) Total Credits = $29,600 ($150 + $29,400)
(b) General Ledger Accounts Payable Date Explanation Nov. 1 Balance 31
Ref.
CP10
Debit
Credit
No. 201 Balance 19,500 6,100
13,400
Accounts Payable Subsidiary Ledger Cotton Balls Ltd Date Explanation Nov. 1 Balance 30
Ref.
CP10
Debit
5,000
Credit
Balance 9,000 4,000
Nail Polish Professionals Date Explanation
Ref.
Nov. 1 Balance 19
CP10
Plastic Nails Pty Ltd Date Explanation
Ref.
Nov. 1 Balance 15
CP10
Creams & Oils R Us Date Explanation
Ref.
Nov. 1 Balance 5
I
CP10
Debit
Credit
4,700 2,100
2,600
Debit
Credit
Balance 2,000 0
2,000
Debit
Balance
Credit
3,800
Accounts payable balance
$6,100
Accounts payable subsidiary account balances: Cotton Balls Ltd Nail Polish Professionals Total
$4,000 2,100 $6,100
Balance 3,800 0
PROBLEM SET A 6.10 Tippy Toes Ltd (a) Purchases Journal P1 Date
July 1 2 5 13 15 15 18 24 26 28
Other Accounts Dr
Account Credited (Debited)
Post Ref
Little Feet Ltd Quick Shipping Grant and Sons Shoe Supplies Little Feet Lepa Ltd Shoe Advertisements Pty Ltd Grant and Sons Shoe Supplies Quick Shipping
√ 510/√ √ 126√ √ √ 610/√ √ 157/√ 510/√
Inventory Dr
Accounts Payable Cr
9,600 600 6,000 1,080 4,320 3,480 372 4,320 360 504 2,916 (x)
27,720 (120)
9,600 600 6,000 1,080 4,320 3,480 372 4,320 360 504 30,636 (201)
Helpful Hint: This is a multicolumn purchases journal so purchases of items other than inventory can be recorded. Note in the case of a multicolumn purchases journal, separate columns are needed for Inventory and Accounts Payable. Furthermore, a Freight In account must be added to the Chart of Accounts. Freight In is account number 510.
Sales Journal S1 Date
Account Debited
July 3 3 16 16 21 21 30
Pete’s Shoes Ltd Teeny Feet Ltd Martin’s Spartans Ltd Teeny Feet Ltd Pete’s Shoes Ltd Sandles Ltd Martin’s Spartans Ltd
Post Ref √ √ √ √ √ √ √
Accounts Receivable Dr Sales Cr 2,160 2,400 4,140 648 310 3,360 4,680 17,698 (112)/(401)
Cost of Sales Dr. Inventory Cr 1,512 1,680 2,898 454 217 2,352 3,276 12,389 (505)/(120)
General Journal G1 Date
Account Titles and Explanations
Ref
July 8 Accounts Payable – Grant and Sons Inventory (Received a credit note on inventory returned)
201/√ 120
600
412 112/√
60
22 Sales Returns and Allowances Accounts Receivable – Pete’s Shoes Ltd (Granted an allowance for inventory damaged in shipment)
Debit
Credit
600
60
(b) General Ledger Accounts Receivable Date Explanation
Ref
July 22 31
G1 S1
Inventory Date Explanation July 8 31 31
Ref. G1 P1 S1
Supplies Date Explanation
Ref.
July 15
P1
Equipment Date Explanation
Ref.
July 26
P1
Accounts Payable Date Explanation
Ref.
July 8 31
G1 P1
Debit
Credit
No. 112 Balance
60 17,698
Debit
Credit 600 12,389
Credit
No. 126 Balance
1,080
Debit
1,080
Credit
360
Debit
No. 120 Balance 600CR 27,120DR 14,731DR
27,720
Debit
60CR 17,638
No. 157 Balance 360
Credit
600 30,636
No. 201 Balance 600DR 30,036CR
Sales Date Explanation
Ref.
July 31
S1
Sales Returns and Allowances Date Explanation
Ref.
July 22
G1
Cost of Sales Date Explanation
Ref.
July 31
S1
Freight In Date Explanation
Ref.
July 2 28
P1 P1
Advertising Expense Date Explanation
Ref.
July 18
P1
Debit
Credit
No. 401 Balance
17,698
Debit
Credit
No. 412 Balance
60
Debit
60
No. 505 Credit
Balance
12,389
Debit
12,389
Credit
No. 510 Balance
600 504
Debit
17,698
600 1,104
Credit
No. 610 Balance
372
372
Helpful Hint: When posting the individual amounts from the ‘Other Accounts’ column in the Purchases Journal (at the end of the month), the 31 July date can be used or the actual date of the transaction. Both are acceptable. Accounts Receivable Subsidiary Ledger Pete’s Shoes Ltd Date Explanation July 3 21 22
Teeny Feet Ltd Date Explanation July 3 16
Ref. S1 S1 G1
Ref. S1 S1
Debit
Credit
2,160 310 60
Debit 2,400 648
Credit
Balance 2,160 2,470 2,410
Balance 2,400 3,048
Martin’s Spartans Ltd Date Explanation
Ref.
July 16 30
S1 S1
Sandles Ltd Date Explanation
Ref.
July 21
S1
Debit
Credit
4,140 4,680
Debit
Balance 4,140 8,820
Credit
3,360
Balance 3,360
Accounts Payable Subsidiary Ledger Little Fleet Ltd Date Explanation July 1 15
Ref
Debit
P1 P1
Credit
Balance
9,600 4,320
9,600 13,920
Credit 6,000 4,320
Balance 6,000 5,400 9,720
Grant and Sons Date Explanation July 5 8 24
Ref P1 G1 P1
Debit
Shoe Supplies Date Explanation July 13 26
Ref P1 P1
Debit
Credit 1,080 360
Balance 1,080 1,440
Quick Shipping Date Explanation
Ref
Debit
Credit
Balance
July 2 24
Lepa Ltd Date Explanation July 15
600
P1 P1
Ref P1
Debit
600 504
600 1,104
Credit 3,480
Balance 3,480
Shoe Advertisements Pty Ltd Date Explanation July 18
Ref P1
Debit
Credit 372
Accounts Receivable Control Balance Subsidiary account balances: Pete’s Shoes Ltd Teeny Feet Ltd Martin”s Spartans Ltd Sandles Ltd Total
17,638
$2,410 3,048 8,820 3,360 $17,638
Accounts Payable Control Balance Subsidiary account balances: Little Feet Ltd Shoe Supplies Grant and Sons Quick Shipping Lepa Ltd Shoe Advertisements Total (d)
Balance 372
$30,036
$13,920 1,440 9,720 1,104 3,480 372 $30,036
The advantages of using a computerised accounting system over a manual system is that it is possible to process a much larger number of transactions in a much shorter period of time. Data entry is minimal and posting of the transactions is done immediately by the computer. Information can be obtained on a more timely basis and with fewer errors. The disadvantages include the need for hardware and software to be compatible, the possibility that data is lost due to power failures or viruses, the need to have staff with suitable training, and the possibility of computer hacking or fraud.
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 6.1 Creek’s Hardware (a) Cash Payments Journal CP1 Date
Chq No.
Account Debited
Post Ref
Other Accounts Dr
Nov 1 3 5 11 15 16 19 25 30
11 12 13 14 15 16 17 18 19
Inventory Equipment Wald Bros. Inventory R. Snyder V. Creek, Drawing G. Paul Prepaid Insurance R. Huff
120 157 √ 120 √ 306 √ 130 √
900 1,700
Discount Received Dr
1,900
19
1,000
30
1,300
26
2,500 6,700 (201)
75 (120)
2,000 500 3,000 8,100 (X)
Cross-footing Totals:
Accounts Payable Dr
Dr = 14,800
Cash Cr 900 1,700 1,881 2,000 970 500 1,274 3,000 2,500 14,725 (101)
Cr = 14,800
(b) General Ledger Accounts Payable Control Date Explanation Nov. 1 Balance 30
Post √ CP1
Debit
Credit
6,700
No. 201 Balance 9,750 3,050
Accounts Payable Subsidiary Ledger R. Huff Date Explanation Nov. 1 Balance 30
Post √ CP1
Debit
G. Paul Date Explanation Nov. 1 Balance 19
Post √ CP1
Debit
R. Snyder Date Explanation Nov. 1 Balance 15
Post √ CP1
Debit
Wald Bros. Date Explanation Nov. 1 Balance 5
Post √ CP1
Debit
(c)
Accounts payable control balance: Subsidiary account balances: R. Huff G. Paul
Credit
Balance 4,500 2,000
Credit
Balance 2,350 1,050
Credit
Balance 1,000 0
Credit
Balance 1,900 0
2,500
1,300
1,000
1,900
$3,050
$2,000 1,050 $3,050
(d) The ethical response is for Mr.Dodgy to offer and make it known to R.Snyder that purchases will only be made in the best interests, and as required by Creeks Hardware.
PROBLEM SET B 6.2 Virginia Ltd (a) Purchases Journal P1 Date
Account Credited (Debited)
Post Ref
May 2 3 8 8 15 16 16 18 25 28
Vons Ltd The Freight People Golden Ltd Dorn Ltd Engle Supply (Supplies) Vons Ltd Golden Ltd The Freight People Ball Advertising (Adv. Exp.) Engle Supply (Equipment)
√ 510 √ √ 126/√ √ √ 510 610/√ 157/√
Other Accounts Dr
Inventory Dr
Accounts Payable Cr
9,500
9,500 400 8,000 8,700 900 4,500 6,000 500
400 8,000 8,700 900 4,500 6,000 500 900
900 250
250 2950 (X)
36700 (120)
39.650 (201)
Sales Journal
Date
Account Debited
Ref
May 5 5 5 23 23
Penner Ltd Hend Ltd Nelles Ltd Hend Ltd Nelles Ltd
√ √ √ √ √
Accounts Receivable Dr Sales Cr 1,750 2,700 1,500 2,400 2,200 10,550 (112)(401)
S1 Cost of Sales Dr Inventory Cr
1,225 1,890 1,050 1,680 1,540 7,385 (505)(120)
General Journal Date
Account Titles and Explanation
Ref
Debit
May 10 Accounts Payable - Dorn Ltd Inventory
201/√ 120
500
17 Accounts Payable –Engle Supply Supplies
201/√ 126
100
20 Accounts Payable –Vons Ltd Inventory
201/√ 120
300
412
200
26 Sales Returns and Allowances Accounts ReceivableNelles Ltd
Credit
500
100
300
112/√
200
(b) General Ledger Accounts Receivable Date Explanation May 31 26
Inventory Date Explanation May 10
Ref S1 G1
Ref G1
Debit 10,550
Debit
No. 112 Credit Balance 10,550 200 10,350
Credit 500
No. 120 Balance 36200
20
G1
300 35900
31
P1
31
S1
36700
36700 7,385 28515
Supplies Date Explanation May 15 17
Equipment
Ref P1 G1
Debit 900
No. 126 Credit Balance 900 100 800
No. 157
Date Explanation May 28
Ref P1
Debit 250
Credit
Accounts Payable Date Explanation May 10 17 20 31
Ref G1 G1 G1 P1
Debit 500 100 300
Credit
Sales Date Explanation May 31
Ref S1
Debit
Sales Returns and Allowances Date Explanation May 26
Ref G1
Debit 200
Cost of Sales Date Explanation May 31
Ref S1
Debit 7,385
Freight In Date Explanation May 3 18
Ref P1 P1
Debit 400 500
Advertising Expenses Date Explanation May 25
Ref P1
Debit 900
Balance 250
No. 201 Balance 39,150 39,050 38,750 39,650 39,650
No. 401 Credit Balance 10,550 10,550
Credit
No. 505 Credit
Credit
Credit
No. 412 Balance 200
Balance 7,385
No. 510 Balance 400 900
No. 610 Balance 900
Accounts Receivable Subsidiary Ledger Penner Ltd Date Explanation May 5
Ref S1
Debit 1,750
Credit
Balance 1,750
Hend Ltd Date Explanation May 5 23
Ref S1 S1
Debit 2,700 2,400
Credit
Balance 2,700 5,100
Nelles Ltd Date Explanation May 5 23 26
Ref S1 S1 G1
Debit 1,500 2,200
Credit
200
Balance 1,500 3,700 3,500
Accounts Payable Subsidiary Ledger The Freight People Date Explanation May 3 18
Ref P1 P1
Debit
Credit 400 500
Balance 400 900
Vons Ltd Date Explanation May 2 16 20
Ref P1 P1 G1
Debit
Credit 9,500 4,500
Balance 9,500 14,000 13,700
Engle Supply Date Explanation May 15 17 28
Ref P1 G1 P1
Debit
Credit 900 250
Balance 900 800 1,050
Golden Ltd Date Explanation May 8 16
Ref P1 P1
Debit
Credit 8,000 6,000
Balance 8,000 14,000
Dorn Ltd Date Explanation May 8 10
Ref P1 G1
Debit
Credit 8,700
Balance 8,700 8,200
300
100
500
Ball Advertising Date Explanation May 25
(c)
Ref P1
Debit
Accounts receivable balance Subsidiary account balances Penner Ltd Hendrix Ltd Nelles Ltd Total
$10,350
$1,750 5,100 3,500 $10,350
Accounts payable balance Subsidiary account balances The Freight People Vons Ltd Engle Supply Golden Ltd Dorn Ltd Ball Advertising Total
Credit 900
$38,750
$ 900 13,700 1,050 14,000 8,200 900 $38,750
Balance 900
PROBLEM SET B 6.3 Ramos Pty Ltd (a), (b) & (c) Sales Journal
Date
Account Debited
Oct. 4 17 25 30
Parker Ltd L. Boyton Ltd Green Ltd L. Boyton Ltd
Invoice No.
Ref.
204 205 206 207
√ √ √ √
S1 Cost of Sales Dr Inventory Cr
Accounts Receivable Dr Sales Cr 9,000 5,350 5,220 4,600 24,170 (112)(401)
5,400 3,210 3,132 2,760 14,502 (505)(120)
Purchases Journal P1 Date
Account Credited
Ref
Oct. 2 10 27 30
Mason Ltd Quinn Ltd Schmid Ltd Mason Ltd
√ √ √ √
Inventory Dr Accounts Payable Cr 18,500 4,200 8,500 14,000 45,200 (120)(201)
General Journal Date
Accounts and Explanations
Oct. 13 Accounts Payable – Quinn Ltd Inventory 25 Supplies Accounts Payable - Frey Ltd
Ref
Debit
201/√ 120
250
126
260
201/√
G1 Credit
250
260
Cash Receipts Journal
Date
Account Credited
Oct. 7 10 Parker Ltd 14 16 Land 21 25 L. Boyton Ltd
Ref
√ 140
√
28
Cash Dr 9,160 8,820 8,190 27,000 8,465 5,243 8,540 75,408 (101)
Discount Allowed Dr
Accounts Receivable Cr
180
9,000
Sales Cr
Other Accounts Cr
CR1 Cost of Sales Dr Inventory Cr
9,160
5,496
8,180
4,908 27,000
107 287 (112)(401)
8,465
5,079
8,540 34,345 (401)
5,124 20,607 (505)(120)
5,350 14,350 (112)
27,000 (X)
Cross-footing Totals $96,302 Dr Total = $96,302 ($75,408 + $287 + $20,607) Cr Total = $96,302 ($14,350 + $34,345 + $27,000 + $20,607)
Cash Payments Journal CP1 Date
Oct 5 9 18 23 26
Account Debited
Supplies Mason Ltd Inventory Quinn Ltd Land Buildings 30 Advertising Expense
Ref
126 √ 120 √ 140 145 610
Other Accounts Dr
Accounts Payable Dr
Discount Received Dr
80 18,500
370
2,125 3,950
Cash Cr 80 18,130 2,125 3,950
21,000 14,000
35,000
400 37,605 (X)
400 59,685 (101)
22,450 (201)
370 (120)
Balancing Totals $60,055 Dr Total = $60,055 ($37,605 + $22,450) Cr Total = $60,055 ($370 +$59,685) (d) It is helpful to place ledger account numbers and ticks in the journals to cross reference to ledgers and to indicate that this part of the accounting cycle has been completed.
PROBLEM SET B 6.4 Lemon Lights (a) Cash Receipts Journal CR4
Date
Account Credited
Apr. 1 F Lemon, Capital 4 Smith 5 North Ltd 8 Cash Sales 10 Horn 11 Inventory 23 North Ltd 29 Harris
Ref
Cash Dr
301
6,000
√ √
1,666 620 7,245
√ 120 √ √
800 550 1,500 1,200 19,581 (101)
Discount Allowed Dr
Accounts Receivable Sales Cr Cr
Other Accounts Cr
Cost of Sales Dr Inventory Cr
6,000 34
1,700 620 7,245
4,347
800 550 1,500 1,200 5,820 (112)
34 (414)
7,245 (401)
6,550 (x)
4,347 (505)/(120)
Cross-footing Totals $23,962 Dr Total = $23,962 ($19,581 + $34 + $4,347) Cr Total = $23,962 ($5,820 + $7,245 + $6,550 + $4,347)
(b) General Ledger Accounts Receivable Date Explanation Apr. 1 Balance 30
Ref
Debit
CR4
Credit
No. 112 Balance
5,820
7,350 1,530
Accounts Receivable Subsidiary Ledger Horn Date Explanation Apr. 1 Balance 10
Ref
CR4
Debit
Credit
800
Balance 1,550 750
Harris Date Explanation
Ref
Apr. 1 Balance 29
CR4
North Ltd Date Explanation
Ref
Apr. 1 Balance 5 23
CR4 CR4
Smith Date Explanation
Ref
Apr. 1 Balance 4
CR4
(c)
(d)
Debit
Credit
1,200
Debit
Credit
620 1,500
Debit
Credit
1,700
Accounts receivable balance
$1,530
Accounts Receivable subsidiary account balances: Horn North Ltd Total
$750 780 $1,530
Balance 1,200 0
Balance 2,900 2,280 780
Balance 1,700 0
The advantages to the seller of offering a settlement discount are that the seller is able to shorten the operating cycle by converting the accounts receivable to cash earlier. The disadvantages are that the seller receives less cash as well as the additional work to keep track of whether customers had appropriately calculated the discount and paid within the discount period. The advantage for the buyer is that the buyer saves money and the disadvantage is that the buyer would have to pay for the goods earlier.
PROBLEM SET B 6.5 Channel Pty Ltd (a) Cash Payments Journal CP10
Date
Ch. No.
Account Debited
Oct. 1 3 5 10 15 16
63 64 65 66 67 68
19 29
69 70
Inventory Equipment Hester Ltd Inventory Tario Ltd L Simpson, Drawing Milos Ltd Pagan and Sons
Ref
Other Accounts Dr
Accounts Payable Dr
Inventory Dr
Discount Received Cr
1400 157 √
1600 3,400
68 4,500
√ 306
2,800 800
√ √
2,800 5,200 2,400 (x)
14,200 (201)
5,900 (120)
Cash Cr 1400 1600 3,332 4,500 2,800 800
56
2,744 5,200
124 (405)
22,376 (101)
Cross-footing Totals = $22,500 Total Debits = $22,500 ($2,400 + $14,200 + $5,900) Total Credits = $22,500 ($124 + $22,276)
(b) General Ledger Accounts Payable Date Explanation Oct. 1 Balance 31
Ref
CP10
Debit
Credit
No. 201 Balance 18,600 4,400
14,200
Accounts Payable Subsidiary Ledger Hester Date Explanation
Ref
Oct. 1 Balance 5
CP10
Milos Ltd Date Explanation
Ref
Oct. 1 Balance 19
CP10
Debit
Credit
3,400 0
3,400
Debit
2,800
Balance
Credit
Balance 5,000 2,200
Tario Ltd Date Explanation
Ref
Oct. 1 Balance 15
CP10
Pagan and Sons Date Explanation
Ref
Oct. 1 Balance 29
(c)
CP10
Debit
Credit
2,800 0
2,800
Debit
Balance
Credit
5,200
Accounts Payable Control balance
$4,400
Accounts Payable subsidiary account balances: Milos Ltd Pagan and Sons Total
$2,200 2,200 $4,400
Balance 7,400 2,200
PROBLEM SET B 6.6
Clark Ltd (a), (b) & (c) Sales Journal
Date
Account Debited
Jan. 4 9 17 31
Gilbert Mays Ltd Amber Ltd Gilbert
Invoice No.
Post Ref
371 372 373 374
√ √ √ √
Accounts Receivable Dr Sales Cr 7,250 5,800 1,200 9,330 23,580 (112)/(401)
S17 Cost of Sales Dr Inventory Cr
4,350 3,480 720 5,598 14,148 (505)/(120)
Purchases Journal
Date
Account Credited
Ref
Jan. 3 8 11 23 24
Bell Bros. Law Ltd Hoble Bell Bros. Levine
√ √ √ √ √
P13 Inventory Dr Accounts Payable Cr 10,000 4,500 3,700 7,800 4,690 30,690 (120)/(201)
General Journal Date
Account Titles and Explanation
Ref
Debit
Jan. 5 Accounts Payable – Bell Bros. Inventory (Returned damaged goods purchased previously on credit)
201/√ 120
300
19 Equipment Accounts Payable – Johnson Ltd (Purchased equipment on account)
157 201/√
5,500
G14 Credit
300
5,500
Cash Receipts Journal CR15 Date
Account Credited
Ref
Jan. 6 13 14 Mays Ltd 17 Gilbert 20 27 30 Amber Ltd
√ √
√
Cash Dr
3,150 5,340 5,742 7,250 3,200 3,730 1,200 29,612 (101
Discount Allowed Dr
Accounts Receivable Cr
58
Sales Cr
Other Accounts Cr
Cost of Sales Dr Inventory Cr
3,150 5,340
1,890 3,204
3,200 3,730
1,920 2,238
5,800 7,250
1,200 14,250 (112)
58 (716)
15,420 (401)
0 (x)
9,252 (505)/(120)
Balancing Totals $38,922 Dr Total = $38,922 ($29,612 + $58 + $9,252) Cr Total = $38,922 ($14,250 + $15,420 + $9,252) Cash Payments Journal CP15
Date
Account Debited
Jan. 4 Supplies 13 Bell Bros. 15 Salaries Expense 20 Law Ltd 31 Salaries Expense
Ref 126 √ 726 √ 726
Other Accounts Dr
Accounts Payable Dr
Inventory Dr
Discount Received Cr
80
80 *9,506 14,300
9,700
194
4,500
90
4,410 13,200
284 (416)
41,496 (101)
14,300
13,200 27,580 (x)
Cash Cr
14,200 (201)
0 (x)
Cross-footing Totals = $41,780 Total Debits = $41,780 ($27,580 + $14,200) Total Credits = $41,780 ($284 + $41,496) *Helpful Hint: Purchased $10,000 from Bell Bros on 3 Jan. 5 Jan returned $300 damaged goods. Balance paid is $9,700 less 2% discount.
PROBLEM SET B 6.7 Tassie Carpets (b) & (c) Cash Receipts Journal CR1
Account Credited
Date
Cash Dr
Ref
Jan 7 S Devine 12 B Senton 23 29 Commission Receivable
√ √
115
Discount Allowed Dr
3,500 3,920 8,600 40,000 56,020 (101)
80
Accounts Receivable Sales Cr Cr
Other Accounts Cr
Cost of Sales Dr Inventory Cr
3,500 4,000 8,600
80 (714)
7,500 (112)
5,590 40,000 40,000 (x)
8,600 (401)
5,590 (505)/(120)
Cross-footing Totals $61,690 Dr Total = $61,690 ($56,020 + $80 + $5,590) Cr Total = $61,690 ($7,500 + $8,600 + $40,000 + $5,590)
Cash Payments Journal CP1 Account Debited
Date
Jan. 11 12 15 18
Freight In Rent Expense D Harms Sales Salaries Expense 18 Office Salaries Expense 20 R Grilson 27 S Warren
Ref
Other Accounts Dr
Accounts Payable Dr
Inventory Cr
Discount Received Cr
Cash Cr
506 729 √ 726
300 1,000 2,800
300 1,000 14,850 2,800
727
1,500
1,500
15,000
√ √ 5,600 (x)
Cross-footing Totals = $39,550 Dr Total = $39,550 ($5,600 + $33,950) Cr Total = $39,550 ($150 + $39,400)
18,000 950 33,950 (201)
150
0 (x)
150 (415)
18,000 950 39,400 (101)
Sales Journal
Date
Account Debited
July 5 B Senton 24 B Cole
Post Ref
S1 Cost of Sales Dr Inventory Cr
Accounts Receivable Dr Sales Cr
√ √
4,000 7,700 11,700 (112)/(401)
2,600 5,005 7,605 (505)/(120)
Purchases Journal
Date
Account Credited
Jan. 5 S Warren 17 D Lapeska
Terms
Ref
2/7, n/30 2/7, n/30
√ √
Inventory Dr Accounts Payable Cr 2,500 1,600 4,100 (120)/(201)
General Journal Date
Account Titles and Explanation
Ref
Jan. 14 Sales Returns and Allowances Accounts Receivable – R Barton Inventory Write Down Expense ($700 x .65) Cost of Sales (Issue a credit return for return of damaged inventory from a customer) 30 Accounts Payable – D Lapeska Inventory (Returned inventory to supplier)
Debit
412 √/112
700
750 505
455
√/201 120
500
G1 Credit
700
455
500
(a) & (c) General Ledger Cash Date Explanation Jan. 1 Balance 31 31
Ref CR1 CP1
Debit 56,020
No. 101 Credit Balance 41,500 97,520 39,400 58,120
Accounts Receivable Control Date Explanation Jan. 1 Balance 14 31 31
Commissions Receivable Date Explanation Jan. 1 Balance 29
Inventory Date Explanation Jan. 1 Balance 30 31 31 31
Equipment Date Explanation Jan. 1 Balance
Accumulated Depreciation - Equipment Date Explanation Jan. 1 Balance
Accounts Payable Control Date Explanation Jan. 1 Balance 30 31 31
S Alomar, Capital Date Explanation Jan. 1 Balance
Ref G1 CR1 S1
Ref
Debit
11,700
Debit
CR1
Ref G1 P1 CR1 S1
Ref
Ref
Ref G1 P1 CP1
Ref
Debit
4,100
Debit
Debit
Debit 500 33,950
Debit
No. 112 Credit Balance 15,000 700 14,300 7,500 6,800 18,500
No. 115 Balance 45,000 40,000 5,000
Credit
No. 120 Credit Balance 23,000 500 22,500 26,600 5,590 21,010 7,605 13,405
Credit
No. 157 Balance 6,450
Credit
No. 158 Balance 1,500
No. 201 Credit Balance 43,000 42,500 4,100 46,600 12,650
Credit
No. 301 Balance 86,450
Sales Date Explanation Jan. 31 31
Commissions Revenue Date Explanation Jan. 31
Sales Returns and Allowances Date Explanation Jan. 14
Discount Received Date Explanation Jan. 31
Ref CR1 S1
Ref
Ref G1
Ref CP1
No. 401 Credit Balance 8,600 8,600 11,700 20,300
Debit
Debit
Debit 700
Credit
No. 405 Balance 0
Credit
No. 412 Balance 700
No. 415 Credit Balance 150 150
Debit
Cost of Sales Date Explanation Jan. 31 31 14
Ref CR1 S1 G1
No. 505 Debit Credit 5,590 7,605 455
Freight In Date Explanation Jan. 11
Ref CP1
Debit 300
Discount Allowed Date Explanation Jan. 31
Sales Salaries Expense Date Explanation Jan. 18
Office Salaries Expense Date Explanation Jan. 18
Ref CR1
Ref CP1
Ref CP1
Balance 5,590 13,195 12,740
Credit
No. 506 Balance 300
Credit 80
No. 714 Balance 80
Debit 2,800
Credit
No. 726 Balance 2,800
Credit
No. 727 Balance 1,500
Debit
Debit 1,500
Rent Expense Date Explanation Jan. 12
Ref CP1
Debit 1,000
Credit
No. 729 Balance 1,000
Inventory Write Down Expense Date Explanation Jan. 14
Ref G1
Debit 455
Credit
No. 750 Balance 455
Accounts Receivable Subsidiary Ledger R Barton Date Explanation Jan. 1 Balance 14
B Cole Date Explanation Jan. 1 Balance 24
Ref
Debit
G1
Ref S1
S Devine Date Explanation Jan. 1 Balance 7
CR1
B Senton Date Explanation Jan. 5 13
Ref S1 CR1
Ref
Credit 700
Debit
Credit
Balance 7,500 15,200
Credit
Balance 5,000 1,500
7,700
Debit
3,500
Debit 4,000
Balance 2,500 1,800
Credit 4,000
Balance 4,000 0
Accounts Payable Subsidiary Ledger S Field Date Explanation Jan. 1 Balance
R Grilson Date Explanation Jan. 1 Balance 20
Ref
Debit
Credit
Balance 10,000
Ref
Debit
Credit
Balance 18,000 0
CP1
18,000
D Harms Date Explanation Jan. 1 Balance 15
CP1
D Lapeska Date Explanation Jan. 17 30
Ref P1 G1
Debit
S Warren Date Explanation Jan. 5 27
Ref P1 CP1
Debit
Ref
Debit
Credit
Balance 15,000 0
Credit 1,600
Balance 1,600 1,100
Credit 2,500
Balance 2,500 1,550
15,000
500
950
(d) Tassie Carpets Trial Balance as at 31 January 2014 Debit 101 112 115 120 157 158 201 301 401 412 415 505 506 714 726 727 729 750
Cash Accounts Receivable Commissions Receivable Inventory Equipment Accumulated Depreciation – Equipment Accounts Payable S Alomar, Capital Sales Sales Returns and Allowances Discount Received Cost of Sales Freight In Discount Allowed Sales Salaries Expense Office Salaries Expense Rent Expense Inventory Write Down Expense
Credit
$58,120 18,500 5,000 13,405 6,450 $1,500 12,650 86,450 20,300 700 150 12,740 300 80 2,800 1,500 1,000 455 $121,050
$121,050
(e) Accounts Receivable Subsidiary Ledger: R Barton B Cole S Devine
Accounts Receivable Control Accounts Payable Subsidiary Ledger: S Field D Lapeska S Warren
Accounts Payable Control
$1,800 15,200 1,500 $18,500 $18,500
$10,000 1,100 1,550 $12,650 $12,650
PROBLEM SET B 6.8 Collins Bikes (a), (d) & (g) General Ledger Cash Date Explanation July 31 31
Ref CR1 CP1
Debit 98,265
No. 101 Credit Balance 98,265 38,472 59,793
No. 112 Credit Balance 17,900 13,900 4,000
Accounts Receivable Date Explanation July 31 31
Ref S1 CR1
Debit 17,900
Inventory Date Explanation July 31 29 31 31
Ref P1 CR1 S1 CR1
Debit 42,320
Credit
Store Supplies Date Explanation July 4 31
Ref CP1 G1
Debit 600
Credit
Prepaid Rent Date Explanation July 11 31 Adjusting entry
Ref CP1 G1
Debit 6,000
Credit
Accounts Payable Date Explanation July 31 31
Collins, Capital Date Explanation July 1
Ref P1 CP1
Ref CR1
Debit 29,600
Debit
No. 120 Balance 42,320 450 41,870 11,635 30,235 2,600 27,635
No. 127 Balance 600 460 140
No. 131 Balance 6,000 500 5,500
No. 201 Credit Balance 42,320 42,320 12,720
No. 301 Credit Balance 80,000 80,000
Collins, Drawings Date Explanation July 19
Ref CP1
Debit 2,500
Sales Date Explanation July 31 31
Ref S1 CR1
Debit
Discount Received Date Explanation July 31
Cost of Sales Date Explanation July 31 31
Discount Allowed Date Explanation July 31
Ref CP1
Ref S1 CR1
Ref CR1
Credit
No. 306 Balance 2,500
No. 401 Credit Balance 17,900 17,900 4,000 21,900
No. 405 Credit Balance 228 228
Debit
No. 505 Debit Credit 11,635 2,600
Balance 11,635 14,235
Credit 85
No. 614 Balance 85
Debit
Supplies Expense Date Explanation July 31 Adjusting entry
Ref G1
Debit 460
Credit
No. 631 Balance 460
Rent Expense Date Explanation July 31 Adjusting entry
Ref G1
Debit 500
Credit
No. 729 Balance 500
Helpful Hint: No page numbers are specified in the question for the sales, cash receipts and general journals. In this solution the following numbers are used: CR1, S1, G1.
(b) Sales Journal
Date
Account Debited
Post Ref
July 6 8 10 21
Hardy Co. D Wasburn L Lemansky S Kane
√ √ √ √
Accounts Receivable Dr Sales Cr. 5,400 3,600 4,900 4,000 17,900 (112)/(401)
S1 Cost of Sales Dr Inventory Cr 3,510 2,340 3,185 2,600 11,635 (505)/(120)
Cash Receipts Journal
Date July 1 7 13 16 20 29
Account Credited
Ref
Collins, Capital
301
D Wasburn L Lemansky Hardy Co. Inventory
√ √ √ 120
Cash Dr 80,000 4,000 3,564 4,851 5,400 450 98,265 (101)
Discount Allowed Dr
Accounts Receivable Cr
Sales Cr
Other Accounts Cr
CR1 Cost of Sales Dr Inventory Cr
80,000 4,000 36 49
3,600 4,900 5,400
85 (614)
13,900 (112)
4,000 (401)
2,600
450 80,450 (x)
2,600 (505)/(120)
Cross-footing Totals $100,950 Dr Total = $100,950 ($98,265 + $85 + $2,600) Cr Total = $100,950 ($13,900 + $4,000 + $80,450 + $2,600) (c) Accounts Payable Subsidiary Ledger J Dixon Date Explanation July 4 15
Ref P1 CP1
Debit
W Engel Date Explanation July 5 10
Ref P1 CP1
Debit
Credit 6,800
Balance 6,800 0
Credit 7,500
Balance 7,500 0
6,800
7,500
R Gamble Date Explanation July 11
Ref P1
Debit
Credit 3,920
Balance 3,920
M Hill Date Explanation July 13 21
Ref P1 CP1
Debit
Credit 15,300
Balance 15,300 0
D Jacob Date Explanation July 20
Ref P1
Debit
Credit 8,800
Balance 8,800
Credit
Balance 5,400 0
15,300
Accounts Receivable Subsidiary Ledger Hardy Co. Date Explanation July 6 20
Ref S1 CR1
Debit 5,400
S Kane Date Explanation July 21
Ref S1
Debit 4,000
Credit
Balance 4,000
L Lemansky Date Explanation July 10 16
Ref S1 CR1
Debit 4,900
Credit
Balance 4,900 0
D Wasburn Date Explanation July 8 13
Ref S1 CR1
Debit 3,600
5,400
4,900
Credit 3,600
Balance 3,600 0
(e) Collins Bikes Trial Balance as at 31 July 2013 Debit 101 112 120 127 131 201 301 306 401 405 505 614
Cash Accounts Receivable Inventory Store Supplies Prepaid Rent Accounts Payable Collins, Capital Collins, Drawings Sales Discount Received Cost of Sales Discount Allowed
Credit
$59,793 4,000 27,635 600 6,000 $12,720 80,000 2,500 21,900 228 14,235 85 $114,848
$114,848
(f) Accounts Payable Control Balance
$12,720
Subsidiary accounts balance: D Jacob R Gamble
$8,800 3,920 $12,720
Accounts Receivable Control Balance
$4,000
Subsidiary accounts balance: S Kane
$4,000
(b) & (g) General Journal Date
Account Titles and Explanation
Ref
July 31 Supplies Expense Store Supplies (Adjusting entry to record supplies used)
631 127
460
729 131
500
31 Rent Expense Prepaid Rent (Adjusting entry to recognise July rent expense)
Debit
G1 Credit
460
500
(h) Collins Bikes Adjusted Trial Balance as at 31 July 2013 Debit 101 112 120 127 131 201 301 306 401 405 505 614 631 729
(i)
Cash Accounts Receivable Inventory Store Supplies Prepaid Rent Accounts Payable Collins, Capital Collins, Drawings Sales Discount Received Cost of Sales Discount Allowed Supplies Expense Rent Expense
Credit
$59,793 4,000 27,635 140 5,500 $12,720 80,000 2,500 21,900 228 14,235 85 460 500 $114,848
$114,848
Adjusting entries are needed to ensure that the recognition criteria are followed for all assets, liabilities, revenues and expenses. Without adjusting entries, some asset and liability accounts may be overstated, while others will be understated. The corresponding revenues and expenses thus will also show incorrect balances. The net effect will be that financial position and performance will not faithfully represent the substance of the underlying events.
PROBLEM SET B 6.9 Surfin” Supplies Pty Ltd (a) Cash Receipts Journal
CR4 Date
Account Credited
Ref
Cash Dr
Apr. 1 4 5 8 10 11 23 29
Beach Boy, Capital Wet Suits Galore Sand Wedge Ltd Cash Sales Board Barn Inventory Sand Wedge Ltd I’m Board Ltd
301 √ √
18,000 4,998 1,860 21,736 2,400 1,650 4,500 3,600 58,744 (101)
√ 120 √ √
Discount Allowed Dr
Accounts Receivable Cr
Other Accounts Cr
Sales Cr
COS Dr Inventory Cr
18,000 102
5,100 1,860 21,736
13,040
2,400 1,650 4,500 3,600 17,460 (112)
102 (414)
21,736 (401)
19,650 (x)
13,040 (505)/(120)
Cross-footing $71,886 Dr Total = $71,886 ($58,744 + $102 + $13,040) Cr Total = $71,886 ($17,460 + $21,736 + $19,650 + $13,040)
(b) General Ledger Accounts Receivable Date Explanation Apr. 1 Balance 30
Ref.
Debit
CR4
Credit
17,460
No. 112 Balance 22,050 4,590
Accounts Receivable Subsidiary Ledger Board Barn Ltd Date Explanation
Ref.
Apr. 1 Balance 10
CR4
I’m Board Ltd Date Explanation
Ref.
Apr. 1 Balance 29
CR4
Debit
Credit
2,400
Debit
Credit
3,600
Balance 4,650 2,250
Balance 3,600 0
Sand Wedge Ltd Date Explanation
Ref.
Apr. 1 Balance 5 23
CR4 CR4
Wet Suits Galore Pty Ltd Date Explanation
Ref.
Apr. 1 Balance 4
Debit
Credit
1,860 4,500
Debit
Credit
CR4
Accounts receivable balance Accounts Receivable subsidiary account balances: Hair Barn Sand Wedge Ltd Total
Balance 8,700 6,840 2,340
Balance
5,100
5,100 0
$4,590 $2,250 2,340 $4,590
PROBLEM SET B 6.10 Fang Ltd (a) Purchases Journal P1 Date
Dec 2 3 8 8 15 16 16 18 25 28
Other Accounts Dr
Account Credited (Debited)
Post Ref
Celtic Ltd Fast Delivery Ripping Ltd Lamb Ltd Office Supply Celtic Ltd Ripping Ltd Fast Delivery Striking Advertising Office Supply
√ 510/√ √ √ 126√ √ √ 510/√ 610/√ 157√
Inventory Dr
Accounts Payable Cr
28,500 1,200 24,000 26,100 2,700 13,500 18,000 1,200 2,700 750 8,550 (x)
110,100 (120)
28,500 1,200 24,000 26,100 2,700 13,500 18,000 1,200 2,700 750 118,650 (201)
Helpful Hint: This is a multicolumn purchases journal so purchases of items other than inventory can be recorded. Note in the case of a multicolumn purchases journal, separate columns are needed for Inventory and Accounts Payable. Furthermore, a Freight In account must be added to the Chart of Accounts. Freight In is account number 510. In some versions of the book no amount has been specified for the freight charge on the invoice received on 18th December. This solution assumes the amount is the same as the amount invoiced on 3 December (ie: $1,200) Sales Journal S1 Date
Account Debited
Dec 5 5 5 23 23
Wang Ltd Singh Ltd Smith Ltd Singh Ltd Smith Ltd
Post Ref √ √ √ √ √
Accounts Receivable Dr Sales Cr 5,250 8,100 4,500 2,400 6,600 26,850 (112)/(401)
Cost of Sales Dr. Inventory Cr 3,675 5,670 3,150 1,680 4,620 18,795 (505)/(120)
General Journal G1 Date
Account Titles and Explanations
Ref
Debit
Dec 10 Accounts Payable – Lamb Ltd Inventory (Received a credit note on inventory returned)
201/√ 120
1,500
17 Accounts Payable – Office Supply Supplies (Received a credit note on supplies returned)
201 126
300
20 Accounts Payable – Celtic Ltd Inventory
201/√ 120
900
26 Sales Returns and Allowances Accounts Receivable – Smith Ltd (Granted an allowance for inventory damaged in shipment)
412 112/√
600
Credit
1,500
300
900
600
(b) General Ledger Accounts Receivable Date Explanation
Ref
Dec 26 31
G1 S1
Inventory Date Explanation
Ref.
Dec 10 20 31 31
G1 G1 P1 S1
Supplies Date Explanation
Ref.
Dec 15 17
P1 G1
Debit
Credit
No. 112 Balance
600 26,850
Debit
Credit
No. 120 Balance
1,500 900
1,500CR 2,400CR 107,700DR 88,905DR
110,100 18,795
Debit
Credit
600CR 26,250
No. 126 Balance
2,700 300
2,700 2,400
Equipment Date Explanation
Ref.
Dec 28
P1
Accounts Payable Date Explanation
Ref.
Dec 10 17 20 31
G1 G1 G1 P1
Sales Date Explanation
Ref.
Dec 31
S1
Sales Returns and Allowances Date Explanation
Ref.
Dec 26
G1
Cost of Sales Date Explanation
Ref.
Dec 31
S1
Freight In Date Explanation Dec 3 18
Ref. P1 P1
Advertising Expense Date Explanation
Ref.
Dec 25
P1
Debit
Credit
No. 157 Balance
750
Debit
750
Credit
No. 201 Balance
1,500 300 900
Debit
118,650
1,500DR 1,800DR 2,700DR 115,950
Credit
No. 401 Balance
26,850
Debit
Credit
600
18,795
2,700
Balance 18,795
Credit
1,200 1,200
Debit
No. 412 Balance 600
No. 505 Debit Credit
Debit
26,850
No. 510 Balance 1,200 2,400
Credit
No. 610 Balance 2,700
Helpful Hint: When posting the individual amounts from the ‘Other Accounts’ column in the Purchases Journal (at the end of the month), the 31 December date can be used or the actual date of the transaction. Both are acceptable.
Accounts Receivable Subsidiary Ledger Wang Ltd Date Explanation Dec 5
Singh Ltd Date Explanation Dec 5 23 Smith Ltd Date Explanation Dec 5 23 26
Ref. S1
Ref. S1 S1
Ref. S1 S1 G1
Debit
Credit
5,250
Debit
5,250
Credit
8,100 2,400
Debit
Balance
Balance 8,100 10,500
Credit
4,500 6,600 600
Balance 4,500 11,100 10,500
Accounts Payable Subsidiary Ledger Celtic Ltd Date Explanation Dec 2 16 20
Ref P1 P1 G1
Debit
Credit
Balance
28,500 13,500
28,500 42,000 41,100
900
Ripping Ltd Date Explanation Dec 8 16
Ref P1 P1
Debit
Credit 24,000 18,000
Balance 24,000 42,000
Lamb Ltd Date Explanation Dec 8 10
Ref P1 P1
Debit
Credit 26,100
Balance 26,100 24,600
Fast Delivery Date Explanation
Ref
Debit
Credit
Balance
Dec 3 18
P1 P1
1,500
1,200 1,200
1,200 2,400
Office Supply Date Explanation Dec 15 17 28
Ref P1 G1 P1
Debit
Striking Advertising Date Explanation Dec 25
Ref P1
Debit
Credit 2,700 750
Balance 2,700 2,400 3,150
Credit 2,700
Balance 2,700
300
Accounts Receivable Control Balance Subsidiary account balances: Wang Ltd Singh Ltd Smith Ltd Total
26,250
$5,250 10,500 10,500 $26,250
Accounts Payable Control Balance Subsidiary account balances: Celtic Ltd Ripping Ltd Lamb Ltd Fast Delivery Office Supply Striking Advertising Total
(d).
$115,950
$41,100 42,000 24,600 2,400 3,150 2,700 $115,950
The advantages of using a computerised accounting system over a manual system is that it is possible to process a much larger number of transactions in a much shorter period of time. Data entry is minimal and posting of the transactions is done immediately by the computer. Information can be obtained on a more timely basis and with fewer errors. The disadvantages include the need for hardware and software to be compatible, the possibility that data is lost due to power failures or viruses, the need to have staff with suitable training, and the possibility of computer hacking or fraud.
COMPREHENSIVE PROBLEM CHAPTERS 3 TO 6
Students are required to include additional account names and numbers to record the transactions. Please note the following accounts are required, however, students may have used different account names and numbers. Crows Furniture Pty Ltd The chart of accounts includes the following account names and numbers: Account number 306 350 401 412 415 417 510 512 516 627 711 722 725 727 728 729
Account name P Crow Drawings Income Summary Sales Sales Returns and Allowances Discount Received Commissions Revenue Purchases Purchase returns and allowances Freight in Sales salaries expense Depreciation expense Insurance expense Discount allowed Office salaries expense Office supplies expense Rent expense
(a) Sales Journal S1 Date
Account Debited
Jan. 3 The Furniture Warehouse 3 Beautiful Homes Ltd 11 Couch City 11 Lowell Chairs 22 The Furniture Warehouse 22 Couch City 25 Table Top Ltd 25 Beautiful Homes Ltd
Invoice No.
Post Ref
Accounts Receivable Dr Sales Cr
510
√
3,720
511 512 513 514
√ √ √ √
2,160 1,560 1,080 2,040
515 516 517
√ √ √
960 4,200 7,320 23,040 (112)/(401)
Purchases Journal
Date
Account Credited
Jan. 5 5 16 16 16 27 27 27
Walden & Co D Landell Nordin Office Furniture Lee Importers Walden & Co Nordin Office Furniture D Landell Walden & Co
Terms
Ref
P1 Purchases Dr Accounts Payable Cr
√ √ √ √ √ √ √ √
3,600 2,640 18,000 17,040 1,800 17,400 1,440 3,360 65,280 (510)/(201)
Cash Receipts Journal CR1
Cash Dr Date
Account Credited
Ref
Jan. 7 Lowell Chairs 7 Table Tops Ltd 10 13 The Furniture Warehouse 13 Beautiful Homes Ltd 20 21 Lowell Chairs 31 31 Commissions Rec’d
√ √ √
4,752 2,376 18,600 3,720
√
1,800
√ 115
21,000 972 25,560 46,800 125,580 (101)
Discount Allowed Dr
Accounts Receivable Cr
48 24
4,800 2,400
Sales Cr
Other Accounts Cr
18,600 3,720 1,800 21,000 108
1,080 25,560 46,800
180 (725)
13,800 (112)
65,160 (401)
46,800 (x)
Cash Payments Journal
Date
Account Debited
Ref.
Jan. 8 9 9 12 15 17 21 23 23 28 31
Freight In Lee Importers Nordin Office Furniture Rent Expense P Crow, Drawings
516 √ √ 729 306
I Keah Nordin Office Furniture Lee Importers
Sales Salaries Expense 31 Office Salaries Expense
Cash Cr
627
216 10,692 13,002 1,200 960 480 18,000 18,000 16,800 240 5,160
727
3,120
√ √ √
Discount Received Cr
87,870 (101)
Accounts Payable Dr
Office Supplies Dr
CP1 Other Accounts Dr 216
108 198
10,800 13,200 1,200 960 480 18,000 18,000 16,800 240 5,160 3,120
306 (415)
76,800 (201)
720 (125)
10,656 (x)
(a) & (e) General Journal
Date
Account name (narration)
Jan. 9 Sales Returns and Allowances Accounts Receivable – Beautiful Homes Ltd (Issued credit for goods returned)
Ref
Debit
412 √/112
360
√/201 512
240
31 Office Supplies Expense Office Supplies (Office supplies used)
728 125
1,320
31 Insurance Expense Prepaid Insurance (January insurance expense (1/10 x 2,400))
722 130
240
18 Accounts Payable –Lee Importers Purchase Returns and Allowances (Received credit for returned goods)
G1 Credit
360
240
Adjusting Entries:
1,320
240
Date
Account name (narration) 31 Depreciation Expense Accumulated Depreciation – Equipment (Depreciation expense (1/12 x 1,800))
Ref 711 158
Debit 150
31 Commissions Receivable Commissions Revenue (Accrued commissions revenue)
115 417
26,400
31 Inventory (Jan. 31) Sales Discount Received Commissions Revenue Purchase Returns and Allowances Income Summary
120 401 415 417 512 350
19,200 88,200 306 26,400 240
31 Income Summary Inventory (Jan 1) Sales Returns and Allowances Purchases Freight In Rent Expense Sales Salaries Expense Office Salaries Expense Office Supplies Expense Insurance Expense Depreciation Expense Discount Allowed
350 120 412 510 516 729 627 727 728 722 711 725
98,826
31 Income Summary P Crow, Capital
350 301
35,520
31 P. Crow, Capital P Crow, Drawings
301 306
960
Ref
Debit
Credit
CR1 CP1
125,580
Credit 150
26,400
Closing Entries
134,346
21,600 360 65,280 216 1,200 5,160 3,120 1,320 240 150 180
35,520
960
(b) & (e) General Ledger Cash Date Jan. 1 31 31
Explanation Balance Various Receipts Various Payments
No. 101 Balance 42,900 168,480 87,870 80,610
Accounts Receivable Date Explanation Jan. 1 Balance 31 Credit Sales 31 Cash and discount 9 Sales Returns
Commissions Receivable Date Explanation Jan. 1 Balance 31 Cash receipt 31 Commission revenue
Inventory Date Explanation Jan. 1 Balance 31 Income summary 31 Income Summary
Office Supplies Date Explanation Jan. 1 Balance 31 Cash 31 Office supplies expense
Prepaid Insurance Date Explanation Jan. 1 Balance 31 Insurance expense
Equipment Date Explanation Jan. 1 Balance
Accumulated Depreciation - Equipment Date Explanation Jan. 1 Balance 31 Depreciation expense
Ref S1 CR1 G1
Ref CR1 G1
Ref G1 G1
Ref CP1 G1
Ref
Debit 23,040
Debit
26,400
Debit 19,200
Debit 720
Debit
G1
Ref
Ref G1
Debit
Debit
No. 112 Credit Balance 15,600 38,640 13,800 24,840 360 24,480
No. 115 Balance 46,800 46,800 0 26,400
Credit
No. 120 Balance 21,600 40,800 21,600 19,200
Credit
No. 125 Credit Balance 1,200 1,920 1,320 600
No. 130 Balance 2,400 240 2,160
Credit
Credit
No. 157 Balance 7,740
No. 158 Credit Balance 1,800 150 1,950
Accounts Payable Date Explanation Jan. 1 Balance 31 Purchases 31 Cash 28 Purchases Returns and allowances
Ref P1 CP1 G1
Debit
76,800 240
P Crow, Capital Date Explanation Jan. 1 Balance 31 Income summary 31 Drawings
G1 G1
P Crow, Drawings Date Explanation Jan. 15 Balance 31 Capital
Ref CP1 G1
Debit 960
Income Summary Date Explanation Jan. 31 Revenues 31 Expenses 31 P Crow Capital;
Ref G1 G1 G1
Debit
Sales Date Jan. 31 31 31
Explanation Accounts receivable Cash Income Summary
Sales Returns and Allowances Date Explanation Jan. 9 Accounts receivable 31 Income Summary
Discount Received Date Explanation Jan. 31 Cash 31 Income Summary
Ref
Ref S1 CR1 G1
Ref G1 G1
Ref CP1 G1
Debit
960
98,826 35,520
Debit
88,200
Debit 360
Debit 306
No. 201 Credit Balance 42,000 65,280 107,280 30,480 30,240
No. 301 Balance 94,440 35,520 129,960 129,000
Credit
No. 306 Balance 960 960 0
Credit
No. 350 Credit Balance 134,346 134,346 35,520 0
No. 401 Credit Balance 23,040 23,040 65,160 88,200 0
No. 412 Credit Balance 360 360 0
No. 415 Credit Balance 306 306 0
Commissions Revenue Date Explanation Jan. 31 Commission Receivable 31 Income Summary
Ref G1 G1
Debit 26,400
Purchases Date Explanation Jan. 31 Accounts payable 31 Income Summary
Ref P1 G1
Debit 65,280
Purchase Returns and Allowances Date Explanation Jan. 18 Accounts Payable 31 Income Summary
Ref G1 G1
Debit
Freight In Date Explanation Jan. 8 Cash 31 Income Summary
Ref CP1 G1
Debit 216
Sales Salaries Expense Date Explanation Jan. 31 Cash 31 Income Summary
Ref CP1 G1
No. 417 Credit Balance 26,400 26,400 0
No. 510 Credit Balance 65,280 65,280 0
Credit 240
240
No. 512 Balance 240 0
No. 516 Balance 216 216 0
Credit
Debit 5,160
No. 627 Credit Balance 5,160 5,160 0
No. 711 Credit Balance 150 150 0
Depreciation Expense Date Explanation Jan.31 Accumulated depreciation 31 Income Summary
Ref G1 G1
Debit 150
Insurance Expense Date Explanation Jan. 31 Prepaid Insurance 31 Income Summary
Ref G1 G1
Debit 240
Credit
Discount Allowed Date Explanation Jan. 31 Cash 31 Income Summary
Ref CR1 G1
Debit 180
Credit
No. 722 Balance 240 240 0
No. 725 Balance 180 180 0
Office Salaries Expense Date Explanation Jan. 31 Cash 31 Income Summary
Ref CP1 G1
Debit 3,120
No. 727 Credit Balance 3,120 3,120 0
No. 728 Credit Balance 1,320 1,320 0
Office Supplies Expense Date Explanation Jan. 31 Office Supplies 31 Income Summary
Ref G1 G1
Debit 1,320
Rent Expense Date Explanation Jan. 12 Cash 31 Income Summary
Ref CP1 G1
Debit 1,200
No. 729 Balance 1,200 1,200 0
Credit
Accounts Receivable Subsidiary Ledger Couch City Date Explanation Jan. 1 Balance 11 22
S1 S1
1,560 960
Beautiful House Ltd Date Explanation Jan. 3 9 13 25
Ref S1 G1 CR1 S1
Debit 2,160
Ref
Debit
Table Tops Date Explanation Jan. 1 Balance 7 25
Lowell Chairs Date Explanation Jan. 1 Balance 7 11 21
Ref
CR1 S1
Ref CR1 S1 CR1
Debit
Credit
Balance 1,800 3,360 4,320
Credit
Balance 2,160 1,800 0 7,320
360 1,800 7,320
Credit 2,400
4,200
Debit
Credit 4,800
1,080 1,080
Balance 9,000 6,600 10,800
Balance 4,800 0 900 0
The Furniture Warehouse Date Explanation Jan. 3 13 22
Ref S1 CR1 S1
Debit 3,720
Credit 3,720
2,040
Balance 3,720 0 2,040
Accounts Payable Subsidiary Ledger D Landell Date Explanation Jan. 5 27
Lee Importers Date Explanation Jan. 1 Balance 9 16 18 23
I Keah Date Explanation Jan. 1 Balance 21
Nordin Office Furniture Date Explanation Jan. 1 Balance 9 16 23 27
Walden & Co Date Explanation Jan. 5 16 27
Ref P1 P1
Debit
Credit 2,640 1,440
Balance 2,640 4,080
Ref
Debit
Credit
Balance 10,800 0 17,040 16,800 0
CP1 P1 G1 CP1
Ref CP1
Ref CP1 P1 CP1 P1
Ref P1 P1 P1
10,800 17,040 240 16,800
Debit
Credit
Balance 18,000 0
Credit
17,400
Balance 13,200 0 18,000 0 17,400
Credit 3,600 1,800 3,360
Balance 3,600 5,400 8,760
18,000
Debit 13,200
18,000 18,000
Debit
(c)
Crows Furniture Pty Ltd
No.
Account Name
Worksheet for the month ended 31 January 2015
Trial Balance Dr
Adjustments
Cr
Dr
Adjusted Trial Balance
Cr
Dr
Cr
Statement of financial position
Income Statement Dr
Cr
Dr
Cr
101
Cash
80,610
80,610
80,610
112
Accounts Receivable
24,480
24,480
24,480
115
Commissions Receivable
120
Inventory
125
Office Supplies
1,920
(1) 1,320
130
Prepaid Insurance
2,400
(2)
240
157
Equipment
7,740
158
Accum. Depreciation – Equipment
1,800
(3)
150
201
Accounts Payable
301
P Crow, Capital
306
P Crow, Drawings
401
Sales
412
Sales Returns and Allowances
415
Discount Received
510
Purchases
512
Purchase Returns and Allowances
516
Freight In
627
Sales Salaries Expense
725
Discount Allowed
727 729
(4) 26,400
26,400
19,200
26,400
21,600
21,600
600
600 2,160
7,740
7,740 1,950
1,950
30,240
30,240
30,240
94,440
94,440
94,440
960
960
960 88,200
360
360 306
88,200 360
306
65,280
65,280 240
306 65,280
240
240
216
216
216
5,160
5,160
5,160
180
180
180
Office Salaries Expense
3,120
3,120
3,120
Rent Expense
1,200
1,200
1,200
$215,226
19,200
2,160
88,200
Totals
19,200
$215,226
728
Office Supplies Expense
(1) 1,320
1320
1320
722
Insurance Expense
(2)
240
240
240
711
Depreciation Expense
(3)
150
150
150
417
Commissions Revenue Totals Profit
(4) 26,400 $28,110
$28,110
26,400 $241,776
$241,776
26,400 98,826
134,346
162,150
35,520 Totals
$134,346
126,630 35,520
$134,346
$162,150
$162,150
(d) Crows Furniture Pty Ltd Income Statement for the month ended 31 January 2015
OPERATING REVENUE Sales revenues: Gross sales Less: Sales returns and allowances Net sales revenue Cost of sales: Beginning inventory, 1/1/08 Purchases Less: Purchase returns and allowances Net purchases Freight in Cost of goods available for sale Less: Ending inventory 31/1/04 Cost of sales Gross profit
$88,200 (360) 87,840
$21,600 $65,280 (240) 65,040 216
67,656 20,184
OTHER OPERATING REVENUE Commissions Revenue Discount Received OPERATING EXPENSES Selling expenses: Sales salaries expense Administrative expenses: Office salaries expense Rent expense Office supplies expense Insurance expense Depreciation expense Financial expenses: Discount Allowed Profit
65,256 86,856 (19,200)
26,400 306
26,706 46,890
$5,160 $3,120 1,200 1,320 240 150
6,030
180
11,370 $35,520
Chapter 6: Accounting subsystems
Crows Furniture Pty Ltd Statement of financial position as at 31 January 2015
ASSETS Current assets: Cash Accounts receivable Commissions receivable Inventory Office supplies Prepaid insurance Total current assets Non-current assets: Equipment Less: Accumulated depreciation Total non-current assets LIABILITIES Current liabilities: Accounts payable Total liabilities NET ASSETS
$80,610 24,480 26,400 19,200 600 2,160 $153,450 $7,740 (1,950) 5,790 159,240
30,240 30,240 $129,000
EQUITY Owners Equity
$129,000
Crows Furniture Pty Ltd Calculation of Owner’s Equity for the month ended 31 January 2015
P Crow, Capital 1 January 2015 Add: Profit Less: Drawings P Crow, Capital, 31 January 2015
$94,440 35,520 129,960 (960) $129,000
(f) Crows Furniture Pty Ltd Post-Closing Trial Balance as at 31 January 2015 No
Account Name
Debit
101 112 115 120 125 130 157 158 201 301
Cash Accounts Receivable Commissions Receivable Inventory Office Supplies Prepaid Insurance Equipment Accumulated Depreciation – Equipment Accounts Payable P Crow, Capital
$80,610 24,480 26,400 19,200 600 2,160 7,740
$161,190 Accounts Receivable Control Balance Accounts Receivable subsidiary ledger account balances: Couch City Beautiful House Ltd Table Tops The Furniture Warehouse
$1,950 30,240 129,000 $161,190 $24,480
$4,320 7,320 10,800 2,040
Accounts Payable Control Balance Accounts Payable subsidiary ledger account balances: D Landell Nordin Office Furniture Walden & Co
Credit
$24,480 $30,240
$4,080 17,400 8,760
$30,240
Chapter 6: Accounting subsystems
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS 6.1
FINANCIAL REPORTING PROBLEM Domino’s Pizza Enterprises Ltd
(a)
Domino’s would use control accounts, subsidiary ledgers and special journals because it is an efficient and effective way for a large business to process numerous transactions (see pages 312 and 315 text). Domino’s has many customers and creditors, a large amount of property, plant and equipment and many shareholders – the company is likely to have subsidiary ledgers and control accounts for these items. The 2007 Consolidated Balance Sheets revealed the following: Receivables (customers) Payables (creditors) Property, plant and equipment Contributed equity (shareholders)
$24,801,000 $26,882,000 $33,496,000 $48,722,000
Control accounts and subsidiary ledgers are needed to continually record, monitor and update these large accounts. Domino’s pays out and receives large amounts of cash (see the statement of cash flows), it also buys and sells a large number of goods (see the statement of financial performance), so the company is likely to use special journals for sales, purchases, cash receipts and payments. (b)
There are no obvious disadvantages to Domino’s in using control accounts, subsidiary ledgers and special journals but there are many advantages. Advantages of Subsidiary Ledgers Subsidiary ledgers have several advantages. 1. They show transactions affecting one customer or one creditor in a single account, thus providing up-to-date information on specific account balances. 2. They free the general ledger of excessive details. As a result, a trial balance of the general ledger does not contain vast numbers of individual account balances. 3. They provide effective control through the periodic comparison of the total of the schedule of the subsidiary ledger with the balance in the corresponding control account. 4. They make possible a segregation of duties in posting. One employee can post to the general ledger while someone else posts to the subsidiary ledgers.
Advantages of special journals. The use of a special journal to record transactions has a number of advantages. First, all like transactions are grouped at the initial stage of recording. Second, the one-line entry for each transaction saves time. Third, only totals, rather than individual entries, are posted to the general ledger. This saves posting time and reduces the possibilities of errors in posting. Finally, a segregation of duties can be achieved because one person can take responsibility for the sales journal, another for the cash receipts and so on.
6.2
FINANCIAL REPORTING PROBLEM – Manual Mini Practice Test Murraturra Music Shop
(a) Sales Journal
Date
Account Debited
Invoice No.
Post Ref
Jan. 6 6 11 11 22 22 25 25
J Hendrix N Jones R Danforth S Levin J Hendrix R Danforth B Jiminez N Jones
510 511 512 513 514 515 516 517
√ √ √ √ √ √ √ √
Accounts Receivable Dr Sales Cr 4,480 2,520 1,820 1,260 3,780 1,120 4,900 8,540 28,420 (112)/(402)
S1 Cost of Sales Dr Inventory Cr
2,688 1,512 1,092 756 2,268 672 2,940 5,124 17,052 (505)/(120)
Purchases Journal P1 Date
Account Credited
Terms
Ref.
Jan. 3 3 17 17 17 27 27 27
Guitar World Drums R Us Aging Violins Microphones ltd Guitar World Aging Violins Drums R Us Guitar World
n/30 n/30 1/7, n/30 2/7, n/30 n/30 1/7, n/30 n/30 n/30
√ √ √ √ √ √ √ √
Inventory Dr Accounts Payable Cr 4,200 3,080 22,400 19,880 2,100 20,300 1,680 6,720 80,360 (120)/(201)
Chapter 6: Accounting subsystems
Cash Receipts Journal
Date Jan 7 7 10 12 13 15 16 20 31 31
Account Credited
Ref
S Levin B Jiminez
√ √
J Hendrix N Jones Bank Loan S Levin
√ √ 200 √
Discount Allowed Dr
Cash Dr 5,600 2,800 21,700 4,390 2,058 14,000 1,235 24,500 29,820 500 106,603 (101)
Accounts Receivable Cr
Sales Cr
CR1 Cost of Sales Dr Inventory Cr
Other Accounts Cr
5,600 2,800 21,700 90 42
13,020
4,480 2,100 14,000
25
1,260 24,500 29,820
157 (614)
16,240 (112)
76,020 (401)
14,700 17,892 500 14,500 (x)
45,612 (505)/(120)
Dr Total = $152,372 ($106,603 + $157 + $45,612) Cr Total = $152,372 ($16,240 + $76,020 + $14,500 + $45,612) Cash Payments Journal
Date Jan 8 9 9 12 15 17 21 23 23 28 31 31
Account Debited
Ref
Freight In Microphones Ltd Aging Violins Rent Expense Peter Dawes, Drawings
417 √ √ 729 306
R Manual Aging Violins Microphones Ltd
√ √ √
Sales Salaries Expense Office Salaries Expense
Dr = 98242 Cr = 98242
627 727
Cash Cr 252 12,348 15,246 1,400 1,120 560 15,000 22,176 19,208 280 6,020 3,640 97,250 (101)
Discount Received Cr
Accounts Payable Dr
CP1 Office Other Supplies Accounts Dr Dr 252
252 154
12,600 15,400 1,400 1,120 560
224 392
15,000 22,400 19,600 280
1,022 (417)
85,000 (201)
840 (125)
6,020 3,640 12,432 (x)
(a) & (e) General Journal Date
Account Titles and Explanation
Ref
Debit
412 √/112
420
Inventory ($420 x .60) Cost of Sales (Issued credit for goods returned)
120 505
252
18 Accounts Payable – Microphones Ltd Inventory (Received credit for returned goods)
√/201 120
280
31 Office Supplies Expense Office Supplies (Office supplies used)
728 125
1,140
31 Insurance Expense Prepaid Insurance (One month’s insurance expense 2,000/10 = 200)
722 130
200
31 Depreciation Expense Accumulated Depreciation – Equipment (One month’s depreciation expense: 1,500/12 = 125)
711 158
125
31 Interest Expense Interest Payable (Interest owing on bank loan)
718 230
840
401 417 350
104,440 1,022
Jan. 9 Sales Returns and Allowances Accounts Receivable – N Jones
G1 Credit
420
252
280
Adjusting Entries
1,140
200
125
840
Closing Entries 31 Sales Discount Received Income Summary
105,462
Chapter 6: Accounting subsystems
Date Account Titles and Explanation Jan. 31 Income Summary Sales Returns and Allowances Cost of Sales Freight In Discount Allowed Rent Expense Sales Salaries Expense Depreciation Expense Interest Expense Insurance Expense Office Salaries Expense Office Supplies Expense
Ref 350 412 505 515 614 729 627 711 718 722 727 728
Debit 76,606
31 Income Summary Peter Dawes, Capital
350 301
28,856
31 Peter Dawes, Capital Peter Dawes, Drawings
301 306
1,120
Credit 420 62,412 252 157 1,400 6,020 125 840 200 3,640 1,140
28,856
1,120
(b) & (e) General Ledger Cash Date Explanation Jan. 1 Balance 31 31
Accounts Receivable Date Explanation Jan. 1 Balance 31 31 9
Inventory Date Explanation Jan. 1 Balance 31 31 31 9 18
Ref
Debit
CR1 CP1
106,603
Ref
Debit
S1 CR1 G1
Ref P1 S1 CR1 G1 G1
28,420
Debit 80,360
252
No. 101 Credit Balance 35,750 142,353 97,250 45,103
No. 112 Balance 14,600 43,020 16,240 27,780 420 26,360
Credit
No. 120 Balance 18,000 98,360 17,052 81,278 45,612 35,666 35,918 280 35,668
Credit
Office Supplies Date Explanation Jan. 1 Balance 31 31
Prepaid Insurance Date Explanation Jan. 1 Balance 31
Equipment Date Explanation Jan. 1 Balance
Accumulated Depreciation - Equipment Date Explanation Jan. 1 Balance 31
Bank Loan Date Explanation Jan. 15
Ref CP1 G1
Ref
Debit 840
No. 125 Credit Balance 1,000 1,840 1,140 700
No. 130 Balance 2,000 200 1,800
Debit
Credit
Ref
Debit
Credit
Ref
Debit
Credit
Debit
No. 200 Credit Balance 14,000 14,000
G1
G1
Ref CR1
No. 157 Balance 45,450
No. 158 Balance 1,500 125 1,625
Accounts Payable Date Explanation Jan. 1 Balance 31 31 18
P1 CP1 G1
Interest Payable Date Explanation Jan. 31
Ref G1
Debit
No. 230 Credit Balance 840 840
Revenue Received in Advance Date Explanation Jan. 31
Ref CR1
Debit
No. 235 Credit Balance 500 500
Ref
Debit
85,000 280
No. 201 Credit Balance 43,000 80,360 123,360 38,360 38,080
Chapter 6: Accounting subsystems
Peter Dawes, Capital Date Explanation Jan. 1 Balance 31 31
Ref G1 G1
Debit
1,120
P Dawes, Drawings Date Explanation Jan. 15 31
Ref CP1 G1
Debit 1,120
Income Summary Date Explanation Jan. 31 31 31
Ref G1 G1 G1
Debit 76,606 28,855
Sales Date Explanation Jan. 31 31 31
Ref S1 CR1 G1
Debit
Sales Returns and Allowances Date Explanation Jan. 9 31
Ref G1 G1
Debit 420
Discount Received Date Explanation Jan. 31 31
Cost of Sales Date Explanation Jan. 31 31 9 31
Ref CP1 G1
Ref S1 CR1 G1 G1
104,440
Debit 1,022
No. 505 Debit 17,052 45,612
No. 301 Balance 72,300 28,856 101,155 100,036
Credit
No. 306 Credit Balance 1,120 1,120 0
No. 350 Credit Balance 105,461 105,461 28,855 0
No. 401 Credit Balance 28,420 28,420 76,020 104,440 0
No. 412 Balance 420 420 0
Credit
No. 417 Credit Balance 1,022 1,022 0
Credit
252 62,412
Balance 17,052 62,664 62,412 0
Freight In Date Explanation Jan. 8 31
Discount allowed Date Explanation Jan. 31 31
Ref CP1 G1
Ref CR1 G1
Debit 252
Credit 252
Debit 157
No. 614 Credit Balance 157 157 0
No. 627 Credit Balance 6,020 6,020 0
Sales Salaries Expense Date Explanation Jan. 31 31
Ref CP1 G1
Debit 6,020
Depreciation Expense Date Explanation Jan.31 31
Ref G1 G1
Debit 125
Credit
Interest Expense Date Explanation Jan. 31 31
Ref G1 G1
Debit 840
Credit
Insurance Expense Date Explanation Jan. 31 31
Ref G1 G1
No. 515 Balance 252 0
No. 711 Balance 125 125 0
No. 718 Balance 840 840 0
Debit 200
No. 722 Credit Balance 200 200 0
No. 727 Credit Balance 3,640 3,640 0
Office Salaries Expense Date Explanation Jan. 31 31
Ref CP1 G1
Debit 3,640
Office Supplies Expense Date Explanation Jan. 31 31
Ref G1 G1
Debit 1,140
No. 728 Balance 1,140 1,140 0
Credit
Chapter 6: Accounting subsystems
Rent Expense Date Explanation Jan. 12 31
Ref CP1 G1
Debit 1,400
No. 729 Balance 1,400 1,400 0
Credit
Accounts Receivable Subsidiary Ledger R Danforth Date Explanation Jan. 1 Balance 11 22
S1 S1
1,820 1,120
N Jones Date Explanation Jan. 6 9 13 25
Ref S1 G1 CR1 S1
Debit 2,520
Ref
Debit
B Jiminez Date Explanation Jan. 1 Balance 7 25
Ref
CR1 S1
S Levin Date Explanation Jan. 1 Balance 7 11 16
CR1 S1 CR1
J Hendrix Date Explanation Jan. 6 12 22
Ref S1 CR1 S1
Ref
Debit
Credit
Balance 1,500 3,320 4,440
Credit
Balance 2,520 2,100 0 8,540
420 2,100 8,540
Credit 2,800
4,900
Debit
Credit 5,600
1,260 1,260
Debit 4,480
Credit 4,480
3,780
Balance 7,500 4,700 9,600
Balance 5,600 0 900 0
Balance 4,480 0 3,780
Accounts Payable Subsidiary Ledger Drums R Us Date Explanation Jan. 3 27
Microphones Ltd Date Explanation Jan. 1 Balance 9 17 18 23
R Manual Date Explanation Jan. 1 Balance 21
Ref P1 P1
Debit
Credit 3,080 1,680
Balance 3,080 4,760
Ref
Debit
Credit
Balance 12,600 0 19,880 19,570 0
CP1 P1 G1 CP1
Ref CP1
Aging Violins Date Explanation Jan. 1 Balance 9 17 23 27
CP1 P1 CP1 P1
Guitar World Date Explanation Jan. 3 17 27
Ref P1 P1 P1
Ref
12,600 19,880 280 19,600
Debit
Credit
Balance 15,000 0
Credit
20,300
Balance 15,400 0 22,400 0 20,300
Credit 4,200 2,100 6,720
Balance 4,200 6,300 13,020
15,000
Debit 15,400
22,400 22,400
Debit
Chapter 6: Accounting subsystems
(c) Murraturra’s Music Shop Worksheet for the month ended 31 January 2014 Account Titles
Cash Accounts Receivable Inventory Office Supplies Prepaid Insurance Equipment Accum. Depreciation – Equipment Bank Loan Accounts Payable Interest Payable Revenue Received in Advance Peter Dawes, Capital Peter Dawes, Drawings Sales Discount Received Sales Returns and Allowances Discount Allowed Cost of Sales Freight In Sales Salaries Expense Office Salaries Expense Rent Expense Totals Office Supplies Expense Insurance Expense Depreciation Expense Interest Expense Totals Profit Totals
Trial Balance Dr 45,103 26,360 35,668 1,840 2,000 45,450
Cr
Adjustments
Adjusted Trial Balance
Dr
Dr 45,103 26,360 35,668 700 1,800 45,450
Cr
(1) 1,140 (2) 200 1,500 14,000 38,080
(3)
125
(4)
840
Cr
Dr 45,103 26,360 35,668 700 1,800 45,450
Cr
1,625 14,000 38,080 840 500 72,300
1,120 104,440 1,022
420 157 62,412 252 6,020 3,640 1,400 231,842
Dr
Balance Sheet
1,625 14,000 38,080 840 500 72,300
500 72,300 1,120
Cr
Income Statement
1,120 104,440 1,022
104,440 1,022
420 157 62,412 252 6,020 3,640 1,400
420 157 62,412 252 6,020 3,640 1,400
1,140 200 125 840 232,807
1,140 200 125 840 76,606 28,856 105,461
231,842 (1) 1,140 (2) 200 (3) 125 (4) 840 2,305
2,305
232,807
105,461
156,201
105,461
156,201
127,345 28,856 156,201
d) Murraturra Music Shop Income Statement for the month ended 31 January 2014
OPERATING REVENUE Sales revenues: Gross sales Less: Sales returns and allowances Net sales revenue Cost of Sales: Cost of sales Freight in Gross profit Other Operating Revenue: Discount Received
104,440 (420) 104,020 62,412 252
62,664 41,356 1,022 42,377
OPERATING EXPENSES Selling expenses: Sales salaries expense Administrative expenses: Office salaries expense Rent expense Office supplies expense Insurance expense Depreciation expense
6,020
Financial expenses: Interest Expense Discount Allowed Profit
3,640 1,400 1,140 200 125
6,506
840 157
997
13,522 28,856
Murraturra Music Shop Calculation of Owner’s Equity as at 31 January 2014
Peter Dawes, Capital, 1 January 2011 Add: Profit
72,300 28,856 101,155 (1,120) 100,036
Less: Drawings Peter Dawes, Capital, 31 January 2011
6.117
Chapter 6: Accounting subsystems
Murraturra Music Shop Balance Sheet as at 31 January 2014
ASSETS Current assets: Cash Accounts receivable Inventory Office supplies Prepaid insurance
45,103 26,360 35,668 700 1,800
Total current assets Non-current assets: Property, Plant and Equipment: Equipment Less: Accumulated depreciation Total non-current assets Total assets LIABILITIES AND OWNER’S EQUITY Current liabilities: Accounts payable Interest payable Revenue Received in Advance Total current liabilities Non-current liabilities: Bank loan Total non-current liabilities Total liabilities Owner’s Equity: Peter Dawes, Capital Total liabilities and owner’s equity
109,631
45,450 (1,625) 43,825 153,456
38,080 840 500 39,420
14,000 14,000 53,420
100,036 153,456
(f) Murraturra Music Shop Post-Closing Trial Balance as at 31 January 2014 Debit Cash Accounts Receivable Inventory Office Supplies Prepaid Insurance Equipment Accumulated Depreciation – Equipment Bank Loan Accounts Payable Revenue Received in Advance Interest Payable Peter Dawes, Capital
Credit
45,103 26,360 35,668 700 1,800 45,450
_ _____ 155,081
Accounts Receivable Control Balance
1,625 14,000 38,080 840 500 100,036 155,081 $26,360
Accounts Receivable subsidiary ledger account balances: R Danforth N Jones B Jiminez J Hendrix
$4,440 8,540 9,600 3,780
Accounts Payable Control Balance
$26,360 $38,080
Accounts Payable subsidiary ledger account balances: Drums R Us Aging Violins Guitar World
6.119
$4,760 20,300 13,020
$38,080
Chapter 6: Accounting subsystems
6.3
FINANCIAL REPORTING PROBLEM
There are many companies that sell computerised accounting software packages such as MYOB and QuickBooks. These companies provide detailed product information and many provide trial versions on the web site. The aim of this question is to allow students to find out more about computerised accounting software packages and experience using them.
CRITICAL THINKING BUILDING BUSINESS SKILLS 6.4 GROUP DECISION CASE Lee & Jones (a)
The special journals for Lee & Jones should be: (1) sales journal; (2) purchases journal; (3) cash receipts journal; and (4) cash payments journal. (1)
Sales Journal columns: ▪ Date ▪ Account Debited ▪ Invoice Number ▪ Post Reference ▪ Accounts Receivable, Dr. and Sales – Appliances, Cr. ▪ Cost of Sales, Dr. and Inventory, Cr.
(2)
Purchases Journal columns: ▪ Date ▪ Account Credited ▪ Terms ▪ Post Reference ▪ Accounts Payable, Cr. ▪ Inventory – Appliances, Dr. ▪ Inventory – Parts, Dr.
Note: Because two different types of inventory are purchased on credit, a three-column purchases journal might be used. (3)
Cash Receipts columns: ▪ Date ▪ Account Credited ▪ Post Reference ▪ Cash, Dr. ▪ Accounts Receivable, Cr. ▪ Sales – Appliances, Cr. ▪ Sales – Parts, Cr. ▪ Revenue from Repairs, Cr. ▪ Other Accounts, Cr. ▪ Cost of Sales, Dr. and Inventory, Cr.
-
Note: A Discount Allowed, Dr. column is not needed because all credit terms are net/30 days. (4)
Cash Payments Journal columns: ▪ Date ▪ Cheque Number ▪ Accounted Debited ▪ Post Reference ▪ Other Accounts, Dr. ▪ Accounts Payable, Dr. ▪ Advertising Expense, Dr. ▪ Salaries Expense, Dr. ▪ Discount Received, Cr. ▪ Cash, Cr.
Note: A Discount Received column is needed as practically all suppliers offer cash discounts and it is company policy to take all discounts. (b)
Lee & Jones should have: (1) (2)
An accounts receivable control account with individual customers accounts in a customers’ subsidiary ledger. An accounts payable control account with individual creditors accounts in a creditors’ subsidiary ledger.
The use of control accounts and subsidiary ledgers will: (1) (2) (3) (4)
(c)
provide necessary up-to-date information on specific customer and creditor balances free the general ledger of excessive detail help locate errors in individual accounts make possible a division of labour in posting.
It appears that the accounting information system for the business is still inefficient despite hiring two additional bookkeepers to assist with the accounting work. Reasons for this could include more than one person requiring the ledger to post from the journal. In addition, the daily posting of transactions continues to be very time consuming, manual processes are more subject to errors and it is time consuming trying to locate and correct errors
. (d)
The recommended changes would be to introduce a computerised accounting system to improve efficiency and accuracy of recording transactions. Advantages of computerised systems include: -
less staff are required so in the long run lower salary costs computerised systems can process numerous transactions quickly built in automatic posting error reduction faster response time – e.g. for producing reports in built checks – e.g. not processing a transaction if there are not equal debits and credits
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Chapter 6: Accounting subsystems
6.5
COMMUNICATION ACTIVITY
MEMORANDUM To:
Pete Smith
From:
What’s My Name
Subject:
Customer relationship management
Dear Pete I have conducted research into customer relationship management (CRM). Please find attached report detailing how your business could benefit from CRM to assist you in understanding and satisfying customer needs and improve profitability. Customer relationship management is a difficult term to define as it means many different things to different people. Generally, it refers to the process by which companies manage interaction with their customers, by collecting and analysing data related to customers, and delivering ‘tailor made’ value propositions to individual customers. The rationale behind this is that customers are all different, and they require different levels of services (e.g. ‘premium’ customers that require constant attention, versus ‘passive’ customers who are happy with the basic service at lower costs). The goal of CRM is to increase customer loyalty by providing personalised attention to customers but without “wasting” company resources on services that customers do not value. CRM often requires the support of different technologies, such as using the company websites to ‘research’ your customers (e.g. which links did they click on?). Amazon.com, for example, often provides personalised recommendations to users when they log on, based on their previous visits and purchases. Other data analysis/data mining tools can also be used to better understand customer behaviour and categorise them into different ‘customer segments’, and in doing so, building customer behaviour models. There are many benefits to CRM, the most obvious one is to allow organisations to more effectively manage their resources by serving the customers the ‘right way’, and ensuring a lower level of customer turnover. As it is generally more expensive to acquire new customers than to sell to existing customers, CRM allows companies to stop the “customer leakage” and maximise profit from their existing accounts. If you have any further queries, please do not hesitate to contact me. Regards
XXXXXX
6.6
ETHICS CASE Tyler Products Ltd
(a)
The stakeholders in this case are: ▪ Don Henke, manager of Tyler Products’ centralised computer accounting operation. ▪ The employees of Tyler Products’ three divisions at Moorebank, Smithfield and Tempe.
(b)
Don’s instructions to assign the Tempe code to all uncoded and incorrectly coded sales documents overstates the sales of Tempe and understates the sales of Moorebank and Smithfield, thereby affecting the employee bonus plan. Don’s intent and actions are unethical. He is increasing the sales of his wife’s, relatives’ and friends’ Tempe division sales and unfairly aiding them in the bonus competition.
(c)
Tyler Products Ltd should have a written policy covering uncoded and incorrectly coded sales documents. This would prevent the manager from arbitrarily designating the division to be credited for the uncoded sales. Tyler Products could design new sales documents which identify clearly from which division the sales were made.
6.7
RESEARCH CASE
Answers will vary depending on the resources chosen by the students. However, at a minimum they should look at 2007 annual report and here are some possible solutions from the report: Store expansion: In the Chairman’s report in the 2007 report it was stated: “At the end of 2006-07, the Company operated 663 stores across Australia, New Zealand, France, Belgium and The Netherlands, having added an additional 225 stores to the network during the 12 months, including 155 stores from the European acquisition”. Hence, the store expansion objective has been met Innovative stores menues and marketing: In the 2007 annual report ”In 2006-07 we introduced many exciting new marketing initiatives and menu items to entice our customers and deliver the best customer service”. Page 13 ….for example “In New Zealand the launch of the Meat Pie Pizza attracted considerable attention with the marriage of the Meat Pie and the Pizza. Held at Auckland’s high-profile church” page 12….Another example “The launch of our Jumbo Chicken Wings created fun and excitement when safari-dressed promotional teams joined our team members in each major Australian city, to hand out free Jumbo Chicken Wing samples and hunt for (possibly) the biggest, tastiest wings in history. page 13 Hence it appears that Dominos have introduced new items and innovative marketing strategies Technology making it easier to serve customers:
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Chapter 6: Accounting subsystems
Page 14 2007 annual report “We make it easy for our customers to order from us with in-store, internet, home phone and mobile phone ordering. Our unique internet ordering system is now in 73.5%* of all stores, allowing customers to order from us quickly and easily. Customers can also watch the progress of their pizzas on-line in real time with our special “anticipation clock”. Thus it appears that Dominos achieved this objective as well in 2007 Management
actively
seeking
improvements
in
operations
and
efficiencies
Page 9 “New ways to improve store and network efficiency and profitability is also vital to the Company’s growth strategy Our point-of-sale (POS) system – PULSE - is now in 93%* of Australian and New Zealand stores helping to streamline operations. PULSE further provides for internet ordering to be available in 73.5%* of Australian and New Zealand stores, with this number increasing quickly.” Again it appears that management is achieving its objectives from 2006
6.8
JEWELS, JEWELS AND MORE JEWELS LTD (a)
Corporate social responsibility (CSR) is ‘social responsibility’ applied in a business environment and involves businesses acting with regard to social principles and acting ethically. Basically, it is about business people’s obligation to act responsibly for the benefit society when carrying on business activities. This responsibility can be by passive by not engaging in activities that could be socially harmful (eg polluting the air), or active, by engaging in activities that directly support people and enhance social goals (eg building public playgrounds and parks). For each business what is considered to be ‘socially responsible’ differs, however there are key guiding principles including ensuring quality of life, economic function of the society and social investment.
(b) If the customers of Jewels, Jewels and more Jewels Ltd are aware that one of their main suppliers acquires blood diamond, they may choose to buy their products from socially responsible businesses and they will lose profits. Jewels, Jewels and more Jewels Ltd may also get bad press and exacerbate the decrease in profits. (c)
Jewels, Jewels and more Jewels Ltd could do a number of things to avoid negative consequences including: 1
Find another ethical diamond supplier ASAP and make this information public
2
Obtain assurance and evidence from Big Diamond Factory that they are ethical socially responsible suppliers and then make that information publicly available.
3
Put policies into place to ensure all future suppliers are socially responsible and make this information public
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 7 INTERNAL CONTROL, CASH AND RECEIVABLES– INVENTORIES ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1.
Identify the principles of internal control.
1
1, 2
1A, 3A, 5A, 1B, 3B, 5B
2.
Explain the application of internal control principles to handling cash.
2
2
1A, 3A,1B, 3B
3.
Prepare a bank reconciliation.
3
2A, 3A, 4A, 2B, 3B, 4B
4.
Discuss the basic principles of cash management.
5.
Identify the different types of receivables.
6.
Apply methods used to account for receivables, including bad debts.
7.
4, 11
5
6, 7
6
Describe how receivables are reported in financial statements.
7
7
8.
Explain the principles of receivables management.
7, 8
8, 9, 10,12
9.
Explain the operation of a petty cash fund.
4
5
7.1
6A, 7A, 8A, 9A, 6B, 7B, 8B, 9B
10A, 10B
Chapter 7: Internal control, cash and receivables
CHAPTER 7 – INTERNAL CONTROL, CASH AND RECEIVABLES ANSWERS TO QUESTIONS 1.
Disagree. Internal control is also concerned with the effectiveness and efficiency of operations, compliance with laws and regulations, and the safeguarding of company assets from employee theft, robbery and unauthorised use.
2.
Cash should be reported at $17,850 ($5,000 + $850 + $12,000).
3.
Cash registers are readily visible to the customer. Thus, they prevent the sales clerk from ringing up a lower amount and pocketing (stealing) the difference. In addition, the customer receives an itemised receipt, and the cash register provides a record, on tape or electronically, for further verification.
4.
The basic principles of cash management are:
5.
(1)
increase the speed of collection of receivables
(2)
keep inventory levels low
(3)
don’t make payments earlier than necessary
(4)
plan timing of major expenditures
(5)
invest idle cash.
(a)
A dishonoured cheque occurs when the bank on which the cheque is drawn refuses to pay the cheque, because it has been cancelled or because the balance of the account on which it is drawn is less than the amount of the cheque.
(b)
It reduced the balance of the bank account reported on the bank statement. The dishonoured cheque should be recorded in the Cash at Bank account. It does not appear in the bank reconciliation statement.
(c)
A dishonoured cheque should be entered into the cash receipts as a reduction in cash receipts. The adjusting entry in the company’s ledger accounts is a debit to Accounts Receivable and a credit to Cash.
7.2
Solutions manual to accompany Accounting: building business skills 4e
6.
The activities in a petty cash system and the related principles are: (a)
(1)
Establishing the fund. ▪
(2)
Making payment from the fund. ▪
(3)
Documentation procedures, such as the use of a pre-numbered petty cash receipt and evidence of authorisation of payments.
Replenishing the fund. ▪
(b)
Establishment of responsibility for custody of the fund.
Independent internal verification of schedule of petty cash receipts because the request for replenishment must be approved before the cheque is signed.
Journal entries are required for a petty cash fund when it is established and replenished. Entries are also required when the size of the fund is increased or decreased.
7.
Accounts receivables are amounts owed by customers on account. They result from the sale of goods and services in the normal course of business operations (i.e. in trade). Notes receivable represent claims that are evidenced by formal instruments of credit.
8.
Soo Eng should realise that the decrease in the recoverable amount occurs when estimated uncollectables are recognised in an adjusting entry. The write-off of an uncollectable account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, the recoverable amount does not change.
9.
(a)
$900,000 of the Trade Debtors should be classified as current receivables; and $100,000 as non-current receivables.
(b)
The 90-day promissory note is a current receivable.
10.
A receivable turnover of 8 times means accounts receivable is turned into cash 8 times in a year, or it takes on average 46 days (365/8) to collect the receivable. If the business has a credit term of 30 days, this suggests that collection policy is not very effective. The business should promptly follow up overdue accounts.
7.3
Chapter 7: Internal control, cash and receivables
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7.1 Marion Ltd (a) (b) (c)
Separation of duties. Independent internal verification. Documentation procedures.
BRIEF EXERCISE 7.2 Franklin Office Supplies Ltd There was weakness in the internal controls in this situation. Responsibility was not clearly established and there was no segregation of duties as Aaron could both order and approve his own purchase, leading to possible exploitation of the system. BRIEF EXERCISE 7.3 Ridley Pty Ltd Cash balance per bank
$8,420
Add:
2,700
Outstanding deposits
11,120 Less: Unpresented cheques
862
Balance of Cash at Bank account
$10,258
Note: The Bank Service Charge of $20 will have already been included in the cash balance per bank.
BRIEF EXERCISE 7.4 Gimbal Mar. 20
Postage Expense Supplies Travel Expense Cash
52 26 10 88
BRIEF EXERCISE 7.5 (a) (b) (c)
Other receivables. Notes receivable. Accounts receivable.
7.4
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 7.6 Massey Ltd (a)
(b)
Bad Debts Expense [($500,000 x 1%) - $3,000] Allowance for Doubtful Debts
2,000
Bad Debts Expense [($500,000 x 1%) + $800] Allowance for Doubtful Debts
5,800
2,000
5,800
BRIEF EXERCISE 7.7 Wendy Ltd (a)
(b)
(c)
Bad Debts Expense Allowance for Doubtful Debts
40,000 40,000
Current Assets: Cash Accounts receivable Less: Allowance for doubtful debts Inventory Prepaid expenses Total Current Assets Credit risk ratio =
$90,000 $600,000 (40,000)
560,000 130,000 13,000 $793,000
$40,000 = 6.7% $600,000
Receivables turnover ratio =
$3,000,000 = 5.7 times $530,000
Average collection period =
365 days = 64 days 5.7
BRIEF EXERCISE 7.8 (a)
(b)
Cash at Bank ($200 - $8) Credit Card Services Expense ($200 x 4%) Sales Cash at Bank ($50,000 - $2,000) Discount on Sale of Receivables ($50,000 x 4%) Accounts Receivable Note the discount on sale of receivables is an expense.
7.5
192 8 200 48,000 2,000 50,000
Chapter 7: Internal control, cash and receivables
SOLUTIONS TO EXERCISES EXERCISE 7.1 Galenti’s Pizza 1.
Establishment of responsibility. The counter clerk is responsible for handling cash. Other employees are responsible for making the pizzas.
2.
Segregation of duties. Employees who make the pizza do not handle cash.
3.
Documentation procedures. The counter clerk uses your order invoice (ticket) in registering the sale on the cash register. The cash register produces a tape of all sales.
4.
Physical, mechanical and electronic controls. A cash register is used to record the sale.
5.
Independent internal verification. The counter clerk handling the pizza compares the type of the pizza with the type indicated on the orders.
EXERCISE 7.2 (a)
(b)
Procedure
Weakness
Principle
Recommended change
1.
Inability to establish responsibility for cash.
Establishment of responsibility
There should be separate cash drawers and register codes for each clerk.
2.
Cash is not adequately Physical, mechanical, protected from theft. and electronic controls.
Cash should be stored in a safe until it is deposited in the bank.
3.
Cash is not independently counted.
Independent internal verification.
A cashier office supervisor should count cash.
4.
The accountant should Segregation of duties. not handle cash.
The cashier’s department should make the deposits.
7.6
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 7.3 Shoe City Ltd (a)
(b)
Balance as per bank statement Add: Outstanding deposits Less: Unpresented cheques Balance as per Cash at Bank account (1)
$4,392.20 708.00 5,100.20 (876.00) $4,224.20
(1)
$4,770.20
Cash balance per books Less: Dishonoured cheque Bank charges Adjusted cash balance per books
$516.00 30.00
455.00 $4,224.20
(In general journal form) Accounts Receivable Cash at Bank
516.00
Bank Charges Cash at Bank
30.00
516.00
30.00
EXERCISE 7.4 Nick Scali Furniture The cash to daily cash expenses ratio is calculated by first calculating average daily cash expenses.
$92,728 = $254 thousand per day 365 Then cash on hand is divided by average daily cash expenses:
$17,312 = 68.2 days $254 Nick Scali’s cash on hand is adequate. It has enough cash on hand to pay for 68 days of expenses. This, combined with positive cash provided by operations indicates strong liquidity.
7.7
Chapter 7: Internal control, cash and receivables
EXERCISE 7.5 Hair Styles Pty Ltd (In general journal form) Date Account Titles and Explanation Oct. 1 Petty Cash Cash at Bank
Debit
Credit 130 130
31 Office Supplies Telecommunications Expense Postage Expense Freight-out Cash Short and Over Cash at Bank
36.50 21.30 53.70 8.80 1.40 121.7
Petty Cash Cash at Bank
130 130
EXERCISE 7.6 Garcia Pty Ltd (a) Accounts Receivable Current 1-30 days past due 31-90 days past due Over 90 days
(b)
(c)
Amount
%
$65,000 12,600 8,500 6,400
2.0 5.0 30.0 50.0
Mar. 31 Bad Debts Expense Allowance for Doubtful Debts ($7,680 - $1,600)
Estimated Uncollectables $1,300 630 2,550 3,200 $7,680
6,080 6,080
The total balance of receivables increased from 2011 to 2012. However, of concern is the fact that each of the three categories of older accounts increased substantially during 2012. That is, customers are taking longer to pay and bad debts are likely to increase. Management needs to investigate the causes of this change.
7.8
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 7.7 Deere Ltd Notes to the Financial Statements as at 30 June 2012 (in millions) Receivables: Trade Receivables: Notes Receivable Accounts Receivable Less: Allowance for Doubtful Debts Other Receivables Net Receivables
$955 2,907 31
2,876 228 $4,059
Note: It is assumed that Notes Receivables are part of Trade Receivables. EXERCISE 7.8 Honey Factory Ltd (a) 2012
2011
Receivables turnover ratio =
$1,113.0 (($146.6 − $6.3) + ($104.3 − $5.7)) / 2
$899.3 (($104.3 − $5.7) + ($126 − $8.2)) / 2
= 9.3 times
=8.3 times
Average collection period =
365 days = 39.2 days or 39 days 9 .3
365 days = 43.9 days or 44 days 8.3
(b) 2012 Credit risk ratio =
(c)
2011
$6.3 = 4.3% $146.6
$5.7 = 5.5% $104.3
The credit and collection policies in Honey Factory Ltd. seemed to have worked well in 2012. The company’s receivables turnover has improved from 8.3 times in 2011 to 9.3 times in 2012, with the corresponding average collection period shortened from 44 days to 39 days. The company’s credit risk has also improved from 5.5% to 4.3% in 2012.
EXERCISE 7.9 Virtual Appliances Date Mar. 3
Account Titles and Explanation Cash at Bank ($900,000 - $36,000) Discount on Sale of Receivables (1) Accounts Receivable
Debit 864,000 36,000
Credit
900,000
(1) Note this is an expense account. The amount is calculated as 4% x $900,000.
7.9
Chapter 7: Internal control, cash and receivables
EXERCISE 7.10 Continuous Curtains Ltd Date May 10
Account Titles and Explanation Cash at Bank ($4,800 - $144) Credit Card Services Expense (3% x $4,800) Sales
Debit 4,656 144
Credit
4,800
EXERCISE 7.11
(a) Average daily cash expenses
Cash to daily cash expenses
Burleigh Heaven =[ (Cash payment to suppliers & employees) +(Cash payment for interest & other finance costs) +(Cash payment for income tax) ]/365
Miami Paradise =[ (Cash payment to suppliers & employees) +(Cash payment for interest & other finance costs) +(Cash payment for income tax) ]/365
= ($63,905+$6,780+$17,672)/365
=($55,802+$16,383+$12,239)/365
=$88,357/365
=$84,424/365
=$242.07
=$231.30
=Cash/Average daily cash expense =$7,110/$242.07
=Cash/Average daily cash expense =$4,289/$231.30
=29.3 days
=18.5 days
(b) If the adequacy of cash is the only factor for the investment decision, Burleigh Heaven appears to be the superior candidate it has a higher cash adequacy then Miami Paradise (29 days compared with 19 days). EXERCISE 7.12 Lifestyle Furniture Ltd (a) 1.Receivable turnover 2. Average collection period 3. Credit risk ratio: 2012 2011
(b)
Queensland =$1,498/[($152-$7.2)+($197-$10)/2] = 9 times
Victoria = $1,388/[($128-$6.2)+($120-$5.2)/2] = 11.7 times
= 365/9 = 40.6 days
= 365/11.7 = 31.2 days
=$10/$197 = 5.08% =$7.2/$152 = 4.74%
=$5.2/$120 = 4.33% =$6.2/$128 = 4.84%
The Victoria Division has a higher accounts receivable turnover (11.7 vs. 9 times) which means it is collecting accounts receivable 9 days faster than its Queensland counterpart. In terms of credit risk, VIC not only has lower credit risk ratios for both years, it is also on an improving trend while Queensland’s credit risk is deteriorating. In conclusion, Victoria division seems to have a more effective credit collection policy and credit risk control.
7.10
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 7.1 Burlington Theatre (a) Principles
Application to cash receipts
Establishment of responsibility.
Only cashiers are authorised to sell tickets. Only the manager and cashier can handle cash.
Segregation of duties.
The duties of receiving cash and admitting customers are assigned to the cashier and to the doorperson. The manager maintains custody of the cash, and the company accountant records the cash.
Documentation procedures.
Tickets are pre-numbered. Cash count sheets are prepared. Deposit slips are prepared.
Physical, mechanical, and electronic A safe is used for the storage of cash and a controls. machine is used to issue tickets. Independent internal verification.
(b)
Cash counts are made by the manager at the end of each cashier’s shift. Daily comparisons are made by the company treasurer.
Actions by the doorperson and cashier to misappropriate cash include: (1)
Instead of tearing the tickets, the doorperson could return the tickets to the cashier who could resell them, and the two could divide the cash.
(2)
The cashier could issue a lower priced ticket than paid for and the doorperson would admit the customer. The difference between the ticket issued and the cash received could be divided between the doorperson and cashier.
7.11
Chapter 7: Internal control, cash and receivables
PROBLEM SET A 7.2 KONA Ltd Bank Reconciliation Statement 31 December 2012 Balance as per bank statement Add: Outstanding deposit
19,580.00 1,190.40 20,770.40
Less: Unpresented cheques No. Amount 3470 720.10 3474 1,050.00 3478 538.20 3481 807.40 3484 832.00 3486 1,389.50
5,337.20
Balance as per Cash at Bank account
15,433.20
Original balance of Cash at Bank account Transposition error (deposit 20/12: 2945-2954) Transposition error (cheque#3485: 540.8-450.8) Collection of note NSF cheque (A. Jordan)
13,034.30 (9.00) (90.00) 3,145.00 (647.10)
Adjusted balance of Cash at Bank Account:
15,433.20
(b) Dec. 31
Cash………………………………………………………………3,145.00 Miscellaneous Expense ........................................................ 15.00 Notes Receivable ................................................... Interest Revenue ....................................................
3,000.00 160.00
Accounts Receivable—A. Jordan.......................................... 647.10 Cash .............................................................
647.10
Accounts Payable ...................................................................... 90.00 Cash .............................................................
90.00
Dec. 31 Accounts Receivable ................................................................. 9.00 Cash .............................................................
9.00
31
31
7.12
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 7.3
Delicious Pies Pty Ltd Bank Reconciliation Statement 31 October 2011 (a) Balance as per bank statement Add: Undeposited receipts
(b)
(c)
$25,732.00 5,313.71 31,045.71
Less: Unpresented cheques: No. Amount 62 $177.45 183 210.00 284 354.55 862 266.99 863 317.52 864 231.39
(1,557.90)
Balance as per Cash at Bank account (1)
$29,487.81
(1)
$30,369.81 280.00 30,649.81 (1,162.00) $29,487.81
Original Balance of Cash at Bank account Add: Bank credit (collection of note receivable) Adjusted balance per books (before theft) Less: Theft Adjusted balance of Cash at Bank account
The cashier attempted to cover the theft of $1,162 by: 1.
Not listing as unpresented three cheques totalling $742.00 (No. 62, $177.45; No. 183, $210.00 and No. 284, $354.55).
2.
Understating the unpresented cheques listed by $140. (The correct total of the 3 cheques listed is $815.90).
3.
Did not add $280 credit note to the book balance.
1.
The principle of independent internal verification has been violated because the cashier prepared the bank reconciliation.
2.
The principle of segregation of duties has been violated because the cashier had access to the accounting records and also prepared the bank reconciliation.
7.13
Chapter 7: Internal control, cash and receivables
PROBLEM SET A 7.4 (a) Computec Ltd Bank Reconciliation Statement 31 May 2012
Balance as per bank statement Add: Outstanding deposits Bank error – Teller cheque
$7,784.60 $836.15 600.00
Less: Unpresented cheques Balance as per Cash at Bank account (1) (1)
Original Cash at Bank balance per books Add: Collection of note receivable
Less: Dishonoured cheque Error in 12 May receipt Error in recording cheque no. 1181 Bank cheque printing charge Adjusted Cash at Bank account balance
(b)
1,436.15 9,220.75 (1,276.25) $7,944.50 $5,681.50 3,060.00 8,741.50
($700.00) (10.00) (27.00) (60.00)
(797.00) $7,944.50
(In general journal form) Date Account Titles and Explanation May 31 Cash at Bank Bank Charges Note Receivable Interest Revenue
Debit 3,060 20
Credit
3,000 80
31 Accounts Receivable – W Hoad Cash at Bank
700
31 Sales Cash at Bank
10
31 Accounts Payable – M Helms Cash at Bank
27
31 Bank Charges Cash at Bank
60
700
10
27
60
7.14
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 7.5 Ethical issues in this scenario included: •
Shaun’s falsification of repair invoices
•
Unauthorised transfers of money from Hayden’s property management account to Shaun’s bank account
Potential weaknesses of internal control in the management of Hayden’s investment property: •
There is no segregation of duties
•
Shaun is responsible for authorising repairs and paying for those repairs
Suggestion for improvement: •
Set a limit for which Shaun can approve and pay for repairs
•
Any repair work above the limit needs to be authorised by Hayden before works are being carried out and paid for
7.15
Chapter 7: Internal control, cash and receivables
PROBLEM SET A 7.6 Phuang Ltd (a)
Dec.
31
Bad Debts Expense............................................ 25,450 Allowance for Doubtful Debts ................................. ($37,450 – $12,000)
25,450
(a) & (b) Bad Debts Expense Date 31/12/2012
Particular Allowance for Doubtful Debt
Allowance for Doubtful Debt Date 31/12/2012 31/12/2012 31/3/2013
Particular Balance Bad Debts Expense Accounts Receivable (Bad Debts Write-off)
31/5/2013
Accounts Receivable (Reverse Bad Debts Write-Off)
(1)
(2)
Mar.
May
(c) Dec. 31
Dr $25,450
Cr
Balance Dr Cr $25,450
Dr
Cr
Dr
$25,450
Balance Cr $12,000 $37,450
$500
$36,950
$500
$37,450
2013 31 Allowance for Doubtful Debts ........................... 500 Accounts Receivable ...................................
500
31 Accounts Receivable........................................ 500 Allowance for Doubtful Debts...................................................
500
31 Cash .............................................................. 500 Accounts Receivable ...................................
500
2013 Bad Debts Expense............................................ 31,100 Allowance for Doubtful Debts ................................. ($30,300 + $800)
7.16
31,100
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 7.7 Somerville Ltd (a)
$29,000.
(b)
$7,000 [($460,000 X 5%) – $16,000].
(c)
$34,500 [(460,000 X 5%) + $11,500].
(d)
Under the direct write-off method, accounts receivable are overstated because future estimated write-offs are not anticipated—write-offs are journalised as they occur. In contrast, under the allowance method, anticipated write-offs are estimated and reduce the ending accounts receivable balance. The resulting estimated balance of accounts receivable, stated at recoverable amount, then represents the present value of the cash flows expected to be derived from the receivable.
PROBLEM SET A 7.8 Lexington Pty Ltd (a)
The allowance method. Since the balance in the allowance for doubtful debts is given, it must be using this method because the account would not exist if it were using the direct write-off method.
(b)
Dec 31 Bad Debts Expense……………………………………….10,750 ($11,750 – $1,000) Allowance for Doubtful Debts...................................................
(c)
(d)
(e)
(f)
Dec. 31
10,750
Bad Debts Expense............................................ 12,750 ($11,750 + $1,000) Allowance for Doubtful Debts...................................................
12,750
Allowance for Doubtful Debts …………………………………….5,000 Accounts Receivable ............................................................
5,000
Bad Debts Expense .................................................................. 5,000 Accounts Receivable ................................................................
5,000
The allowance for doubtful debt is a contra-asset account. It is subtracted from the gross amount of accounts receivable so that accounts receivable is reported at recoverable amount.
7.17
Chapter 7: Internal control, cash and receivables
7.18
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 7.9 Diego Ltd Jan. 5 Accounts Receivable—George Company ............................. 16,000 Sales............................................................
16,000
Notes Receivable…………………………………………16,000 Accounts Receivable—George Company ...............................................................
16,000
Notes Receivable ................................................. 8,000 Sales ......................................................................
8,000
20
Feb. 18
Apr.
20
30
May 25
Aug. 18
25
Sept. 1
Cash ($16,000 + $360) ............................................... 16,360 Notes Receivable .......................................................... Interest Revenue ........................................................... ($16,000 X 9% X 3/12)
16,000 360
Cash ($15,000 + $600) ............................................... 15,600 Notes Receivable .......................................................... Interest Revenue ........................................................... ($15,000 X 12% X 4/12)
15,000 600
Notes Receivable 6,000 Accounts Receivable—Avery Inc................................... Cash ($8,000 + $400) ................................................... 8,400 Notes Receivable .......................................................... Interest Revenue ........................................................... ($8,000 X 10% X 6/12) Accounts Receivable—Avery Inc. ................................. 6,120 ($6,000 + $120) Notes Receivable ................................................... Interest Revenue.................................................... ($6,000 X 8% X 3/12) Notes Receivable ................................................. 10,000 Sales .............................................................................
7.19
6,000
8,000 400
6,000 120
10,000
Chapter 7: Internal control, cash and receivables
PROBLEM SET A 7.10 Qantas and Air New Zealand (a) Qantas A$ million
Receivables turnover ratio
Average collection period
Air New Zealand NZ$ million
$13,772 ($1,054 − $27 + $1,088 − $6)/2
$4,046 ($274 − $2 + $322 − $3)/2
=13.06 times
=13.69 times
365 = 28 days 13.06
365 = 26.7 days or 27 days 13.69
Qantas and Air New Zealand appeared to have very similar collection experiences in the latest financial period, as shown by the receivable turnover ratio of 13.06 times and 13.60 times, and the corresponding collection period of 28 days and 27 days.
(b)
Start End
Ratio of allowance for doubtful debts to gross accounts receivable (credit risk ratio): Qantas
Air New Zealand
$27 ÷ $1,054= 2.56% $6÷ $1,088 = 0.55%
$2 ÷ $274 = 0.73% $3 ÷ $322 = 0.93%
Qantas appeared to have tightened its credit-granting practices as the allowance for doubtful debt has decreased substantially and the corresponding credit risk ratio has improved from the start to the end of the year. On the other hand, Air New Zealand appeared to have continued with the same creditgranting practices over the year as both the allowance for doubtful debt and the associated credit risk ratio are maintained.
7.20
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B
PROBLEM SET B 7.1 Rabbit Ears Pet Food Ltd
Principles
Application to Cash Disbursements
Establishment of responsibility.
Only the accountant and assistant accountant are authorised to sign cheques.
Segregation of duties.
Invoices must be approved by both the purchasing manager and the receiving department supervisor. Payment can only be made by the accountant or assistant accountant, and the cheque signatories do not record the cash disbursement transactions.
Documentation procedures.
Cheques are pre-numbered.
Physical, mechanical, and electronic controls.
Blank cheques are kept in a safe in the treasurer’s office. Only the accountant and assistant accountant have access to the safe.
Independent internal verification.
The cheque signatory compares the check with the approved invoice prior to issue. Bank and book balances are reconciled monthly by the assistant accountant.
Other controls.
Following payment, the invoices are stamped PAID.
7.21
Chapter 7: Internal control, cash and receivables
PROBLEM SET B 7.2 Zurich Pty Ltd Bank Reconciliation Statement 30 November 2012 (a) Balance as per bank statement Add: Outstanding deposits
$17,394.60 1,225.00 18,619.60
Less: Unpresented cheques: No. 2451 No. 2472 No. 2478 No. 2482 No. 2484 No. 2485 No. 2487 No. 2488
$1,260.40 426.80 538.20 612.00 829.50 974.80 398.00 800.00 (5,839.70) $12,779.90
Balance as per Cash at Bank account (1) (1) Original Balance of Cash at Bank account Add: Note collected by bank Less:
Cheque printing charge Error in recording cheque no. 2479 ($1,750 - $1,570) Error in 20-11 receipt ($2,954 - $2,945) Adjusted balance of Cash at Bank account
(b)
$11,133.90 1,905.00 13,038.90 (70.00) (180.00) (9.00)
(259.00) $12,779.90
Debit 1,905 15
Credit
(In general journal form) Date Account Titles and Explanation Nov. 30 Cash at Bank Bank Charges Note Receivable Interest Revenue
1,800 120
30 Bank Charges Cash at Bank
70
30 Accounts Payable Cash at Bank
180
30 Accounts Receivable Cash at Bank
9
70
180
9
7.22
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 7.3 Wizards and Dragons Pty Ltd Bank Reconciliation Statement 31 October 2012 (a) Balance as per bank statement Add: Undeposited receipts
(b)
(c)
$18,380.00 3,795.51 22,175.51
Less: Unpresented cheques: No. Amount 62 $126.75 183 150.00 284 253.25 862 190.71 863 226.80 864 165.28
(1,112.79)
Balance as per Cash at Bank account (1)
$21,062.72
(1)
$21,892.72 200.00 22,092.72 (1,030.00) $21,062.72
Original Balance of Cash at Bank account Add: Bank credit (collec’n of note receivable) Adjusted balance per books (before theft) Less: Theft Adjusted balance of Cash at Bank account
The cashier attempted to cover the theft of $1,030.00 by: 1.
Not listing as unpresented three cheques totalling $530.00 (No. 62, $126.75’ No. 183, $150.00 and No. 284, $253.25).
2.
Understating the unpresented cheques listed by $100. (The correct total is $582.79).
3.
Subtracting the $200 credit from the bank balance instead of adding it to the book balance, thereby concealing $400 of the theft.
1.
The principle of independent internal verification has been violated because the cashier prepared the bank reconciliation.
2.
The principle of segregation of duties has been violated because the cashier had access to the accounting records and also prepared the bank reconciliation.
7.23
Chapter 7: Internal control, cash and receivables
PROBLEM SET B 7.4 (a) Interactive Ltd Bank Reconciliation Statement 31 May 2012
Balance as per bank statement Add: Outstanding deposits Bank error – Teller cheque
$15,569.20 $1,672.30 1,200.00
Less: Unpresented cheques Balance as per Cash at Bank account (1)
2,872.30 18,441.50 (2,552.50) $15,889.00
Adjustment to bank account balance (1)
Original Cash at Bank balance per books Add: Error in recording cheque no. 1181 Add: Collection of note receivable
Less: Dishonoured cheque Error in 12 May receipt
6,120.00 17,429.00 ($1,400.00) (20.00)
Bank cheque printing charge Adjusted Cash at Bank account balance
(b)
$10,949.00 360.00
(120.00)
(1,540.00) $15,889.00
(In general journal form) Date Account Titles and Explanation May 31 Cash at Bank Bank Charges Note Receivable Interest Revenue 31 Accounts Receivable – W Hoad Cash at Bank
Debit 6,120 40
Credit
6,000 160 1,400 1,400
31 Sales Cash at Bank
20
31 Cash at bank Accounts Payable – M Helms
360
31 Bank Charges Cash at Bank
120
20
360
120
7.24
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 7.5 The ethical issue involved in this scenario is that Louisa was able to amend the date of invoice for the company’s customers. Potential weaknesses of internal control in Louisa’s company: •
Invoice details could be amended without proper authority
Suggestion for improvement: •
Invoice details should not be amended without proper authority from either sales manager or the billing and collection department manager.
7.25
Chapter 7: Internal control, cash and receivables
PROBLEM SET B 7.6 (a) & (b) Cain Ltd (a) Date Account Titles and Explanation Dec. 31 Bad Debts Expense Allowance for Doubtful Debts ($34,930 – 10,000)
Debit 24,930
Credit 24,930
(a) & (b) Bad Debts Expense Date 31/12/2012 Allowance for Doubtful Debt Date 31/12/2012 31/12/2012
Particular Allowance for Doubtful Debt
31/3/2013
Particular Balance Bad Debts Expense Accounts Receivable (Bad Debts Write-off)
31/5/2013
Accounts Receivable (Reverse Bad Debts Write-Off)
Dr $24,930
Cr
Balance Dr Cr $24,930
Dr
Cr
Dr
$24,930 $600
Balance Cr $10,000 $34,930 $34,330
$600
$34,930
(b) 2013 (1) Mar. 1 Allowance for Doubtful Debts Accounts Receivable
600 600
(2) May 1 Accounts Receivable Allowance for Doubtful Debts
600
1 Cash at Bank Accounts Receivable
600
600
600
(c) Dec. 31 Bad Debts Expense Allowance for Doubtful Debts ($29,100 + $1,100)
7.26
30,200 30,200
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 7.7 Bantax Ltd
(a) $7,250. (b) $1,750 [($115,000 X 5%) – $4,000]. (c) $8,625 [($115,000 X 5%) + $2,875]. (d) Under the direct write-off method, accounts receivable are overstated because future estimated write-offs are not anticipated—write-offs are journalized as they occur. In contrast, under the allowance method, anticipated write-offs are estimated and reduce the ending accounts receivable balance. The resulting estimated balance of accounts receivable, stated at recoverable amount, then represents the present value of the cash flows expected to be derived from the receivable.
PROBLEM SET B 7.8 Gleason Ltd (a)
The allowance method. Since the balance in the allowance for doubtful debts is given, it must be using this method because the account would not exist if it were using the direct write-off method.
(b)
Dec. 31
(c)
(d)
(e)
(f)
Dec. 31
Bad Debts Expense ($16,750 - $1,500) Allowance for Doubtful Debts
15,250
Bad Debts Expense ($16,750 + $1,500) Allowance for Doubtful Debts
18,250
Allowance for Doubtful Debts Accounts Receivable
4,500
Bad Debts Expense Accounts Receivable
4,500
15,250
18,250
4,500
4,500
The allowance for doubtful debt is a contra-asset account. It is subtracted from the gross amount of accounts receivable so that accounts receivable is reported at recoverable amount.
7.27
Chapter 7: Internal control, cash and receivables
PROBLEM SET B 7.9 Elam Ltd General Journal Date Account Titles and Explanation Jan. 5 Accounts Receivable Sales Feb. 2 Notes Receivable Accounts Receivable
Debit 6,000
Credit 6,000
6,000 6,000
12 Notes Receivable Sales
7,800
26 Accounts Receivable Sales
4,000
Apr. 12 Cash at Bank Notes Receivable
7,800
June 2 Cash at Bank Notes Receivable
6,000
July 15 Notes Receivable Sales
3,000
Aug. 15 Cash at Bank Interest Expense Notes Receivable
2,940 60
7,800
4,000
7,800
6,000
3,000
3,000
7.28
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 7.10 CSR and CCA (a)
Receivables turnover ratio
Average collection period
CSR $M
CCA $M
$3,754.9 ($562.1− $9 + $491.9 − $7.5) / 2
$4,546.8 ($671 − $7.8 + $777.6 − $9) / 2
= 7.24 times
= 6.35 times
365 = 50.4 days 7.24
365 = 57.5days 6.35
CSR’s receivable turnover ratio was slightly higher than CCA’s, which means on average, CSR was more efficient than CCA in turning receivables into cash in that year. This may reflect differences in the terms allowed to customers and the types of customers (retail versus business customers). (b)
Start End
Ratio of allowance for doubtful debts to gross accounts receivable (credit risk ratio): CSR
CCA
$9 ÷ $562.1 = 1.6% $7.5 ÷ $491.9 = 1.5%
$7.8 ÷ $671 = 1.2% $9 ÷ $777.6 = 1.2%
Both companies did not appear to have changed their credit-granting practices over the year as the credit risk ratios are maintained from the start to the end of the year.
7.29
Chapter 7: Internal control, cash and receivables
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 7.1
FINANCIAL REPORTING PROBLEM Domino’s Pizza
(a)
The consolidated balance sheet in 2010 shows cash and cash equivalents as $16,241 (in thousands) as at 4 July 2010. The cash balance was $17,426 (in thousands) at the start of the 2009/2010 financial year.
(b)
Cash is defined as including cash on hand and in banks net of outstanding bank overdrafts. Cash comprises cash on hand and demand deposits. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash, which are subject to an insignificant risk of changes in value and have a maturity of three months or less at the date of acquisition.
(c)
The consolidated statement of cash flows indicates net cash provided by operations was $23,752 (in thousands) during 2009/2010.
(d)
The ratio of cash to daily cash expenses for 2010 was: Cash balance reported in the Balance sheet is (in thousands) $16,241 Cash payments for operation (in thousands) $235,795+$797+$3,720 = $240,312 Daily cash expenses (in thousands) $240,312 /365 = $658.39 per day $16,241/$658.39 = 24.7 days
BUILDING BUSINESS SKILLS 7.2
COMPARATIVE ANALYSIS PROBLEM Domino’s Pizza
(a)
Dollars are in $’000 2010 Cash/cash equivalents balance Cash expenses Average daily cash expenses Ratio of cash to daily cash expenses
(b)
$16,241 $240,312 $658.39 24.7 days
2009 $17,426 $241,977 $662.95 26.29 days
2009 has a slightly stronger cash position as indicated by the ratio of cash to daily cash expenses.
7.30
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 7.3
RESEARCH CASE
(a)
(Refer to p.6 of reading) Internal controls are methods or procedures adopted in a business to safeguard its assets, ensure financial information is accurate and reliable, ensure compliance with financial and operational requirements, and generally assisting in achieving the business’ objectives.
(b)
Other reasons why internal control is important for the business: (listed below are some ‘sample answers’, refer to the negative and positive consequences of internal control in the reading) • Improve business decisions, e.g. accurate information about cash balances will ensure that a business does not overspend; also ensure that decisions are appropriately made only by those who have the relevant experience and understanding of the business • More efficient allocation of resources (e.g. reducing resources spent on rectifying mistakes) • Better communication • Early detection of errors • Provide protection to staff • Deterrent to those who wants to commit fraud.
(c)
Different types of internal control: • Control to safeguard assets - e.g. installing security cameras • Controls to ensure financial information is accurate and reliable - e.g. regular reconciliation of accounts • Controls to ensure compliance with financial and operational requirements - e.g. obtain feedback from staff • Controls to assist in achieving the business objectives - e.g. provide correct training to staff.
(d) • •
(e)
Example A: possible controls include regular reconciliation of accounts; implement validation checks and produce exception reports from the system. Example B: possible controls include: ensure payments are on original invoices and not copies or faxes; produce reports that highlight identical payments (e.g. identical amounts or invoice numbers).
Control in a cinema: inter alia… • Ticket sales: pre-numbered tickets, reconcile sales register with takings and credit card receipts; approval required if selling ‘movie money’ worth more than $200. • Entrance: have two ‘ticket checker’ at the ticket entrance to avoid staff letting friends into the cinema without a valid ticket. • Cash and banking: have employees balance cash at the end of shift before handing over to employees of the next shift; regular internal audits.
7.31
Chapter 7: Internal control, cash and receivables
BUILDING BUSINESS SKILLS 7.4
E-BUSINESS FOCUS
a) Possible reasons of small and medium enterprises suffering disproportionately large losses from fraud include: • •
Small and medium enterprises did not give enough consideration to security procedures when embracing electronic banking; Opportunity for thieves arises when small businesses attempt to minimise cost by minimising the number of people involved in administrative tasks such as payment processing. In other word, no proper segregation of duties was delegated.
b) Common mistakes committed by small business operators that make them vulnerable to electronic fraud are: • Placing too much trust in a single employee with limited oversight; • Failing to adopt new security measures designed by banks; • Poor password security. c) Security measures around electronic banking to safeguard against online fraud include: • All transactions should require at least two authorisations; • Make sure that the electronic banking package does not allow an administrator to amend the number of authorisers; • Adopt two-factor authentication.
CRITICAL THINKING BUILDING BUSINESS SKILLS 7.5
GROUP DECISION CASE Campus Fashions
(a)
(b)
2013
2012
2011
Net credit sales
$600,000
$720,000
$480,000
Credit and collection expenses: Collection agency fees Salary of accounts receivable clerk Uncollectible accounts Invoicing and mailing costs Credit investigation fees Total Total expenses as a percentage of net credit sales
$2,940 4,560 9,600 3,000 900 $21,000 3.5%
$3,000 4,560 11,520 3,600 1,080 $23,760 3.3%
$1,920 4,560 7,680 2,400 720 $17,280 3.6%
Average accounts receivable (5%)
$30,000
$36,000
$24,000
Investment earnings (10%)
$3,000
$3,600
$2,400
Total credit and collection expense per above Add: Investment earnings* Net credit and collection expense
$21,000 3,000 $24,000
$23,760 3,600 $27,360
$17,280 2,400 $19,680
7.32
Solutions manual to accompany Accounting: building business skills 4e
Net expense as a percentage of net sales
4.0%
3.8%
4.1%
*The investment earnings on the cash tied up in accounts receivables is an additional expense of continuing the existing cash policies. (c)
The analysis shows that the credit card fee of 4% of net credit sales will be higher than the percentage cost of credit and collection expenses in each year before considering the effect of earnings from other investment opportunities. However, after considering investment earnings, the credit card fee of 4% will be less than the company’s percentage cost if annual net credit sales are less than $600,000. Finally, the decision hinges on: (1) the accuracy of investment earnings (2) the expected trend in credit sales (3) the effect the new policy will have on sales. Non-financial factors include the effects on customer relationships of the alternative credit policies and whether the Berkvoms want to continue with the handling of their own accounts receivable.
BUILDING BUSINESS SKILLS 7.6
ETHICS CASE Shirts Galore Ltd
(a)
The stakeholders in this situation are: The managing director of Shirts Galore Ltd The chief accountant of Shirts Galore Ltd The shareholders of Shirts Galore Ltd Any other users of the financial statements of Shirts Galore Ltd.
(b)
Yes. The chief accountant is posed with an ethical dilemma – should he/she follow the managing director’s ‘suggestion’ and prepare misleading financial statements (understated net profit and assets) or should he/she attempt to stand up to and possibly anger the managing director by preparing true and fair financial statements.
(c)
Shirts Galore’s growth rate should be a product of the change in profit resulting from the application of generally accepted accounting principles in the preparation of financial statements, not vice versa. That is, one should not prepare financial statements with the objective of achieving or sustaining a predetermined growth rate. The growth rate should be a product of management and operating results, not of creative accounting.
7.33
Chapter 7: Internal control, cash and receivables
BUILDING BUSINESS SKILLS 7.7
COMMUNICATION ACTIVITY
Ms I Rich Manager Aardvark Pty Ltd
Dear Ms Rich During our audit of your financial statements we reviewed the internal controls over cash receipts. The weaknesses we discovered and our suggested improvements are listed below. 1.
Weaknesses A list of cheques received is not prepared by the person who opens the mail.
Suggested Improvement This list should be prepared so that it can later be compared with the daily cash summary. While this procedure does not assure that all cheques will be listed, it does allow the company to verify that all cheques on the list were deposited.
2.
Mail is opened by only one When this occurs, there is no assurance that all person. incoming cheques are forwarded to the cashier’s department.
3.
The cashier is allowed to Under this arrangement it is possible for the cashier to open the mail. open the mail, prepare the cash summary and make the bank deposit. This involves no segregation of duties as the cashier controls the cash from the time it is received until it is deposited in the bank.
4.
The accounts receivable Again, there is poor segregation of duties. In this clerk is allowed to open the case, the clerk could write off a customer’s account as mail. uncollectible and then misappropriate the collection when it is received.
5.
Mail receipts are deposited This makes the receipts vulnerable to robbery and to weekly. misappropriation. The receipts should be deposited intact daily.
We would be pleased to discuss the weaknesses and our recommended improvements with you at your convenience. Yours sincerely
Farmers, Chartered Accountants
7.34
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 7.8
COMMUNICATION ACTIVITY “Trail of guilt”
(a)
The demand for forensic accountants has been increasing over the past decade because of the increase of investigation in the number of corporate fraud cases being committed by unscrupulous staff in the wake of the global financial crisis. Demand is also driven by the number of corporate collapses being investigated by regulators and creditors.
(b)
Some of the emerging areas of forensic investigation include:
(c)
(d)
•
Consulting-style of work
•
Helping companies with their risk-management programs
•
Data mining
Some of the forensic accounting work against high-tech corporate crimes include: •
Investigating stealing by setting up “ghost” employees on the payroll;
•
Detecting inconsistencies in funds transfers and non-existent tax-file numbers.
•
Interrogating very complex and large databases to match bank account details for payments
Discussion question on whether students will consider taking on forensic accounting work.
7.35
Chapter 8: Reporting and analysing non-current assets
CHAPTER 8 – REPORTING AND ANALYSING NON-CURRENT ASSETS ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
Learning Objectives
Exercises
Problems
1
1
1A, 2A, 1B, 2B
2, 3
2, 3, 4, 7, 10
2A, 4A, 6A, 7A, 8A, 2B, 4B, 6B, 7B, 8B
1.
Describe how the cost principle applies to property, plant and equipment assets.
2.
Explain the concept of depreciation.
3.
Calculate depreciation using various methods and contrast the expense patterns of the methods.
4.
Account for subsequent expenditures.
4
5.
Account for asset impairments.
5
5A, 5B
6.
Account for the revaluation of property, plant and equipment assets.
6, 7
4A, 6A, 4B, 6B
7.
Account for the disposal of property, plant and equipment assets.
4
6, 8
2A, 3A, 4A, 2B, 3B, 4B
8.
Describe the use of an asset register.
9.
Identify the basic issues related to reporting intangible assets.
5
9, 10, 11
9A, 9B
10.
Describe the common types of intangible assets.
11.
Explain the nature and measurement of agricultural assets.
12.
Account for the acquisition and depletion of natural resources.
13.
Indicate how non-current assets are reported in the statement of financial position, and explain the methods of evaluating the use of non-current assets.
8.2
10
6, 7
10, 12
2A, 10A, 2B, 10B
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 8 – REPORTING AND ANALYSING NON-CURRENT ASSETS ANSWERS TO QUESTIONS 1.
For PPE assets, the cost principle states that PPE assets are recorded at cost, which consists of all expenditure necessary to acquire the asset and make it ready for its intended use.
2.
The primary advantages of leasing are:
3.
(a)
reduced risk of obsolescence
(b)
nil or low down payment
(c)
shared tax advantages
(d)
reduced recorded assets and liabilities.
The effects of the three methods on annual depreciation expense are: (a)
Straight-line – constant amount
(b)
Diminishing-balance – decreasing amount
(c)
Units-of-production – varying amount.
4.
Capital expenditures are additions and improvements incurred to increase the operating efficiency, productive capacity or the expected useful life of the asset. These expenditures are usually material in amount, incur infrequently and are recorded as debits to the PPE asset affected, whereas expenses are expenditures for the ordinary repairs made to maintain the operating efficiency and expected productive life of the asset. These expenditures usually occur frequently and are recorded as a debit to the Repairs and Maintenance Expense account as incurred and are an expense in the income statement.
5.
In a sale of PPE assets, the carrying (book) value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the carrying value of the PPE asset, a gain on disposal occurs. If the proceeds of the sale are less than the carrying value of the PPE asset sold, a loss on disposal occurs.
6.
Depreciation, amortisation and depletion are all concerned with writing off the cost of an asset to expense over the periods benefited. Depreciation refers to allocating the cost of a PPE asset to expense over its useful life in a rational and systematic manner. Amortisation is the allocating of the cost of an intangible asset to expense. Depletion is the allocating of the capitalised preproduction costs of natural resources to inventory to reflect the units removed. The depleted amounts are recognised as expenses as part of Cost of Sales, when the natural resource inventory is sold.
7.
The favourable attributes which could result in goodwill include exceptional management, desirable location, good customer relations, skilled employees, high quality products, fair pricing policies and harmonious relations with trade unions.
8.3
Chapter 8: Reporting and analysing non-current assets
8.
After initial recognition of cost, each class of non-current asset may be measured on the cost or fair value basis. Any revaluations of non-current assets must be carried out by class of asset. For intangibles to be revalued there must be an active market. Increments and decrements within the same class must not be offset against one another. Any initial revaluation to a value above the up-to-date carrying amount is referred to as a revaluation increment and is credited directly to equity to an account entitled Revaluation Surplus. Any initial revaluation to a value below the up-to-date carrying amount is a revaluation decrement. A revaluation decrement is treated as an expense in the income statement. If in a subsequent period the initial revaluations reverse, the revaluation increment (decrement) for an asset it should be offset against the previous revaluation decrement (increment) of that asset, to the extent of the amount of the previous revaluations. For reversals against the Revaluation Surplus there must be balances available for that asset in the reserve. The steps to record the revaluation are: (a)
Record the depreciation (if it is a depreciable asset) to date of revaluation
(b)
Transfer the balance of the contra account, Accumulated Depreciation, to the asset account to give the assets carrying value
(c)
Record the revaluation.
9.
Agricultural assets are living animals and plants (biological assets) that are a result of agricultural activity. Agricultural assets include forests, livestock, crops, fruit bearing trees and produce of acquaculturalists. Once the assets are mature and no longer ‘living’ – the tree is felled, the crops harvested, sheep shorn or animals are slaughtered – the assets fall within the scope of AASB 102 ‘Inventories’ and are measured according to that standard.
10.
By selecting a higher estimated useful life, Betty Ltd is spreading the PPE asset’s cost over a longer period of time. The depreciation expense reported in each period is lower and profit is higher. Barney’s choice of a shorter estimated useful life will result in higher depreciation expense reported in each period and lower profit. Therefore, Betty Ltd may appear to be a better performer.
8.4
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8.1 Sunway Ltd All of the expenditure should be included in the cost of the land. Therefore, the cost of the land is $98,500 ($80,000 + $7,000 + $5,000 + $3,000 + $3,500). BRIEF EXERCISE 8.2 Cunningham Ltd Depreciable Amount is $60,000 ($62,000 - $2,000). With a 6-year useful life Annual depreciation is $10,000 ($60,000 ÷ 6). Under the straight-line method, depreciation is the same each year. Thus, depreciation is $10,000 for both the first and second years.
BRIEF EXERCISE 8.3 Cunningham Ltd The declining-balance rate is 25% (1/6 x 1.5) and this rate is applied to book value at the beginning of the year. The calculations are: Carrying Amount X
Rate
Year 1
$62,000
25%
$15,500
Year 2
($62,000 - $15,500)
25%
$11,625
8.5
=
Depreciation
Chapter 8: Reporting and analysing non-current assets
BRIEF EXERCISE 8.4 Ross Ltd (a) Accumulated Depreciation – Delivery Equipment Delivery Equipment
61,000
(b) Accumulated Depreciation – Delivery Equipment Loss on Disposal Delivery Equipment
55,000 6,000
Cost of delivery equipment Less accumulated depreciation Carrying value at date of disposal Proceeds from sale Loss on disposal
61,000
61,000 $61,000 55,000 6,000 0 $ 6,000
BRIEF EXERCISE 8.5 Popper Ltd (a) Patent Amortisation Expense ($360,000 ÷ 10) Accumulated Amortisation Patents
36,000
(b) Intangible Assets
36,000 $324,000
In the notes to the financial statements the patent cost less accumulated amortisation would be shown.
BRIEF EXERCISE 8.6 Sharkey Ltd (a)
Average useful life =
(b)
Average Age =
(c)
Asset turnover ratio =
Average cost of PPE assets ($30.1b+$21.8b) 2 = = 21.4 years $1.212b Depreciati on expense
$8.5b Accumulated depreciation = = 7.0 years $1.212b Depreciati on expense Net sales $18.6b = = 0.65 times ($27.3b+$29.7b) 2 Average total assets
8.6
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 8.7 Welsh Ltd Partial Statement of Financial Position as at 31 March 2012
Non-Current Assets Property, plant and equipment Goodwill Other intangibles assets
Note
$ ‘000
13 15 16
2,246.4 69.8 36.3
In the Notes to the financial statements the following disclosures would be made: Note 13 Property, plant and equipment Land and buildings Plant and equipment Accumulated depreciation Total property, plant and equipment
$ ‘000 $654.4 3,082.2 (1,490.2)
$ ‘000
$2,246.4
Notes 15 & 16 Goodwill Goodwill Impairment of goodwill Other intangibles Accumulated amortisation Total goodwill and intangible assets
8.7
$ ‘000 $322.3 (252.5) 110.6 (74.3)
$ ‘000 $69.8 36.3 $106.1
Chapter 8: Reporting and analysing non-current assets
SOLUTIONS TO EXERCISES EXERCISE 8.1 Salvador Ltd (a)
The following points explain the application of the cost principle in determining the acquisition of PPE assets. 1. Under the cost principle, the acquisition cost for a PPE asset includes all expenditures necessary to acquire the asset and make it ready for its intended use. 2. For example, the cost of factory machinery includes the purchase price, freight costs paid by the purchaser, insurance costs during transit, and installation costs. 3. Cost is the fair value at acquisition date of all assets given up or liabilities undertaken, plus any incidental costs. 4. Fair value is the amount for which an asset could be exchanged between knowledgeable willing parties in an arm’s-length transaction.
(b)
1. 2. 3. 4.
Land Factory Machinery Delivery Truck Land Improvements
5. 6. 7. 8.
8.8
Delivery truck Factory Machinery Prepaid Insurance Motor Vehicle Expense
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 8.2 Troy Ltd Cost of new machine $114,000 purchased 1 October 2012 Balance date 31 December Estimated residual $18,000 Depreciable amount = Cost less Residual = $114,000 - $18,000 = $96,000 (a)
(b)
Straight line depreciation rate
=
100% ÷ 5 years = 20%
2012 Depreciation expense
= = =
Depreciable amount x dep’n rate x 3 months $96,000 x 20% x 3/12 $4,800
2013 Depreciation expense
= = =
Depreciable amount x dep’n rate $96,000 x 20% $19,200
Diminishing-balance method: Straight line rate doubled (given in question) 20% x 2 = 40% 2012 depreciation
=
$114,000 x 40% x 3/12 = $11,400
Carrying value January 1, 2013 = $114,000 - $11,400 = $102,600 Remember the Diminishing-balance method applies the rate to the carrying value not the depreciable amount. 2013 depreciation (c)
Units-of-production method: Depreciation cost per unit
2012 depreciation
=
$102,600 x 40% = $41,040
= = =
Depreciable amount ÷ Total units of production $96,000 ÷ 20,000 hours $4.80 per hour
=
900 hours x $4.80 = $4,320.
8.9
Chapter 8: Reporting and analysing non-current assets
EXERCISE 8.3 Galway Bus Lines Ltd (a)
Bus purchased $258,000 and residual value $8,000. Therefore the depreciable amount $250,000 ($258,000 - $8,000). Depreciation cost per unit
= = =
(b)
Depreciable amount ÷ Total units of production $250,000 ÷ 100,000 kilometres $2.50 per kilometre
Calculation
Years 2012 2013 2013 2015
End of Year
Units of Depreciation Production X Cost/Unit 28,000 $2.50 28,000 2.50 30,000 2.50 14,000 2.50 100,000
Annual Depreciation = Expense $70,000 70,000 75,000 35,000 $250,000
8.10
Accumulated Depreciation $70,000 140,000 215,000 250,000
Carrying Value $188,000 118,000 43,000 8,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 8.4 Walrus Ltd Balance date 30 June 1 January 2013
Equipment Cost Estimated Residual Depreciable Amount
$90,000 10,000 $80,000
Straight line depreciation rate (a)
(b)
(c)
=
100% ÷ 5 years = 20%
Depreciation expense for fiscal year 2013 $80,000 x 20% x 6 months
=
$8,000
Depreciation expense for fiscal year 2014 $80,000 x 20%
=
$16,000
Journal entry for overhaul Equipment Cash/Payables
$4,000 $4,000
Depreciation expense for fiscal year 2016
Carrying value at 30/6/15 $90,000 less ($8,000 + $16,000 + $16,000) = $50,000. 1 July 2015 addition $4,000. Therefore the carrying amount is now $54,000 which will also be the depreciable amount as the expected residual is nil. Depreciation rate is 100% ÷ 4 years = 25% Depreciation expense 2016 is $54,000 x 25% = $13,500.
8.11
Chapter 8: Reporting and analysing non-current assets
EXERCISE 8.5 Abbey Ltd Balance date 30 June 1 Oct 2013
Equipment Cost Estimated Residual Depreciable Amount
$80,000 5,000 $75,000
Useful life is 5 years depreciation rate 20% Depreciation 30/6/2014 = $75,000 x 20% x 9/12 = $11,250
Carrying amount 30/6/2014= $80,000 - $11,250 = $68,750 Recoverable amount $48,750 is the higher of the net selling price ($48,750) and value in use ($45,000). Impairment write down = $68,750 - $48,750 = $20,000
1/10/13
30/6/14
1/7/14
Journal Entries Machinery $80,000 Cash/Payables (Being purchase) Depreciation Expense 11,250 Accumulated Dep’n Machinery (Being annual depreciation) Impairment Loss 20,000 Accumulated Impairment Loss (Being impairment writedown)
8.12
$80,000
11,250
20,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 8.6 Walpole Ltd 1 April 2012 Equipment Cost Estimated Residual Depreciable Amount
$53,000 5,000 $48,000
Useful life 8 years. Depreciation rate 100% ÷ 8 years = 12.5% Annual depreciation is $6,000 p.a. ($48,000 ÷ 8 or $48,000 x 12.5%) After revaluation 1 July 2014, new depreciation is over 7 years. 1/4/12
30/6/12
30/6/13
30/6/14
Journal Entries Equipment Cash (Being purchase of equipment)
Sale 1/1/16
1/1/16
$ 53,000 53,000
Depreciation Expense Accumulated Depreciation Equipment ($48,000 ÷ 8 x 3/12)
1,500
Depreciation Expense Accumulated Depreciation Equipment ($48,000 ÷ 8)
6,000
Depreciation Expense Accumulated Depreciation Equipment ($48,000 ÷ 8)
6,000
Revaluation 1/7/14 Accumulated Depreciation Equipment Equipment (Carrying value before revaluation = $39,500)
30/6/15
$
1,500
6,000
6,000
13,500 13,500
Equipment Revaluation Surplus (new carrying amount $39,500 + $11,000 = $50,500)
11,000
Depreciation Expense Accumulated Depreciation Equipment [($50,500 - $5,000) ÷ 7 years]
6,500
Depreciation Expense Accumulated Depreciation Equipment [($50,500 - $5,000) 7 years x 6/12 dep’n to date of sale]
3,250
Accumulated Depreciation Equipment Cash Equipment Gain on sale of equipment (Being disposal of equipment)
9,750 42,000
11,000
6,500
3,250
50,500 1,250
Calculation of gain on sale Cost Accumulated Depreciation (6,500 + 3,250) Carrying amount of equipment sold Proceeds from sale Gain on sale
8.13
$50,500 (9,750) 40,750 42,000 $1,250
Chapter 8: Reporting and analysing non-current assets
EXERCISE 8.7 Warren Ltd Balance date 30 June 1 July 2011 Equipment Cost Estimated Residual Depreciable Amount
$180,000 20,000 $160,000
Useful life 10 years. Depreciation rate 100% ÷ 10 years = 10.0% Annual depreciation is $16,000 p.a. ($160,000 x 10%) Journal Entries Equipment Cash (Being purchase of equipment)
$ 180,000
30/6/12 Depreciation Expense Accumulated Depreciation Equipment ($160,000 x 10%)
16,000
30/6/13 Depreciation Expense Accumulated Depreciation Equipment ($160,000 x 10%)
16,000
1/7/11
Revaluation 1/7/13 Accumulated Depreciation Equipment Equipment (Carrying value before revaluation = $148,000) Equipment Revaluation Surplus (new carrying amt $148,000 + $17,000 = $165,000) 30/6/14 Depreciation Expense Accumulated Depreciation Equipment [($165,000 - $15,000) ÷ 6 years]
1/1/15
1/1/15
Revaluation downward Depreciation Expense Accumulated Depreciation Equipment [($165,000 - $15,000) ÷ 6 years x 6/12]
180,000
16,000
16,000
32,000 32,000
17,000 17,000
25,000 25,000
12,500 12,500
Accumulated Depreciation Equipment Equipment (Carrying value before devaluation = $127,500)
37,500
Revaluation Surplus Revaluation Expense Equipment (Being revaluation downward by $25,000)
17,000 8,000
8.14
$
37,500
25,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 8.8 Chen Ltd 2013 Jan. 1
June 30
June 30
Accumulated Depreciation – Machinery Machinery (Machine scrapped fully depreciated)
Dec 31
2,500
Cash Accumulated Depreciation – Computer Gain on Disposal Computer
25,000 17,500
2,500
7,500 35,000
$35,000 (17,500) 17,500 25,000 $7,500
Depreciation Expense Accumulated Depreciation – Truck [($27,000 - $3,000) x 1/8] (Update depreciation)
3,000
Loss on Scrapping Accumulated Depreciation – Truck [($27,000 - $3,000) x 5/8] Delivery Truck (Removal of asset from books)
12,000 15,000
8.15
$ 62,000
Depreciation Expense Accumulated Depreciation – Computer ($35,000 x 1/7 x 6/12 – dep’n to date of sale)
Calculation of gain on disposal Cost Accumulated Depreciation (5,000 x 3 years + 2,500) Carrying amount of equipment sold Proceeds from sale Gain on disposal Dec 31
$ 62,000
3,000
27,000
Chapter 8: Reporting and analysing non-current assets
EXERCISE 8.9 Collins Ltd
2/1/12
1/7/12
1/9/12
Patents Cash (Purchase of patent useful life 7 years)
$ 420,000
420,000
Franchise Cash (Purchase of franchise – remaining useful life 6 years)
450,000
Research and development expense Cash (Assumed it was basic research)
185,000
Amortisation calculations Patent Expense ($420,000 ÷ 7) Franchise Expense [($450,000 ÷ 6) X 6/12]
450,000
185,000
60 000 37,500
31/12/12 Amortisation Expense Accumulated Amortisation Patents Accumulated Amortisation Franchise Ending balances 31/12/12: Patent = Franchises =
$
97,500 60,000 37,500
$360,000 ($420,000 - $60,000) $412,500 ($450,000 - $37,500)
EXERCISE 8.10 (a)
A company should depreciate its buildings because depreciation is necessary in order to allocate the cost of the buildings to the reporting periods in which the future benefits were consumed. Without depreciation, the depreciable assets would be overstated and not be a faithful representation of their future benefits.
(b)
A building can have a nil carrying value if it had no estimated residual value and it was fully depreciated – that is, if it has been used for a period longer than its expected life. Because depreciation is used to allocate cost rather than to reflect market value, it is not at all unlikely that a building could have a low or nil carrying value, but a positive market value.
(c)
Examples of intangibles that might be found on a university campus are; franchises of a bookstore chain or food outlets, and patents developed by academics.
(d)
Typical company or product trade names are: Clothes: Perfume: Cars: Shoes: Breakfast Cereals:
Colorado, Billabong, Esprit, Lisa Ho, King Gee, Guess. Tommy Hilfiger, Estee Lauder, Chanel No. 5, Lancôme. Daewoo, Nissan, Holden, Ford, Toyota. Nike, Diesel, Vans, Diana Ferrari, Sachi. Rice Bubbles, Coco Pops, Weet-Bix, Uncle Toby’s.
Trade names and trademarks are reported on statement of financial position, if the trade name or trademark is purchased. If it is developed by the entity it cannot be recognised. 8.16
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 8.11 SoftKey International Issue to be raised in the memo includes: By increasing the estimated life on its capitalised software costs, SoftKey will increase its reported profit because amortisation expense will decrease. From an analyst’s perspective, one concern would be whether this twelve-year life is reasonable given that software products become obsolete very quickly. Another concern is that the qualitative characteristic of comparability is affected: for example, it becomes more difficult to compare the current year’s results with previous years’ because previous years used the three-year estimated life. EXERCISE 8.12 Alpha Ltd Year ended 31 January 2012. (a)
Average useful life of PPE Assets
= = =
(b)
Average age of PPE Assets
= = =
(c)
Asset turnover ratio
= = =
Average cost of PPE assets Depreciati on expense ($105,282 + $90,861) 2 $6,399 15.3 years Accumulated depreciation Depreciati on expense $38,797 $6,399 6 years
Net sales Average total assets $1,663,970 ($609,041 + $515,357 ) 2 3 times
(d) The average age of PPE assets is often compared with the average useful life calculation. If the ratios are close together, the company may need to replace its assets in the near future, assuming the assumptions made in calculating the ratios are correct. (A test of these assumptions might be to compare the calculations with industry averages or those of competitors.) The asset turnover ratio is one indicator of how efficient a company is using its assets, usually the higher the ratio the better.
8.17
Chapter 8: Reporting and analysing non-current assets
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 8.1 Fleming Ltd Item 1 2 3 4 5 6 7 8 9
Land $250,000
Building
Other Accounts $4,900
Land Improvements
31,800 5,320
Land Improvements Land Tax Expense
27,000 7,270 $21,900 51,000 629,500
(12,700) $271,570
$702,400
$42,020
PROBLEM SET A 8.2 Balance date is 30 June Pouncer Ltd (a) 2013 Aug 1
$ 2,630,000
Land Cash (Purchase of Land)
Oct 1
Oct 1
Dec 1
$ 2,630,000
Depreciation Expense Accumulated Dep’n – Equipment ($675,000 x 1/10 x 3/12)
16,875
Cash Accumulated Dep’n – Equipment Equipment Gain on Disposal
350,000 455,625
Cost (1/1/06) Accum. Dep’n – Equipment [($675,000 x 1/10 x 6.75yrs)] Carrying amount Cash proceeds Gain on disposal
$675,000 $455,625
Cash
1,800,000
Land Gain on Disposal (Sale of Land)
16,875
675,000 130,625
219,375 350,000 $130,625
300,000 1,500,000
8.18
Solutions manual to accompany Accounting: building business skills 4e
2013 Jan 1
June 30
Equipment Cash (Purchase of Equipment)
1,000,000 1,000,000
Accumulated Dep’n – Equipment Equipment (Equipment fully depreciated on 31/12/2011)
470,000
Depreciation Expense Accumulated Dep’n – Buildings ($28,500,000 x 1/40)
712,500
470,000
(b) 2013 June 30
June 30
712,500
Depreciation Expense Accumulated Depreciation - Equipment
4,735,500
$46,855,000* x 1/10 $1,000,000 x 1/10 x 6/12
4,685,500 50,000 4,735,500
4,735,500
*($48,000,000 - $675,000 - $470,000) (c) Pouncer Ltd Partial Statement of financial position as at 30 June 2013 Property, plant and equipment* Land Buildings Less: Accumulated depreciation – buildings Equipment Less: Accumulated depreciation – equip. Total property, plant and equipment
$6,330,000 $28,500,000 12,812,500 47,855,000 8,826,750
15,687,500 39,028,250 $61,045,750
* See T-accounts which follow. Note that in the external reports the total of Property, plant and equipment would be a one line item in the statement of financial position and the detailed breakdown above would be disclosed in the notes to the financial statements.
8.19
Chapter 8: Reporting and analysing non-current assets
30/06/12 Bal. B/d 1/8/12 Cash 30/6/13
Bal. b/d
Bal. b/d
30/06/12 01/01/13 Cash
30/06/13 Bal. b/d
01/10/12 30/06/13 30/06/13
Cash Bal. c/d
300,000 6,330,000 6,630,000
Buildings 28,500,000
30/06/12
30/06/13
Land 4,000,000 1/12/12 2,630,000 30/6/13 6,630,000 6,330,000
Accumulated Depreciation - Buildings 30/06/12 12,812,500 30/06/13 Dep’n Exp. 12,812,500 30/06/13 Bal b/d Equipment 48,000,000 1/10/12 1,000,000 30/6/13 - 30/06/13 49,000,000 47,855,000
Cash, etc. Acc. Depr. Bal. c/d
Accumulated Depreciation - Equipment Equipment, etc. 455,625 30/06/12 Equip. 470,000 1/10/12 Dep’n Exp. Bal. c/d 8,826,750 30/06/13 Dep’n Exp. 9,752,375 31/12/13 Bal. b/d
8.20
12,100,000 712,500 12,812,500 12,812,500
675,000 470,000 47,855,000 49,000,000
5,000,000 16,875 4,735.500 9,752,375 8,826,750
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 8.3 Donut Ltd 2012 Jan 1
Accumulated Dep’n – Machinery Machinery (scrapping machinery fully depr’d 31/12/11) June 30 Depreciation Expense Accumulated Dep’n – Computer (update depreciation $49,000 x 1/7x 6/12) June 30 Cash Accumulated Depreciation – Computer Gain on Disposal Computer (Sale of computer ) Calculation of disposal Cost (1/1/09) Accum. Dep’n – Equipment [($49,000 x 1/7 x 3.5yrs)] Carrying amount Cash proceeds Gain on disposal Dec 31
Dec 31
Depreciation – Truck Accumulated Dep’n – Truck ( [ ($27,000- $3,000) x 1/8] update depr’n) Accumulated Dep’n – Truck (5yrs) Loss on Disposal Truck (scrapping of truck after 5 years)
8.21
$ 52,000
$ 52,000
3,500 3,500 31,000 24,500 6,500 49,000
$49,000 24,500 24,500 31,000 $6,500 3,000 3,000 15,000 12,000 27,000
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET A 8.4 Trelivings Ltd Year ending 30 June 2013 (a)
1/7/12
1/10/12
(b)
30/6/13
$ 400,000 250,000
Land Buildings Cash/Payables
650,000
Machinery Cash/Payables
12,000
Depreciation Expense Accumulated Depreciation - Building Accumulated Depreciation - Machinery (Depreciation Building $250,000 ÷ 20 = $12,500) (Depreciation Machinery
55,700
Rate
$
120,000
12,500 43,200
= 1 − 4 9,000
120,000
= 1 - .5233 = 48% (approximately) Dep’n 30/06/13= $120,000 x 48% x 9/12 =$43,200
(c)
1/7/13
Land
80,000 Revaluation Surplus
1/7/13
(d)
31/12/13
31/12/13
80,000
Accumulated Depreciation – Building Revaluation Expense Building
12,500 50,000
Depreciation Expense Accumulated Depreciation - Machinery [($120,000 - $43,200) x 48% x 6/12]
18,432
72,500
18,432
Cost of Machinery Accumulated Dep’n ($43,200 + $18,432) Carrying amount at date of sale Proceeds Loss on disposal
$120,000 (61,632) 58,368 50,000 $8,368
Cash Accumulated Depreciation – Machinery Loss on Disposal Machinery
50,000 61,632 8,368
8.22
120,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 8.5 Dragon Ltd Year ending 30 June
(a) 30/6/13
(b) 30/0/13
Depreciation Expense – Machinery Accumulated Depreciation – Machinery ($50,000 x 1/5 or #1 $2000, #2 $5000, #3 $3000) Impairment Loss Accumulated Impairment Loss Machine #2 (Writedown of mach #2 to recoverable amount) Machine 1 2 3
(c) 30/6/14
(d) 30/6/14
CV Recoverable Amt $8,000 $9,000 20,000 13,000 12,000 13,000
$ 10,000
10,000
7,000 7,000
Adj nil 7,000 nil
Depreciation Expense – Machinery Accumulated Depreciation – Machinery (Depn #1 $2000, #2 $3,250(13,000/4), #3 $3000)
8,250
Accumulated Impairment Loss Machine #2 Income – Impairment Loss Reversal (Writedown of mach #2 to recoverable amount)
5,250
Machine 1 2 3
CV Recoverable Amt Adj $6,000 6,500 nil 9,750* 17,000 5,250** 9,000 9,500 nil
* $25,000 -5,000-7,000-3,250=$9,750 **#2CV had the machine not been impaired $25,000-$5,000-$5,000=$15,000 max reversal permitted $15,000-9750 =$5,250 This will reinstate #2 to CV of $15,000
8.23
$
8,250
5,250
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET A 8.6 Payne Ltd Journal Entries (a) 30/6/12 Land – Brisbane Land – Sydney Revaluation Surplus (Revaluation of land Bris $250,000, Syd $200,000)
30/6/12 Accumulated Dep’n – Buildings Buildings– Sydney (to close off the accumulated dep’n to asset A/c) Revaluation Surplus Loss on revaluation of building Buildings– Sydney (Revalue building from $425,000 to $375,000)
(b) 30/6/13 Depreciation Expense – Buildings Accumulated Dep’n – Buildings (Depreciation expense for the year $375,000 x 1/15)
8.24
$
$
250,000 200,000 450,000
75,000 75,000 25,000 25,000 50,000
25,000 25,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 8.7 Marion Ltd Balance date 31 December (a)
Year
Accumulated Depreciation 31/12
2009 2010 2011 2012
Calculation MACHINE 1 $43,500 X 10% = $4,350 $43,500 X 10% = $4,350 $43,500 X 10% = $4,350 $43,500 X 10% = $4,350
2010 2011 2012
MACHINE 2 $38,400 x 18.75% = $7,200 $31,200 x 18.75% = $5,850 $25,350 x 18.75% = 4,753(rounding)
$7,200 13,050 17,803
2010 2011 2012
MACHINE 3 1,000 X $2.00a = $2,000 3,000 x $2.00 = $6,000 4,000 x $2.00 = $8,000
$2,000 8,000 16,000
$4,350 8,700 13,050 17,400
a
$20,000 ÷ 10,000 hours = $2.00 per machine hour
(b) Depreciation expense for Machine 3 in 2012 under: • Straight-line method: ($26,000-$6,000)/5 = $4,000 • Diminishing-balance rate (assuming 1.5 straight-line rate) = 1.5x 1/5 = 30% o 2010 = $26,000 x 30% = $7,800 o 2011 = ($26,000-$7,800) x 30% = $5,460 o 2012 = ($26,000-$7,800-$5,460) x 30% = $3,822 • Units-of-production (from answer (a) above for 2012 = $16,000 Depreciation expense in 2012 is highest under Units-of-production method. The higher the expense, the lower the tax payment. So Units-of-production method is the preferred method for tax purposes for Machine 3 in 2012. (c) As a manager whose bonus is linked to profit, I would prefer a depreciation method that resulted in the lowest expense. From (b) above, Diminishing-balance method resulted in the lowest depreciation expense for Machine 3 in 2012. However, it should be noted that diminishing-balance method results in higher depreciation expenses in the earlier year of an asset’s life.
8.25
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET A 8.8 Floral Ltd (a) STRAIGHT-LINE DEPRECIATION Calculation Depreciable Years Cost 2012 *$360,000 2013 360,000 2014 360,000 2015 360,000
X
End of Year
Depreciation Rate 25% 25% 25% 25%
=
Annual Depreciation Expense $90,000 90,000 90,000 90,000
Accumulated Carrying Depreciation Amount $90,000 $310,000 180,000 220,000 270,000 130,000 360,000 40,000
* ($400,000 – $40,000)
DIMINISHING-BALANCE DEPRECIATION
Years 2012 2013 2014 2015
Calculation Carrying Amount Depreciation Beginning of x Rate# Year $400,000 44% 224,000 44% 125,440 44% 70,246 44%
End of Year
=
Annual Depreciation Expense $176,000 98,560 55,194 *30,246
Accumulated Depreciation
Carrying Amount
$176,000 274,560 329,754 360,000
$224,000 125,440 70,246 40,000
* Adjusted for rounding error so ending carrying amount will equal residual value. # Depreciation rate
= 1 − 4 $40,000
$400,000
= 1 – 0.5623 = 44% approximately
(b)
Straight-line depreciation provides the lowest amount for 2012 depreciation expense ($90,000) and, therefore, the highest 2012 profit. Diminishing-balance depreciation provides the highest amount for 2012 depreciation expense ($176,000) and, therefore, the lowest 2012 profit. Over the four-year period, both methods result in the same total depreciation expense ($360,000) and, therefore, the same total profit.
8.26
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 8.9 Chan Ltd Year end 30 June 2013 (a) Jan 2 Patents Cash (successful defence of patent)
$ 25,000
25,000
Jan June
Development Cost (Asset) Cash
100,000
April 1
Advertising Expense Cash
60,000
Copyright Cash
250,000
May 1
$
100,000
60,000
250,000
(b) Amortisation journals entries for year ended 31 December 2013 June 30
June 30
(c)
Amortisation Expense Accumulated amortisation Patents [($80,000 ÷8 years) + (($25,000 ÷6.5years )]
13,846
Amortisation Expense Accumulated amortisation Copyrights [($36,000 x 1/10) + ($250,000 x 1/50 x 2/12)]
4,433
Intangible Assets Patents ($105,000 cost less $23,846 amortisation) (1) Copyrights ($286,000 cost less $18,833 amortisation (2) Development Costs (transferred to patents 1/07/14) Total intangible assets
13,846
4,433
$81,154 267,167 100,000 $448,321
(1) Cost ($80,000 + $25,000); amortisation ($10,000 + $13,846) (2) Cost ($36,000 + $250,000); Amortisation ($14,400 + $4,433). (d) The intangible assets of Chan Ltd consist of two patents and two copyrights. One patent with a cost of $105,000 is being amortised over 10 years; the other patent was granted 1 July 2014 was developed at a cost $100,000 and will be amortised over its legal life of 20 years. A copyright with a cost of $36,000 is being amortised over 10 years; the other copyright with a cost of $250,000 is being amortised over 50 years.
8.27
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET A 8.10 Barnaby Ltd & Jane Ltd (a) Barnaby Ltd
(b)
Jane Ltd
(1)
Average age of PPE assets
$1,420,000 = 3.3 years $420,000
$937,500 = 7.2years $130,000
(2)
Average useful life
$3,360,000 = 8 years $420,000
$2,000,000 = 15 years $130,000
(3)
Asset turnover ratio
$12,600,000 $10,300,000 = 3.36times = 2.3times $3,750,000 $4,480,000
Based on the asset turnover ratio, Jane Ltd. is more effective in using assets to generate sales as its asset turnover ratio is higher than Barnaby Ltd’s ratio.
One factor that complicates the comparison of the asset turnovers of the two companies is the wide difference in average age of the PPE assets. Assuming the estimated useful lives are realistically measured, Barnaby Ltd’s assets are in need of replacement much sooner than Jane Ltd’s (8-3.3 years versus 15-7.2 years). Another factor is the different composition of total assets for each company. For example, Barnaby Ltd has recorded goodwill, but Jane Ltd does not. Deleting the goodwill from Barnaby Ltd’s asset turnover ratio improves the ratio to about 2.5. Also, a much greater proportion of Barnaby Ltd’s total assets consist of PPE and intangibles. Finally, we are not told which valuation models are being used. If one company uses the revaluation model and the other the cost model, the comparison would become even more problematic.
8.28
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 8.1 Fish Ltd Item 1 2 3 4 5 6 7 8 9 10
Land $260,000
Building
Other Accounts $6,750 Land Improvements
19,000 $23,000 2,179 29,000 Land Improvements 40,000 6,500 Land Tax Expense 600,000 (5,000) $276,179
$663,000
8.29
$42,250
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET B 8.2 General Ltd 2013 (a)
April 1
$ 2,400,000
Land Cash
May 1
May 1
June 1
2,400,000
Depreciation Expense Accumulated Dep’n – Equipment ($720,000 x 1/10 x 4/12)
24,000
Cash Accumulated Dep’n – Equipment Equipment Gain on Disposal
420,000 312,000
Cost (1/1/09) Accum. Dep’n – Equipment [($720,000 x 1/10 x 4 + $24,000)] Carrying value Cash proceeds Gain on disposal
$720,000 $312,000
Cash
1,800,000
24,000
720,000 12,000
408,000 420,000 $12,000
Land Gain on Disposal July 1
Dec. 31
Dec. 31
(b)
Dec. 31
Dec. 31
$
500,000 1,300,000
Equipment Cash
2,000,000 2,000,000
Depreciation Expense Accumulated Dep’n – Equipment ($500,000 x 1/10- machine to be scrapped)
50,000
Accumulated Dep’n – Equipment Equipment (Equipment at 31/12/13 is now fully depreciated)
500,000
Depreciation Expense Accumulated Dep’n – Buildings ($31,800,000 x 1/40)
795,000
50,000
500,000
795,000
Depreciation Expense Accumulated Depreciation - Equipment
4,778,000
$46,780,000* x 1/10 $2,000,000 x 1/10 x 6/12
$4,678,000 100,000 $4,778,000
*($48,000,000 - $720,000 - $500,000)
8.30
4,778,000
Solutions manual to accompany Accounting: building business skills 4e
(c) General Ltd Partial Statement of financial position as at 31 December 2013 Property, plant and equipment* Land Buildings Less: Accumulated depreciation – buildings Equipment Less: Accumulated depreciation – equip. Total property, plant and equipment
$5,500,000 $31,800,000 15,315,000 48,780,000 10,040,000
16,485,000 38,740,000 $60,725,000
* See T-accounts which follow. Note that in the external reports the total of Property, plant and equipment would be a one line item in the statement of financial position and the detailed breakdown above would be disclosed in the notes to the financial statements.
31/12/12 1/4/13
Bal. B/d Cash
31/12/13
Bal. b/d
Bal. b/d
31/12/12 1/7/113
Cash
31/12/13
Bal. b/d
1/5/13 31/12/13 31/12/13
Cash Bal. c/d
500,000 5,500,000 6,000,000
Buildings 31,800,000
31/12/12
31/12/13
Land 3,600,000 1/6/13 2,400,000 31/12/13 6,000,000 5,500,000
Accumulated Depreciation - Buildings 31/12/12 15,315,000 31/12/13 Dep’n Exp. 15,315,000 31/12/13 Bal b/d Equipment 48,000,000 1/5/13 2,000,000 31/12/13 - 31/12/13 50,000,000 48,780,000
Cash, etc. Accum. Depr. Bal. c/d
Accumulated Depreciation - Equipment 312,000 31/12/12 Equipment 500,000 1/5/13 Dep’n Exp. 31/12/13 Dep’n Exp. Bal. c/d 10,040,000 31/12/13 Dep’n Exp. 10,852,000 31/12/13 Bal. b/d
8.31
14,520,000 795,000 15,315,000 15,315,000
720,000 500,000 48,780,000 50,000,000
6,000,000 24,000 50,000 4,778,000 10,852,000 10,040,000
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET B 8.3 Chancellor Ltd 2013 Jan 1
June 30
June 30
$ $ Accumulated Dep’n – Machinery Machinery (scrapping machinery fully depreciated 31/12/12)
Dec 31
78,000
Depreciation Expense Accumulated Dep’n – Office Equipment (update depreciation $73,500 x 1/5x 6/12)
7,350
Cash Accumulated Depreciation – Office Equipment Gain on Disposal Office Equipment (Sale of office equipment )
30,000 51,450
Calculation of disposal Cost (1/1/2010) Accumulated Depreciation – Office Equipment [($73,500 x 1/5 x 3.5yrs)] Carrying value Cash proceeds Gain on disposal
Dec 31
78,000
7,350
7,950 73,500
$73,500 51,450 22,050 30,000 $7,950
Depreciation – Truck Accumulated Depreciation – Truck ( [ ($40,500 - $4,500) x 1/8] update depreciation)
4,500
Accumulated Depreciation – Truck (5yrs) Loss on Disposal Truck (scrapping of truck after 5 years)
22,500 18,000
8.32
4,500
40,500
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 8.4 Engineering Ltd Year ending 30 June 2013
(a)
1/7/12
1/10/12
(b)
30/6/13
$ 1,200,000 500,000
Land Buildings Cash/Payables
1,700,000
Machinery Cash/Payables
120,000
Depreciation Expense Accumulated Depreciation - Building Accumulated Depreciation - Machinery (Depreciation Building $500,000 ÷ 40 = $12,500) (Depreciation Machinery
55,700
Rate
$
120,000
12,500 43,200
= 1 − 4 9,000
120,000
= 1 - .5233 = 48% (approximately Depreciation 30/06/13= $120,000 x 48% x 9/12 =$43,200 (c)
1/7/13
Land
200,000
Revaluation Surplus Note: The $200,000 is considered “other comprehensive income” and would appear on the Statement of Comprehensive Income per IAS 1. 1/7/13
(d)
31/12/13
31/12/13
200,000
Accumulated Depreciation – Building Revaluation Expense Building
12,500 25,000
Depreciation Expense Accumulated Depreciation - Machinery [($120,000 - $43,200) x 48% x 6/12]
18,432
Cost of Machinery Accumulated Depreciation ($43,200 + $18,432) Carrying amount at date of sale Proceeds Loss on disposal
$120,000 (61,632) 58,368 50,000 $8,368
Cash Accumulated Depreciation – Machinery Loss on Disposal Machinery
8.33
37,500
18,432
50,000 61,632 8,368 120,000
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET B 8.5 Fox Ltd Year ending 30 June
(a) 01/07/12
30/6/13
(b) 30/6/13
10,000
Impairment Loss Accumulated Impairment Loss - Machinery (Writedown of machine to recoverable amount)
14,000
(d) 30/0/14
CV $75,000
$ 85,000
Depreciation Expense – Machinery Accumulated depreciation – Machinery (($85,000-$5,000) ÷8)
Machine 30/6/13 (c) 30/6/14
$ 85,000
Machinery Cash (purchase of machine)
10,000
14,000
Recoverable Amt Adj $61,000 $14,000
Depreciation Expense – Machinery Accumulated Depreciation – Machinery (Depreciation ($61,000-$5000) ÷7yrs remaining)
8,000
Accumulated Impairment Loss - Machinery Income – Impairment Loss Reversal (Write-down of machine to recoverable amount)
12,000
Maximum reversal $85,000 – $20,000* = $65,000 *2 years of normal depreciation had the asset not been impaired Machine CV Recoverable Amt Adj 30/6/11 $53,000** $70,000 $12,000 **$85,000 -$10,000-$8,000-$14,000= $53,000 The max reversal is to a carrying value of $65,000 Adjustment $53,000 - $65,000 = $12,000
8.34
8,000
12,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 8.6 Rosie Ltd Journal Entries 30/6/13 Land – Bourke Revaluation Surplus (Revaluation of land Bourke to $600,000)
$ 200,000
30/6/13 Revaluation Surplus Land – Melbourne (Revalue Land – Melbourne to $1,000,000)
200,000
30/6/13 Accumulated Depreciation – Buildings Buildings– Melbourne (to close off the accumulated depreciation to asset account)
150,000
Revaluation Surplus Loss on Revaluation - Building Buildings – Melbourne (Revalue building from $650,000 to $500,000)
8.35
$ 200,000
200,000
150,000
100,000 50,000 150,000
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET B 8.7 Sonja Ltd Balance date 31 December (a)
Year
Accumulated Depreciation 31/12
2009 2010 2011 2012
Calculation MACHINE 1 $108,750 X 10% = $10,875 $108,750 X 10% = $10,875 $108,750 X 10% = $10,875 $108,750 X 10% = $10,875
2010 2011 2012
MACHINE 2 $96,000 x 18.75% = $18,000 $78,000 x 18.75% = $14,625 $63,375 x 18.75% = 11,883 (rounding)
$18,000 32,625 44,508
2010 2011 2012
MACHINE 3 1,000 X $5.00a = $5,000 3,000 x $5.00 = $15,000 4,000 x $5.00 = $20,000
$5,000 20,000 35,000
$10,875 21,750 32,625 43,500
a
$50,000 ÷ 10,000 hours = $5.00 per machine hour
(b) Depreciation expense for Machine 3 in 2012 under: • Straight-line method: ($65,000-$15,000)/5 = $10,000 • Diminishing-balance rate (assuming 1.5 straight-line rate) = 1.5x 1/5 = 30% o 2010 = $65,000 x 30% = $19,500 o 2011 = ($65,000-$19,500) x 30% = $13,650 o 2012 = ($65,000-$19,500-$13.650) x 30% = $9,555 • Units-of-production (from answer (a) above for 2012 = $35,000 Depreciation expense in 2012 is highest under Units-of-production method. The higher the expense, the lower the tax payment. So Units-of-production method is the preferred method for tax purposes for Machine 3 in 2012. (d) As a manager whose bonus is linked to profit, I would prefer a depreciation method that resulted in the lowest expense. From (b) above, Diminishing-balance method resulted in the lowest depreciation expense for Machine 3 in 2012. However, it should be noted that diminishing-balance method results in higher depreciation expenses in the earlier year of an asset’s life.
8.36
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 8.8 Daisy Ltd (a) STRAIGHT-LINE DEPRECIATION Calculation
Years 2012 2013 2014 2015 2016
Depreciable Cost *$270,000 270,000 270,000 270,000 270,000
X
End of Year
Depreciation Rate 20% 20% 20% 20% 20%
=
Annual Depreciation Expense $54,000 54,000 54,000 54,000 54,000
Accumulated Carrying Depreciation Amount $54,000 $256,000 108,000 202,000 162,000 148,000 216,000 94,000 270,000 40,000
* ($310,000 – $40,000)
DIMINISHING-BALANCE DEPRECIATION
Years 2012 2013 2014 2015 2016
Calculation Carrying Value Depreciation Beginning of x Rate# Year $310,000 34% 204,600 34% 135,036 34% 89,124 34% 58,822 34%
End of Year
=
Annual Depreciation Expense
Accumulated Depreciation
Carrying Amount
$105,400 174,964 220,876 251,178 270,000
$204,600 135,036 89,124 58,822 40,000
$105,400 69,564 45,912 30,302 *18,822
* Adjusted so ending carrying value will equal residual value. # Depreciation rate
= 1 − 5 40,000
310,000
= 1 – 0.6639 = 34% approximately
(b)
Straight-line depreciation provides the lowest amount for 2012 depreciation expense ($54,000) and, therefore, the highest 2012 profit. Diminishing-balance depreciation provides the highest amount for 2012 depreciation expense ($105,400) and, therefore, the lowest 2012 profit. Over the five-year period, both methods result in the same total depreciation expense ($270,000) and, therefore, the same total profit.
8.37
Chapter 8: Reporting and analysing non-current assets
PROBLEM SET B 8.9 Elmo Ltd Year ended 31 December 2014
(a)
Jan 2
$ 13,500
Patents Cash (defence of patent)
13,500
Jan June
Development Costs Cash (Development costs for a patent)
180,000
July 1
Patents Development Costs (patent granted 1 July 2005)
180,000
Advertising Expense Cash (advertising cost paid)
45,000
Copyright Cash (Copyright useful life 50 years)
200,000
Sept. 1
Oct. 1
$
180,000
180,000
45,000
200,000
(b) Amortisation journals for year ended 31 December 2014 Dec. 31
Dec. 31
(c)
Patent Amortisation Expense Accumulated Amortisation Patents [($80,000 x 1/10) + ($13,500 x 1/9)+( $180,000 x 1/20 x 6/12)]]
14,000
Copyrights Amortisation Expense Accumulated Amortisation Copyrights [($64,000 x 1/10) + ($200,000 x 1/50 x 3/12)]
7,400
Intangible Assets Patents ($273,500 cost less $22,000 amortisation) (1) Copyrights ($264,000 cost less $33,000 amortisation (2) Total intangible assets
14,000
7,400
$251,500 231,000 $482,500
(1) Cost ($80,000 + $13,500+ $180,000); amortisation ($8,000 + $14,000) (2) Cost ($64,000 + $200,000); Amortisation ($25,600 + $7,400).
(d) The intangible assets of Elmo Ltd consist of two patents and two copyrights. One patent with a cost of $93,500 is being amortised over 10 years; the other patent was obtained at a cost of $180,000 and is being amortised over 20 years. A copyright with a cost of $64,000 is being amortised over 10 years; the other copyright with a cost of $200,000 is being amortised over 50 years.
8.38
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 8.10 Zhou Ltd & Wang Ltd (a)
(b)
Zhou Ltd $360,000 = 2.25 years $160,000
Wang Ltd $750,000 = 6.05 years $124,000
(1)
Average age of PPE assets
(2)
Average useful life
$1,160,000 $1,410,000 = 9.35 years =8.81 years $124,000 $160,000
(3)
Asset turnover ratio
$3,440,000 $3,680,000 = 1.72 times = 1.3 times $2,000,000 $2,840,000
Based on the asset turnover ratio, Wang Ltd is more effective in using assets to generate sales. Its asset turnover ratio is 30% higher than Zhou Ltd’s ratio. One factor that complicates the comparison of the asset turnovers of the two companies is the wide difference in average age of the PPE assets. Assuming the estimated useful lives are realistically measured, Wang Ltd’s assets are in need of replacement much sooner than Zhou Ltd’s (9.35-6.05 years versus 8.81-2.25 years). Another factor is the different composition of total assets for each company. For example, Zhou Ltd has recorded goodwill, but Wang Ltd does not. Deleting the goodwill from Zhou Ltd’s asset turnover ratio improves the ratio to about 1.5. Also, a much greater proportion of Zhou Ltd’s total assets consist of PPE and intangibles. Finally, we are not told which valuation models are being used. If one company uses the revaluation model and the other the cost model, the comparison would become even more problematic.
8.39
Chapter 8: Reporting and analysing non-current assets
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 8.1
FINANCIAL REPORTING PROBLEM
Domino’s Pizza Enterprises Ltd (a)
At 4 July 2010 the carrying (book) value of property, plant and equipment was $30,812,000 as shown on the balance sheet. Refer note 18 for details of the cost Cost $52,487,000.
(b)
Depreciation is calculated on a straight-line basis so as to write off the cost of each asset over its expected useful life to its estimated residual value. Leasehold improvements are depreciated over the period of the lease or the estimated useful life, whichever is the shorter, using the straight-line method the assets (refer to note 3.15). The estimated useful lives, residual values and depreciation method are reviewed at the end of each annual reporting period, with the effect of any changes recognised on a prospective basis.
(c)
Depreciation and amortisation expense as disclosed in note 11.2 is 2010 $8,004,000, 2009 $6,449,000. Note 11.2 reveals depreciation expense for 2010 $ 6,507,000 and 2009 $5,720,000 and amortisation expense 2010 $1,497,000 and 2009 $729,000.
(d)
Additions to non-current assets. See notes 18, 19, 20: Item
2010 $’000 10,440 11 5,281 4,491
Plant & Equipment Equipment under finance lease Goodwill Other intangible assets
(e)
2009 $’000 5,799 31 4,850 2,721
Note 27 and 38 disclose that the company has financial leases with present value of lease payments of $26,000 and operating leases for premises, and motor vehicles of $42,517,000. Therefore, it appears the company mainly engages in operating leases. The split between the motor vehicles and the premises is not given. The implication for financial statement analysis is that there are assets and liabilities not disclosed in the financial statements.
8.40
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 8.2
COMPARATIVE ANALYSIS PROBLEM CSR Ltd vs Boral Ltd
(a)
CSR Ltd (1) Average useful life of PPE assets
Average cost of PPE assets Depreciati on expense
(2) Average age of PPE assets Accumulated depreciation Depreciati on expense
(3) Asset turnover ratio Net sales Average total assets
(b)
Boral Ltd
=
=
(2,083.4 + 2,017.8) 2 88.1
(3,228.5 + 2,919.7) 2 167.4
=
23.3 years
18.4 years
=
1,048.4 88.1
1,719.7 167.4
=
11.9 years
10.3 years
=
1,970.8 (2,349.9 + 2,735.5) 2
4,029.5 (4,510.5 + 4,037.9) 2
=
0.775 times
0.94 times
=
=
The average useful life and the average age of PPE assets are useful to compare these ratios with averages of other companies in the same industry. CSR’s and Boral’s PPE assets have been used for 11.9 years and 10.3 years respectively. Boral’s PPE assets have a shorter estimated life than Boral’s PPE assets. The remaining estimated life of CSR’s PPE assets is 11.4 years (23.3 – 11.9), while Boral’s PPE assets have a remaining estimated life of 8.1 years (18.4-10.3). So on average CSR’s PPE assets are newer. The asset turnover ratio measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. CSR’s asset turnover ratio is 0.775 times and Boral’s 0.94 times. Therefore, it can be concluded that Boral is more efficient in usage of assets.
8.41
Chapter 8: Reporting and analysing non-current assets
BUILDING BUSINESS SKILLS 8.3 Safe Drug Ltd and Reflex Ltd (a)
The primary intangibles of a healthcare products company would probably be patents, goodwill and trademarks. The nature of each of these is quite different; thus an investor would normally want to know what the composition of intangible assets is if it is material. If all intangibles were classified as goodwill then investors would be concerned as they would expect to see the company recognising patents from their development expenditures.
(b)
The asset turnover ratio is calculated as net sales divided by average total assets. This would be calculated as follows for these two companies:
Safe Drug Ltd Reflex Ltd. $47,314 $53,796 = 1.01 =0.89 ($63,706 + $42,906) 2 ($54,422 + $51,472) 2
This suggests that Reflex Ltd is slightly more effective in using its assets to generate sales. (c)
Many corporate executives complain that investors are too concerned about the short-term and don’t reward good long-term planning. As a consequence, they feel that the requirement that research and development expenditures be expensed immediately penalises those executives who do invest in the future. As a consequence, when profit does not look good, it is always tempting to cut research and development expenditures, since this will cause a direct increase in current year reported profits. Of course, it will also diminish the company’s long-term prospects.
(d)
If an entity reports goodwill on its statement of financial position, it can only have resulted from one thing – the entity must have purchased another entity. This is because entities are not allowed to record internally created goodwill. They can only report purchased goodwill. Ironically, if you want to report a large amount of goodwill, all you have to do is overpay when you purchase another business – the more you overpay, the more goodwill you will report. Obviously, reporting a lot of goodwill is not such a good thing. There is an asset impairment test which requires an entity to test annually for the impairment of goodwill.
BUILDING BUSINESS SKILLS 8.4
FINANCIAL ANALYSIS ON THE WEB
The answer to this question will vary on the company the student selects. Try and encourage students within the class to select different industries to be examined and then the class discussion can also focus on the differences between industries.
8.42
Solutions manual to accompany Accounting: building business skills 4e
CRITICAL THINKING BUILDING BUSINESS SKILLS 8-5
COMMUNICATION ACTIVITY
The CEO would be arguing for recognising the internally generated intangibles THE AASB member would be arguing for the AASB 138 rule which prohibits the recognition of internally generated brands, mastheads, publishing titles, customer lists and items similar in substance. Some of the issues to be raised in the memo: 1. One of the primary underlying principals in accounting is that the transaction or event needs to be clearly identified. Expenditures on internally generated assets, such as brands, mastheads, publishing titles and customer lists, may not be recognised as an asset because the costs incurred are considered indistinguishable from expenditure incurred to develop the business as a whole (internally generated goodwill). This is specifically mentioned in AASB 138 paragraph 64 which states that expenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognised as intangible assets. 2. One of the issues is how to measure the internally generated intangibles. They are treated in a similar vein to the internally generated goodwill and AASB 138 imposes the restriction of only recognising the item when it is purchased. This restriction has been imposed on the basis of the uncertainty surrounding the value of internally generated goodwill. It is difficult to audit the value assigned to these assets. 3. The AASB framework as such does not prohibit the recognition of the internally generated intangibles. The recognition of an asset would not be dependent upon the requirement that the future economic benefit be purchased, only that it be controlled. The CEO would argue strongly that the value of the intangible can be reliably measured. If other entities can purchase these types of assets then they must be able to be measured. 4. There is international controversy regarding the treatment of goodwill. The argument for amortisation is that a company pays a premium for the future earning capacity of the entity it purchased and this is realised over time and as such should be amortised against the future earnings. The counter argument is that the premium paid is for the synergies of the new earning capacity of the investor and investee companies and, as such, it should only be written down or amortised if the asset is impaired. The current standard on goodwill does not require amortisation, but an impairment test. 5. The main issue at hand is that there is an inconsistency if you wish to compare the performance of two entities which are structured differently. Company A may have grown internally and developed intangibles which are valuable and vital to the company’s performance. Company B may have grown by purchasing other business entities and as such have identified and recognised on their statement of financial position various intangible assets. The issue is how Company A can communicate to the market that they are strong performers. One side issue is that if the assets are not recognised in Company A then their return on assets will look superior to that of Company B who has more assets recognised on their statement of financial position.
8.43
Chapter 8: Reporting and analysing non-current assets
BUILDING BUSINESS SKILLS 8.6
ETHICS CASE Plastics Ltd
(a)
The stakeholders in this situation are: ▪ Paula Firth, managing director of Plastics Ltd ▪ John Straight, accountant ▪ The shareholders of Plastics Ltd ▪ Potential investors in Plastics Ltd
(b)
The intentional misstatement of the life of an asset or the amount of the residual value is unethical for whatever the reason. There is nothing unethical per se about changing the estimate either of the life of an asset or of an asset’s residual value if the change is an attempt to improve the allocation of the asset’s depreciable cost over the asset’s useful life. In this case, it appears from the accountant’s reaction that the revisions in the useful life and residual value are intended only to improve earnings which would be unethical. The fact that the competition uses a longer life on its equipment is not necessarily relevant. The competition’s maintenance and repair policies and activities may be different. The competition may use its equipment fewer hours a year (e.g. one shift rather than two shifts daily) than Plastics Ltd.
(c)
Profit (Ignoring income tax) in the year of change is increased $215,385 implementing the managing director’s proposed changes.
Asset cost Estimated residual Depreciable amount Depreciation per year ($3,200,000 ÷ 8)
Asset cost Estimated residual Depreciable amount Depreciation taken to date ($400,000 x 2)
Remaining life in years Depreciation per year Change in depreciation $400,000 - $184,615=
8.44
Old Estimates $3,500,000 300,000 3,200,000 $400,000 Revised Estimates $3,500,000 300,000 3,200,000 800,000 $2,400,000 13 years $184,615 $215,385
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 8.7
GROUP DECISION CASE
Sydney Ltd & Brisbane Ltd Straight-line method (a) Annual Depreciation Building [($380,000 - $40,000) x 2.5%*] Equipment [($150,000 - $10,000) x 10%**] Total annual depreciation
$8,500 14,000 $22,500
Total accumulated depreciation ($22,500 x 3)
$67,500
* (100% ÷ 40 years) = 2.5% **(100% ÷ 10 years) = 10%
(b)
Year 2012 2013 2014 Total profit
(c)
Sydney Ltd Profit $126,000 123,800 117,500 $367,300
Brisbane Ltd Profit as Adjusted $128,500 133,550 141,347 $403,397
Calculation for Brisbane Ltd $102,000 + $49,000 - $22,500 = $128,500 $114,000 + $42,050 - $22,500 = $133,550 $127,500 + $36,347 - $22,500 = $141,347
As shown above, when the two companies use the same depreciation method, Brisbane Ltd is more profitable than Sydney Ltd. When the two companies are using different depreciation methods, Brisbane Ltd has more cash than Sydney Ltd for two reasons: 1. its earnings are generating more cash than the earnings of Sydney Ltd, and 2. depreciation expense has no effect on cash. Cash generated by operations can be arrived at by adding depreciation expense to profit. If this is done, it can be seen that Brisbane Ltd’s operations generate more cash ($343,500 + $127,397 = $470,897) than Sydney Ltd’s ($367,300 + $67,500 = $434,800). Based on the above analysis, Ms Taylor should invest in Brisbane Ltd. Not only is it in a better cash financial position than Sydney Ltd, but it is also more profitable.
8.45
Chapter 9: Reporting and analysing liabilities
CHAPTER 9 – REPORTING AND ANALYSING LIABILITIES ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief Exercises
Exercises
Problems
1.
Explain the differences between current and noncurrent liabilities.
1
2.
Identify common types of current liabilities and explain how to account for them.
2
1, 2
1A, 2A, 1B, 2B
3.
Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.
7
3, 4
3A, 4A, 3B, 4B
4.
Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long-term debt.
1, 3, 4
5, 6
5A, 6A, 11A, 5B, 6B, 11B
5.
Identify the advantages of leasing and explain the difference between an operating lease and a finance lease.
6.
Complete basic journal entries for accounting for leases and explain how to report leases.
11, 12, 13
12A, 12B
7.
Explain the differences between provisions, contingencies and other types of liabilities.
8.
Explain how to report contingent liabilities.
9.
Prepare entries to record provisions for warranties.
5, 6
7A, 8A, 7B, 8B
10.
Evaluate an entity’s liquidity and solvency.
8, 9
9A, 10A, 9B, 10B
7
8, 9, 10
9.2
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 9 – REPORTING AND ANALYSING LIABILITIES ANSWERS TO QUESTIONS 1. While this is generally true, more precisely a current liability is a debt that can reasonably be expected to be paid within one year or the operating cycle, whichever is longer.
2. (a)
The entry when the tickets are sold is: Cash at Bank .............................................................. 900,000 Football Ticket Revenue Received in Advance ....................
900,000
(b) The entry after each game is: Football Ticket Revenue Received in Advance ........... 180,000 Football Ticket Revenue........................................................
180,000
3. No, Jack is not right. The market price on any note is a function of three factors: (1) the dollar amounts to be received by the investor (interest and principal), (2) the length of time until the amounts are received (interest payment dates and maturity date), and (3) the market interest rate.
4. $1000 ($50 000 x 8% x 3/12)
5. A provision is a liability for which the amount or timing of the future sacrifice is uncertain (AASB 137 para 10). It requires estimation. For example, a provision for long service leave requires estimation of the proportion of employees who will stay with the entity long enough to receive long service leave entitlements. The amount of the future sacrifice of other liabilities, such as trade creditors and mortgages, is quantified by an invoice or contractual arrangement.
6. A provision is a liability for which the amount or timing of the future sacrifice is uncertain (AASB 137 para 10). It requires estimation for recognition as a liability. An example is a provision for warranty claims. A contingent liability is not recognised because they are not probable or are unable to be measured reliably, or both. A liability may be classified as a contingent liability because it is so uncertain that it cannot be measured reliably, or because it does not satisfy the probability criterion, or if it is dependent upon the occurrence of a future uncertain event outside the control of the entity. An example of a contingent liability is an unresolved lawsuit brought against the company. It is contingent upon the outcome of the court case.
7. Ms Dwyer is incorrect. The obligation for a warranty arises when the sale is made. The warranty contract commences at that point in time. The sacrifice of economic benefits arises when the company honours the customer’s warranty claim. This is similar to having an obligation to pay employees. The obligation arises when the employee performs the service but the sacrifice of economic benefits, that is, the payment, is usually made in the following week.
9.3
Chapter 9: Reporting and analysing liabilities
8. A mortgage loan is a secured liability, repayable in regular instalments over the period of the loan. A mortgage liability should be reported as an interest-bearing liability. The current and non-current components of the mortgage liability should be reported separately. That is, the current portion of the mortgage liability should be included in financial liabilities (also referred to as borrowings) that are classified as current liabilities. The non-current portion of the mortgage liability should be included in the financial liabilities that are classified as non-current liabilities.
9. Many financially healthy companies have current ratios below 2:0. In order to reduce costs, many companies today keep low amounts of inventory on hand. Consequently, liquidity ratios are generally lower than they used to be. Another measure that could be checked is the quick ratio. This ratio is a measure of a company’s immediate short-term liquidity and inventory is not included in this calculation. Another measure of liquidity is working capital.
10. A finance lease is a lease in which substantially all the risks and rewards of ownership of the leased assets are transferred from the lessor to the lessee in exchange for a series of payments over the lease term. If substantially all the risks and rewards of ownership are not transferred, the lease is classified as an operating lease.
9.4
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9.1 Fresno Ltd (a)
A note payable due in two years is a non-current liability.
(b)
Part of the mortgage payable is a current maturity of long-term debt. This amount should be reported as a current liability.
(c)
Interest payable is a current liability, assuming it is due for payment within the next 12 months.
(d)
Accounts payable is a current liability because it is due for payment within the next 12 months.
BRIEF EXERCISE 9.2 Rome Ltd (a)
(b)
July
Dec.
1
31
Cash at Bank ................................................... $60,000 Notes Payable .................................................... Interest Expense.............................................. $3,000 Interest Payable .................................................. ($60,000 X 10% X 6/12)
BRIEF EXERCISE 9.3 31 May 13
Interest Expense $ 902 Loan Payable $4,098 Cash at Bank (To record the loan payment for May)
BRIEF EXERCISE 9.4 30 Sept. 13
Interest Expense $ 736 Loan Payable $4,264 Cash at Bank $5,000 (To record the loan payment for September)
9.5
$5,000
$60,000
$3,000
Chapter 9: Reporting and analysing liabilities
BRIEF EXERCISE 9.5 Trish’s Toasters Pty Ltd 30 June
Warranty Expense $36,000 Warranty Provision $36,000 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date)
BRIEF EXERCISE 9.6 Mac’s Auto Repairs Pty Ltd 30 June
Warranty Expense $9,300 Warranty Provision $9,300 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date)
BRIEF EXERCISE 9.7 Keystone Ltd (a)
(b)
(c)
Jan.
July
Dec.
1
1
31
Cash at Bank ................................... $1,000,000 Debentures Payable ............................... (1,000 X $1,000)
$1,000,000
Interest Expense.............................. $45,000 Cash at Bank .......................................... ($1,000,000 X 9% X 1/2)
$45,000
Interest Expense.............................. $45,000 Interest Payable ...................................... ($1,000,000 X 9% X 1/2)
$45,000
BRIEF EXERCISE 9.8 Dolby Machinery Ltd (a) (b) (c) (d)
Working capital = $1,107,535 – $656,700 = $450,835 Current ratio = $1,107,535 ÷ $656,700 = 1.69:1 Quick ratio = ($88,642 + $2,459 + $764,340) ÷ $656,700 = 1.30:1 Debt to total assets = $1,140,879 ÷ $2,369,154 = 0.48:1
9.6
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 9.9 Fresh Flowers Ltd 30 June
31 Aug
Delivery truck lease receivable Delivery truck lease revenue
$100
Cash
$300
$100
Delivery truck lease receivable Delivery truck lease revenue
$100 $200
SOLUTIONS TO EXERCISES
EXERCISE 9.1 (a)
(b)
May
May
1
31
Cash at Bank.................................................... $15,000 Note Payable.......................................................
$15,000
Interest expense............................................... $100 ($15,000 X .08 X 1/12) Interest Payable ..................................................
$100
(c)
Interest payable accrued each month ........................ $100 Number of months from borrowing to year end .......... x 8 Balance in interest payable account .......................... $800
(d)
Jan.
1
Note Payable.................................................... $15,000 Interest Payable ................................................. 800 Cash at Bank.......................................................
$15,800
EXERCISE 9.2 Transfield Pty Ltd June 30
Salaries and Wages Expense ................. $105,000 General Health Fund ...................................... PAYG Withheld Tax Payable .......................... Superannuation Payable ................................ Union Fees Payable ....................................... Salaries and Wages Payable ..........................
9.7
$6,750 11,250 9,450 2,000 75,550
Chapter 9: Reporting and analysing liabilities
EXERCISE 9.3 Fairy Wren Ltd (a)
(b) (c)
Jan.
1
July Dec.
1 31
Cash at Bank ............................................. $100,000 Unsecured Notes Payable ..............................
$100,000
Interest Expense........................................ $5,000 Cash at Bank ($100,000 X 10% X 1/2)……………….
$5,000
Interest Expense............................................ $5,000 Interest Payable ..............................................
$5,000
Debentures Payable .................................. $130,000 Loss on Redemption of Debentures ................ 2,600 Cash at Bank ($130,000 X 102%)..................
$132,600*
Debentures Payable $180,000 Gain on Redemption of Debentures ....... Cash at Bank ($180,000 X 98%)............
$3,600 176,400
EXERCISE 9.4 (a)
(b)
June 30
June
30
EXERCISE 9.5 (a)
30 June
Interest Expense $861 Loan Payable 4,139 Cash at Bank $5,000 (To record the loan payment for June)
. (b)
The current portion of the mortgage liability is $53,014 ($81,994 - $28,980).
(c)
The non-current portion is $28,980. This is the loan balance at 30 June 2014.
(d)
It is important to classify liabilities as current or non-current because readers of the financial statements use this information to assess a company’s liquidity. A liquidity analysis focuses on current liabilities, often comparing them to current assets, for example. The inability to meet obligations as they become due could lead to bankruptcy. Examples of current liabilities are accounts payable, unearned revenues, wages and salaries, provisions and interest.
9.8
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 9.6 (a)
30 June
Interest Expense Loan Payable Cash at Bank (To record the loan payment for June)
$2,202 7,798 $10,000
(b)
The carrying amount of the mortgage liability after the above entry is $212,434.
(c)
The current portion of the mortgage liability is $99,884 ($212,434 - $112,550)
(d)
The non-current portion is $112,550.
EXERCISE 9.7 a. An unquantifiable liability for restoring a polluted river - Contingent liabilities b. Accounts payable – Other liabilities c. Wages payable – Other liabilities d. Obligation for unexpired warranty costs - Provisions e. Trade creditors – Other liabilities f. Obligations for employees’ long service leave - Provisions g. Accrued interest liability – Other liabilities h. Mortgage loan – Other liabilities i. Guarantee for another’s loan, which will be payable if the other party defaults – Contingent liabilities unless, at end of reporting period, it is probable that the other party will default. If so, the guarantee should be recognised as a provision (settlement date is uncertain).
9.9
Chapter 9: Reporting and analysing liabilities
EXERCISE 9.8 Olden Motor vehicles Ltd (a) Summary entry for claims during the year ended 30 June 2013 Warranty Provision $65,000 Inventory $30,000 Wages Payable 35,000 (To record motor vehicle repairs under warranty) 30 June Warranty Expense $70,000 Warranty Provision $70,000 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date $75,000 estimate less $5,000 credit balance at 30/06/13.) (b)
Entities offer warranties because there is a statutory obligation to ensure that the goods or services are of a satisfactory standard. In order to gain consumer confidence and satisfaction and perhaps to increase sales, entities often offer a warranty period greater than that required by law.
EXERCISE 9.9 Robert de Builder Pty Ltd Summary entry for claims during the year ended 31 December, 2012 Warranty Provision $85,000 Wages Payable $85,000 (To record work performed under warranty) 31 Dec
Warranty Expense $75,000 Warranty Provision $75,000 (To adjust the liability for Warranty Provision account to the total estimated liability for contracts outstanding at balance date--.01 X $7,000,000 = $70,000 plus the $5,000 debit balance.)
EXERCISE 9.10 AMI Pty Ltd (a) (1) (2) (3) (4) (5)
Working capital = $312.2 – $236.7 = $75.5 Current ratio = $312.2 ÷ $236.7 = 1.32:1 Quick ratio = ($34.4 + $191.0) ÷ $236.7 = 0.95:1 Debt to total assets ratio = $613.6 ÷ $1,269.4 = 0.48:1 Times interest earned = ($110.4 + $5.9) ÷ $5.9 = 19.7 times
9.10
Solutions manual to accompany Accounting: building business skills 4e
(b)
Financial statement users are not only interested in a company’s trends, but also how the entity has performed relative to its competitors. Ratios vary from industry to industry. A positive trend in the debt to asset ratio gains more meaning if the company’s debt to asset ratio compares favorably in comparison to competitors and entities in similar industries.
9.11
Chapter 9: Reporting and analysing liabilities
EXERCISE 9.11 Delivery Australia Ltd 30 June Delivery Australia Ltd is renting a truck from U Bute Trucks Ltd under an operating lease. The journal entry is to record accrual of lease expense for the period ending 30 June. 31 August This entry records the payment made by Delivery Australia Ltd to U Bute Trucks Ltd on 31 August. Part of the payment is for the lease accrued to 30 June and the rest is for lease due in the current accounting period. 30 June This journal entry is for U Bute Trucks to record accrual of operating lease revenue earned from Deliver Australia Ltd up to 30 June. 31 August This journal entry is for U Bute Trucks to record the receipt from Delivery Australia Ltd of operating lease revenue. Part of the receipt is for lease accrued to 30 June and the rest is for lease due in the current accounting period.
EXERCISE 9.12 30 June
31 July
30 June
31 July
Sunny Nursery Ltd (lessee) Gardening tools lease expense Gardening tools lease payable Gardening tools lease expense Gardening tools lease payable Cash
Bunning’s Rentals Ltd (lessor) Gardening tools lease receivable Gardening tools lease revenue Cash Gardening tools lease receivable Gardening tools lease revenue
9.12
$400 $400 $400 400 $800
$400 $400 $800 $400 400
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 9.13 Grand Design Ltd (lessee) 30 Jun
31 Aug
30 Nov
Office Space lease expense Office Space lease payable
$500
Office Space lease expense Office Space lease payable Cash
$1000 500
Office Space lease expense Cash
$1500
$500
$1500
$1500
Doby Ltd (lessor) 30 Jun
31 Aug
Office Space lease Receivable $500 Accrued Office Space lease revenue Cash
$1500 Office Space lease receivable Office Space lease revenue
30 Nov
$500
Cash
$500 1500 $1500
Office Space lease revenue
9.13
$1500
Chapter 9: Reporting and analysing liabilities
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 9.1 Cling-on Ltd (a)
Sept.
1
30
Oct.
1
31
Nov.
Nov.
Dec.
1
30
1
31
Inventory or Purchases .................................. $16,000 Notes Payable ...................................................
$16,000
Interest Expense ............................................ $120 ($16,000 X .09 X 1/12) Interest Payable ................................................
$120
Climbing Wall ................................................. $10,000 Notes Payable ...................................................
$10,000
Interest Expense ............................................ $220 ($10,000 X .12 X 1/12 + $120) Interest Payable ................................................
$220
Vehicles ......................................................... $26,000 Notes Payable ................................................... Cash at Bank .....................................................
$18,000 8,000
Interest Expense ............................................ $430 ($18,000 X .14 X 1/12 + $100 + $120) Interest Payable ................................................
$430
Notes Payable................................................ $16,000 Interest Payable ............................................... 360 Cash at Bank .....................................................
$16,360
Interest Expense ($100 + $210) ..................... $310 Interest Payable ................................................
$310
9.14
Solutions manual to accompany Accounting: building business skills 4e
(b) Notes Payable $
$
1/12
16,000 1/9 1/10 Clos. Bal. 28,000 1/11
16,000 10,000 18,000
44,000
44,000 Op. Bal.
28,000
Interest Payable $ 1/12
Clos. Bal.
720
$ 360 30/9 31/10 30/11 31/12
120 220 430 310
1,080
1,080 Op. Bal.
720
Interest Expense $ 30/9 31/10 30/11 31/12
$ 120 Closing 220 Entry to 430 P/L summary 310 1,080
1,080 1,080
Note: The general ledger account Interest Expense will be closed to Income Summary at the end of each accounting period.
(c)
Current liabilities Notes payable ................................................................................... $28,000 Interest payable .................................................................................. 720
(d)
Total interest expense is $1,080.
(e)
The advantage of using notes payable for purchasing inventory is that the purchaser will probably have a longer period of time to pay for the inventory than under the normal credit terms for accounts payable. The disadvantage is that interest will have to be paid on the notes whereas accounts payable is usually interest free. In fact, suppliers often offer a discount for early payment. That would not be available in a notes payable scenario.
. 9.15
Chapter 9: Reporting and analysing liabilities
PROBLEM SET A 9.2 Annie Clothing Ltd (a)
July
14
20
24
(b)
July
31
31
Revenue Received in Advance ........................ $7,500 Service Revenue .................................................
$7,500
PAYG Withheld Tax Payable ........................... $1,750 Cash at Bank.......................................................
$1,750
Cash at Bank ................................................... $27,000 Notes Payable .....................................................
$27,000
Interest Expense ............................................... $71 Interest Payable .................................................. ($27,000 X 12% X 8/365 = $71) Salaries and Wages Expense .......................... $20,000 Health Fund Payable ........................................... PAYG Withheld Tax Payable ............................... Superannuation Payable ..................................... Salaries and Wages Payable ..............................
$71
$1,400 1,900 1,800 14,900
(c)
Current liabilities Notes payable ................................................................................... $ 27,000* Accounts payable ............................................................................. 78,000* Revenue in advance ($21,000 – $7,500) ........................................ 13,500* Interest payable ................................................................................. 71* Health Fund Payable ........................................................................ 1,400* PAYG withheld tax payable .............................................................. 1,900* Superannuation payable ................................................................... 1,800* Salaries and wages payable ............................................................. 14,900* Total current liabilities .............................................................. $138,571
(d)
Examples of other costs employers might incur in relation to their employees include obligations for sick leave, annual leave, union dues, and charitable contributions.
9.16
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 9.3 Sandy Oil Ltd (a)
(b)
2014 Jan
July
1
1
Interest Payable................................... $240,000** Cash at Bank ........................................
$240,000
Interest Expense................................ $240,000** ($4,000,000 X .12 X 1/2) Cash at Bank ........................................
$240,000
Unsecured Notes Payable ................... $2,000,000** Loss on Redemption of Unsecured Notes ............................................... 60,000 Cash at Bank ($2,000,000 X 1.03) ........
$2,060,000
2015 (c)
(d)
July
1
The advantages of debt financing over issuing shares are: • debt financing does not affect shareholder control of the entity because no additional shares are issued. • the interest paid on the debt is tax deductible whereas dividends paid to shareholders are not and • earnings per share may end up being higher even though interest has to be paid, because of the effects of financial leverage, i.e., if EBIT (earnings before interest and taxes) generated from the debt exceeds interest expense, then the benefit will go to the existing owners.
PROBLEM SET A 9.4 Carlsbad Electric Ltd (a)
(b)
2012 Jan.
1
Cash at Bank ........................................... $3,000,000* Debentures Payable ................................. $3,000,000
July
1
Interest Expense......................................... $150,000* Cash at Bank ............................................
$150,000
Interest Expense......................................... $150,000* Interest Payable ........................................
$150,000
Dec. 31
(c)
2013 Dec. 31
Debentures Payable ................................. $3,000,000 Loss on Redemption of Debentures....... 120,000* Cash at Bank ($3,000,000 X 104%)………………. $3,120,000
9.17
Chapter 9: Reporting and analysing liabilities
PROBLEM SET A 9.5 Southbank Mechanic Ltd (a)
April. 1
Cash at Bank
$112,550
Loan Payable
$112,550
(To record loan from the bank) (b) Month Ending 30.4.12
Beginning Balance $112550
Interest $1126
Reduction of Principal $8875
Closing Balance $103676
Payment $10000
31.5.12 30.6.12
103676 94712
10000 10000
1037 947
8963 9053
94712 85659
31.7.12 31.8.12 30.9.12 31.10.12 30.11.12 31.12.12 31.1.13 28.2.13 31.3.13
85659 76516 67281 57954 48533 39019 29409 19703 9900
10000 10000 10000 10000 10000 10000 10000 10000 10000
857 765 673 580 485 390 294 197 100
9143 9235 9327 9420 9515 9610 9706 9803 9900
76516 67281 57954 48533 39019 29409 19703 9900 0
* rounding of $1 has been adjusted against interest expense (c)
30 April
Interest Expense Loan Payable Cash at Bank (To record the loan payment for April)
$1,126 8,875
31 May
$1,037 8,963
$10,000
Interest Expense Loan Payable Cash at Bank (To record the loan payment for May)
9.18
$10,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 9.6 Cottonvalues Ltd (a)
Interest Expense $6,000 Loan Payable 4,000 Cash at Bank $10,000 (To record the loan payment to Eastpac Bank) Interest Expense $2,500 Loan Payable 9,500 Cash at Bank $12,000 (To record the loan payment to State Bank) Interest Expense $7,500 Loan Payable 32,500 Cash at Bank $40,000 (To record the loan payment to NZA Bank)
(b)
Interest expense for the current month is $16,000.
(c)
Interest expense will be less than $16,000 in the next month because the opening balance of each mortgage liability, on which the interest is calculated, will be lower.
PROBLEM SET A 9.7 Botch’s Watches Ltd Summary entry for the year ended 30 June 2014 (a)
Warranty Provision $1,500 Parts Inventory Wages Payable (To record watch repairs under warranty)
$500 1,000
(b)
30 Jun.
Warranty Expense $1,500 Warranty Provision $1,500 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date)
(c)
Holding product quality constant (no change in suppliers), the Warranty Provision is likely to be understated at $1,200. In the previous year, a provision of $1,200 was demonstrated to be inadequate: the provision account had a debit balance prior to adjusting entries on 30 June 2014. Furthermore, the current estimate does not reflect the increased sales volume. An increase in the number of watches sold during the year (indicated by the increase in sales revenue in the absence of an increase in prices) suggests that there will be additional warranty claims in the coming year. 9.19
Chapter 9: Reporting and analysing liabilities
PROBLEM SET A 9.8 Lincoln Plumbing Pty Ltd (a) WARRANTY PROVISION ACCOUNT Spare parts inventory (amount of warranty claims) $11,000 2012 Beginning balance Warranty Expense (amount of adjusting journal entry) Closing balance 13,000 $24,000 2013 Beginning balance (b)
$10,000
14,000 $24,000 $13,000
Summary entry for the year Warranty Provision $11,000 Spare Parts Inventory $11,000 (To record plumbing repairs under warranty)
Balance day adjustment Warranty Expense $14,000 Warranty Provision $14,000 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date)
PROBLEM SET A 9.9 (a) TELECOM HEAVEN LTD ($ IN MILLIONS) (1) (2) (3) (4)
(b)
Current ratio = $138,565 ÷ $49,558 = 2.80:1 Quick ratio = ($22,434 + $67,709) ÷ $49,558 = 1.82:1 Debt to total assets ratio = $129,055 ÷ $360,472 = 0.36:1 Times interest earned = ($51,151 + $2,280) ÷ $2,280 = 23.43 times
Liquidity can be measured using the current and quick ratios. In 2010 Telecom Heaven outperformed Telecom New Zealand in both measures. Telecom Heaven also has a much lower debt to total assets ratio (a measure of solvency) than Telecom New Zealand, indicating a smaller proportion of assets financed by creditors and lower financial risk as a result. The lower debt/asset ratio contributes to Telecom Heaven’s much greater times interest earned. In conclusion, Telecom Heaven appears to be more liquid and solvent than Telecom New Zealand.
9.20
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 9.10 Gifts For You Ltd (a) (1) (2) (3) (4) (5) (b)
Current ratio = $9434 ÷ $5353 = 1.75:1 Quick ratio = ($4207 + $2743 + 1230) ÷ $5353 = 1.53:1 Debt to total assets ratio = $25295 ÷ $57875 = 0.44:1 Working capital = $9434 – $5353 = $4081 Times interest earned = ($46950 + $11440) ÷ $11440 = 5.1 times
Even though the current ratio would appear to be adequate, i.e., current assets are sufficient to cover current liabilities, it still falls below the rule of thumb of 2:1. But as a measure of liquidity risk, the current ratio has certain failings, including ignoring the composition of current assets. The quick ratio compensates for that failing by including only the most liquid current assets in its numerator. Being greater than the rule of thumb of 1:1, this is good news for Gifts For You Ltd. Because the working capital also is positive, all three liquidity calculations indicate that Gifts For You Ltd is likely to be able to meet its short term debts. Although nearly half the assets are funded by creditors, the times interest earned ratio is greater than 3, which is the minimum level creditors like to see and suggests that Gifts For You Ltd is not facing a solvency problem. Even though it appears from the calculations in part (a) that Gifts for You Ltd is quite capable of meeting its long and short term debts, ratios should always be compared with industry averages.
9.21
Chapter 9: Reporting and analysing liabilities
PROBLEM SET A 9.11 (a)
Month Ending 30.6.2012
Beginning Balance
Payment
Interest
Reduction of Principal
Closing Balance
$200,000
$55,480
$24,000
$31,480
$168,520
30.6.2013
168,520
55,480
20,222
35,258
133,262
30.6.2014
133,262
55,480
15,991
39,489
93,774
30.6.2015
93,774
55,480
11,253
44,227
49,547
5,934*
49,546
0
30.6.2016
49,547 55,480 *Rounding error $12 adjusted against interest
(b) 2012 30 Jun.
Interest Expense $24,000 Loan Payable 31,480 Cash at Bank (To record the annual loan payment)
$55,480
2013 30 Jun.
Interest Expense $20,222 Loan Payable 35,258 Cash at Bank (To record the annual loan payment)
(c) Current Liabilities Current portion of long term loan
$39,488
Non Current Liabilities Loan payable
$93,774
9.22
$55,480
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 9.12
Cameron Ltd (a) Lease repayment schedule:
Date
Lease Payment $
Interest 8% $
Principal reduction $
Balance lease obligation $
01.07.2012 30.6.2013
100,000 38,803
8,000
30,803
69,197
30.6.2014
38,803
5,536
33,267
35,930
35,929
0
30.6.2015
38,803 2,875* *Rounding error $1 adjusted against interest
(b) 2013 30 Jun
30 Jun
Lease Liability Interest Expense Cash at Bank (To record the annual lease repayment)
$30,803 8,000
Lease Amortisation Expense $33,333 Accumulated Amortisation (To record the lease amortization expense At the end of the period $100,000 ÷ 3)
(c) Statement of Financial Position (Extract) As at 30 June 2013 Non-current assets Lease asset Less: Accumulated amortisation
$100,000 ( 33,333) 66,667
Current liabilities Lease liability
$33,267
Non-current liabilities Lease liability
35,930
9.23
$38,803
$33,333
Chapter 9: Reporting and analysing liabilities
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 9.1
(a)
Mar.
1
31
Apr.
1
30
May
1
31
Jun.
1
30
Mountain Bikes Pty Ltd Bikes ............................................................... $8,000 Notes Payable ...................................................
$8,000
Interest Expense .................................................. $60 ($8,000 X .09 X 1/12) Interest Payable ................................................
$60
Land ............................................................. $20,000 Notes Payable ...................................................
$20,000
Interest Expense ............................................ $260 ($20,000 X .12 X 1/12 + $60) Interest Payable ................................................
$260
Cash at Bank ................................................. $15,000 Notes Payable ...................................................
$15,000
Interest Expense ............................................ $335 ($15,000 X .06 X 1/12 + $200 + $60) Interest Payable ................................................
$335
Notes Payable.................................................. $8,000 Interest Payable ............................................... 180 Cash at Bank .....................................................
$8,180
Interest Expense ($75 + $200) ....................... $275 Interest Payable ................................................
$275
9.24
Solutions manual to accompany Accounting: building business skills 4e
(b) Notes Payable $
$
1/6
8,000 1/3 1/4 Clos. Bal. 35,000 1/5
8,000 20,000 15,000
43,000
43,000
Op. Bal. Interest Payable
35,000
$ 1/12
Clos. Bal.
750
$ 180 31/3 30/4 31/5 30/6
60 260 335 275
930
930 Op. Bal.
750
Interest Expense $ 31/3 30/4 31/5 30/6
$ 60 Closing 260 Entry to 335 P/L summary 275
930
930 930
(c)
Current liabilities Notes payable ................................................................................... $35,000 Interest payable .................................................................................. 750
(d)
Total interest expense is $930.
(e)
The advantage of using notes payable for purchasing inventory is that the purchaser will probably have a longer period of time to pay for the inventory than under the normal credit terms for accounts payable. The disadvantage is that interest will have to be paid on the notes whereas accounts payable is usually interest free. In fact, suppliers often offer a discount for early payment. That would not be available in a notes payable scenario.
9.25
Chapter 9: Reporting and analysing liabilities
PROBLEM SET B 9.2 Jasmine Ltd (a)
Jan
Jan
1
16
22
(b)
Jan.
31
31
Cash at Bank ................................................... $30,000 Notes Payable .....................................................
$30,000
Service Revenue Received in Advance ............. $2,000 Service Revenue .................................................
$2,000
PAYG Taxes Payable ...................................... $1,320 Cash at Bank.......................................................
$1,320
Interest Expense ............................................... $250 Interest Payable .................................................. ($30,000 X 10% X 1/12 = $250) Salaries and Wages Expense .......................... $16,000 Health Fund Payable ........................................... PAYG Taxes Payable .......................................... Superannuation Payable ..................................... Salaries and Wages Payable ..............................
$250
$2,000 1,450 1,440 11,110
(c)
Current liabilities Notes payable .......................................................................... $ 30,000* Accounts payable ...................................................................... 8,500* Revenue in advance ($3,800 – $2,000) ................................... 1,800* Interest payable ...................................................................... 250* Health Fund Payable ............................................................... 2,000* PAYG Taxes payable............................................................... 1,450* Superannuation payable .......................................................... 1,440* Salaries and wages payable .................................................... 11,110* Total current liabilities $56,550*
(d)
Examples of other costs employers might incur in relation to their employees include obligations for sick leave, annual leave, union dues, and charitable contributions.
9.26
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 9.3 Storage Box Ltd 2014 (a) Jan.
(b)
Jul.
2015 (c) Jul
1
1
1
Interest Payable................................................. $360,000 Cash at Bank ............................................
$360,000
Interest Expense............................................... $360,000 Cash at Bank ............................................
$360,000
Debentures Payable ....................................... $3,000,000 Loss on Redemption of Debentures.................. 90,000 Cash at Bank ($3,000,000 X 103%) .....................
$3,090,000
(d) The advantages of debt financing over issuing shares are: • debt financing does not affect shareholder control of the entity because no additional shares are issued. • the interest paid on the debt is tax deductible whereas dividends paid to shareholders are not and • earnings per share may end up being higher even though interest has to be paid, because of the effects of financial leverage, i.e., if EBIT (earnings before interest and taxes) generated from the debt exceeds interest expense, then the benefit will go to the existing owners.
PROBLEM SET B 9.4 Thompson Ltd (a)
(b)
2012 Jul.
2012/13 Dec. 31
Jun.
(c)
1
30
2014 Dec. 31
Cash at Bank ................................................. $4,000,000* Debentures Payable ................................. $4,000,000
Interest Expense............................................... $180,000* Cash at Bank ............................................
$180,000
Interest Expense............................................... $180,000* Cash at Bank ............................................
$180,000
Debentures Payable .................................... $4,000,000 Loss on Redemption of Debenture ................ 80,000 Cash at Bank ($4,000,000 X 102%) .....................
$4,080,000
9.27
Chapter 9: Reporting and analysing liabilities
PROBLEM SET B 9.5 Toowong Florist Ltd (a)
April 1
Cash at Bank
$56,870
Loan Payable
$56,870
(To record loan from the bank) (b) Month Ending
Beginning Balance
Payment
Interest
Reduction of Principal
Closing Balance
30.4.13
$56870
$5000
$474
$4526
$52344
31.5.13
52344
5000
436
4564
47780
30.6.13
47780
5000
398
4602
43178
31.7.13
43178
5000
360
4640
38538
31.8.13
38538
5000
321
4679
33859
30.9.13
33859
5000
282
4718
29141
31.10.13
29141
5000
243
4757
24384
30.11.13
24384
5000
203
4797
19587
31.12.13
19587
5000
163
4837
14751
31.1.14
14751
5000
123
4877
9874
28.2.14
9874
5000
82
4918
4956
31.3.14 4956 5000 44 4956 * rounding of $3 has been adjusted against interest expense
0
(c)
30 April
Interest Expense Loan Payable Cash at Bank (To record the loan payment for April)
$474 4,526
31 May
$436 4,564
$5,000
Interest Expense Loan Payable Cash at Bank (To record the loan payment for May)
9.28
$5,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 9.6 Tables Galore Ltd (a)
Interest Expense $1,500 Loan Payable $3,500 Cash at Bank $5,000 (To record the loan payment to Aussie Bank) Interest Expense $1,125 Loan Payable $4,875 Cash at Bank $6,000 (To record the loan payment to Kiwi Bank) Interest Expense $1,750 Loan Payable $18,250 Cash at Bank $20,000 (To record the loan payment to Bank Outback)
(b)
Interest expense for the current month is $4,375.
(c)
Interest expense will be less than $4,375 in the next month because the opening balance of each mortgage liability, on which interest is calculated, will be lower.
PROBLEM SET B 9.7 Mikes Mechanics Ltd Summary entry for the year ended 30 June 2013 (a)
Warranty Provision $3,000 Parts Inventory Wages Payable (To record car repairs under warranty)
$1,000 2,000
(b)
30 Jun.
Warranty Expense $3,000 Warranty Provision $3,000 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date)
(c)
Holding product quality constant (no change in suppliers),the Warranty Provision is likely to be understated at $2,400. In the previous year, a provision of $2,400 was demonstrated to be inadequate: the provision account had a debit balance prior to adjusting entries on 30 June 2013. Furthermore, the current estimate does not reflect the increased sales volume. An increase in the number of car repairs and service during the year (indicated by the increase in revenue from car repairs in the absence of an increase in prices) suggests that there will be additional warranty claims in the coming year. 9.29
Chapter 9: Reporting and analysing liabilities
PROBLEM SET B 9.8 Leader’s Ladders Pty Ltd (a) WARRANTY PROVISION ACCOUNT Spare parts inventory (amount of warranty claims) $33,000 2012 Beginning balance Warranty Expense (amount Closing balance 39,000 of adjusting journal entry) $72,000 2013 Beginning balance (b)
$30,000 42,000 $72,000 $39,000
Summary entry for the year Warranty Provision $33,000 Spare Parts Inventory $33,000 (To record plumbing repairs under warranty)
Balance day adjustment Warranty Expense $42,000 Warranty Provision $42,000 (To adjust the liability for Warranty Provision account to total estimated liability for contracts outstanding at balance date)
PROBLEM SET B 9.9 TELECOM UTOPIA Ltd ($ In Millions) (a) (1) (2) (3) (4)
b)
Current ratio = $346412 ÷ $123896 = 2.80:1 Quick ratio = ($56086 + $169272) ÷ $123896 = 1.82:1 Debt to total assets ratio = $322638 ÷ $901180 = 0.36:1 Times interest earned = ($127877 + $5700) ÷ $5700 = 23.43 times
Liquidity can be measured using the current and quick ratios. In 2010 Telecom Utopia outperformed Telecom New Zealand in both measures. Telecom Utopia also has a much lower debt to total assets ratio (a measure of solvency) than Telecom New Zealand, indicating a smaller proportion of assets financed by creditors and lower financial risk as a result. The lower debt/asset ratio contributes to Telecom Utopia’s much greater times interest earned. In conclusion, Telecom Utopia appears to be more liquid and solvent than Telecom New Zealand.
9.30
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 9.10 Ink Blob Ltd ($ In Millions) (a) Current ratio:
1) Current ratio 2) Quick ratio 3) Debt to total assets 4) Working capital 5) Times interest earned
(b)
2013 $3322 $5190 = 0.64 $2757 $5190 = 0.53 $11734 $17574 = 0.67 $3322 - $5190 = ($1868) $1098 $260 = 4.2
2012 $3954 $4767 = 0.83 $3165 $4767 = 0.66 $11712 $16974 = 0.69 $3954 - $4767 = ($813) $567 $172 = 3.3
Both the current ratio and the quick ratio declined during 2013, and working capital was a larger negative amount. The current and quick ratios were both below 1.0 and should be monitored closely. The debt to asset and times interest earned ratios measure solvency. Whereas the debt to asset ratio showed little change, the times interest earned ratio showed improvement in 2013.The interest cover improved as a result of increased profit rather than reduced borrowing costs. In fact, the slight reduction in long-term debt did not result in lower borrowing costs, perhaps explained in part by an increase in interest rates.
9.31
Chapter 9: Reporting and analysing liabilities
PROBLEM SET B 9.11 (a) Month Ending 30.6.2012 30.6.2013 30.6.2014 30.6.2015 30.6.2016 •
Beginning Balance
Payment
Interest
Reduction of Principal
$100000
$26380
$10000
$16380
$83620
83620 65602
26380 26380
8362 6560
18018 19820
65602 45782
45782 23980
26380 26380
4578 2400*
21802 23980
23980 0
Rounding error $2 adjusted against interest
(b) 2012 30 Jun.
Interest Expense $10,000 Loan Payable 16,380 Cash at Bank $26,380 (To record the annual loan payment)
30 Jun.
Interest Expense $8,362 Loan Payable 18,018 Cash at Bank $26,380 (To record the annual loan payment)
2013
(c) Current Liabilities Current portion of long term loan
$19,820
Non Current Liabilities Loan payable
$45,782
9.32
Closing Balance
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 9.12
Coen Ltd (a) Lease repayment schedule:
Date
Lease Payment $
Interest 12% $
Principal reduction $
Balance lease obligation $
01.7.2012 30.6.2013
75000 20,805
9,000
11,805
63,195
30.6.2014
20,805
7,583
13,222
49,973
30.6.2015
20,805
5,997
14,808
35,165
30.6.2016
20,805
4,220
16,585
18,580
18,575
0
30.6.2017 •
20,805 2,235* Rounding error $5 adjusted against interest
(b) 2013
30 Jun
30 Jun
(c) 2014
30 Jun
30 Jun
(d)
Lease Liability Interest Expense Cash at Bank (To record the annual lease repayment)
$11,805 9,000 $20,805
Lease Amortisation Expense $15,000 Accumulated Amortisation (To record the lease amortization expense At the end of the period $75,000 ÷ 5) Lease Liability Interest Expense Cash at Bank (To record the annual lease repayment)
$13,222 7,583
Lease Amortisation Expense $15,000 Accumulated Amortisation (To record the lease amortization expense At the end of the period $75,000 ÷ 5)
Statement of Financial Position (Extract) As at 30 June 2014 Non-current assets Lease asset $75,000 Less: Accumulated amortisation ( 30,000) 45,000 Current liabilities Lease liability $14,808 Non-current liabilities Lease liability
35,165 9.33
$15,000
$20,805
$15,000
Chapter 9: Reporting and analysing liabilities
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS
BUILDING BUSINESS SKILLS 9.1
FINANCIAL REPORTING PROBLEM
Domino’a Pizza Enterprises Ltd (a)
Current liabilities were $31,101,000 at 4 July 2010.
(b)
Current provisions were $2,171,000 at 4 July 2010.
(c)
Total liabilities decreased by $6,028,000 from $54,355,000 in 2009 to $48,327,000 in 2010.
(d)
All dollar amounts are in $’000.
Working capital Current ratio
2010 $48,959 - $31,101 = $17,858 $48,959 $31,101 = 1.57
Quick ratio Debt to total assets
($16,241 + $21,724) $31,101 = 1.22 $48,327 $148,674 = 0.33
Times interest earned
($23,722 + $797) $797= 30.8 times
9.34
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 9.2
COMPARATIVE ANALYSIS PROBLEM
Fantastic Holdings Ltd vs. Nick Scali Ltd (a)
Working capital Current ratio Quick ratio Debt to total assets Times interest earned
Fantastic Holdings 2010 (in $’000) $102,111 - $58,265 = $43,846 $102,111 $58,265= 1.75 ($5,086+ $9,432) $58,265 = 0.25
Nick Scali 2010 (in $’000) $32,919 - $19,359 = $13,560 $32,919 $19,359 = 1.7 ($17,312 + $610 ) $19,359 = 0.93
$77,697 $168,185 = 0.46 ($25,116 + $876) $876 = 29.7 times
$19,645 $41,075= 0.48 Not applicable because Nick Scali has no interest expense
(b) Both entities have positive working capital. Fantastic Holdings Ltd has a similar current ratio as Nick Scali Ltd and in both cases the current ratios appear to be comfortably greater than 1. However, when the quick ratios are calculated, Fantastic’s ratio is very much lower than 1 due to the large proportion of inventory in its current assets (83%). On the other hand, Nick Scali’s quick ratio is much closer to 1 as it has a relatively less proportion of inventory in its current assets (42%). Fantastic Holdings’ quick ratios would be of concern in the absence of industry average information and inventory turnover ratios as it would appear that it may have liquidity problems. Both companies have similar leverage, that is, their debt to total assets ratios are similar. Fantastic Holdings Ltd has a high interest cover and Nick Scali Ltd’s times interest earned cannot be calculated because it has no interest bearing liabilities.
9.35
Chapter 9: Reporting and analysing liabilities
BUILDING BUSINESS SKILLS 9.3 A GLOBAL FOCUS Drawing on note 18 to the 2010 financial statements, Telstra has borrowings in the following foreign currencies: • Euro • United States dollars • British pounds sterling • New Zealand dollars • Swiss francs • Hong Kong dollars • Chinese renminbi • Japanese yen
Companies borrow overseas or in different currencies for a variety of reasons, including: • • •
convenience for off-shore operations due to restrictions on international currency flows and foreign investment regulations imposed by governments of other countries; to reduce exposure to foreign currency risk generated by off-shore assets or exports; to take advantage of lower interest rates available in other countries.
The major risk involved in off-shore borrowing is that the Australian dollar (or New Zealand dollar for a New Zealand company) might devalue against the currency in which the entity has the off-shore loan. This would mean that the company would have to repay more in terms of its local currency than it had originally borrowed. The extra cost resulting from local currency devaluation would also result in greater interest payments in the local currency. For example, if the Australian and New Zealand dollars devalued against the US dollar, it would take more Australian and New Zealand dollars to repay US loans borrowed by Australian and New Zealand companies, such as Telstra and Telecom New Zealand.
BUILDING BUSINESS SKILLS 9.4 FINANCIAL ANALYSIS ON THE WEB (a)
The two key areas of services offered by Moody’s are: • Investors Service which is a provider of credit ratings, research and risk analysis. The ratings and analysis track debt covering more than 110 countries, 12,000 corporate issuers, 25,000 public finance issuers and 106,000 structured finance obligations. • Analytics which offers tools for measuring and managing risk by providing software, advisory services and research.
(b)
Moody’s takes the view that most fixed-income market participants are long-term investors and are, therefore, more concerned about the long-terms prospects of a corporation or investment product. Accordingly, Moody’s focuses on assessing the ability of an entity to meet its credit obligations over the long term rather than on temporary fluctuations in prices and returns. Moody’s long term view is, generally a time horizon of five-to-ten years, set to capture at least one full economic cycle. They focus on the risks specific to each borrower’s industry, country and region within the long-term horizon.
9.36
Solutions manual to accompany Accounting: building business skills 4e
CRITICAL THINKING BUILDING BUSINESS SKILLS 9.5
GROUP DECISION CASE Mall Ltd
2014 (a)
Jan. 1
Debentures Payable (net) ................... $1,144,000 Gain on Redemption of Debentures ..................... Cash at Bank ....................................................... (To record repurchase of 10% debentures)
$144,000 1,000,000
Jan.1
Cash at Bank ...................................... $1,000,000 Debentures Payable............................................. $1,000,000 (To record sale of 10-year, 17.36% debentures at face value)
(b)
Dear Ms Payne, The early redemption of the 10%, 5-year debentures results in recognising an increase in profit of $144,000 that increases current year profit by the after-tax effect of the gain. The amount of the liabilities on the balance sheet will be lowered by the issue of the new debentures and retirement of the 5-year debentures. 1.
The annual cash flow of the company as it relates to debentures payable will be adversely affected as follows: Annual interest payments on the new issue ($1,000,000 X .17.36%) Annual interest payments on the 5-year debentures ($1,200,000 X .10) Additional cash outflows per year
2.
$173,600 120,000 $ 53,600
The amount of interest expense shown on the income statement will be higher as a result of the decision to issue new debentures. These comparisons hold for only the 3-year remaining life of the 10%, 5-year debentures. There will of course be a cash saving on the repayment of the principal five years later but the company will be committed to a higher interest rate for five years. The company must contemplate either redemption of the debentures at maturity, 1 January 2017, or refinancing of that issue at that time and consider what interest rates will be in 2017 in evaluating a redemption and issue in 2014.
Sincerely,
9.37
Chapter 9: Reporting and analysing liabilities
BUILDING BUSINESS SKILLS 9.6 COMMUNICATION ACTIVITY
To:
Board of Directors, Dundee Pty Ltd
From:
I. M. Student
Subject:
Revenue Recognition on Research Contract
The revenue from the research contract, and corresponding expenses, associated with the research contract should be recognised by reference to the stage of completion when the outcome can be measured reliably (AASB 118). No revenue is recognised on entering into the contract because at that time no work has been performed. The performance of services in relation to the research contract differs from the timing of the cash flows of the contract. Recognising revenue by reference to the stage of completion would result in 50% of the revenue being recognised in year ended 30 June 2013, when half of the research work is to be performed. Of the $600,000 received that year, $500,000 should be accounted for as revenue when 50% of the research is complete. The other $100,000 is a liability for revenue received in advance. The remaining 50% of the revenue would be recognised in the year ended 30 June 2014, when the remaining half of the research is to be performed. It is not necessary to delay the recognition of revenue until the cash is received unless there is uncertainty that it will flow to the entity. As stated above the recognition of revenue is subject to the outcome being able to be measured reliably. The outcome of a transaction involving the performance of services is considered to be able to be measured reliably if: (1) Revenue can be recognised reliably (2) It is probable that economic benefits will flow to the entity (3) The stage of completion can be measured reliably and (4) The costs incurred for the transaction and the costs to complete can be measured reliably (AASB 118 para. 20, also discussion in chapter three of this text). The revenue can be measured reliably because the contact has a fixed price. The recommendations for recognition of revenue in 2013 and 2014 are based on assumptions that the stage of completion at 30 June 2013 and 30 June 2014 will be 50% and 100%, respectively. If different levels of completion apply at the time, the actual percentages of completion should be used, assuming they can be measured reliably. It is also assumed that it is probable that benefits will flow to the entity (that is, that this is not a loss making contract). Lastly, it is assumed that the costs incurred on the research contract and expected future costs can be measured reliably at 30 June 2013 and 30 June 2014 when revenue is to be recognised. Signed
9.38
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 9.7
ETHICS CASE Candy Bars Ltd
(a) The stakeholders in this situation are: shareholders; potential shareholders; creditors; potential creditors; any users of the financial statements; customers, including any consumers of the product; and potential customers, including any potential consumers of the product. (b) Creditors and potential creditors may be harmed by the non-disclosure because they may underestimate the financial risk of extending credit to Candy Bars Ltd. Prospective investors may also be harmed as they may understate the risk attached to future profits, cash flows and dividends of Candy Bars Ltd and consequently pay too much for the shares. Existing shareholders may also be harmed because the non-disclosure may affect their decision to continue investing in the company and if Candy Bar Ltd loses the case, the value of shares to the shareholders may decline. Some people may have avoided that potential loss, at least partially, if, with full disclosure, they would have decided to sell their shares earlier. The stock market as a whole is disadvantaged because if investors cannot rely on companies to disclose information relevant to the value of the shares, investing in companies becomes a much riskier activity. This would be reflected in the cost of capital to companies in general. Customers may be harmed or disadvantaged. However, annual reports are not generally used by consumers as a source of product information. (c) While there are arguments that ethics is a matter of individual judgement, many people would consider this behaviour as unethical. Users are being misinformed about relevant information. This can result in some (such as existing shareholders who wish to sell) obtaining a benefit at the expense of another group (such as future shareholders). One often hears attempts to use directors’ obligations to act in the interests of shareholders as justification for unethical behaviour (and in some extreme instances, fraud and deception). However, this argument is flawed because behaviour that would be unethical if done by one party (shareholders) cannot become ethical simply because it is done by that party’s agent (the directors) acting under some duty to put the interests of his principal above all others. However, even if one did hold to the point of view that directors’ conduct can be justified on the basis that it is in the interests of shareholders, it is not clear in the present case that shareholders (present and future) would benefit from the non-disclosure of the company’s contingent liability for damages caused by one of its products.
9.39
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 10 – REPORTING AND ANALYSING EQUITY ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1,2,8,9
1A,2A,3A,9A, 1B,2B,3B,9B
1.
Identify and discuss the main characteristics of a corporation.
2.
Record the issue of ordinary shares.
1, 3
3.
Describe the effects of share splits.
5
4.
Prepare the entries for cash dividends and share dividends.
2,4,5
2,3,4
5.
Understand the concept of earning power and indicate how irregular items are presented.
6
5
6.
Indentify the components of comprehensive income and changes in equity
7.
Identify the items that affect retained earnings.
8.
Evaluate a company’s dividend and earnings performance from a shareholder’s perspective.
9.
Evaluate debt and equity as alternative sources of finance.
5A,5B, 2A,3A,4A,5A, 6A, 7A,8A,9A, , 2B,3B,4B,5B, 6B, 7B, 8B, 9B,
5A,6A,7A,8A, 9A,5B,6B, 7B, 8B, 9B
10.1
6,7
5A,6A,7A,8A, 9A,5B, 7B, 8B, 9B
7
10
5A,6A,7A,8A, 9A, 5B, 6B,7B, 8B,9B
8
11
10A, 10B
Chapter 10: Reporting and analysing equity
CHAPTER 10 – REPORTING AND ANALYSING EQUITY ANSWERS TO QUESTIONS 1.
(a) Separate legal existence. A company is separate and distinct from its owners and it acts in its own name rather than in the name if its shareholders. In contrast to a partnership, the acts of the owners (shareholders) do not bind the company unless the owners are duly appointed agents of the company. (b) Limited liability of shareholders. Because of its separate legal existence, creditors of a company ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of shareholders is normally limited to their investment in the corporation. (c)
Transferable ownership rights. Ownership of a company is represented in transferable units called shares. Shareholders may dispose of part or all of their interest by simply selling their shares. The transfer of ownership to another party is entirely at the discretion of the shareholder unless the need for further authorisation is specified in the company’s constitution.
(d) Company Management. The shareholders own a company but the business is managed through the Board of Directors. The Directors are elected by the shareholders. The Directors who work fulltime as employees for the business are the executive Directors. The managing director is the chief executive officer (CEO) and the head accountant is the chief financial officer (CFO). Some owners who are also directors do have an active role in the management of the business. 2.
(a) Corporate management is an advantage to a company because it can hire professional managers to run the company. Corporate management is also a disadvantage to a company because it prevents owners from having an active role in directly managing the company. (b) Other disadvantages of a company are government and other regulations. A company is subject to numerous regulations, such as laws for issuing and recording the issue of shares and lodging annual returns.
3.
In the absence of restrictive provisions, the basic ownership rights of ordinary shareholders are the rights to: (1) vote for the election of the board of directors and in corporate actions that require shareholders’ approval. (2) share in company profits. (3) share in assets upon liquidation
4.
The rules for dividend payment are the same for Australia and New Zealand. Companies can only pay a dividend if: the assets exceed liabilities by more than the amount of dividend proposed; it is fair and reasonable to shareholders as a whole and it does not materially prejudice the company’s ability to pay its creditors.
10.2
Solutions manual to accompany Accounting: building business skills 4e
5.
A cash dividend decreases assets, retained earnings and total equity. A share dividend decreases retained earnings, increases paid-in capital, and has no effect on total assets and total equity.
6.
A two for one share issue: (a) increases the number of shares on issue by 100%; (b) has no effect on the share capital account; and (c) has no effect on equity.
7.
The adjustment required is to decrease assets and decrease retained earnings in the current period. In presenting financial statements for 2012, the comparative figures for 2011 should be adjusted by decreasing assets and increasing expenses with resulting decreases in profit and closing retained earnings for 2011.
8.
No. The additional depreciation results from a change in accounting estimates and should be recognised as an expense.
9.
(a)
The change to an accelerated method of depreciation means that there will be an increase in the amount of depreciation expense in the current year, part of which will be catching up on depreciation that would have been charged previously, if accelerated depreciation had been used in prior years. This will result in reduced profit being reported.
(b)
The nature of the change, reasons for the change, the effect on current year’s profit and the cumulative effect on prior year income statements should be disclosed in the notes to the financial statements. If practical, comparative information should be restated.
10.
The Statement of comprehensive income shows the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners. The income statement forms part of the statement of comprehensive income and shows the income and expenses for the period resulting in the profit or loss which is then transferred to retained earnings. As the name suggests, the statement of changes in equity reflects the net changes in the equity accounts for the period. It shows the total comprehensive income for the period; the effects of any retrospective adjustments for accounting errors, changes in accounting policies and reclassification of amounts, as outlined in the previous section in this chapter; and the results of transactions with owners/shareholders in their capacity as owners, that is, contributions and distributions. Lastly, the statement of changes in equity must show, for each equity account, a reconciliation between the opening and closing balances, separately disclosing each change.
11.
Share capital is increased by the issue of shares. Reserves are increased by upward asset revaluations (in the case of the Revaluation Reserve) and transfers from Retained Earnings. Retained earnings are increased when profit is closed to retained earnings from Income Summary account.
12.
One alternative to purchasing the assets is to lease them through an operating lease agreement (refer chapter 8) in which the lease payments are recorded as an
10.3
Chapter 10: Reporting and analysing equity
expense. This allows the lessee to keep the leased assets and lease liabilities off the statement of financial position. Another option is to issue shares to raise money for the acquisition of the truck. This would reduce the debt to total assets ratio rather than increase it. 13.
Some companies maintain low dividend payout because they prefer use the money for investment. Another reason for low dividend payout ratios is poor liquidity.
14.
The return on equity increases when the company makes more profit. However, the company may choose to retain more profit and save cash that would otherwise be spent on dividends. If this occurs, shareholders may receive lower dividends even though the return on equity has increased. Lydia should not be concerned if the company is reducing dividends to finance expansion of profitable activities.
10.4
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10.1 Eagle Ltd General Journal Date Account name (narration) June 1 Cash at Bank Share Capital (To record share issue by private placement)
Debit $ 6 000
G 203 Credit $ 6000
BRIEF EXERCISE 10.2 Satina Ltd General Journal Date Dec 1
Dec 31
Account name (narration) Debit $ Retained earnings 240 000 Share Dividend Payable (To record dividend declared) Share Dividend Payable 240 000 Share Capital (To record the issue of shares as per dividend declared)
Credit $ 240 000
240 000
BRIEF EXERCISE 10.3 Jason Ltd General Journal Date March 31
April 1
April 1
April 1
April 30
Account name (narration)
Debit $
Credit $
Bank Trust 200 Application 200 (To record receipt of money due on application) Application 200 Share Capital 200 (To record issue of shares 1000 shares, 20c due on application) Cash at Bank 200 Bank Trust 200 (To record the transfer of money to Jason Ltd’s bank account on issue of shares) Allotment 200 Share Capital 200 (To record monies due on allotment) Cash at Bank 200 Allotment 200 (To record receipt of allotment money)
10.5
Chapter 10: Reporting and analysing equity
BRIEF EXERCISE 10.4 Homespun Yarn Ltd General Journal Date 2013 June 30
July 31
Account name (narration)
Debit $
Dividend Declared/Retained Earnings 500 Dividend Payable (To record declaration of dividend (5000 X $0.10) Dividend Payable 500 Cash at Bank (To record the payment of the dividend)
Credit $
500
500
BRIEF EXERCISE 10.5 Doubles Ltd General Journal Date Dec 31
Jan 31
Jun 30
Account name (narration)
Debit $
Dividend Declared/Retained Earnings 200 Dividend Payable (Being declaration of interim dividend(1000 X $0.20) Dividend Payable 200 Cash at Bank (Being payment of interim dividend) Dividend Declared/Retained Earnings 400 Dividend Payable(2000 X $0.20) (Being declaration of final dividend)
Credit $
200
200
400
BRIEF EXERCISE 10.6 Jones Ltd Income statement (Partial) For the year ended xxx Profit before income tax
$300,000
Income tax expense
72,000
Profit for the period
$228,000
The prior period adjustment is adjusted in retained earnings. BRIEF EXERCISE 10.7 Kelly Edwards Ltd Dividend payout = $15 000/$60 000 = 25% Return on shareholders’ equity = $ 60 000/$300 000 = 20%
10.6
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 10.8 Olga Ltd Issue Shares
Issue Unsecured Notes
Profit before interest and taxes Interest ($2,000,000 X 8%) Profit before income taxes Income tax expense (30%) Profit (a)
$1,000,000 0 1,000,000 300,000 $ 700,000
$1,000,000 160,000 840,000 252,000 $ 588,000
Shareholders’ equity (b) Earnings per share (a) ÷ (b)
900,000 $ 0.78
700,000 $ 0.84
Profit is higher if shares are used. However, return on shareholders’ equity is lower than if unsecured notes are used because of the additional equity.
10.7
Chapter 10: Reporting and analysing equity
SOLUTIONS TO EXERCISES EXERCISE 10.1 Kweensland Ltd General Journal Date (a) Jan 10
Account name (narration) Debit $ Credit $ Share issue by private placement Cash at Bank 50 000 Share Capital 50 000 Being issue of shares by private placement (50 000x $1) July 1 Cash at Bank 240 000 Share Capital 240 000 Being issue of shares by private placement (30 000x $8) (b) Public offer for July 1 transactions July 1 Cash Trust 60 000 Application 60 000 Being monies received on application to trust a/c (30 000 x $2) July 1 Application 60 000 Share Capital 60 000 Being the issue of shares on allotment date July 1 Cash at bank 60 000 Cash Trust 60 000 Being trust monies transferred to bank a/c July 1 Allotment 120 000 Share Capital 120 000 Being allotment monies due (30 000 x $4) July 31 Cash at Bank 120 000 Allotment 120 000 Being allotment monies received Dec 1 Call 60 000 Share Capital 60 000 Being call monies due (30 000 x $2) Dec 31 Cash at Bank 60 000 Call 60 000 Being call monies received
10.8
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 10.2 Hinckley Ltd General Journal Date April 1
June 15
July 10
Dec 1
Dec 15
Account name (narration) Debit $ Cash at Bank 44 000 Share Capital Being share issue (4,000 X $11) Retained Earnings 118 500 Dividends Payable Being dividend declared (79,000 X $1.50) Dividends Payable 118 500 Cash at Bank Being payment of dividend Cash at Bank 39 000 Share Capital Being share issue (3,000 X $13) Retained Earnings 147 600 Dividends Payable Being dividend declared (82 000 x$1.80)
Credit $ 44 000
118 500
118 500
39 000
147 600
b) workings : Issued capital is now 82,000 shares. Opening Capital $750 000 +$44 000 + $39 000. = $833 000 Hinckley Ltd Statement of financial position (Partial) as at 31 December 20X0 $
$
Equity: Share capital Retained earnings Total equity
833 000 483 900 $1 316 900
Note balance of retained earnings not given in question. So assume Closing retained earnings is $483,900. (c) Companies can only pay a dividend if: the assets exceed liabilities by more than the amount of dividend proposed; it is fair and reasonable to shareholders as a whole and it does not materially prejudice the company’s ability to pay its creditors.
10.9
Chapter 10: Reporting and analysing equity
EXERCISE 10.3 Sanders Ltd
Equity Contributed equity Retained earnings Total equity Issued shares
Before Action
After Share Dividend
After Cash Dividend
600,000 200,000 $800,000
630,000 170,000 $800,000
600,000 170,000 $770,000
60,000
63,000
60,000
Share dividend: 60 000 shares x 5% x $10 per share Cash dividend: 60 000 shares x $0.50 From the analysis above the retained earnings is the same with either method chosen, but the share dividend does not use cash reserves the year you pay the dividend, so these funds can be reinvested into the business. However if the shareholders expect the same dividend per share in the future as the current dividend then the company will need increased profits and funds to be able to meet the future dividends as now the shareholders have 3,000 more shares.
EXERCISE 10.4 Hyde Ltd General Journal Date 1. Dec 31
Account name (narration) Retained earnings Interest expense (To correct error in recording dividend)
Debit $ $ 10 000
Credit $ $ 10 000
2 Dec 31
Retained Earnings 2 000 Dividends Payable 10 000 Share Dividend Payable 12 000 (To record the dividend as a share dividend and not as a cash dividend and at the correct amount of $12 per share not $10)
10.10
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 10.5 Libano Ltd (a) Current year profit i) Prior period sales (deduct) ii) Less gain on sale of component of business Earning power
$1,250,000 (20,500) . (82,280) $1,147,020
iii) Depreciation is not adjusted as affects future earnings iv) Contingent liability is not adjusted but need to read details in the notes to the financial statements as judge the likely affect on the company. Taxes are ignored for this question (b) It is important for potential investors to understand the concept of earning power as the financial reports particularly the profit is used as a predictor of future cash flows. Earning power is the profit adjusted for irregular items thereby better reflecting the future earning capacity of the company EXERCISE 10.6 Rich Ltd Statement of Changes in Retained Earnings For the year ended 30 June 2012 Retained earnings 1 July 2011* Add: Profit
$15 000 20 000 35 000
Less: Interim dividend (100 000 X $0.08) (8 000) Final dividend (100 000 X $0.10) (10 000) Transfer to general reserve (7 000) (25 000) Retained earnings 30 June 2012 $10 000 *Note need to determine opening balance by working back EXERCISE 10.7 Express Deliveries Statement of Changes in Retained Earnings For the year ended 31 December 2012 Retained earnings 1 January 2012 Add: Profit
$24 000 16 000 40 000
Less: Interim dividend (20 000 x $0.10) Final dividend (20 000 x $0.20) Transfer to dividends equalisation reserve Retained earnings 31 December 2012
10.11
(2 000) (4 000) (6 000)
(12 000) $28 000
Chapter 10: Reporting and analysing equity
EXERCISE 10.8 (a) North Island Skiwear Ltd General Journal Date 2013 Jan 10
Mar 1
May 1
Sept 1
Nov 1
Account name (narration)
Debit $
Credit $
Cash at Bank 160 000 Share Capital Being private issue of shares (80,000 X $2) Cash at Bank 15 000 Share Capital Being private issue of shares (5,000 X $3) Cash at Bank 240 000 Share Capital Being private issue of shares (80,000 X $3) Cash at Bank 40 000 Share Capital Being private issue of shares (10,000 X $4) Cash at Bank 6 000 Share Capital Being private issue of shares (1,000 X $6)
160 000
15 000
240 000
40 000
6 000
(b) Date
Dec 31
(c)
Account name
Closing bal.
SHARE CAPITAL Amount Date 2013 Jan 1 Mar 1 May 1 Sept 1 461 000 Nov 1 $461 000 Dec 31
Share capital at 31 December 2013 is $461 000.
10.12
Account name
Amount
Cash at bank Cash at bank Cash at bank Cash at bank Cash at bank
160 000 15 000 240 000 40 000 6 000 $461 000 $461 000
Opening Bal*
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 10.9 (a) Smithers Ltd General Journal Date 2013 Jan 10
Mar 1
May 1
Sept 1
Nov 1
Account name (narration)
Debit $
Credit $
Cash at Bank 800 000 Share Capital Being private issue of shares (160,000 X $5) Cash at Bank 300 000 Share Capital Being private issue of shares (50000 X $6) Cash at Bank 480 000 Share Capital Being private issue of shares (80,000 X $6) Cash at Bank 70 000 Share Capital Being private issue of shares (10,000 X $7) Cash at Bank 120 000 Share Capital Being private issue of shares (15,000 X $8)
800 000
300 000
480 000
70 000
120 000
(b) SHARE CAPITAL Date
Dec 31
(c)
Account name
Closing bal.
Amount
1 770 000 $1 770 000
Date 2013 Jan 1 Mar 1 May 1 Sept 1 Nov 1
Account name
Amount
Cash at bank Cash at bank Cash at bank Cash at bank Cash at bank
Dec 31
Opening Bal
800 000 300 000 480 000 70 000 120 000 $1 770000 $1 770 000
Share capital at 31 December 2013 is $1 770 000
EXERCISE 10.10 Lloyd’s Tabs Pty Ltd Dividend payout rate = $20 000/$50 000 = 40% Return on shareholders’ equity = $50 000/[($110 000 + $140 000)/2] = 40% Shareholders’ equity at 30 June 2013 = $110 000 + $50 000 - $20 000 =$140 000
10.13
Chapter 10: Reporting and analysing equity
EXERCISE 10.11 Trackwork Trains Ltd
Profit before interest and taxes Interest ($2,400,000 X 13%) Profit before taxes Income tax expense (30%) Profit Equity Return on equity
(a) Plan One Issue Shares
(b) Plan Two Issue Debentures
$800,000 0000,000 800,000 240,000 $560,000 $3,400,000 16%
$800,000 312,000 488,000 146,400 $341,600 $1 000,000 34%
(b) Factors would include: • • • •
Ability to generate cash to meet the interest payments (Plan Two) or possible dividend payments (Plan One) in the future. Tax deductibility of Interest. The stability of interests rates in the future and their effect on the early retirement of the debt. The increase in financial risk from issuing more debt compared with the increased ROE from increased leverage.
10.14
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 10.1 (a) Public issue of shares Marge Arena Ltd General Journal Date 2013 Jan 10
Account name (narration)
Mar 1
Cash Trust 400 000 Application Being application monies received (20,000 X $20) Application 400 000 Share Capital Being allotment of shares (20,000 X $20) Cash at bank 400 000 Cash Trust Being the transfer of funds from trust a/c to coy bank a/c Allotment 400 000 Share Capital Being allotment monies due (20,000 X $20) Cash at Bank 400 000 Allotment Being receipt of allotment monies Call 200 000 Share Capital Being call monies due(20,000 X $10) Cash at Bank 200 000 Call Being receipt of call monies(20,000 X $10)
2 Mar.
Mar 2.
Mar 2
Mar 31.
Nov 1
Nov 30
Debit $
Credit $
No entry
400 000
400 000
400 000
400 000
400,000
200,000
200 000
(b) Application 2/3
$ 400,000
1/3
400,000
Allotment $ 400,000
$ 31/3 400,000
$
400,000
400,000
2/3
Share Capital $ Bal. C/b 1,000,000 1,000,000
1/12 Bal
400,000 Call
$ 2/3 2/3 1/11
400,000
$
400,000 400,000 200,000 1,000,000 1,000,000 10.15
30/11 200,000
200,000
$ 1/11
200000
200,000
Chapter 10: Reporting and analysing equity
(c)
MARGE ARENA LTD
Share capital .....................
10.16
$1,000,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 10.2 (a) Seven Teas Ltd General Journal Date 2013 Jan 9
Jun 10
Jul 10
(b)
Account name (narration)
Debit $ $ 600 000
Cash at Bank Share Capital Being issue of shares for cash (100,000 X $6) Retained Earnings 160,000 Dividend Payable Being cash dividend declared ($1,600,000 X 10%) Dividend Payable 160,000 Cash at Bank Being payment of dividend
Equity section of the statement of financial position Seven Teas Ltd Statement of financial position As at 30 June 2013 EQUITY $ Issued capital 1 600 000 Revaluation Reserve 500 000 Retained earnings* 740,000 TOTAL EQUITY $ 2,840,000 *Retained earnings $900,000 less dividend $160 000 = $740 000
10.17
Credit $ $ 600 000
160,000
160,000
Chapter 10: Reporting and analysing equity
PROBLEM SET A 10.3 Bell Consulting Pty Ltd General Journal Account name (narration) Debit $
Date 2011 May
1
Cash
Credit $
10 000
Share Capital (To record initial capital investment ) 2
3
5
9
10 000
Rent Expense GST Paid Cash (To record office rent paid)
800 80
Office Supplies GST Paid Accounts Payable (Purchased office supplies on account)
500 50
Advertising Expense GST Paid Cash (Paid advertising)
50 5
880
550
55
Cash
1 100
GST Collected Sales (To record Cash for services) 12
15
17
20
23
100 1 000
Retained Earnings/Dividend Cash (To record dividend payments)
200 200
Accounts receivable GST Collected Sales (To record service provided on credit)
3 300
Salaries Expense PAYG withholding Cash (To record salaries paid)
2 950
300 3 000
450 2 500
Accounts Payable Cash (To record payment of creditor)
550 550
Cash
2 200
Accounts Receivable (To record debtor receipt) 26
2 200
Cash
5 000
Bank Loan (To record loan from bank) 29
30
5 000
Office Equipment GST Paid Accounts Payable (To record equipment purchase on account) Electricity Expense GST Paid Cash (To record electricity payment)
10.18
2 400 240 2 640 150 15 165
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 10.4 (a) Jake Ltd General Journal Date 2013 Feb 1
Account name (narration)
Mar 1
July 1
Debit $
Credit $
Retained Earnings 40 000 Dividends Payable Being dividend declared (50,000 X $0.80)
40 000
Dividends Payable Cash at Bank Being dividend payment
40 000
40 000
Retained Earnings 75 000 Share Dividends Payable Being share dividend declared (50,000 x 5% x$30)
July 31
Share Dividends Payable Share Capital Being issue of share from share dividend
Dec 1
75 000
75 000 75 000
Retained Earnings 21 000 Dividends Payable Being final dividend declared (52 500 x $0.40)
21 000
(b) Share Capital $ C/B 1,075,000 1,075,000
$ 1/1 Bal. 1,000,000 31/7 75,000
1/2 2/7
1,075,000 31/12 bal 1,075,000
Retained Earnings $ $ 40,000 1/1 Bal. 600,000 75,000
1/12 21,000 31/12 bal 464,000
.
600,000
600,000 31/12 bal 464,000 Share Dividends Payable
Dividends Payable $ 1/3 Bal
40,000 . 21,000
$ 1/2 1/12
40,000 21,000
31/12 bal
61,000 21,000
61,000
$ 31/7
10.19
75,000 75,000
$ 7/1
75,000 75,000
Chapter 10: Reporting and analysing equity
(c) Equity section of the statement of financial position Jake Ltd Statement of financial position (partial) As at 31 December 2013 EQUITY Share capital General Reserve Retained earnings TOTAL EQUITY
$ 1 075 000 200 000 464,000 $ 1,739,000
10.20
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 10.5 (a) Loco Ltd General Journal Date 2012 Dec 31
2013 15 Jan 10
30 Jun 10
Account name (narration)
Debit $
Credit $
Dividend Declared/Retained Earnings Dividend Payable Being declaration of interim dividend
1 000
Dividend Payable Cash at Bank Being payment of interim dividend Dividend Declared/Retained Earnings Dividend Payable Being declaration of final dividend
1 000
1 000
1 000 2 000 2 000
10 February there is no entry for the share split but the number of issued shares becomes 20 000 and affects the subsequent cash dividend. (b) Loco Ltd Statement of changes in Retained Earnings For the year ended 30 June 2013 Retained earnings 1 July 2012 Add: Profit
$8 000 6 000 14 000
Less: Interim dividend (10 000 x $0.10) Final dividend (20 000 x $0.10) Retained earnings 30 June 2013
(1 000) (2 000)
3 000 $11 000
(c)
Dividend payout = ($1000 + $2000)/$6000 = 50%
(d)
Equity increased by $3 000, being the increase in retained earnings. The share split has no effect on equity accounts.
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Chapter 10: Reporting and analysing equity
PROBLEM SET A 10.6 (a) Redrock Ltd General Journal Date 2012 Sept 30
Oct 10
2013 Mar 31
Account name (narration)
Debit $
Credit $
Dividend Declared/Retained Earnings 10 000 Share Dividend Payable 10 000 Being declaration of interim share dividend (50 000 x .20 x $1) Share Dividend Payable 10 000 Share Capital 10 000 Being payment of interim share dividend Dividend Declared/Retained Earnings 12 000 Dividend Payable Being declaration of final dividend (12 000 x $0.10)
(b) Redrock Ltd Statement in Changes of Retained Earnings For the year ending 31 March 2013 Retained earnings 1 April 2012 Add: Profit
$30 000 18 000 48000
Less: Interim share dividend Final cash dividend Retained earnings 31 March 2013
(10 000) (12 000)
(c)
Cash Dividend payout = $12 000/$18 000 = 67%
(d)
Share capital increased by Retained earnings decreased by Increase in shareholders’ equity
22 000 $26 000
$10,000 ( 4,000) $ 6,000
10.22
12 000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 10.7 (a) Dunmore Pty Ltd General Journal Date 2013
Account name (narration)
Debit $
Jun 30
Dividend Declared/Retained Earnings Dividend Payable Being declaration of final dividend
18 000
Credit $
18 000
(b)
Dividend ratio = $18,000/$30 000 = 60%
(c)
Return on shareholders’ equity = $30 000/[($55 010 + $43,010)/2] = 61% As the only change in reserves is a transfer from retained earnings (i.e., within equity) the opening shareholders’ equity can be derived as follows: Closing equity Less profit Add back dividends Opening equity
$55 010 (30,000) 18,000 $43 010
(d) Dunmore Pty Ltd Statement of Changes in Equity For the Year ending 30 June 2013
Balance 1 July 2012 Profit Cash Dividends Transfer to reserve Balance 30 June 2013
Issued Capital $ 10
General Reserve $ 10 000
$10
5 000 $15 000
10.23
Retained earnings $ 33 000 30 000 (18 000) (5 000) $40 000
Total
43 010 30 000
$55 010
Chapter 10: Reporting and analysing equity
PROBLEM SET A 10.8 (a) Good Oil Ltd General Journal Date 2013 Dec 31
Account name (narration)
Debit $
Dividend Declared/Retained Earnings Dividend Payable Being declaration of final dividend
24 000
Credit $
24 000
(b)
Dividend payout ratio = $24,000/$50,000 = 48%
(c)
Return on shareholders’ equity = $50,000/[($4,226,000 + $4,252,000)/2] = 1.2%
(d) Good Oil Ltd Statement of Changes in Equity For the Year ending 31 December 2013 Issued General Retained Capital Reserve earnings $’000 $’000 $’000 Balance 1 January 2013 4 000 206 20 Profit 50 Cash Dividends (24) Transfer to reserve 10 (10) Balance 31 December 2013 $4 000 $216 $40 000 Opening balances for equity need to be derived. Share capital has not changed. Reserves increased by $10,000 so opening balance is $206,000 Retained earnings =$4,226,000 -$4,000,000-$206,000=$20,000
10.24
Total
4 226 30 000
$55 010
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 10.9 (a) Africa Ltd General Journal Date 2013 Aug 15
Oct 1
2014 Jan 6
Mar 15
Jun 30
Account name (narration)
Debit $
Credit $
Dividend Declared/Retained Earnings 36 000 Dividend Payable Being declaration of interim dividend (200 000 x $0.18) Dividend Payable 36 000 Cash at Bank Being payment of interim dividend
36 000
36 000
Dividend Declared/Retained Earnings 40 000 Share Dividend Payable 40 000 Being declaration of interim share dividend (200 000 x 10% x$2) Share Dividend Payable 40 000 Share Capital 40 000 Being payment of interim share dividend Retained Earnings 15 000 General Reserve 15 000 Being transfer to general reserve
(b)
Balance 1 July 2013 Profit Share issue dividend Cash Dividends Transfer to reserve Balance 30 June 2014
Africa Ltd Statement of Changes in Equity For the Year ending 31 December 2014 Issued Revaluation General Capital Reserve Reserve $ $ $ 400 000 50 000 40 000
$440 000
$50 000
15 000 $15 000
Retained earnings $ 100 000 150 000 (40 000) (36 000) (15 000) $159 000
Total $ 550 000 150 000 (36 000) $664 000
(c)
Equity increased by $150 000 profit less cash dividend $36,000 = $114 000 $664,000 less $550,000 = $114,000
(d)
Dividend to be paid out of 2014 profits is interim cash dividend $36,000 plus final dividend of $0.18 x 220,000 shares = $ 39 600 Dividend payout = $75 600/$150 000 = 50.4% Return on shareholders’ equity = $150,000/[($664,000 + $550,000)/2] = 24.71%
10.25
Chapter 10: Reporting and analysing equity
PROBLEM SET A 10.10 Investor Ltd
Profit before interest and tax Interest expense 8% x $2,500,000 Tax expense 30% profit before tax Profit Shareholders’ equity Return on shareholders’ equity
Borrow at 8% $1,200,000 (200,000) (300,000) 700,000 5,000,000 14%
Issue More Shares $1,200,000 (360,000) 840,000 7,500,000 11%
Borrowing yields the greater return for Investor Ltd’s shareholders given the current interest rate. Other factors that should be considered include the liquidity and solvency risk associated with future interest and principal payments and potential changes in interest rates. Also to be considered is the change in ownership structure under the share issue alternative.
10.26
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 10.1 (a) Boxer Ltd General Journal Date 2013 Mar 13
Account name (narration)
May 1
Cash Trust 500 000 Application Being application monies received (100 000 x $5) Application 500 000 Share Capital Being allotment of shares (100,000 X $5) Cash at bank 500 000 Cash Trust Being the transfer of funds from trust a/c to coy bank a/c Allotment 300 000 Share Capital Being allotment monies due (100,000 X $3) Cash at Bank 300,000 Allotment Being receipt of allotment monies Call 200 000 Share Capital Being call monies due (100,000 X $2) Cash at Bank 200 000 Call Being receipt of call monies (100,000 X $2)
May 2
May 2
May 2
May 31
Aug 1
Aug 15
Debit $
Credit $
No entry
500 000
500 000
500 000
300 000
300,000
200 000
200 000
(b) Application 2/5
$ 500,000
1/5
500,000
Allotment $ 500,000
$ 31/5 300,000
500,000
300,000
$ 2/5
Share Capital $ Bal. C/b 1,000,000 1,000,000 (c)
BOXER LTD
300,000 300,000 Call
$
$ 30/8 200,000
2/5 2/5 1/8
500,000 1/8 300,000 200,000 1,000,000 200,000 1/9 Bal 1,000,000 Share capital ............. $1,000,000 10.27
$ 200000
200,000
Chapter 10: Reporting and analysing equity
PROBLEM SET B 10.2 (a)
Date 2013 Mar 15
June 10
(b)
Martha Ltd General Journal
Account name (narration)
Debit $
Cash at Bank 600 000 Share Capital Being issue shares for cash (200,000 X $3) Retained Earnings 840 000 Dividend Payable Being dividend declared ($5,600,000 X 15%) Dividend Payable 840 000 Cash at Bank Being dividend payment
Equity section of the statement of financial position EQUITY Issued share capital Revaluation Reserve Retained earnings TOTAL EQUITY
$ 5 600 000 300 000 960 000 $ 6 860 000
10.28
Credit $
600 000
840 000
840 000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 10.3 Family Tree Ltd General Journal Date
Account name (narration)
$ Debit
Cash
40 000
$ Credit
April
1.
Share Capital (Issue shares for cash) 2.
3.
4.
5.
6.
7.
8.
9.
10.
40 000
Rent Expense GST Paid Cash (paid office rent)
400 40 440
Office equipment GST Paid Cash (Purchase of office equipment for cash)
3 000 300
Advertising Expense GST Paid Accounts Payable (To record advertising on account)
1 300 130
3 300
1 430
Office Supplies GST Paid Cash (Paid office supplies)
800 80
Accounts receivable Cash Sales GST Collected (Sales month April)
17 600 3 300
880
19 000 1 900
Dividends/Retained earnings Cash (Paid cash dividend)
400 400
Accounts Payable Cash (Paid supplier)
1 430
Salaries Expense Cash PAYG Withholding (Salaries for April)
1 500
Cash
7 700
1 430
1 200 300
Accounts receivable (Customers paid account)
7 700
10.29
Chapter 10: Reporting and analysing equity
PROBLEM SET B 10.4 (a) Mask Ltd General Journal Date 2013 Aug 1
Sept. 1
Oct. 1
Oct 31
Dec 1
Account name (narration)
Debit $ $ 150 000
Credit $ $
Retained Earnings Dividends Payable Being dividend declared (300 000 x $0.50) Dividends Payable 150 000 Cash at Bank Being dividend payment Retained Earnings 225 000 Share Dividends Payable Being share dividend declared (300 000 x 5% x $15) Share Dividends Payable 225 000 Share Capital Being issue of share dividend Retained Earnings 126 000 Dividends Payable Being cash dividend declared (315 000 x $0.40)
150 000
150 000
225 000
225 000
126 000
(b) Share Capital (Equity) $ $ 1/7 Bal. 3,000,000 C/B 3,225,000 31/10 225,000 3,225,000 2 225,000 31/12 bal 3,225,000
Dividends Payable (Liability) 1/9 Bal
$ 150,000 . 126,000 276,000
1/8 1/12 31/12 bal
$ 150,000 126,000 276,000 126,000
Retained Earnings (Equity) $ $ 1/8 150,000 1/7 Bal. 1,800,000 1/10 225,000 1/12 126,000 31/12 bal 1299,000 . 1,800,000 1,800,000 31/12 bal 1299,000 Share Dividends Payable (Equity) 31/10
10.30
$ 225,000 225,000
1/10
$ 225,000 225,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 10.5 (a) Alpha Ltd General Journal Date 20X0 Dec 30
15 Jan
30 Jun
30 Jun
Account name (narration)
Debit $
Credit $
Dividend Declared/Retained Earnings 10 000 Dividend Payable Being declaration of interim dividend (10 000 x $1) Dividend Payable 10 000 Cash at Bank Being payment of interim dividend Dividend Declared/Retained Earnings 40 000 Dividend Payable Being declaration of final dividend (40,000 x $1) Retained Earnings 15 000 General Reserve Being transfer to general reserve
10 000
10 000
40 000
15 000
March 31 no entry but now 40,000 shares on issue (b) Alpha Ltd Statement in Changes of Retained Earnings For the year ending 30 June 20X0 Retained earnings 1 July Add: Profit
$50 000 40 000 90 000
Less: Transfer to General reserve Interim share dividend Final cash dividend Retained earnings 30 June 20X0
(15 000) (10 000) (40 000)
65 000 $25 000
(c) Alpha Ltd Statement of financial position (Partial) As at 30 June 20X0 EQUITY Share capital (40,000) shares
$100 000
Reserves
95 000
Retained earnings
25 000
TOTAL EQUITY
$220 000
(d) Cash Dividend payout = $40 000/$40 000 = 100% Return on shareholders’ equity = $40,000/[($230,000 + $220,000)/2] = 17.8%
10.31
Chapter 10: Reporting and analysing equity
PROBLEM SET B 10.6 (a) Greenstone Ltd General Journal Date 2012 Dec 31
2013 Jan 10
30 Jun 06
Account name (narration)
Debit $
Credit $
Dividend Declared/Retained Earnings 8 000 Share Dividend Payable 8 000 (Being declaration of interim share dividend 20,000 x $.20 x $2) Share Dividend Payable 8 000 Share Capital 8 000 (Being payment of interim share dividend, 4000 shares @ $2) Dividend Declared/Retained Earnings 4 800 Dividend Payable 4 800 (Being declaration of final dividend 20c per share on 24,000 shares)
(b) Greenstone Ltd Statement in Changes of Retained Earnings For the year ending 30 June 2013 Retained earnings 1 July 2012 Add/(Less): Profit (loss)
$100 000 (10 000) 90 000
Less: Interim share dividend Final cash dividend Retained earnings 31 March 2013
(c)
(8 000) (4 800)
Share capital increased by Retained earnings decreased by Decrease in equity
12 800 $77 200
$ 8,000 (22,800) ($14 800)
It may be helpful to point out to students that the decrease in equity is the sum of the loss and the cash dividend.
10.32
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 10.7 (a) Rosy’s Roses Pty Ltd General Journal Date 2013 Jun 30
(b)
Account name (narration)
Debit $
Dividend Declared/Retained Earnings Dividend Payable (Being declaration of final dividend )
Credit $
12 000 12 000
Dividend ratio = $12 000/$15 000 = 80% (b) Return on shareholders’ equity = $15,000/[($27,002 + $30,002)/2] = 53% As the only change in reserves is a transfer from retained earnings (i.e., within equity) the opening shareholders’ equity can be derived as follows: Closing equity Less profit Add back dividends Opening equity
30,002 (15,000) 12,000 27,002
(d)
Balance 1 July 2012 Profit Cash Dividends Transfer to reserve Balance 30 June 2013
Rosy’s Roses Pty Ltd Statement of Changes in Equity For the Year ending 30 June 2013 Issued General Retained Capital Reserve earnings $ $ $ 2 15 000 12 000 15 000 (12 000) 5 000 (5 000) $2 $20 000 $10 000
10.33
Total $ 27 002 15 000 (12 000) $30 002
Chapter 10: Reporting and analysing equity
PROBLEM SET B 10.8 (a) Danish Ltd General Journal Date 2013 Jun 30
Account name (narration)
Debit $
Dividend Declared/Retained Earnings Dividend Payable (Being declaration of final dividend )
150 000
Credit $
150 000
(b)
Dividend ratio = $150 000/$185 000 = 81%
(c)
Return on shareholders’ equity = $185 000/[($3 432 000 +$3 397 000)/2] = 5.4%
(d)
Balance 1 July 2012 Profit Cash Dividends Transfer to reserve Balance 30 June 2013
Danish Ltd Statement of Changes in Equity For the Year ending 30 June 2013 Issued General Retained Capital Reserve earnings $’000 $’000 $’000 3 000 345 52 185 (150) 15 (15) $4322 $360 $72
Total $’000 3 397 185 (150) $3 432
NOTE opening balances split can be calculated from the movement during the year.
10.34
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 10.9 (a) Aura Ltd General Journal Date 2013 Aug 15
Oct 1
2014 Jan 6
Mar 15
Jun 30
Account name (narration)
Debit $
Credit $
Dividend Declared/Retained Earnings 12 000 Dividend Payable (Being declaration of final dividend (100 000 x $0.12)) Dividend Payable 12 000 Cash at Bank (Being payment of interim dividend)
12 000
12 000
Dividend Declared/Retained Earnings 15 000 Share Dividend Payable 15 000 (Being declaration of interim share dividend (100 000 x 10% x$1.5) Share Dividend Payable 15 000 Share Capital 15 000 (Being payment of interim share dividend) Retained Earnings 10 000 General Reserve 10 000 (Being transfer to general reserve)
(b)
Balance 1 July 2013 Profit Share dividend Cash Dividends Transfer to reserve Balance 30 June 2014
Aura Ltd Statement of Changes in Equity For the Year ending 30 June 2014 Issued General Retained Capital Reserve earnings $ $ $ 200 000 50 000 50 000 50 000 15 000 (15 000) (12 000) 10 000 (10 000) $215 000 $60 000 $63 000
Total $ 300 000 50 000 (12 000) $338 000
(c) Aura Ltd Equity increased by $50 000 profit less cash dividend $12,000 = $38 000 (c) Dividend to be paid out of 2014 profits is interim share dividend $12,000 plus final dividend of $0.10 x 110,000 shares = $ 11 000 Dividend payout formula is cash dividend so only $11 000 was to be paid in cash Cash Dividend payout = $11 000/$ 50 000 = 22% Return on shareholders’ equity = $50,000/[($338,000 + $300,000)/2] = 15.67%
10.35
Chapter 10: Reporting and analysing equity
PROBLEM SET B 10.10 William Ltd
Profit before interest and tax Interest expense 10% x $3,000,000 Tax expense 30% profit before tax Profit Shareholders’ equity Return on shareholders’ equity
Borrow at 10% 500,000 (300,000) (60,000) 140,000 4,500,000 3%
Issue More Shares 500,000 150,000 350,000 7,500,000 5%
Equity yields the greater return for William Ltd’s shareholders given the current interest rate. Other factors that should be considered include the lower liquidity and solvency risk associated with equity financing, and the change in shareholding and ownership that would result from the share issue.
10.36
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 10.1
FINANCIAL REPORTING PROBLEM
Dominos Pizza Enterprises Ltd (a)
68,001,507 fully paid ordinary shares had been issued by 28 June 2009.
(b)
278,667 shares were issued during 2010 under executive share scheme and option plan. (see note 28.1 (a) )
(c)
Issued Capital at 4 July 2010 was $64,243,000. (Being 68,280,174 shares)
(d)
All dollar amounts are in $’000.
2010 $’000 2009 $’000 Dividend payout rate $12,152 ÷ $17,814 = 68% $8,421÷ $15,353= 50% Return on shareholders’ $17,814 $15,353 equity ($100,347+$94,905)/2 = ($94,905+$79,254)/2 = 18.2% 17.6% *2010 dividends are Interim 6.0 cents and the final dividend 11.8 cents (not recognised at reporting date) $4,095,000 + $8,057,000= $12,152,000, 2009 dividends are Interim 4.4 cents and the final dividend 8.0 cents $2,977,000 + $5,444,000 = $8,421,000 See note 31.
10.37
Chapter 10: Reporting and analysing equity
BUILDING BUSINESS SKILLS 10.2
FINANCIAL REPORTING PROBLEM
(a)
The company first listed on the ASX on the 16th May 2005.
(b)
The company changed its name from Domino’s Pizza Australia New Zealand Ltd to Domino’s Pizza Enterprises Ltd effective 18th December 2006. The reason for the change to better reflect the global positioning of the company following the European acquisitions on 3rd July 2006. The company no longer just operated in Australia and New Zealand.
(c)
The Executive Share and Option Plan (ESOP) exists to rewards the efforts of the employees so they work diligently in their endeavors for Domino’s. In the director’s report the following is discussed “Performance-linked compensation includes both short-term and long-term incentives and is designed to reward key management personnel for meeting or exceeding their financial and personal objectives. The short-term incentive (“STI”) is an ‘at risk’ bonus provided in the form of cash, while the long-term incentive (“LTI”) is provided as options over ordinary shares of the Company under the rules of the Domino’s Pizza Executive Share and Option Plan (“ESOP”).”
Extract note 28.1 During the year, 278,667 options were exercised (2009: 957,167). A total of $831,467 was received as consideration for 278,667 fully paid ordinary shares of Domino’s Pizza Enterprises Limited on exercise of the options in the current financial year (2009: $2,105,767). Note students are not expected to answer in any more depth than this as this is covered in more advanced financial accounting courses. (d)
During 2009-10 financial year there were no issues under the dividend reinvestment plan (DRP) : On 18th August 2009 the Directors resolved to suspend the DRP until further notice so all dividends for 2010 were paid in cash only.
10.38
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 10.3 COMPARATIVE ANALYSIS PROBLEM Fantastic Holdings vs. Nick Scali Ltd (a) Fantastic $’000 $10 523 $18 527 = 56.8%
Nick Scali $’000 $7 290 $11 255 = 64.8%
Dividend payout ratio 2009
$9 483 $18 593 = 51.0%
$4 869 $4 817 = 101.1%
Return on shareholders’ equity 2010
$18,527 . ($90,988+$79,535)/2 =21.7%
$11 255 . ($21,430+$18,424)/2 = 56.5%
Dividend payout rate 2010
(b)
Based on the return on shareholders’ equity Nick Scali was more profitable. Nick Scali generated 56.0 cents for every dollar of shareholders funds invested. However, analysts, investors and managers would usually look at more than one year before drawing conclusions about which company is more profitable. Both companies have high dividend payout rates and stable dividend policies. Fantastic Holdings rate seems to have dropped. Nick Scali 2009 payout was 100% of profit but the amount per share has increased in 2010 as profit improved. From 2010 Nick Scali accounts - “When added to the interim dividend of 4.5 cents per share the total dividend for the 2009-10 financial year amounts to 9.0 cents per share, fully franked. This compares with 6.0 cents per share (fully franked) for the previous year.”
10.39
Chapter 10: Reporting and analysing equity
BUILDING BUSINESS SKILLS 10.3 (a)
A GLOBAL FOCUS
“Singapore Exchange (SGX) is the Asian Gateway, connecting investors in search of Asian growth to corporate issuers in search of global capital. SGX offers its clients Asia’s broadest span of equity index derivatives, uniquely centred on Asia’s three largest economies – China, India and Japan. SGX represents the premier access point for managing Asian capital and investment exposure, and is Asia’s most internationalised exchange with more than 40% of companies listed on SGX originating outside of Singapore. In addition to offering a fully integrated value chain from trading and clearing, to settlement and depository services, SGX is also Asia’s pioneering central clearinghouse. Headquartered in Asia’s most globalised city, and centred within the AAA strength and stability of Singapore’s island nation, SGX is a peerless Asian counterparty for the clearing of financial and commodity products.”
(b)
The following is reproduced from the website of the Singapore Stock Exchange, accessed 14 December 2010: (a publication titled Singapore Exchange Your Asian Gateway) The SGX Mission “We aim to offer a highly trusted securities and derivatives marketplace for capital raising, risk transfer, trading, clearing and settlement, and to serve our stakeholders.” As part of this the product and services they offer is reproduced below:”
“SGX offers a diverse and exciting suite of securities and derivatives products via a global network of broking members. They provide market participants with convenient access to these products through an array of distribution channels.. Our securities products, traded on an electronic screen-based system, include: • Bonds, Debentures and Loan Stocks • Business Trusts • Equities • Exchange Traded Funds (ETFs) • Global Depository Receipts (GDRs) • Infrastructure Funds • Real Estate Investment Trusts (REITs) • Warrants Our derivatives products consist of a wide range of international risk management and trading instruments. The products, traded electronically, include: • Short-Term Interest Rate Futures and Options on Futures • Long-Term Interest Rate Futures and Options on Futures • Equity Index Futures and Options on Futures • Structured Warrants • Certificates SGX operates an over-the-counter clearing facility, SGX AsiaClear®, for the clearing of oil and freight derivatives. We also operate a commodities exchange that now trades and clears TSR 20 Rubber and Crude Palm Oil contracts. We also offer a wide range of data and information services providing both historical and “live” data and prices to our customers, including: • SGX SecuritiesBook • SGX DerivativesQuote • SGX News • Orders and Trade Data • Mobile Data Services • Listed Companies Data • Historical Market Data • Publications
10.40
Solutions manual to accompany Accounting: building business skills 4e
(c)
As an illustration, an answer is provided using Matex International Limited, accessed 23/11/2011
1. Full Company Name: 2. Incorporated in: 3. Incorporated on: 4. Registered Office:
Matex International Limited SINGAPORE 30 September 1989
5. Website
http://www.matex.com.sg.
6. 7. 8. 9.
15 Tuas View Square Singapore 637556
Issued & Paid-up Capital: $17,507,000 Listed on 18 February 2004 on SGX Mainboard Auditors: Ernst & Young LLP The Company was incorporated on 30 September 1989 in Singapore under the name of Matex Specialty Chemicals Pte Ltd. On 17 December 2003, the Company changed its name to Matex International Limited. The Group is engaged in the manufacturing, formulating and sale of specialty chemicals used on both synthetic and natural fibres for textile fabrics, garments and home furnishings. It also provides services to its customers by distributing third party products such as specialty process equipment and computerised control systems; ultra-fresh antimicrobial products; and X-rite spectrophotometer for colour measurements.
. 10. “Matex was incorporated on 30 September 1989 in Singapore and we started our operation in the name of Matex Specialty Chemicals Pte Ltd under the stewardship of Dr Alex Tan Pang Kee. Our principal activities include manufacturing, formulation and sale of specialty chemicals focusing on dyestuffs and auxiliaries for the textile industry. Between 1989 and 1998, we took many initiatives to go regional and increase our market presence in several overseas markets. We established subsidiaries, distributors and agents spanning across Asia and Europe, including the PRC, Sri Lanka, Taiwan, Myanmar, Malaysia, Vietnam, Indonesia, Thailand, India, Bangladesh, Syria, Egypt, North Africa, Portugal, UK, Turkey, Columbia and etc.” .Source : Matex Limited website under corporate history
10.41
Chapter 10: Reporting and analysing equity
CRITICAL THINKING BUILDING BUSINESS SKILLS 10.5 GROUP DECISION CASE Quickdraw Ltd (a)
The directors should rank the options by comparing return on shareholders’ equity. However this should not be the only consideration. The issue of additional shares may affect the control of the company by existing shareholders. On the other hand, there are risks associated with taking on additional debt, such as rising interest rates (unless the interest is fixed). Another concern is the effect on liquidity and solvency of the need to make periodic interest payments and to subsequently repay the principal. This is of particular concern in the case of Quickdraw because of the high operational risk of its operation. Using debt finance would combine financial risk with the existing high operating risk. This may, in turn, have a negative impact on shareholders if their company has too much risk. This may reduce the value of the company’s shares to its shareholders.
(b)
The advantage of the third option is that it reduces the risk to the company of being unable to repay the debt. If the subsidiary is unable to repay the debt the company as a shareholder is only liable for any unpaid capital. The disadvantage of this would be a loss of reputation. Another consideration is that structuring in a manner so as to avoid risk, while taking the benefits of any profits generated by the activity is not being a good corporate citizen. Assuming borrowing was going to be in the interest of shareholders, arguments could be raised for or against the third option. Some students may argue that structuring the operations in a way that effectively transfers risk to the creditors is acting in the best interests of the shareholders, as is the duty of directors. Others may consider such a structure to be poor business ethics as it is taking advantage of the subsidiary structure and limited liability to enable the company and its shareholders to receive the potential benefits if it succeeds while leaving the creditor to bear the loss if it fails.
10.42
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 10.6
COMMUNICATION ACTIVITY Blue Marlin Ltd
To:
Finn Berg
From:
I. M. Student
Subject:
Debt versus Equity Financing
The advantages of debt financing over equity financing include: 1.
Shareholder control is not usually affected.
2.
Tax savings result because interest is tax deductible.
3.
Return on shareholders’ equity may be higher.
Disadvantages of debt financing over equity financing include: 1. 2. 3.
Interest has to be paid irrespective of whether the company makes a profit or a loss. Risk is increased. Security for debt may be required or higher interest will be payable.
The types of debt that may be issued are: 1.
Debentures
2.
Unsecured notes
3.
Convertible notes, which can be converted into ordinary shares.
4.
Loans from one party, such as a bank.
If the company wishes to raise funds through a public share issue it will need to issue a prospectus with an application to subscribe for shares. Some, or all, of the price of the share is payable on application. This money is held in trust until shares are allotted (issued). If shares are issued by private placement, a prospectus is not required. The money may be banked and shares issued immediately upon receipt.
10.43
Chapter 10: Reporting and analysing equity
BUILDING BUSINESS SKILLS 10.7 Goodman Fielder Sustainability Taken from 2009/10 Sustainability report (a) Goodman Fielder sustainability report applies the Global Reporting Initiative’s G3 Sustainability Reporting Guidelines (GRI Guidelines) to a C level. The GRI Food Processing Sector Supplement was launched in May 2010 and we have incorporated some of these principles into this report. We intend to further integrate these principles in future reports. Note this report is not audited by external auditors but GR intend to have external assurance in the future. (b) Students were asked to summarise the goals and how measured and what was the achievement for three of five areas below. Our people Our suppliers Our environment Our community Our products Note to instructor the response will depend on which sustainability report the student accesses. Below is the link to Goodman Fielder and then click on Sustainability and the environment the report where the instructor can check students facts. http://www.goodmanfielder.com.au/
10.44
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS 10.8
ETHICS CASE
(a)
The stakeholders in this situation are: Vince Ramsey, chief executive officer of Flambeau Ltd. Janice Rahn, financial director. The shareholders of Flambeau Ltd.
(b)
There is nothing unethical in issuing a share dividend. But the chief executive’s order to write a press release convincing the shareholders that the share dividend is just as good as a cash dividend is unethical. A share dividend is not a cash dividend and does not necessarily place the shareholder in the same position.
(c)
A share dividend reduces retained earnings and increases capital, thus reducing distributable profit. However, there may be long-term benefits to shareholders in the form of increased dividends in future. If the company maintains a policy of a constant dividend, in terms of cents per share, shareholders will receive more dividends because they will have more shares after the share dividend. Further, the cash dividend reduces the amount of money available to the company for investment, thus reducing future growth compared with the share dividend. The advantages of growth prospects and increased future dividends are less relevant to shareholders who do not intend to be long-term investors in Flambeau. However, they would be interested in the effect of growth and future prospects on the share price in the short term.
10.45
Chapter 11: Statement of cash flows
CHAPTER 11 – STATEMENT OF CASH FLOWS ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives 1.
Indicate the main purpose of the statement of cash flows.
2.
Distinguish among operating, investing and financing activities.
3.
Prepare a statement of cash flows.
4.
Explain the impact of the product life cycle on an entity’s cash flows.
5.
Use the statement of cash flows to evaluate an entity.
Brief Exercises
Exercises
1, 2
1, 5
2A, 6B
3, 4, 5, 6
2, 4, 6, 7, 8, 9, 11, 12, 13
1A, 2A, 3A, 4A, 5A, 6A, 7A, 8A, 9A, 10A, 1B, 2B, 3B, 4B, 5B, 7B, 8B, 9B, 10B
7
3
4, 10
11.2
Problems
4A, 8A, 4B, 8B
Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 11 – STATEMENT OF CASH FLOWS ANSWERS TO QUESTIONS 1.
The statement of cash flows answers the following questions about cash: (a) (b) (c)
2.
Where did the cash come from during the period? What was the cash used for during the period? What was the change in cash balance during the period?
The three activities are: Operating activities include the cash effects of revenue generating activities (such as the provisions of goods and services) and activities that are not classified as financing or investing activities. Investing activities include: (a)
acquiring and disposing of investments and productive long-lived assets
(b)
lending money and collecting loans.
Financing activities include: (a)
obtaining cash from issuing debt and repaying the amounts borrowed
(b)
obtaining cash from shareholders and providing them with a return on their investment (paying dividends).
3.
Significant non-cash financing and investing activities must be disclosed in notes to the financial statements so that users of financial reports are informed about all of the entity’s financing and investing activities, and not only those involving cash.
4.
(a) (b)
The phases of the company life cycle are the introductory phase, growth phase, maturity phase, and decline phase. During the introductory phase, cash from operations and investing would be expected to be negative, and cash from financing would be positive. During the growth phase, a company would be expected to show some small amounts of cash from operations (moving from negative to positive cash from operations) while continuing to show negative cash from investing and positive cash from financing. During the maturity phase, cash from operations is positive and exceeding investing needs. Financing cash flows become negative as the entity applies the cash surpluses to pay dividends and retire debt. In the decline phase, cash from operations and investment would continue to be positive while cash from financing would be negative.
11.3
Chapter 11: Statement of cash flows
5.
The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate, although with advances in computers and information technology, this cost is of declining significance. The advantage of the indirect method is its reconciliation of profit to net cash provided by operating activities, while its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation.
6.
Sales Less: Increase in receivables Cash receipts from customers
7.
A number of factors could have caused an increase in cash despite the loss for the period. These are: (1) high cash revenues relative to low cash expenses (2) sales of property, plant, and equipment (3) sales of investments (4) issue of debt or shares for cash.
8.
Any five of the following: Depreciation expense. Gain or loss on sale of a non-current asset. Increase/decrease in accounts receivable. Increase/decrease in accounts payable. Increase/decrease in inventory. Increase/decrease in prepayments. Increase or decrease in accrued expenses. Increase/decrease in income tax payable.
9.
This transaction is reported in the note or schedule to the financial statements entitled ‘Noncash investing and financing activities’ as follows: ‘Issue of 2 million ordinary shares in consideration for equipment’.
10.
(a) (b) (c)
$2,000,000 200,000 $1,800,000
The current cash debt coverage ratio is a cash-based ratio that measures liquidity. Solvency can be measured by the cash debt coverage ratio (cash-based). Profitability can be measured by the cash return on sales ratio.
11.4
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11.1 Riley Ltd (a) (b) (c) (d)
Cash inflow from financing activity, Cash outflow from investing activity, Cash inflow from investing activity, Cash outflow from financing activity,
$200,000 $150,000 $ 20,000 $ 50,000
BRIEF EXERCISE 11.2 Anita Baker Pty Ltd
Cash flows from financing activities: Proceeds from issue of debentures Payment of dividends Net cash provided by financing activities
$200,000 (40,000) $160,000
BRIEF EXERCISE 11.3 Kieso Ltd
Cash receipts from customers
=
+ Decrease in accounts receivable - bad debts written off revenues - Increase in accounts receivable
Sales
$588,000 = $600,000 - $10,000 (Increase in accounts receivable) - $2,000
BRIEF EXERCISE 11.4 Hacket Ltd + Increase in prepaid expenses - Decrease in prepaid expenses
Cash payments for operating expenses
=
Operating expenses excluding depreciati on
and + Decrease in accrued expenses payable - Increase in accrued expenses payable
$169,000 = $180,000 - $6,600 - $4,400
11.5
Chapter 11: Statement of cash flows
BRIEF EXERCISE 11.5 Roller Skates Ltd
Profit Adjustments to reconcile profit to net cash provided by operating activities: Decrease in accounts receivable Increase in prepaid expenses Increase in inventories Net cash provided by operating activities
$200,000
$80,000 (12,000) (30,000)
38,000 $238,000
BRIEF EXERCISE 11.6 Wellington Manufacturing Ltd
Original cost of equipment sold Less Accumulated depreciation Carrying amount of equipment sold Add: Gain on sale of equipment Cash flow from sale of equipment
$22,000 (6,000) 16,000 3,000 $19,000
BRIEF EXERCISE 11.7 (a)
Cash from operations would be lower than profit during the growth phase because inventory must be purchased for future projected sales. Since during the growth phase sales are projected to be increasing, inventory purchases must increase and inventory expensed on an accrual basis would be less than inventory purchased on a cash basis. Also, collections on accounts receivable would lag behind sales; thus, accrual sales would exceed cash collections during the period.
(b)
Cash from investing is often positive during the late maturity phase and the decline phase because the firm may sell off excess assets that are no longer needed for productive purposes.
(c)
Cash flow from financing activities is often positive during the introductory and growth phases as finance would often need to be raised either by issuing shares or from borrowings for investment in assets.
11.6
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO EXERCISES EXERCISE 11.1 (a).
Li Eng Ltd Reconciliation of profit after tax to cash provided by operating activities
(a) (b) (c) (d) (e) (f) (g)
Noncash investing and financing activities. Financing activities. Operating activities. Financing activities. Investing activities. Noncash investing and financing activities. Operating activities.
b). Operating activities are the entity’s principal revenue-generating activities such as the provision of goods and services and activities which are not classified as investing or financing activities. Investing activities are the acquisition and disposal of long-term assets, including activities such as purchasing and selling of non-current assets, and lending money and collecting the loans. Financing activities are those that affect the size and composition of contributed equity and borrowing, and include obtaining cash from issuing debt, repaying the amounts borrowed, obtaining cash from shareholders, and paying them dividends or buying back shares/
EXERCISE 11.2 Pesci Ltd
Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Increase in accounts payable Increase in prepaid expenses Loss on sale of equipment Net cash provided by operating activities
11.7
$200,000
$35,000 (15,000) 8,000 (5,000) 5,000
28,000 $228,000
Chapter 11: Statement of cash flows
EXERCISE 11.3 Point in Time A B C D
Phase Maturity phase Decline phase Introductory phase Growth phase
During the introductory phase (point C), cash from operations and investing are expected to be negative while cash from financing would be positive. In the growth phase (point D), a company would continue to show negative cash from operations and investing and positive cash from financing. Cash from operations is approximately equal to profit in the maturity phase (A) and declines in the decline phase (B), when the company also has positive investing cash flows from selling of assets and negative financing cash flows as it retires debt.
11.8
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 11.4 (a) Thorpes Tubing Pty Ltd Statement of Cash Flows for the year ended 30 June 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For other operating expenses For interest For income taxes Net cash provided by operating activities
$969,000 (1) $532,000 (2) 261,000 (3) 15,000 45,000
Cash flows from investing activities: Sale of land Purchase of equipment Net cash used by investing activities
25,000 (60,000)
Cash flows from financing activities: Repayment of notes payable Issue of shares Payment of dividends Net cash used by financing activities
(50,000) 50,000 (43,000)
853,000 116,000
(35,000)
(43,000)
Net increase in cash Cash at beginning of period Cash at end of period
38,000 22,000 $60,000
Computations: (1) Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$978,000 (9,000) $969,000
(2)
Cash payments to suppliers: Cost of sales Deduct: Decrease in inventory Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
11.9
$528,000 (9,000) 519,000 13,000 $532,000
Chapter 11: Statement of cash flows
(3)
Cash payments for operating expenses: Total expenses Deduct: COS Depreciation * Interest expense Tax expense Cash payments for operating expenses
873,000 (528,000) (24,000) (15,000) (45,000) $261,000
* In the absence of any disposals of depreciated assets the change in Accumulated Depreciation is the depreciation expense
(b)
1.
Current cash debt coverage: Net cash provided by
÷
operating activities $116,000 (per part (a))
2.
÷
Average current liabilities
$47,000 + $34,000 = 2.86 times 2
Cash return on sales ratio: Net cash provided by
÷
operating activities
Sales
$116,000 ÷ $978,000 = 11.9%
3.
Cash debt coverage: Net cash provided by
÷
operating activities
$116,000 ÷
Average total liabilities
$247,000 + $184,000 = .54 times 2
* $47,000 + $200,000
**$34,000 + $150,000
EXERCISE 11.5 Thomas Ltd (a) (b) (c) (d)
(h) (i) (j) (k)
Financing activity Operating activity (reconciliation) Financing activity Operating activity
(e) (f)
Investing activity Financing activity Investing activity Non-cash investing and financing activity Operating activity (reconciliation) Financing activity
(l) (m)
(g)
Operating activity
(n)
Non-cash financing activity Investing activity (cash proceeds from sale) Operating activity
11.10
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 11.6 Leslie Mills Pty Ltd
Revenues Deduct: Increase in accounts receivable Cash receipts from customers* Operating expenses Deduct: Increase in accounts payable Bad debts expense Cash payments for operating expenses** Net cash provided by operating activities
Balance, Beginning of year Revenues for the year
Opening Balance
Payments for year Closing Balance
$170,000 (43,000) $127,000 80,000 (33,000) (1,000) 46,000 $81,000
*Accounts Receivable 170,000 Cash receipts for year Closing Balance 170,000 43,000 **Accounts Payable Balance, Beginning of year 46,000 Operating expenses for year 33,000 79,000 Opening Balance
127,000 43,000 170,000
79,000 79,000 33,000
Operating expenses are $79,000 in the reconstruction of Accounts Payable because $1000 of the total operating expenses of $80,000 was for the bad debts expense, a non-cash item.
EXERCISE 11.7 Harry Ltd
(a)
(b)
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Add: Decrease in accounts payable Cash paid to suppliers Cash payments for operating expenses: Operating expenses exclusive of depreciation Deduct: Decrease in prepaid expenses Add: Decrease in accrued expenses payable Cash paid for operating expenses
11.11
$355,000 6,000 361,000 8,000 $369,000
$230,000 ($6,000) 12,000
6,000 $236,000
Chapter 11: Statement of cash flows
EXERCISE 11.8 Flypaper Airlines Ltd Partial Statement of Cash Flows for the year ended 31 December 2012
Cash flows from operating activities: Cash receipts from: Customers Dividends on investment
*$250,000 14,000 264,000
Cash payments: To suppliers for inventory For operating expenses For salaries and wages For interest For income taxes Net cash provided by operating activities
$100,000 20,000 68,000 15,000 16,000
219,000 $45,000
*$60,000 + $190,000
EXERCISE 11.9
Phelps Ltd
Cash payments for rentals: Rent expense Deduct: Decrease in prepaid rent Cash payments for rent
$31,000 (2,900) $28,100
Cash payments for salaries: Salaries expense Deduct: Increase in salaries payable Cash payments for salaries
$54,000 (3,000) $51,000
Cash receipts from customers: Revenue from sales Add: Decrease in accounts receivable Cash receipts from customers
$180,000 3,000 $183,000
11.12
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 11.10 Wellington Waxworks Ltd and Canberra Candlemakers Ltd
Wellington Waxworks Ltd
Canberra Candlemakers Ltd
(a)
Current cash debt coverage ratio
$220,000 = 4.4 times $50,000
$240,000 = 2.4 times $100,000
(b)
Cash debt coverage ratio
$220,000 =1.1 times $200,000
$240,000 = .96 times $250,000
(c)
Cash return on sales ratio
$220,000 = .55 : 1 $400,000
$240,000 = .30 : 1 $800,000
Wellington Waxworks Ltd’s liquidity, solvency and profitability ratios are all higher (better) than Canberra Candlemakers Ltd’s comparable ratios. Wellington Waxworks current cash debt coverage ratio and cash return on sales ratio are almost twice as high as those of Canberra Candlemakers. These ratios indicate that Wellington Waxworks is substantially more liquid and profitable than Canberra Candlemakers and is slightly more solvent.
EXERCISE 11.11 Dynasty Ltd Partial Statement of Cash Flows for the year ended 30 June 2013
Cash flows from operating activities: Cash receipts from: Customers Dividends on investment
*$350,000 19,600 369,600
Cash payments: To suppliers for inventory For operating expenses For salaries and wages For interest For income taxes Net cash provided by operating activities *$84,000 + $266,000
11.13
$140,000 28,000 95,200 21,000 22,400
306,600 $63,000
Chapter 11: Statement of cash flows
EXERCISE 11.12
Dunmore Enterprises Ltd
Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in accounts payable Increase in accrued expenses payable Increase in prepaid expenses
$153,000
$19,000 (31,000) (7,000) 10,000 (5,000) 25,000
Decrease in inventory
11,000 $164,000
Net cash provided by operating activities
11.14
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 11.13
Manor Ltd Partial Statement of Cash Flows (Indirect method) for the year ended 30 June 2013 Reconciliation of profit after tax to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Add Depreciation expense Add loss on sale of equipment Less Increase in current assets Add Decrease in current assets Add Increases in current liabilities Less Decrease in current liabilities Net cash provided by operating activities Cash flows from investing activities Purchase of equipment Sale of equipment * Net cash provided by investing activities Cash flows from financing activities Dividends paid
$67,000
$28,000 $3,000
$xxx xxx
(70,000) 2,000 (68,000)
(14,000)
* Cash flow from sale of equipment Original cost of equipment sold Less Accumulated depreciation Carrying amount of equipment sold Less: Loss on sale of equipment Cash flow from sale of equipment
$35,000 (30,000) 5,000 3,000 $2,000
11.15
Chapter 11: Statement of cash flows
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 11.1 Wong Pty Ltd Partial Statement of Cash Flows for the year ended 30 June 2012
Cash flows from investing activities: Purchase of land Sale of plant and equipment Purchase of plant and equipment Net cash used by investing activities
Opening balance Equipment purchased Opening Balance
(120,000) 20,500 (100,000)
(1) (199,500)
Equipment 355,000 Cost of equipment sold 100,000 Closing 455,000 400,000
balance
55,000 400,000 455,000
(1) Proceeds on sale of equipment = gain on sale plus carrying amount = 6,000 + (55,000 – 40,500) = 6,000 + 14,500 = 20,500
Equipment sold Closing Balance
*Accumulated Depreciation - Equipment 40,500 Balance, Beginning of year Depreciation Expense (2) 200,000 240,500 Opening Balance
195,000 45,500 240,500 200,000
(2) Depreciation expense – equipment = total depreciation expense – building depreciation expense = 95,500 – 50,000 = 45,500
11.16
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 11.2 (a). Operating activities is the most important category because it shows the cash provided or used by operations. This source of cash is generally considered to be the best measure of whether an entity can generate sufficient cash to continue as a going concern and to expand. (b) Breckenridge Ltd Partial Statement of Cash Flows for the year ended 31 March 2014
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses Tax paid Net cash provided by operating activities
$7,200,000 $4,700,000 1,240,000 100,000
(2) (3) (6,040,000) $1,160,000
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Add: Decrease in accounts receivable Cash receipts from customers
$6,900,000 300,000 $7,200,000
Cash payments to suppliers: Cost of sales Deduct: Decrease in inventories Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
$4,700,000 (300,000) 4,400,000 300,000 $4,700,000
Cash payments for operating expenses: Operating expenses, exclusive of depreciation Add: Increase in prepaid expenses Decrease in accrued expenses payable Cash payments for operating expenses
*$990,000 $150,000 100,000
250,000 $1,240,000
*$450,000 + ($600,000 - $60,000) (c) Breckenridge Ltd Note to Statement of Cash Flows for the year ended 31 March 2014 Reconciliation of profit after tax to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by 11.17
$1,050,000
(1)
Chapter 11: Statement of cash flows operating activities: Depreciation expense Decrease in accounts receivable Decrease in inventory Increase in prepaid expenses Decrease in accounts payable Decrease in accrued expenses payable Net cash provided by operating activities
11.18
$60,000 300,000 300,000 (150,000) (300,000) (100,000
110,000 $1,160,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 11.3 Yana Ltd Partial Statement of Cash Flows for the year ended 30 June 2012 (a) Cash flows from operating activities: Cash receipts from customers Cash payments: For operating expenses For income taxes Net cash provided by operating activities
$850,000 (1) $616,000 (2) 46,000 (3)
662,000 $188,000
Computations: (1)
(2)
(3)
Computation of cash receipts from customers: Revenues Add: Decrease in accounts receivable ($57,000 - $47,000) Cash receipts from customers
$840,000 10,000 $850,000
Computation of cash payments: Operating expenses per income statement Deduct: Increase in accounts payable ($41,000 - $33,000) Cash payments for operating expenses
$624,000 (8,000) $616,000
Income tax expense per income statement Add: Decrease in income tax payable ($10,000 - $4,000) Cash payments for income taxes
$40,000 6,000 $46,000
(b) Yana Ltd Note to Statement of Cash Flows for the year ended 30 June 2012 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities
11.19
$90,000
$60,000 26,000 10,000 8,000 (6,000)
98,000 $188,000
Chapter 11: Statement of cash flows
PROBLEM SET A 11.4 (a) O’Reilly Ltd Statement of Cash Flows for the year ended 31 December 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For interest For income taxes Net cash provided by operating activities
$236,000 (1) $199,000 (2) 18,500 (3) 2,000 7,000 (4)
Cash flows from investing activities: Sale of equipment Net cash provided by investing activities
226,500 $9,500
8,500 8,500
Cash flows from financing activities: Redemption of debentures Issue of shares Payment of dividends Net cash used by financing activities
(6,000) 4,000 (2,000) (4,000)
Net increase in cash Cash at beginning of period Cash at end of period
14,000 15,000 $29,000
11.20
Solutions manual to accompany Accounting: building business skills 4e
Computations: (1)
(2)
(3)
(4)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$250,000 (14,000) $236,000
Cash payments to suppliers: Cost of sales Deduct: Decrease in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers
$210,000 (10,000) 200,000 (1,000) $199,000
Cash payments of operating expenses: Operating expenses Deduct: Depreciation * Cash payments for operating expenses
$24,000 (5,500) $18,500
Cash payments for income taxes: Income tax expense Add: Decrease in income taxes payable Cash payments for income taxes
$4,000 3,000 $7,000
Equipment sold Closing Balance
*Accumulated Depreciation 9,500 Balance, Beginning of year Depreciation Expense 20,000 29,500 Opening Balance
11.21
24,000 5,500 29,500 20,000
Chapter 11: Statement of cash flows
(b) O’Reilly Ltd Note to Statement of cash flows for the year ended 31 December 2012 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in income taxes payable Decrease in inventory Increase in accounts payable Net cash provided by operating activities
(c)
(1)
$9,500 [ Per Part (a)]
$10,000
$5,500 (14,000) (3,000) 10,000 1,000
(500) $9,500
$33,000 * + $34,000 * * = .284 : 1 2
*$25,000 + $8,000 **$26,000 + $3,000 + $5,000 (2)
$9,500 $250,000 = .038
(3)
$9,500
$66,000 * + $61,000 * * = .15 times 2
*$25,000 + $8,000 + $33,000 (d)
**$26,000 + $3,000+ $5,000 + $27,000
The ratios calculated in part (c) suggest that O’Reilly Ltd’s cash generated from operating activities in 1 year is 28.4% of it’s short term obligations. It generates enough cash in 1 year from operating activities to meet 28.4% of the obligations that are due within 1 year and its cash generated from operating activities is15% of its total liabilities. It would appear that O’Reilly Ltd may have to liquidate some of its productive assets in order to meet its short term obligations.
11.22
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 11.5 (a) Tasman Oak Ltd Statement of Cash Flows for the year ended 31 March 2013
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes For interest Net cash provided by operating activities
$284,200 (1) $100,410 (2) 15,110 (3) 7,000 2,230
Cash flows from investing activities: Purchase of investments Sale of machinery Purchase of machinery Net cash used by investing activities
(14,000) 1,500 (85,000)
Cash flows from financing activities: Issue of shares Redemption of debentures Payment of cash dividends Net cash used by financing activities
35,000 (15,000) (22,350)
(124,750) 159,450
(97,500)
(2,350)
Net increase in cash Cash at beginning of period Cash at end of period
59,600 38,400 $98,000
11.23
Chapter 11: Statement of cash flows
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$342,000 (57,800) $284,200
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers
$115,460 9,650 125,110 (24,700) $100,410
Cash payments for operating expenses: Operating expenses excluding depreciation Add: Increase in prepaid expenses Decrease in accrued expenses payable Cash payments for operating expenses
$12,410 $2,400 300
2,700 $15,110
(b) Tasman Oak Ltd Note to Statement of Cash Flows (Indirect method) for the year ended 31 March 2013 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Loss on sale of machinery Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in accrued expenses payable Increase in prepaid expenses Net cash provided by operating activities
11.24
$150,900
$46,500 7,500 (57,800) (9,650) 24,700 (300) (2,400)
8,550 $159,450
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 11.6 (a) Tina Maria Ltd Partial Statement of Cash Flows for the year ended 30 June 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses Net cash used by operating activities
$6,590,000 $5,380,000 1,275,000
(2) (3)
(1)
(6,655,000) ($65,000)
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$7,100,000 (510,000) $6,590,000
Cash payments to suppliers: Cost of purchases per statement of financial performance Deduct: Increase in accounts payable Cash payments to suppliers
5,430,000 (50,000) $5,380,000
Cash payments for operating expenses: Operating expenses ($400,000 + $525,000) Add: Increase in prepaid expenses Decrease in accrued expenses payable Cash payments for operating expenses
$925,000 $170,000 180,000
350,000 $1,275,000
(b) Tina Maria Ltd Note to Statement of Cash Flows for the year ended 31 March 2012 Reconciliation of profit after tax to cash used by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Amortisation expense Increase in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in accrued expenses payable Net cash used by operating activities
11.25
$860,000
$75,000 30,000 (510,000) (220,000) (170,000) 50,000 (180,000)
(925,000) ($65,000)
Chapter 11: Statement of cash flows
PROBLEM SET A 11.7 (a) Camel Couriers Ltd Partial Statement of Cash Flows for the year ended 31 March 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: For operating expenses For income taxes Net cash provided by operating activities (1)
(2)
(3)
$570,000 (1) $291,000 (2) 88,000 (3)
379,000 $191,000
Computation of cash receipts from customers: Revenues Deduct: Increase in accounts receivable Cash receipts from customers
$580,000 (10,000) $570,000
Computation of cash payments for operating expenses: Operating expenses Add: Decrease in accounts payable ($41,000 - $30,000) Cash payments for operating expenses
$280,000 11,000 $291,000
Income tax expense: Deduct: Increase income taxes payable ($6,000 - $4,000) Cash payments for income taxes
$90,000 (2,000) $88,000
(b) Camel Couriers Ltd Note to Partial Statement of Cash Flows (Indirect method) for the year ended 31 March 2012 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Increase in accounts receivable Decrease in accounts payable Increase in income taxes payable Net cash provided by operating activities
11.26
$210,000
($10,000) (11,000) 2,000
(19,000) $191,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 11.8 (a) Swan Lake Cruises Ltd Statement of Cash Flows for the year ended 31 December 2013
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For interest For income taxes Net cash provided by operating activities
$246,000 (1) $183,000 (2) 33,000 (3) 2,000 12,000 (4)
Cash flows from investing activities: Sale of boat Purchase of motors Net cash provided by investing activities
10,000 (7,000)
Cash flows from financing activities: Proceeds from issue of shares Proceeds from issue of debentures Payment of cash dividends Net cash used by financing activities
5,000 5,000 (12,000)
230,000 $16,000
3,000
(2,000)
Net increase in cash Cash at beginning of period Cash at end of period
17,000 13,000 $30,000
11.27
Chapter 11: Statement of cash flows
Computations: (1)
(2)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$250,000 (4,000) $246,000
Cash payments to suppliers: Cost of sales Deduct: Decrease in inventory Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
$180,000 (1,000) 179,000 4,000 $183,000
(3)
Operating expenses $28 000 + $16 000 Less depreciation
(4)
Cash payments for income taxes: Income tax expense Add: Decrease in income taxes payable Cash payments for income taxes
$44,000 (11,000) $33,000 $7,000 5,000 $12,000
(b) Swan Lake Cruises Ltd Note to Statement of Cash Flows for the year ended 31 December 2013 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Decrease in accounts payable Decrease in income taxes payable Net cash provided by operating activities
11.28
$17,000
$11,000 (4,000) 1,000 (4,000) (5,000)
(1,000) $16,000
Solutions manual to accompany Accounting: building business skills 4e
(c)
(1)
Current cash debt coverage
$16,000
$44,000 * + $53,000 * * = .33 times 2
*$29,000 + $15,000
**$33,000 + $20,000
(2)
Cash return on sales ratio
$16,000 ÷ $250,000 = 6.4% or .064:1
(3)
Cash debt coverage
$16,000
$59,000 * + $63,000 * * = .26 times 2
*$29,000 + $15,000 + $15,000
(4)
(d)
Free cash flow
**$33,000 + $20,000 + $10,000
$16,000 - $7,000 = $9,000
33% of Swan Lake Cruises Ltd’s short term obligations in one year could be covered by the cash generated from its operating activities and the cash flow from operating activities is sufficient to cover 26% of its total obligations. The cash return on sales figure of 6.4% compares favourably to the profit ratio of 6.8% (17,000/250,000) and there is free cash flow of $9,000 which suggests that after investing in new property, plant and equipment to maintain operations at their current level, there is still cash available for expansion or payment of dividends.
11.29
Chapter 11: Statement of cash flows
PROBLEM SET A 11.9 (a) WA Manufacturing Pty Ltd Statement of Cash Flows for the year ended 30 June 2014
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes For interest Net cash provided by operating activities
$270,200 (1) $114,290 (2) 21,400 (3) 7,270 5,440
Cash flows from investing activities: Sale of investments Sale of plant and equipment Purchase of plant and equipment Net cash used by investing activities
2,400 15,550 (92,000)
148,400 $121,800
(4) (74,050)
Cash flows from financing activities: Proceeds from issue of shares Proceeds from issue of debentures Payment of cash dividends Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period
50,000 30,000 (80,000) nil 47,750 47,250 $95,000
11.30
Solutions manual to accompany Accounting: building business skills 4e
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$300,000 (29,800) $270,200
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers Cash payments for operating expenses: Operating expenses Add: Decrease in accrued expenses payable Cash payments for operating expenses
$99,460 19,250 118,710 (4,420) $114,290 $14,670 6,730 $21,400
(4) Balance, Beginning of year Cash (purchase of equipment)
Opening Balance
Plant and Equipment 205,000 Equipment sold 92,000 Closing Balance
47,000 250,000
297,000 250,000
297,000
(b) WA Manufacturing Pty Ltd Note to Statement of Cash Flows (Indirect Method) for the year ended 30 June 2014 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Gain on sale of equipment Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in accrued expenses payable Net cash provided by operating activities
11.31
$132,210
$49,700 (8,750) (29,800) (19,250) 4,420 (6,730)
(10,410) $121,800
Chapter 11: Statement of cash flows
PROBLEM SET A 11.10 (a) Williams Ltd Statement of Cash Flows for the year ended 30 June 2013
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes Net cash provided by operating activities
$636,000 (1) $290,000 (2) 23,000 (3) 63,000 (4)
Cash flows from investing activities: Purchase of land (6) Sale of land Sale of equipment (5) Purchase of equipment (60,000 – 20,000) Net cash provided by investing activities
(80,000) 100,000 30,000 (40,000)
Cash flows from financing activities: Proceeds from issue of shares Payment of cash dividends Repayment of borrowings (100,000 + 60,000) Net cash used by financing activities
50,000 (75,000) (160,000)
Net increase in cash Cash at beginning of period Cash at end of period
376,000 $260,000
10,000
(185,000) 85,000 80,000 $165,000
11.32
Solutions manual to accompany Accounting: building business skills 4e
Computations: (1)
Cash receipts from customers: Sales Add: Decrease in accounts receivable Deduct: Bad debts written off Cash receipts from customers
$620,000 20,000 (4,000) $636,000
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
$240,000 30,000 270,000 20 ,000 $290,000
(3)
Operating expenses $28 000 -$5,000
$23,000
(4)
Cash payments for income taxes: Income tax expense(92,000 + 18,000) deduct: Increase in income taxes payable Cash payments for income taxes
$110,000 (47,000) $63,000
(2)
(b) Williams Ltd Note to Statement of Cash Flows for the year ended 30 June 2013 Reconciliation of profit to cash provided by operating activities Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Loss on sale of office equipment Profit on sale of land Decrease in accounts receivable Increase in allowance for doubtful debts Decrease in prepaid rent Increase in inventory Decrease in accounts payable Increase in accrued expenses Increase in income taxes payable Net cash provided by operating activities
11.33
$100,000
$90,000 $20,000 ($20,000) 20,000 8,000 40,000 (30,000) (20,000) 5,000 47,000
160,000 $260,000
Chapter 11: Statement of cash flows
(5) Balance, Beginning of year Cash (purchase of equipment) Purchase via long term note
Opening Balance
Equipment 280,000 Equipment sold 40,000 Closing Balance 20,000 340,000 250,000
Accumulated Depreciation - Equipment Balance, Beginning of year Accum. Depn. Equip. sold 40,000 Depreciation Expense Closing Balance 110,000 150,000 Opening Balance
90,000 250,000
340,000
90,000 60,000 150,000 110,000
(5) Balance, Beginning of year Land purchased Upward revaluation
Opening Balance
Land 360,000 Land sold 80,000 60,000 Closing Balance 500,000 420,000
11.34
80,000 420,000 500,000
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 11.1 Thomas and Jones Ltd Cash flows from investing activities Proceeds from sale of equipment Purchase of equipment Purchase of land Net cash used by investing activities
Balance, Beginning of year
Opening Balance
Closing Balance
3,000 (80,000) (30,000) (107,000)
Buildings 750,000 Closing Balance
750,000
750,000 750,000
750,000
*Accumulated Depreciation - Buildings Balance, Beginning of year Depreciation Expense 337,500 337,500 Opening Balance
Balance, Beginning of year Cash (purchase of equipment)
Opening Balance
Equipment 240,000 Equipment sold 80,000 Closing Balance
11.35
337,500 337,500
20,000 300,000
320,000 300,000
Total depreciation expense Less depreciation expense - building = depreciation expense – equipment
300,000 37,500
320,000
101,500 37,500 64,000
Chapter 11: Statement of cash flows
Equipment sold Closing Balance
*Accumulated Depreciation - Equipment 16,000 Balance, Beginning of year Depreciation Expense 144,000 160,000 Opening Balance
Carrying amount of equipment sold (20,000 - 16,000) Loss on sale of equipment Proceeds of sale of equipment
11.36
96,000 64,000 160,000 144,000 $4,000 1,000 $3,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 11.2 (a) Charity Ltd Statement of Cash Flows for the year ended 31 December 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses Net cash provided by operating activities
$5,910,000 (1) 3,380,000 (2) 930,000 (3)
Computations: (1) Cash receipts from customers: Sales Add: Decrease in accounts receivable Cash receipts from customers (2)
(3)
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers Cash payments for operating expenses: Operating expenses Add: Increase in prepaid expenses Deduct: Increase in accrued expenses payable Cash payments for operating expenses
11.37
4,310,000 1,600,000
$5,400,000 510,000 $5,910,000
$3,290,000 140,000 3,430,000 (50,000) $3,380,000
$925,000 170,000 (165,000) $930,000
Chapter 11: Statement of cash flows
b) Charity Ltd Note to Statement of Cash Flows (Indirect Method) for the year ended 31 December 2012 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Amortisation expense Decrease in accounts receivable Increase in inventory Increase in accounts payable Increase in prepaid expenses Increase in accrued expenses payable Net cash provided by operating activities
11.38
$1,040,000
$125,000 20,000 510,000 (140,000) 50,000 (170,000) 165,000)
560,000 $1,600,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 11.3 (a). Direct method is a method of presenting cash payments as deductions from cash receipts to determine net cash provided by operating activities. Indirect method is a method of preparing a cash flow statement in which profit is adjusted for timing differences, non-cash items and cash flows classified as investing to determine net cash provided by operating activities. (b). Pigeon Travel Centre Ltd Partial Statement of Cash Flows for the year ended 31 March 2014
Cash flows from operating activities: Cash receipts from customers Cash payments: For operating expenses For income taxes Net cash provided by operating activities (1)
(2)
(3)
$420,000 $291,000 45,000
(2) (3)
(1)
336,000 $84,000
Computation of cash receipts from customers: Revenues Deduct: Increase in accounts receivable Cash receipts from customers
$430,000 (10,000) $420,000
Computation of cash payments for operating expenses: Operating expenses Add: Decrease in accounts payable ($41,000 - $30,000) Cash payments for operating expenses
$280,000 11,000 $291,000
Income tax expense: Deduct: Increase income taxes payable ($6,000 - $4,000) Cash payments for income taxes
$47,000 (2,000) $45,000
(c) Pigeon Travel Centre Ltd Note to Partial Statement of Cash Flows for the year ended 31 March 2014 Reconciliation of profit after tax to cash used by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Increase in accounts receivable Decrease in accounts payable Increase in income taxes payable Net cash used by operating activities
11.39
$103,000
($10,000) (11,000) 2,000
(19,000) ($84,000)
Chapter 11: Statement of cash flows
PROBLEM SET B 11.4 (a) YoYo Ltd Statement of Cash Flows for the year ended 31 December 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes For interest Net cash provided by operating activities
$272,000 (1) 219,000 (2) 29,000 (3) 1,000 (4) 7,000
Cash flows from investing activities: Proceeds from sale of equipment Purchase of plant and equipment Net cash provided by investing activities
10,000 (7,000)
Cash flows from financing activities: Proceeds from issue of bonds Dividends paid Net cash used by financing activities
10,000 (36,000)
256,000 $16,000
(5) 3,000
(6) (26,000)
Net decrease in cash Cash at beginning of period Cash at end of period
(7,000) 33,000 $26,000
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$286,000 (14,000) $272,000
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
$194,000 13,000 207,000 12,000 $219,000
Cash payments for operating expenses: Operating expenses (28 000 – 8,000 + 9,000)
$29,000
11.40
Solutions manual to accompany Accounting: building business skills 4e
(4)
Income tax expense Increase in income tax payable Income taxes paid
$7,000 (6,000) $1,000
(5) Property, Plant and Equipment Balance, Beginning of year 78,000 Equipment sold Cash (purchase of equipment) 7,000 Closing Balance
Opening Balance
85,000 70,000
15,000 70,000 85,000
(6) Dividends paid Closing Balance
Retained Earnings 36,000 Balance, Beginning of year Profit 33,000 69,000 Opening Balance
11.41
28,000 41,000 69,000 33,000
Chapter 11: Statement of cash flows
(b) YoYo Ltd Note to Statement of Cash Flows for the year ended 31 December 2012 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Increase in inventory Decrease in accounts payable Increase in income tax payable Net cash provided by operating activities
$41,000
$8,000 (14,000) (13,000) (12,000) 6,000
(25,000) $16,000
Current cash debt coverage = $16,000 ($57,000 + $63,000)/2 = 0.27:1 Cash debt coverage = $16,000 ($77,000 + $73,000)/2 = 0.21:1 Free cash flow = $16,000 - $7,000 = $9,000
(c)
(1) (2) (3)
(d)
YoYo Ltd has the ability to cover 27% of its short-term liabilities from the cash generated from its operating activities. The cash debt coverage of 0.21 shows that YoYo Ltd’s cash flows from operating activities is sufficient to cover 21% of its total liabilities. After investing in new property, plant and equipment to maintain operations at their current level, Yoyo Ltd still has $9,000 cash available for expansion or payments of dividends, as shown by its free cash flow of $9,000.
11.42
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 11.5 (a) George Ltd Statement of Cash Flows for the year ended 31 December 2013
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes For interest Net cash provided by operating activities
$253,700 (1) $104,290 (2) 21,400 (3) 7,270 2,940
Cash flows from investing activities: Sale of investments Sale of plant and equipment Purchase of plant and equipment Net cash used by investing activities
22,500 15,000 (141,000)
Cash flows from financing activities: Proceeds from issue of shares Proceeds from issue of bonds Payment of cash dividends Net cash provided by financing activities
50,000 70,000 (75,000)
135,900 $117,800
(4) (103,500)
(5) 45,000
Net increase in cash Cash at beginning of period Cash at end of period
59,300 33,400 $92,700
11.43
Chapter 11: Statement of cash flows
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$297,500 (43,800) $253,700
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers
$99,460 19,250 118,710 (14,420) $104,290
Cash payments for operating expenses: Operating expenses Add: Decrease in accrued expenses payable Cash payments for operating expenses
$14,670 6,730 $21,400
(4) Balance, Beginning of year Cash (purchase of equipment)
Opening Balance
Sale of equipment Closing Balance
Plant and Equipment 205,000 Equipment sold 141,000 Closing Balance
36,000 310,000
346,000 310,000
346,000
Accumulated Depreciation – Equipment Balance, Beginning of year 26,000 Depreciation expense 49,500 75,500 Opening Balance
Original cost of equipment sold Less accumulated depreciation Carrying amount of equipment sold Sale price Gain on sale of equipment
11.44
36,000 26,000 10,000 15,000 5,000
40,000 35,500 75,500 49,500
Solutions manual to accompany Accounting: building business skills 4e
(5) Dividends paid Closing Balance
Retained Earnings 75,000 Balance, Beginning of year Profit 175,600 250,600 Opening Balance
107,940 142,660 250,600 175,600
(b) George Ltd Note to Statement of Cash Flows (Indirect Method) for the year ended 31 December 2013 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Gain on sale of equipment Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in accrued expenses payable Net cash provided by operating activities
11.45
$142,660
$35,500 (5,000) (43,800) (19,250) 14,420 (6,730)
(24,860) $117,800
Chapter 11: Statement of cash flows
PROBLEM SET B 11.6 Transaction
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
Where Reported (O), Investing (I), Financing (F) or as non-cash (NC)
Cash Inflow, Cash outflow, No Effect
No effect Outflow Inflow No effect Outflow No effect Inflow No effect Outflow No effect
O I NC F NC O O
PROBLEM SET B 11.7 (a) Talker Ltd Partial Statement of Cash Flows for the year ended 30 November 2012 Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses Net cash provided by operating activities
$7,500,000 (1) $4,740,000 (2) 1,290,000 (3)
6,030,000 $1,470,000
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$7,700,000 (200,000) $7,500,000
Cash payments to suppliers: Cost of purchases per income statement Add: Decrease in accounts payable Cash payments to suppliers
4,400,000 340,000 $4,740,000
Cash payments for operating expenses: Operating expenses ($1,150,000 - $110,000) Add: Increase in prepaid expenses $150,000 Add: Decrease in accrued expenses payable 100,000 Cash payments for operating expenses
11.46
$1,040,000
250,000 $1,290,000
Solutions manual to accompany Accounting: building business skills 4e
(b) Talker Ltd Note to Statement of Cash Flows for the year ended 30 November 2012 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Increase in prepaid expenses Decrease in accounts payable Decrease in accrued expenses payable Net cash provided by operating activities
11.47
$1,650,000
$110,000 (200,000) 500,000 (150,000) (340,000) (100,000)
(180,000) $1,470,000
Chapter 11: Statement of cash flows
PROBLEM SET B 11.8 (a) Tooma Enterprises Ltd Statement of Cash Flows for the year ended 31 December 2013
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For interest For income taxes Net cash provided by operating activities
$492,000 (1) $366,000 (2) 66,000 (3) 4,000 24,000 (4)
Cash flows from investing activities: Sale of machine Purchase of plant Net cash provided by investing activities
20,000 (14,000)
Cash flows from financing activities: Proceeds from issue of shares Proceeds from issue of debentures Payment of cash dividends Net cash used by financing activities
10,000 10,000 (24,000)
460,000 $32,000
6,000
(4,000)
Net increase in cash Cash at beginning of period Cash at end of period
34,000 26,000 $60,000
11.48
Solutions manual to accompany Accounting: building business skills 4e
Computations: (1)
(2)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers
$500,000 (8,000) $492,000
Cash payments to suppliers: Cost of sales Deduct: Decrease in inventory Cost of purchases Add: Decrease in accounts payable Cash payments to suppliers
$360,000 (2,000) 258,000 8,000 $366,000
(3)
Operating expenses $50 000 + $38 000 Less depreciation
(4)
Cash payments for income taxes: Income tax expense Add: Decrease in income taxes payable Cash payments for income taxes
$88,000 (22,000) $66,000 $14,000 10,000 $24,000
(b) Tooma Enterprises Ltd Note to Statement of Cash Flows (Indirect method) for the year ended 31 December 2013 Reconciliation of profit to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Decrease in accounts payable Decrease in income taxes payable Net cash provided by operating activities
11.49
$34,000
$22,000 (8,000) 2,000 (8,000) (10,000)
(2,000) $32,000
Chapter 11: Statement of cash flows
(c)
(1)
Current cash debt coverage = $32,000/ [($88,000* + 106,000**)/2] = 0.33 *$58,000 + $30,000
**$66,000 + $40,000
(2)
Cash return on sales ratio
$32,000 ÷ $500,000 = 6.4% or .064:1
(3)
Cash debt coverage = $32,000/[(118,000* + 126,000**)/2] = 0.26 *$58,000 + $30,000 + $30,000
(4)
(d)
Free cash flow
**$66,000 + $40,000 + $20,000
$32,000 - $14,000 = $18,000
33% of Tooma Enterprises Ltd’s short term obligations in one year could be covered by the cash generated from its operating activities and the cash flow from operating activities is sufficient to cover 26% of its total obligations. The cash return on sales figure of 6.4% compares favourably to the profit ratio of 6.8% (34,000/500,000) and there is free cash flow of $18,000 which suggests that after investing in new property, plant and equipment to maintain operations at their current level, there is still cash available for expansion or payment of dividends.
11.50
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 11.9 (a). Tiki Pty Ltd Statement of Cash Flows for the year ended 30 June 2012
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For income taxes For interest Net cash provided by operating activities
$267,700 $114,290 21,400 7,270 2,940
Cash flows from investing activities: Sale of investments Sale of plant and equipment Purchase of plant and equipment Net cash used by investing activities
2,500 15,550 (92,000)
Cash flows from financing activities: Issue of shares Issuance of debentures Payment of cash dividends Net cash provided by financing activities
50,000 30,000 (78,400)
(2) (3) (145,900) $121,800
(73,950)
1,600
Net increase in cash Cash at beginning of period Cash at end of period
49,450 47,250 $96,700
Computations: (1)
(2)
(3)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Cash receipts from customers Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers Cash payments for operating expenses: Operating expenses Add: Decrease in accrued expenses payable Cash payments for operating expenses
11.51
$297,500 (29,800) $267,700
$99,460 19,250 118,710 (4,420) $114,290 $14,670 6,730 $21,400
(1)
Chapter 11: Statement of cash flows
(b) Tiki Pty Ltd Note to Statement of Cash Flows for the year ended 30 June 2012 Reconciliation of profit after tax to cash provided by operating activities. Cash flows from operating activities: Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Gain on sale of equipment Increase in accounts receivable Increase in inventory Increase in accounts payable Decrease in accrued expenses payable Net cash provided by operating activities
11.52
$132,210
$49,700 (8,750) (29,800) (19,250) 4,420 (6,730)
(10,410) $121,800
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 11.10 (a) Michael Ltd Statement of Cash Flows for the year ended 30 June 2013
Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers For operating expenses For interest expenses For income taxes Net cash provided by operating activities
$6,984,000 (1) $4,423,000 988,000 80,000 600,000
Cash flows from investing activities: Sale of equipment (8) Sale of land (215,000 + 105,000) (6) Purchase of plant & equipment (8) Purchase of office equipment (9) Purchase of building (7) Net cash used by investing activities
215,000 320,000 (348,000) (25,000) (215,000)
Cash flows from financing activities: Proceeds from issue of shares (11) Payment of cash dividends (10) Proceeds from borrowings Net cash provided by financing activities
100,000 (375,000) 400,000
(2) (3) (4) (5)
6,091,000 $893,000
(53,000)
125,000
Net increase in cash Cash at beginning of period Cash at end of period
965,000 610,000 $1,575,000
11.53
Chapter 11: Statement of cash flows
Computations: (1)
(2)
(3)
(4)
(5)
Cash receipts from customers: Sales Deduct: Increase in accounts receivable Deduct: Bad debts written off Cash receipts from customers
$7,063,000 (70,000) (9,000) $6,984,000
Cash payments to suppliers: Cost of sales Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers
$4,438,000 110,000 4,548,000 (125 ,000) $4,423,000
Cash payments for operating expenses: Other expenses + insurance expense ($898,000 + $70,000) Add: Increase in prepaid insurance Add: Decrease in accrued expense payable Cash payments for operating expenses
$968,000 10,000 10,000 $988,000
Cash payments for interest expense: Interest expense Deduct: Increase in interest payable Cash payments for interest expense
$90,000 10,000 $80,000
Cash payments for income taxes: Income tax expense (550,000 + 40,000) add: decrease in income taxes payable Cash payments for income taxes
$590,000 10,000 $600,000
11.54
Solutions manual to accompany Accounting: building business skills 4e
(6) Balance, Beginning of year Upward revaluation
Land 950,000 Land sold 80,000 Closing Balance
1,030,000 Opening Balance 815,000 Proceeds from land sold = 215,000 + gain of 105,000 = $320,000
215,000 815,000 1,030,000
(7) Balance, Beginning of year Purchase
Opening Balance
Closing Balance
Building 835,000 215,000 Closing Balance 1,050,000 1,050,000
1,050,000 1,050,000
Accumulated Depreciation - Building Balance, Beginning of year 270,000 Depreciation expense 270,000
250,000 20,000
Opening Balance
270,000 270,000
Plant and Equipment 629,000 Equipment sold 348,000 Closing Balance
250,000 727,000
(8) Balance, Beginning of year Cash (purchase of equipment)
Opening Balance
Plant sold Closing Balance
977,000 727,000
977,000
Accumulated Depreciation – Plant and Equipment 150,000 Balance, Beginning of year 220,000 Depreciation expense (125,000 –
305,000 65,000
40,000-20,000)
370,000 Opening Balance Carrying amount of plant sold = 250,000 – 150,000 = 100,000 Proceeds from sale = carrying amount + gain = 100,000 + 115,000 = 215,000
(9) 11.55
370,000 220,000
Chapter 11: Statement of cash flows
Balance, Beginning of year Cash (purchase of equipment)
Opening Balance
Office Equipment 190,000 Equipment sold 25,000 Closing Balance 215,000 215,000
0 215,000 215,000
Accumulated Depreciation – Office Equipment Office equipment sold 0 Balance, Beginning of year Closing Balance 135,000 Depreciation expense 135,000 Opening Balance
95,000 40,000 135,000 135,000
(10) Cash dividends declared/paid Transfer to reserve Closing Balance
Cash paid Closing Balance
Retained Earnings 425,000 Balance, Beginning of year 50,000 Profit 1,382,000 1,857,000 Opening Balance
Dividend Payable 375,000 Balance, Beginning of year 300,000 Dividends declared 675,000
809,000 1,048,000 1,857,000 1,382,000
250,000 425,000
Opening Balance
675,000 300,000
Share Capital Balance, Beginning of year Asset revaluation reserve 700,000 Cash 700,000 Opening Balance
500,000 100,000 100,000 700,000 700,000
(11)
Closing Balance
11.56
Solutions manual to accompany Accounting: building business skills 4e
(b) Michael Ltd Note to Statement of Cash Flows (Indirect method) for the year ended 30 June 2013 Reconciliation of profit to cash provided by operating activities Profit Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense Amortisation expense Gain on sale of land Gain on sale of equipment Increase in accounts receivable Increase in allowance for doubtful debts Increase in inventory Increase in prepaid insurance Increase in accounts payable Decrease in accrued expenses Increase in interest payable Decrease in income taxes payable Net cash provided by operating activities
11.57
$1,048,000
$125,000 10,000 ($105,000) ($115,000) (70,000) 5,000 (110,000) (10,000) 125,000 (10,000) 10,000 (10,000)
(155,000) $893,000
Chapter 11: Statement of cash flows
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 11.1
FINANCIAL REPORTING PROBLEM
Domino’s Pizza Enterprises Ltd (a)
Net cash provided by operating activities: 2010 2009
$6,976,000 $19,491,000
Domino’s 2010 cash flows are consistent with the growth phase. Operating cash flows are positive and less than profit. Cash generated by operations is less than profit and Domino’s is still investing heavily. (b)
The decrease in cash for the year ended 30 June 2010 was $10,840,000 and for the year ended 30 June 2009 was $16,585,000 increase in cash.
(c)
The change in borrowings comprised repayments of $27,137,000 and additional borrowings of $30,277,000.
(d)
Total cash used for investing activities in 2010 was ($23,007,000).
(e)
The interest (borrowing cost) paid in 2010 was $2,873,000 and income tax paid was $5,916,000 in 2010.
11.58
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BUILDING BUSINESS SKILLS 11.2
COMPARATIVE ANALYSIS PROBLEM
Company A vs. Company B (a) All dollar amounts are in $’000 Company A
Company B
1. Current cash debt coverage
$48,393 = 0.85 times ($47,907 + $65,769 ) / 2
$66,615 = 0.60 times $(123,896 + $97,582 ) / 2
2. Cash return on sales ratio
$48,393 = 0.11 : 1 $440,754
$66,615 = .10 : 1 $679,285
3. Cash debt coverage
$48,393 = 0.67 times ($59,497 + $84,139 ) / 2
$66,615 = 0.23 times ($322,638 + $269,298 ) / 2
(b)
The current cash debt coverage uses cash generated from operations during the period and provides a better representation of liquidity on an average day than measures such as the current ratio. Company A’s ratio of $0.85 of cash from operations for every dollar of current liabilities was more than Company B’s $0.60 of cash from operations per dollar of current liabilities and indicates that Company A was more liquid than Company B in 2012. The cash return on sales ratio indicates a company’s ability to turn sales into dollars (cash). Since Company A’s cash return on sales ratio was slightly higher than Company B’s (0.11 vs. 0.10), Company A was more efficient in turning sales into cash in 2014. The cash debt coverage ratio shows a company’s ability to repay its liabilities from cash generated from operating activities without having to liquidate the assets employed in its operations. Since Company A’s cash debt coverage was approximately 3 times greater than Company B’s (.67 vs. .23), Company A’s ability to repay liabilities with cash from operations was significantly greater than Company B’s in 2014.
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Chapter 11: Statement of cash flows
BUILDING BUSINESS SKILLS 11.3
INTERPRETING FINANCIAL STATEMENTS
Tiger Fire Systems Ltd All dollar amounts are in $million. Capital expenditure ratio and free cash flow: Capital expenditure ratio $7,433 ÷ $3,683 = 2.02 $7,057 ÷ $3,332 = 2.12 $7,098 ÷ $3,662 = 1.94
2015 2014 2013
Free cash flow $7,433 - $3,683 = $3,750 $7,057 - $3,332 = $3,725 $7,098 - $3,662 = $3,436
, Tiger Fire Systems was able to finance its capital expenditure from the cash provided by operations each year from 2013 to 2015. Free cash flow increased from 2013 to 2014 and remained stable in 2015. The capital expenditure ratio increased in 2014 and declined in 2015, as both CFO and capital expenditure increased. Current cash debt coverage: 2015
$7,433 = 1.11times ($5,834 + $7,576 ) / 2
2014
$7,057 = 1.00 times ($8,230 + $5,834 ) / 2
2013
$7,098 = 0.81times ($9,279 + $8,230 ) / 2
The current cash debt coverage has increased consistently from 2013, when it was below one. The improvement reflected reduced current liabilities in 2014 and increased cash provided by operations in 2015. The increased current cash debt coverage indicates Tiger Fire Systems’ improved liquidity since 2013.
Cash debt coverage: 2015
$7,433 = 0.37 times ($20,177 + $19,632 ) / 2
2014
$7,057 = 0.32 times ($24,113 + $20,177 ) / 2
2013
$7,098 = 0.30 times ($23,751 + $24,113) / 2
The cash debt coverage mirrored the current cash debt coverage. Tiger Fire Systems’ solvency has improved. It has provided more cash from operations for every dollar of liabilities each year from 2013 to 2015. The improvement reflected reduced liabilities in 2014 and increased cash provided by operations in 2015. 11.60
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Cash return on sales ratio: 2015 2014 2013
$7,433 ÷ $20,737 = 0.36 $7,057 ÷ $20,495 = 0.34 $7,098 ÷ $20,196 = 0.35
Tiger Fire Systems’ ability to generate cash from sales has remained stable at around 35% during the three-year period from 2013 to 2015.
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Chapter 11: Statement of cash flows
BUILDING BUSINESS SKILLS 11.4
RESEARCH CASE
(a)
Profit is an accrual-based measure of performance. Net cash provided by operations includes receipts and payments in the period in which cash is paid or received, rather than when the initiating transaction, such as the sale of goods, occurs. The difference between cash provided by operations and profit can be explained quantitatively by examining the reconciliation between profit and cash provided by operations, disclosed in the notes to the financial statements. Students’ answers will vary with the choice of company and year of the annual report used.
(b)
Students’ answers will vary with the choice of company and year of the annual report used.
(c)
Students’ answers will vary with the choice of company and year of the annual report used.
(d)
Students’ answers will vary with the choice of company and year of the annual report used.
BUILDING BUSINESS SKILLS 11.5
FINANCIAL ANALYSIS ON THE WEB
Answers will vary depending on the company chosen by the students and the year of the financial statements.
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CRITICAL THINKING BUILDING BUSINESS SKILLS 11.6
COMMUNICATION ACTIVITY
Computer Services Pty Ltd MEMO To:
Arnold Byte
From:
Student
Date:
XX/MM/YYYY
Subject:
Statement of cash flows
The statement of cash flows provides information about the cash receipts and cash payments of a firm, classified as operating, investing and financing activities. The operating section of your company’s statement of cash flows shows the amount of cash received through operating activities such as the sale of goods and collection of cash from customers. Cash payments relating to operating activities such as the payment of salaries and wages are deducted from cash receipts to determine net cash provided by operating activities. The investing section of the statement reports the cash flows resulting from changes in investments and other non-current assets. The financing section of the statement reports the cash flows resulting from changes in financial liabilities and equity, such as the issue of shares, borrowings and the payment of cash dividends. If you have any further questions, please do not hesitate to contact me.
Signature
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Chapter 11: Statement of cash flows
BUILDING BUSINESS SKILLS 11.7
ETHICS CASE Steadyflow Ltd
(a)
The stakeholders in this situation are: The managing directors of Steadyflow Ltd The Board of Directors The accountant The shareholders of Steadyflow Ltd Any users of Steadyflow’s financial statements.
(b)
The managing director’s statement: ‘We must get that amount above $1million’, puts undue pressure on the accountant and expresses a willingness to report cash flows more favourably than would result from the application of standards and the true and fair principle. This statement along with her statement, ‘I know you won’t let me down’, encourages the accountant to do something unethical. The accountant’s reclassification (intentional misclassification) of a cash inflow from a long-term note (financing activity) issue to an ‘increase in payables’ (affecting the calculation of cash provided by operating activities) is inappropriate and unethical. It provided biased information intended to mislead other directors so that a dividend will be paid in circumstances when it would otherwise not be paid.
(c)
It is unlikely that any board members (other than board members who are also officers of the company) would discover the misclassification. Board members generally do not have detailed enough knowledge of their company’s transactions to detect this misstatement. It is possible that an officer of the bank that made the loan would detect the misclassification upon close reading of Steadyflow Ltd’s statement of cash flows. It is also possible that close scrutiny of the balance sheet and notes to the financial statements showing an increase in notes payable (long-term debt) would reveal that there is no comparable financing activity item (proceeds from note payable) in the statement of cash flows. The auditors (internal or external), who have access to the detail of transactions and journal entries, may detect the misrepresentation in their audit of the financial statements.
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BUILDING BUSINESS SKILLS 11.8 (a) the nature of the environmental laws that have come into effect in some countries Apple Inc operates in is the requirement to provide customers the ability to return the electrical product they purchased form the company at the end of its useful life at no charge to the customer which places the responsibility and the cost for environmentally safe disposal or recycling of components with the Apple Inc. The Waste Electrical and Electronic Equipment Directive (WEEE Directive) is a Eurpean community (EU) directive on waste electical and electronic equipment (WEEE) which became law in Europe 2003. The directive imposes the responsibility for the disposal of waste electrical and electronic equipment on the manufacturers of the equipment. Those companies should establish an infrastructure for collecting WEEE, in such a way that "Users of electrical and electronic equipment from private households should have the possibility of returning WEEE at least free of charge". Also, the companies are compelled to use the collected waste in an ecologically-friendly manner, either by ecological disposal or by reuse/refurbishment of the collected WEEE. (b) Compliance with these environmental laws could materially adversely affect the Company as it would require them to develop the infrastructure to collect products at the end of their life (for example you may have seen the mobile phone recycling bins located in various phone re-seller shops), as well as the infrastructure or the outsourcing to enable the recycling and or disposal of the electrical products in an environmentally friendly manner. All of this takes time and resources which can have negative impact on the finances and operations of Apple Inc’s business.
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CHAPTER 12 – FINANCIAL STATEMENT ANALYSIS ASSIGNMENT CLASSIFICATION TABLE
Brief Exercises
Learning Objectives 1.
Discuss the need for comparative analysis and identify the tools of financial statement analysis.
2.
Explain and apply horizontal analysis.
3.
Explain and apply vertical analysis.
4.
Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business.
5.
Discuss the limitations of financial statement analysis.
Exercises
Problems
1
1, 2, 4
2, 3, 6, 7
3
4, 5, 6, 7
1A, 1B
5, 6, 7
1, 8, 9, 10, 11, 12, 13
1A, 2A, 3A, 4A, 5A, 6A, 7A, 8A, 1B, 2B, 3B, 4B, 5B, 6B, 7B, 8B, 9B 9A, 10B
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Chapter 12: Financial statement analysis
CHAPTER 12 – FINANCIAL STATEMENT ANALYSIS ANSWERS TO QUESTIONS 1. (a) Intra-Entity. This is a comparison within an entity. For example, Company A’s cash balance as of 31 Dec 2011 is compared with Company A’s cash balance as of 31 Dec 2010. Industry Averages. This is a comparison between a company and industry average. For example, Coca Cola’s financial data is compared with beverage industry’s financial data. The beverage industry’s financial data is calculated from all beverage companies’ financial data. Inter-Entity. This is a comparison between different entities. For example, Coca Cola’s Total Sales for the year of 2011 is compared with Pepsi’s Total Sales for the year of 2011. (b) The purpose of an Intra-Entity Basis comparison is to detect changes in financial relationships and significant trends. The purpose of an Industry Averages comparison is to provide information about an entity’s relative position within the industry. The purpose of an Inter-Entity Basis comparison is to provide insight into an entity’s competitive position. 2. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time. Its purpose is to determine the increase or decrease that has taken place, expressed as either an amount or a percentage. For example, Company A has the following data: Year
2009
2010
2011
Net Sales
132,000
120,000
100,000
We can conclude that the Company A has an increase of 20% in Net Sales during 2009 and only an increase of 10% in Net Sales during 2010. Vertical Analysis is a technique for evaluating financial statement data that expresses each item in a financial statement as a percentage of a base amount. For example, on an income statement we might say that selling expenses are 21% of net sales (net sales being the base amount). When analysing a statement of financial position we might say that current assets are 48% of total assets (total assets being the base amount). Obviously, horizontal analysis uses data from more than one period of time while vertical analysis uses data from only one period of time.
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Solutions manual to accompany Accounting: building business skills 4e
3. Current Ratio is Current Asset/Current Liabilities. Quick Ratio is (Cash + Marketable Securities + Net Receivable)/Current Liabilities. Quick Ratio calculation does not include Inventory and Prepaid Expense. Cash, marketable securities (current) and receivables (net) are more liquid when compared with inventory and prepaid expenses. The inventory may not be readily saleable and the prepaid expenses may not be transferable to others. For this reason, the Quick Ratio provides a better picture of a company’s short-term liquidity than the Current Ratio. 4. A disadvantage of the Current Ratio and Quick Ratios is that they use year-end balances of current asset and current liability accounts. These year-end balances may not be representative of the entity’s current position during most of the year. The Current Cash Debt Coverage partially corrects this problem by using net cash provided by operating activities and average current liabilities. Net cash provided by operating activities is from the whole year’s operating activities. Average current liabilities are also obviously better than year-end balance of current liabilities because it has the component of both beginning of year balance and year-end balance. 5. The average collection period of receivables is useful to assess the effectiveness of an entity’s credit and collection policies. The general rule is that the collection period should not greatly exceed the credit term period (i.e. the time allowed for payment). If the collection period is significantly higher than the credit term period, then there is a problem with its receivables collection. For example, if an entity offers 30-day credit terms and has an average collection period of 27 days, this provides an indication that the firm’s credit policy is appropriate and the monitoring of receivables collection is effective. A company whose average collection period is significantly above its credit terms suggests that it may be granting credit to customers who are not credit worthy or need to change their credit policies or collection procedures. 6.
Prestige Plants Ltd’s inventory turnover is much slower than the industry average; its inventory stays on the shelf approximately 45 days compared with 26 days, on average, for the industry. Prestige Plants’ may be carrying excessive inventory relative to its sales volume.
7.
(a)
Asset turnover.
(b)
Average collection period.
(c)
Profit margin.
(d)
Current ratio, Quick ratio or Current ash debt coverage.
8.
The price-earnings (P/E) ratio is a reflection of investors’ assessments of a company’s future earnings. The P/E ratio takes into account such factors as relative risk, stability or profits, trends in profits, and the market’s perception of the company’s growth potential. In this question investors favour Microsoft because it has the higher P/E ratio. The investors feel that Microsoft will be able to generate even higher future profits and so the investors are willing to pay more for the shares.
12.3
Chapter 12: Financial statement analysis
9.
(a)
The decrease in gross profit margin is bad news because it means that a lower percentage of net sales remains as gross profit after deducting cost of sales.
(b)
The decrease in inventory turnover signals bad news because the company is taking longer to sell the inventory and consequently there is a greater chance of inventory obsolescence.
(c)
A decrease in the quick ratio signals bad news because the company’s ability to meet maturing short-term obligations has declined.
(d)
The increase in return on assets is good news for the company because it could mean an increase in profit; or that the company needs to invest less in assets to generate profit.
(e)
The increase in the price-earnings ratio is generally good news because it means that the market price per share has increased (relative to profit) and investors are willing to pay more multiples of profit per share.
(f)
From a solvency perspective, the increase in debt to total assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity ‘buffer’.
(g)
The increase in current cash debt coverage is good news because it means that the company’s ability to meet current liabilities from the cash generated by operations has improved.
10. a) Estimates Financial statements contain numerous estimates. Estimates are used, for example, in determining the allowance for uncollectable receivables, periodic depreciation and the costs of warranties. To the extent that these estimates are inaccurate, the financial ratios and percentages are also inaccurate. b) Cost Traditional financial statements are based on cost and are not adjusted for price-level changes. Comparisons of unadjusted financial data from different periods may be rendered invalid by significant inflation or deflation. For example, if a 5-year comparison of revenues shows a growth of 24%, and the general price level also increased by 24%, the entity’s real growth would be nil. Also, some assets such as property, plant and equipment might be many years old. The carrying amount (cost less accumulated depreciation) at which they are shown on the statement of financial position might be significantly lower than their current market value. Thus, ratios such as return on investment would appear more favourable than if the entity had new assets. c) Alternative Accounting Methods Variations among entities in the application of generally accepted accounting principles may hamper comparability. For example, one entity may use the straight-line method of depreciation, whereas another entity in the same industry may use the diminishing balance method. This would affect ratios that use profit and, to a lesser extent, ratios that use total assets. d) Atypical Data Financial year-end data may not be typical of an entity’s financial condition during the year. In such cases, certain account balances (cash, receivables, payables and inventories) may not be representative of the balances in the accounts during the year.
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e) Diversification Diversification within entities also limits the usefulness of financial statement analysis as it hampers comparison with competitors and industry statistics. Many entities today are so diversified that they cannot be classified by industry. Others appear to be comparable but are not.
12.5
Chapter 12: Financial statement analysis
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12.1 (a) Intra-entity (b) Intra-entity (c) Inter-entity (d) Industry Averages (e) Intra-entity (f) Inter-entity
BRIEF EXERCISE 12.2 Horizontal analysis: 30/6/2014 Accounts receivable % of base year Workings Inventory % of base year Workings Total assets % of base year Workings
30/6/2013
30/6/2012
120
80
Base Year 100
$600,000 $500,000
$400,000 $500000
195
150
$780,000 $400,000
$600,000 $400,000
128.8 112 $3,220,000 $2,800,000 $2,500,000 $2,500,000
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BRIEF EXERCISE 12.3 Vertical analysis: 2014
2013
2012
Amount
%
Amount
%
Amount
%
Accounts receivable
$600,000
18.6%
$400,000
14.3%
$500,000
20%
Workings
$600,000 $3220000
Inventory
$780,000
Workings
$780,000 $3220000
Total assets
$3,220,000
$ 400,000 $2,800,000 24.2%
$ 500,000 $2,500,000
$600,000
21.4%
$ 600,000 $2,800,000 100%
$400,000
16%
$400,000 $2,500,000
$2,800,000
100%
$2,500,000
100%
BRIEF EXERCISE 12.4 Tilden Ltd Comparing the percentages presented results in the following conclusions: The profit for Tilden increased in 2013 because of the combination of an increase in sales and a decrease in both cost of sales and expenses. However, the reverse was true in 2014 as sales decreased, while both cost of sales and expenses increased. This resulted in a decrease in profit.
BRIEF EXERCISE 12.5 Walpole Ltd (a)
Current ratio: Current assets $42,418,000 = .94:1 = Current liabilities $44,844,000
(b)
Quick ratio: Cash + Marketable Securities + Receivable s Current Liabilitie s =
12.7
=
$8,041,000 + $1,947,000 + $12,545,000 $44,844,000
$22,533,000 = .502:1 $44,844,000
Chapter 12: Financial statement analysis
BRIEF EXERCISE 12.6 Liverpool Ltd Accounts receivable turnover =
Net credit sales Average net receivable s
2013
2012
(a)
$6,600,000 =1 0.68 times $618,000
(b)
Average collection period:
$4,920,000 = 8.54 times $576,000
365 = 34.2 days 10.68
365 = 42.7 days 8.54
Liverpool Ltd can be very happy with the effectiveness of its credit and collection policies. The company has decreased the average collection period by over eight days and the collection period of approximately 34 days is well within the 45 days allowed in the credit terms. BRIEF EXERCISE 12.7 Deanna Manufacturing Ltd (a)
Current cash debt coverage: $912,000 = 3.62 times $216,000 + $288,000 2
(b)
Cash return on sales: $912,000 = 11.1% $8,232,000
(c)
Cash debt coverage: $912,000 = .543 times $1,800,000 + $1,560,000 2
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Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO EXERCISES EXERCISE 12.1 (a) Zebra Ltd Ratios for 2013 Current Ratio = Current Asset/Current Liabilities = 9,998,000/7,770,000 = 1.29 :1 Quick Ratio = (Cash + Marketable Securities + Net Receivables)/Current Liabilities = 6,800,000/7,770,000 = 0.88:1 Inventory Turnover = Cost of Sales/Average Inventory = 17,988,000/ [(3,100,000 + 2,290,000)/2] = 6.67 times Average Days in Inventory = 365 days/Inventory Turnover = 365 days/6.67 = 54.72 days Ratios for 2012 Current Ratio = Current Asset/Current Liabilities = 10,151,000/7,753,000 = 1.31:1 Quick Ratio = (Cash + Marketable Securities + Net Receivables)/Current Liabilities = 6,870,000/7,753,000 = 0.89:1 Intra-entity comparison - Cost of Sales has decreased by 0.28% from 2012 to 2013 - Current Assets has decreased by 1.51% from 2012 to 2013 - The sum of cash, net receivables and marketable securities has decreased by 1.02% from 2012 to 2013 - Net receivables has decreased by 8.98% from 2012 to 2013 - Inventory has increased by 35.37% from 2012 to 2013 - Current Liabilities has increased by 4.81% from 2012 to 2013 - Current Ratio has decreased by about 0.02 from 2012 to 2013. This means Zebra is a little less liquid in 2013 compared to the previous year. - Quick Ratio has decreased by about 0.01 from 2012 to 2013. This means Zebra is a little less liquid in 2013 compared to the previous year. - Changes in the current and quick ratios are insignificant so that the entity has essentially remained the same (b) Intra-entity comparisons (comparisons within an entity) are often useful to detect changes in financial relationships and significant trends. Inter-entity comparisons (comparisons made between different entities) provide insights into an entity’s competitive position. Industry comparisons provide information about an entity’s relative position within the industry.
12.9
Chapter 12: Financial statement analysis
EXERCISE 12.2 Merchandise Ltd Condensed Statement of Financial Position as at 30 June Horizontal Analysis Increase / (Decrease) 2015
2014
Current assets Plant assets (net) Total assets
$120,000 400,000 $520,000
$100,000 330,000 $430,000
$20,000 70,000 $90,000
20.0% 21.2% 20.9%
Current liabilities Non-current liabilities Total liabilities Share capital, $1 each Retained earnings Total shareholders’ equity
$91,000 144,000 $235,000 150,000 135,000 $285,000
$70,000 95,000 $165,000 115,000 150,000 $265,000
$21,000 49,000 $70,000 35,000 (15,000) $20,000
30.0% 51.6% 42.4% 30.4% (10.0%) 7.5%
Total liabilities equity
$520,000
$430,000
$90,000
20.9%
&
shareholders’
Amount
Percentage
EXERCISE 12.3 Retail Ltd Partial Statement of Financial Position as at 30 June Horizontal Analysis Increase / (Decrease) 2014
2013
Amount
% change
or % of base
Current assets Property, plant and equipment (net) Total assets
$130,000
$100,000
$30,000
30.0%
130.0%
390,000 $520,000
330,000 $430,000
60,000 $90,000
18.2% 20.9%
118.2% 120.9%
Current liabilities Non-current liabilities Total liabilities Share capital, $1 each Retained earnings Total equity
$97,000 144,000 $241,000 145,000 134,000 $279,000
$70,000 95,000 $165,000 115,000 150,000 $265,000
$27,000 49,000 $76,000 30,000 (16,000) $14,000
38.6% 51.6% 46.1% 26.1% (10.7%) 5.3%
138.6% 151.6% 146.1% 126.1% 89.3% 105.3%
Total liabilities & equity
$520,000
$430,000
$90,000
20.9%
120.9%
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(b)
Although Retail Ltd’s overall increase in total assets was financed mainly by an increase in debt, thus making the company more financially risky than it was in the previous year.
EXERCISE 12.4
(a) Pinewood Ltd Statement of Financial Performance Vertical Analysis
2014 Amount Sales Cost of Sales Gross profit Selling expenses Administrative expenses Total operating expenses Profit before income tax Income tax expense Profit
$800,000 472,000 328,000 120,000 80,000 200,000 128,000 38,400 $89,600
2013 Percent 100.0% 59.0% 41.0% 15.0% 10.0% 25.0% 16.0% 4.8% 11.2%
Amount $600,000 390,000 210,000 72,000 54,000 126,000 84,000 25,200 $58,800
Percent 100.0% 65.0% 35.0% 12.0% 9.0% 21.0% 14.0% 4.2% 9.8%
(b)Horizontal analysis can provide insights into underlying conditions for entities that may not be apparent from the individual components presented in financial statements. Horizontal analysis is even more meaning if it is supplemented with further information such as inter-company comparisons with a competitor in the same industry as well as other relevant information such as general economic conditions, industry trends or averages, information from directors’ reports and media releases. Like horizontal analysis, vertical analysis can provide insights into underlying conditions for entities that may not be apparent from the individual components presented in financial statements. However, vertical analysis is even more meaning if it is supplemented with further information such as general economic conditions, industry trends or averages, information from directors’ reports and media releases. Vertical analysis enables you to compare entities in the same industry even if they are different sizes.
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Chapter 12: Financial statement analysis
EXERCISE 12.5 (a) Swimma Ltd Income Statement Vertical Analysis 2013 Amount Sales Cost of sales Gross profit Selling expenses Administrative expenses Total operating expenses Profit before income tax Income tax expense Profit for the period
(b)
Percent
$1,320,000 778,500 541,500 198,000 120,000 318,000 223,500 57600 $165,900
100.0% 58.98% 41.02% 15.00% 9.09% 24.09% 16.93% 4.36% 12.57%
2012 Amount Percent $900,000 585,000 315,000 108,000 81,000 189,000 126,000 37,800 $88,200
100.00% 65.00% 35.00% 12.00% 9.00% 21.00% 14.00% 4.20% 9.80%
Profit for the period as a percentage of sales increased by 3% from 2012 to 2013. Although selling expenses as a percentage of sales increased 3% over the period, the cost of sales as a percentage of sales decreased approximately 6%. As the cost of sales is a much larger proportion of Swimma Ltd’s expenses, management’s ability to reduce this expense more than offset the increase in selling expenses to explain the increase in profit.
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EXERCISE 12.6 Simply Sandals Ltd Partial Statement of Financial Position as at 30 June 2015 Horizontal Analysis Percentage Change from 2014
2015
2014
Increase (Decrease)
Current assets Property, plant & equipment (net) Intangibles Total assets
$105,600 97,200 37,200 $240,000
$96,000 108,000 48,000 $252,000
$9,600 (10,800) (10,800) ($12,000)
10% (10.0%) (22.5%) (4.8%)
Current liabilities Non-current liabilities Equity Total liabilities & equity
$62,400 162,000 15,600 $240,000
$57,600 180,000 14,400 $252,000
$4,800 (18,000) 1,200 ($12,000)
8.3% (10.0%) 8.3% (4.8%)
(b)
Simply Sandals Ltd Condensed Statement of Financial Position as at 30 June 2015 Vertical Analysis 2015 Amount
2014 Percent
Amount
Percent
Current assets Property, plant & equipment (net) Intangibles Total assets
$105,600 97,200 37,200 $240,000
44.0% 40.5% 15.5% 100.0%
$96,000 108,000 48,000 $252,000
38.1% 42.9% 19.0% 100%
Current liabilities Non-current liabilities Equity Total liabilities & equity
$62,400 162,000 15,600 $240,000
26.0% 67.5% 6.5% 100.0%
$57,600 180,000 14,400 $252,000
22.9% 71.4% 5.7% 100%
(c)
Horizontal analysis gives an investor useful information about trends in an entity’s (intra-entity) performance or financial position. Vertical analyses provide information on the significance of financial statement items as a function of some total on the financial statement. Both types of calculations can be compared with industry averages or companies in the same industry. Because vertical and horizontal analyses are complementary, both are useful when making the investment decision.
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Chapter 12: Financial statement analysis
EXERCISE 12.7 (a) Perth Diners Ltd Condensed Statement of Financial Position as at 30 June 2014 Horizontal Analysis Percentage Change from 2013
2014
2013
Increase (Decrease)
Current assets Property, plant & equipment (net) Intangibles Total assets
$88,000 81,000 31,000 $200,000
$80,000 90,000 40,000 $210,000
$8,000 (9,000) (9,000) ($10,000)
10% (10.0%) (22.5%) (4.8%)
Current liabilities Non-current liabilities Equity Total liabilities & equity
$52,000 135,000 13,000 $200,000
$48,000 150,000 12,000 $210,000
$4,000 (15,000) 1,000 ($10,000)
8.3% (10.0%) 8.3% (4.8%)
(b) Perth Diners Ltd Condensed Statement of Financial Position as at 30 June 2014 Vertical Analysis 2014 $
2013 Percent
$
Percent
Current assets Property, plant & equipment (net) Intangibles Total assets
$88,000 81,000 31,000 $200,000
44.0% 40.5% 15.5% 100.0%
$80,000 90,000 40,000 $210,000
38.1% 42.9% 19.0% 100%
Current liabilities Non-current liabilities Equity Total liabilities & equity
$52,000 135,000 13,000 $200,000
26.0% 67.5% 6.5% 100.0%
48,000 150,000 12,000 $210,000
22.9% 71.4% 5.7% 100%
12.14
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 12.8 Global Retail Ltd Current ratio = 1.59:1.0 ($1,100 ÷ $690) Quick ratio
= 0.60:1.0 ($411 ÷ $690)
Current cash debt coverage = .33 times ($215 ÷ $658.5) Receivables turnover
= 12.0 times ($3,894 ÷ $324.5)
Average collection period
= 30.4 days (365 days ÷ 12.0)
Inventory turnover
= 4.3 times ($2,600 ÷ $607)
Average days in inventory
= 85. days (365 days ÷ 4.3)
EXERCISE 12.9 Region Retail Ltd (a)
Current ratio as of 1 February 2012 = 2 or 2.0:1.0 ($200,000 ÷ $100,000). Feb.
(b)
3
2.0 No change in total current assets or liabilities.
7
1.75 ($175,000 ÷ $100,000). Current assets decrease by $25,000.
11
1.75 No change in total current assets or liabilities.
14
1.87 ($161,000 ÷ $86,000). Current assets and current liabilities decrease by $14,000
18
1.75 ($161,000 ÷ $92,000). Current liabilities increase by $6,000.
Quick ratio as of 1 February 2012= 1.7 or 1.7:1.0 ($170,000 ÷ $100,000). Feb.
3 7
2.4 No change in total quick assets or current liabilities. 1.45 ($145,000 ÷ $100,000). Quick assets decrease by $25,000
11 14
1.42 ($142,000 ÷ $100,000). Quick assets decrease by $3,000. 1.49 ($128, 000 ÷ $86,000). Quick assets and current liabilities decrease by $14,000.
18
1.39 ($128,000 ÷ $92,000). Current liabilities increase by $6,000.
12.15
Chapter 12: Financial statement analysis EXERCISE 12.10
Alice Ltd (a)
(b)
(c)
(d) (e)
(f) (g)
(h)
(i)
Current ratio:
$145, 000 = 2.9 :1.0 $50, 000
Quick ratio:
$85,000 = 1.7 : 1.0 $50,000
Receivables turnover:
$350, 000 = 5.6 times $62,500 (1)
Average collection period:
Inventory turnover:
Cash debt coverage:
$65,000 + $60,000 2
365 days ÷ 5.6 = 65.2 days.
$200, 000 = 3.6 times (2) $55, 000 (2)
Average days in inventory:
Cash return on sales:
(1)
$60,000 + $50,000 2
365 days ÷ 3.6 = 101 days
$50, 000 = 14.3% $350, 000
$50, 000 = .323 times $160, 000 + $150, 000 2
Current cash debt coverage:
$50, 000 = .91 times $60, 000 + $50, 000 2
12.16
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 12.11 Digital Products Ltd 2014 (a)
(b)
(c)
(d)
(e)
(f)
$80, 000 = 10% $800, 000
Profit margin
$800, 000 = 1.54 times $500, 000 + $540, 000 2
Asset turnover
$80, 000 = 15.4% $520, 000
Return on assets
Return on ordinary shareholders’ equity
$80, 000 = 22.5% $310, 000 + $400, 000 2
Cash return on sales
$75, 000 = 9.4% $800, 000
Gross profit rate
$800,000 − $480,000 = 40% $800,000
12.17
Chapter 12: Financial statement analysis
EXERCISE 12.12 Southern Pies Ltd (a)
Earnings per share:
$50, 000 − $5, 000 $45, 000 = = $1.29 per share 35, 000 35, 000
(b)
Price earnings ratio:
$15.00 = 11.6 times $1.29 (c)
Cash dividend payout ratio: Cash dividend payout ratio includes dividends paid to ordinary shareholders only.
$16, 000 = .32 $50, 000
(d)
Times interest earned:
$70, 000 + $30, 000 $30, 000 (e)
=
$100, 000 = 3.3 times $30, 000
Cash return on sales:
$102, 000 = 25.5% $400, 000
12.18
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 12.13 Allover Ltd (a)
Inventory turnover = 3.6 = Cost of sales $200,000+$180,000 2 3.6 x $190,000 = cost of sales Cost of sales = $684,000
(b)
Receivables turnover = 9.4 =
Net sales (credit) $126,000 + $72,500 2
Net sales (all on credit) = 9.4 x $99,250 = $932,950
(c)
Return on ordinary shareholders’ equity = 22% =
Profit ($400, 000 + $113,500 + $400, 000 + $101, 000 ) 2 Profit = .22 x $507,250 = $111,595
(d)
Return on assets = 12.5% =
Average assets =
$111,595 [see (c) above] Average assets
$111,595 = $892, 760 .125
(Total assets June 2010 + $805,000)/2 = $892,760 Total assets (June 2010) = ($892,760 x 2) - $805,000 = $980,520.
12.19
Chapter 12: Financial statement analysis
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 12.1 (a) North Ltd and West Ltd Condensed Income Statement for the year ended 30 June 2013 Vertical Analysis North Ltd Dollars Percent Net sales Cost of Sales Gross profit Operating expenses Interest expense Profit before tax Income tax expense Profit for the period
$1,500,000 1,080,490 419,510 302,275 6,800 110,435 47,840 $62,595
West Ltd Dollars Percent
100.0% 72.0% 28.0% 20.2% .5% 7.4% 3.2% 4.2%
$380,000 238,006 141,994 79,000 1,252 61,742 7,740 $54,002
100.0% 62.6% 37.4% 20.8% .3% 16.2% 2.0% 14.2%
(b) North Ltd appears to be less profitable. It has lower relative gross profit, profit before taxes, and profit for the period. The major difference is the relatively greater cost of sales, lowering North’s gross profit margin which flows through to the other profit measures. North’s return on assets of:
$62,595 a $54, 002 b is lower than West’s return on assets of 25.2% . $829,847.5 $214,172
7.5%
$62,595 $652,892.5
Also, North’s return on ordinary shareholders’ equity of 9.6%
c
is lower than
$54, 002 d . $154, 047
West’s return on ordinary shareholders’ equity of 35.1%
a
$829,847.50 is North’s 2013 average assets:
Current assets Non current assets Total assets
2013 $325,975 521,310 $847,285
12.20
2012 $312,410 500,000 $812,410
=
$1,659,695 2
Solutions manual to accompany Accounting: building business skills 4e
b
$214,172 is West’s 2013 average assets:
Current assets Non current assets Total assets
c
2012 $79,467 125,812 $205,279
=
$428,343 2
=
$1,305, 785 2
=
$308,094 2
$652,892.5 is North’s 2013 average shareholders’ equity:
Share capital Retained earnings Shareholders’ equity
d
2013 $83,336 139,728 $223,064
2013 $500,000 159,190 $659,190
2012 $500,000 146,595 $646,595
$154,047 is West’s 2013 average shareholders’ equity:
Share capital Retained earnings Shareholders’ equity
2013 $120,000 38,096 $158,096
12.21
2012 $120,000 29,998 $149,998
Chapter 12: Financial statement analysis
PROBLEM SET A 12.2 Enchanted Ltd (a)
Earnings per share =
$202,300 = $2.52 per share 80,137
(b) Return on ordinary shareholders’ equity =
(c)
(d)
(e)
(f)
(g) (h)
Return on assets =
Current ratio =
Quick ratio =
$202,300 $465, 400 + $736, 700 2 $202,300 = = 33.7% $601, 050
$202,300 $202,300 = = 20.3% $996,500 $852,800 + $1,140, 200 2
$514,900 = 2.7 :1.0 $193,500
$314,900 = 1.6 :1.0 $193,500
Receivables turnover =
$1,818,500 $1,818,500 = = 14.4 times $126, 400 $102,800 + $150, 000 2
Average collection period = 365 days ÷ 14.4 = 25.4 days. Inventory turnover =
$1, 005,500 $1, 005,500 = = 6.4 times $157,500 $115,500 + $200, 000 2
(i)
Average days in inventory = 365 days ÷ 6.4 = 57.3 days.
(j)
Times interest earned = $18,000 = 17.0 times
(k)
(l)
$307,000
Asset turnover =
$1,818,500 = 1.8 times $996,500
Debt to total assets =
$403,500 = 35.4% $1,140, 200
12.22
Solutions manual to accompany Accounting: building business skills 4e
(m)
(n)
(o)
Current cash debt coverage ratio =
Cash return on sales =
Cash debt coverage =
$280,000 = 1.47 times $187,400 + $193,500 2
$280,000 = 15.4% $1,818,500
$280,000 = .708 times $387,400 + $403,500 2
12.23
Chapter 12: Financial statement analysis
PROBLEM SET A 12.3 (a) Comparative analysis is performed to evaluate an entity’s short-term liquidity, profitability and long-term solvency. Comparisons can detect changes in financial relationships and significant trends, and can provide insight into an entity’s competitive position within its industry. Financial statements may be analysed horizontally, vertically, and with ratios.
Wallaby Ltd (b)
2013 (1)
2012
Profit margin ratio: $44,000 = 6.3% $700,000
(2)
$32,000 = 4.9% $650,000
Gross profit ratio: $250,000 = 38% $650,000
$280,000 = 40% $700,000
(3)
Asset turnover.
$700,000 = 1.1times $590,000 + $640,000 2 (4)
Earnings per share.
$44,000 = $1.38 per share 4,000 30,000 + 2 (5)
$32,000 = $1.07 per share 30,000
Price-earnings ratio.
$5.00 = 4.7 times $1.07
$7.95 = 5.8 times $1.38 (6)
$650,000 = 1.2 times $533,000 + $590,000 2
Cash dividend payout ratio. $24,000 * * = 54.5% $44,000
$20,000 * = 62.5% $32,000
**($125,000 + $44,000 - $145,0000)
*($113,000 + $32,000 - $125,000)
(7)
Debt to total assets. $165,000 = 28% $590,000
$155,000 = 24.2% $640,000
12.24
Solutions manual to accompany Accounting: building business skills 4e
(c)
The underlying profitability of the company appears to have improved. For example, profit margin and earnings per share have both increased. In addition, the company’s priceearnings ratio has increased, which suggests that investors may be looking more favourably at the company. Also, the company appears to be involved in attempting to reduce its debt burden as its debt to total assets has decreased. Similarly, its cash dividend payout ratio has decreased, which should help its overall solvency.
PROBLEM SET A 12.4 Caroline Ltd Liquidity 2013
2012
Change
Current
$364,000 = 1.1 :1.0 $335,000
$343,000 = 1.9 :1.0 $182,000
Decrease
Quick
$209,000 = 0.6 :1.0 $335,000
$195,000 = 1.1 :1.0 $182,000
Decrease
Receivables turnover
$850,000 = 9.2 times $92,000
$790,000 = 8.9 times $89,000
Increase
Inventory turnover
$620,000 = 4.9 times $127,500
$575,000 = 4.8 times $120,000
Increase
Although the amount of current and quick assets to cover current liabilities has declined, in relative terms, the turnover of receivables and inventory has improved. The decline in the current and quick ratios is caused by the notes payable due March 2014, becoming a current liability. 2013
2012
Change
Profit margin
$36,000 = 4.2% $850,000
$35,000 = 4.4% $790,000
Decrease
Asset turnover
$850,000 = 1.3 times $666,000
$790,000 = 1.2 times $639,000
Increase
Return on assets
$36,000 = 5.4% $666,000
$35,000 = 5.5% $639,000
Decrease
Earnings per share
$36,000 = $1.80 per share 20,000
$35,000 = $1.75 per share 20,000
Increase
Profitability
Profitability has remained relatively the same.
12.25
Chapter 12: Financial statement analysis
PROBLEM SET A 12.5
Aust Ltd and Zealand Ltd (a) Ratio
Aust Ltd
Zealand Ltd
(1)
Current ratio
2.0:1
($11,000 ÷ $5,500)
1.2:1
($11,000 ÷ $9,000)
(2)
Receivables turnover
7.3 times
($40,000 ÷ $5,500)
37.3 times
($82,000 ÷ $2,200)
(3)
Average collection period
50 days
(365 ÷ 7.3)
9.8 days
(365 ÷ 37.3)
(4)
Inventory turnover
6.4 times
($32,000 ÷ $5,000)
8.1 times
($65,000 ÷ $8,000)
(5)
Average days in inventory
57 days
(365 ÷ 6.4)
45 days
(365 ÷ 8.1)
(6)
Profit margin
1.8%
($700 ÷ $40,000)
2.4%
($2,000 ÷ $82,000)
(7)
Asset turnover
2.1
($40,000 ÷ $18,752)
3.0
($82,000 ÷ $27,461)
(8)
Return on assets
3.7%
($700 ÷ $18,752)
7.3%
($2,000 ÷ $27,461)
(9)
Return on ordinary shareholders’ equity Debt to total assets
11.3%
($700 ÷ $6,196.5)
20.8%
($2,000 ÷ $9,617)
68.5%
($13,700 ÷ $20,000)
70.2%
($20,000 ÷ $28,481)
(11)
Times interest earned
2.7 times
($1,600 ÷ $600)
4.2 times
($4,200 ÷ $1,000)
(12)
Current cash debt coverage
0.18 times [$1,000÷($5,500+$5,698) ÷2]
0.26 times
[$2,500 ÷ ($9,000+$9,981) ÷ 2]
(13)
Cash return on sales
2.5%
3.0%
($2,500 ÷ $82,000)
(14)
Cash debt coverage*
.08 times [$1,000 ÷ ($13,700 + $11,411)/2]
.14
[$2,500 ÷ ($20,000 + $15,688)/2]
(10)
($1,000 ÷ $40,000)
* Beginning of the year total liabilities can be determined from beginning-of-year figures for total assets and shareholders’ equity as for Aust: $17,504 - $6,093 = $11,411; and for Zealand: $26,441 - $10,753 = $15,688. (b)
A simple comparison of current ratios would suggest that Aust Ltd is more liquid. However, Aust Ltd takes 107 days to convert inventory to cash (sum of average days in inventory and average collection period) whereas Zealand Ltd takes only 55 days. Zealand also has higher current cash debt coverage. While Aust Ltd has a lower debt to total assets ratio, indicating better solvency, Zealand Ltd has a higher cash debt coverage and times interest earned, indicating that it is more able to service its debt. Zealand Ltd was more profitable in the year of this analysis. It has both a higher asset turnover and a higher profit margin contributing to the greater return on assets. Zealand Ltd also has a higher return on shareholders equity and generates more cash with each dollar of sales. 12.26
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 12.6 Ultra Vision Ltd (a)
(b)
(c)
(d) (e)
(f) (g)
(h)
$209, 000 = 1.6 :1.0 $135, 000
Current ratio =
Should be 1.54 8 to 1. So rounding is off. Should be 1.5, if to one decimal. Quick ratio =
$15, 000 + $18, 000 + $92, 000 = 0.9 :1.0 $135, 000
$580, 000 = 7.0 times $92, 000 + $74, 000 2
Receivables turnover =
Average collection period =
365 ÷ 7.0 = 52 days
$400, 000 = 5.2 times $84, 000 + $70, 000 2
Inventory turnover =
Average days in inventory =
365 ÷ 5.2 = 70 days
Profit margin ratio =
$34, 000 = 5.9% $580, 000
Asset turnover =
$580, 000 = 1.0 times $632, 000 + $560, 000 2 (i)
(j)
(k)
$34, 000 = 5.7% $632, 000 + $560, 000 2
Return on assets =
Return on ordinary shareholders’ equity =
$34, 000 = 9.5% $367, 000 + $350, 000 2
$34, 000 = $1.13 per share 30, 000 (1)
Earnings per share =
(1) $150,000 $5.00 (l)
$19.50 = 17.2 times $1.13
Price-earnings ratio =
12.27
Chapter 12: Financial statement analysis
(m)
$17, 000 (2) = 50% $34, 000
Cash dividend payout ratio =
(2) $200,000 + $34,000 - $217,000 (n)
(o)
Debt to total assets =
$265, 000 = 41.9% $632, 000
Times interest earned =
$59, 200 (3) = 8.2 times $7, 200 (3) $34,000 + $18,000 + $7,200
12.28
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 12.7 Vienna Ltd
$11,000,000 Average receivable s
Receivables turnover = 10 =
Average receivables =
$11,000,000 = $1,100,000 10
(Receivables 30 June 12 + $950, 000) = $1,100,000 2 Receivables 30/6/12 = $2,200,000 - $950,000 = $1,250,000
Profit margin = 14.5% = .145 =
Profit $11, 000, 000
Profit = $11,000,000 x .145 = $1,595,000 Profit before income taxes = $1,595,000 + $560,000 = $2,155,000
Return on assets = 22% = .22 =
Average assets =
$1,595,000 Average assets
$1,595,000 = $7,250,000 .22
(Assets (30/6/12) + $7,000,000) = $7,250,000 2 Assets (30/6/12) = $14,500,000 - $7,000,000 = $7,500,000 Total current assets = $7,500,000 - $4,620,000 = $2,880,000 Inventory = $2,880,000 - $1,250,000 - $450,000 = $1,180,000 Total liabilities and shareholders’ equity = $7,500,000 Total liabilities = $7,500,000 - $3,400,000 = $4,100,000 Current ratio = 3:1 =
Current liabilities =
$2,880, 000 Current liabilities $2,880,000 = $960,000 3
12.29
Chapter 12: Financial statement analysis
Non-current liabilities = $4,100,000 - $960,000 = $3,140,000 Inventory turnover = 4.8 = Cost of sales $1,720,000+$1,180,000 2 Cost of sales = $1,450,000 x 4.8 = $6,960,000 Gross profit = $11,000,000 - $6,960,000 = $4,040,000 Gross profit - operating expenses – interest expense = profit before income tax $4,040,000 - $1,665,000 – interest expense = $2,155,000 Interest expense = $2,375,000 - $2,155,000 = $220,000
12.30
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 12.8 DONE AND DUSTED LTD (a) 1. Free cash flow = net cash from operating activities – capital expenditure = 101,344 – 32,560 = 68,784
2. Capital expenditure ratio =
net cash flow from operating activities capital expenditure
=
101,344 3.1: 1 32,560
3. Current cash debt coverage =
=
net cash flow from operating activities average current liabilities
101,344 = 0.5 times [(202,680 + 203,500) ÷ 2]
4. Cash debt coverage =
net cash flow from operating activities average total liabilities
=
101,344 = 0.25 times [(505,000 + 306,500) / 2]
5. Cash return on sales ratio =
=
net cash flow from operating activities net sales 101,344 = 0.17 times 608,000
(b) Traditionally, to evaluate an entity, the ratios most commonly used by investors and creditors have been based on accrual accounting. In this question some cash-based ratios are explored that are gaining increasing acceptance among analysts. FREE CASH FLOW In the statement of cash flows, cash provided by operating activities is intended to indicate the cash-generating capability of the entity. Analysts have noted, however, that net cash provided by operating activities fails to take into account that an entity must invest in new property, plant and equipment just to maintain its current level of operations, and it may need to maintain dividends at current or minimum levels to satisfy investors. Free cash flow is the term used to describe the cash from operations available for expansion or the payment of dividends. It is the amount of cash flow from operating activities remaining after deducting investing expenditure necessary to maintain the current level of operations. For Done and Dusted Ltd Free cash flow of $68,784 is available for the acquisition of new assets, the retirement of debt, or the payment of dividends.
12.31
Chapter 12: Financial statement analysis CAPITAL EXPENDITURE RATIO Another indicator of an entity’s ability to generate sufficient cash to finance the purchase of new property, plant and equipment is the capital expenditure ratio — net cash provided by operating activities divided by capital expenditures. This measure is similar to free cash flow, except that free cash flow reveals the amount of cash available for discretionary use by management, whereas the capital expenditure ratio provides a relative measure of cash provided by operations compared with cash used for the purchase of productive assets. Amounts spent on capital expenditures are listed in the investing activities section of the statement of cash flows. Using the information from Done and Dusted Ltd the calculations reveal its capital expenditure ratio 3.1: 1 The ratio of 3.1:1 suggests that Done and Dusted Ltd could have purchased more than three times as much property, plant and equipment as it did without requiring any additional outside financing. This ratio will vary across industries depending on the capital intensity of the industry. That is, we would expect a manufacturing entity to have a lower ratio (because it has higher capital expenditures) than a software entity, which spends less of its money on non-current assets and more on ‘intellectual’ capital. The phase of an entity’s life cycle will also affect the expected capital expenditure ratio. It is likely to be lower in the introductory and growth phases and higher in the maturity and decline phases. LIQUIDITY Liquidity is the ability of an entity to meet its immediate obligations. One measure of liquidity is the current ratio: current assets divided by current liabilities. A disadvantage of the current ratio is that it uses year-end balances of current asset and current liability accounts, and these year-end balances may not be representative of the entity’s position during most of the year. CURRENT CASH COVERAGE A measure that partially corrects this problem is the current cash debt coverage which is the net cash provided by operating activities divided by average current liabilities. Because net cash provided by operating activities involves the entire year rather than a balance at one point in time, it is often considered a better representation of liquidity. Done and Dusted Ltd net cash provided by operating activities in 1 year is 0.5:1. That is, it generates 50 cents of net cash provided by operating activities for every $1 of current liabilities. It generates enough cash from operating activities in 1 year to meet 50% of the obligations that are due within 1 year. A ratio closer to 1:1 would indicate that it generates 100 cents of net cash provided by operating activities for every $1 of current liabilities. SOLVENCY Solvency is the ability of an entity to survive over the long term. CASH DEBT COVERAGE A measure of solvency that uses cash figures is the cash debt coverage which is measured as the net cash provided by operating activities divided by total debt as represented by average total liabilities. This measure indicates an entity’s ability to repay its liabilities from cash generated from operations, i.e. without having to liquidate productive assets such as property, plant and equipment. The cash debt coverage for Done and Dusted Ltd is 0.25 times. Done and Dusted Ltd’s net cash provided by operating activities is 0.25:1. This means that the entity has 25 cents net cash provided by operating activities for every $1 of average total liabilities. Hence, Done and Dusted Ltd net cash provided by operating activities is 25% of its total liabilities. Another way to consider this measure is to look at the reciprocal, which is 4. It would take Done and Dusted Ltd 4 years to repay all of its liabilities from cash provided by operating activities at the current level. PROFITABILITY Profitability refers to an entity’s ability to generate a reasonable return. In chapter 14 accrual-based ratios that measure profitability are discussed, such as gross profit rate, profit margin and return on assets. In measures of profitability the potential differences between cash accounting and accrual accounting are most pronounced. Although some differences are expected because of the difference in the timing of revenue and expense recognition under cash versus accrual accounting, significant differences should be investigated. A cash-based measure of performance is the cash return on sales ratio. 12.32
Solutions manual to accompany Accounting: building business skills 4e CASH RETURN ON SALES RATIO The cash return on sales ratio is calculated as net cash provided by operating activities divided by net sales. This ratio indicates the entity’s ability to turn sales into dollars. The cash return on sales ratio can be compared with the corresponding accrual-based ratio. A lower cash return on sales ratio should be investigated because it might indicate that the entity is recognising sales that are not really sales (i.e. sales it will never collect), or incurring a lot of expenditure relative to revenue. Alternatively, it may reflect payments for increased inventory and other lags occurring in the growth phase. The cash return on sales ratio for Done and Dusted Ltd is 0.17. 0.17:1, or 17%. This means the entity generates 17 cents in cash for every $1 of sales. When this ratio is compared to Nick Scali’s ratio of .16 or 16% in chapter 11 – we see that Done and Dusted Ltd has a slightly higher cash return on sales ratio. Overall it appears that Done and Dusted Limited ratios indicate the business is profitable and solvent, can replace its assets as needed and has free cash flow. However, further investigation is needed into the liquidity of the business to ensure that there is adequate cash flow to met short term debts as they fall due.
12.33
Chapter 12: Financial statement analysis PROBLEM SET A 12.9
High Ltd and Low Ltd (a) Ratio
High Ltd
Low Ltd
(1)
Return on assets
39.0%
($276,000 ÷ $708,000)
30.3%
($188,000 ÷ $620,000)
(2)
67.6%
($276,000 ÷ $408,000)
58.7%
($188,000 ÷ $320,000)
(3)
Return on ordinary shareholders’ equity Profit margin
27.6%
($276,000 ÷ $1,000,000)
18.8%
($188,000 ÷ $1,000,000)
(4)
Current ratio
4.1:1
($488,000 ÷ $120,000)
3.7:1
($440,000 ÷ $120,000)
(5)
Receivables turnover
5 times
($1,000,000 ÷ $200,000)
5 times
($1,000,000 ÷ $200,000)
Inventory turnover
2.7 times
($552,000 ÷ $208,000)
3.8 times
($600,000 ÷ $160,000)
Debt to equity
73.5%
($300,000 ÷ $408,000)
93.8%
($300,000 ÷ $320,00)
(7)
(b)
Using different accounting methods has affected all measures except the receivables turnover ratio. The use by Low Ltd of weighted average valuation and reducing balance depreciation has increased their expenses, reduced their profit and therefore decreased their total asset and equity values. This in turn causes their return on assets, return on equity, profit margin, current ratio, and debt to equity ratio to be considerably lower than High Ltd.; however, Low Ltd’s inventory turnover was better because the weighted average inventory method (in a period of rising prices) results in a higher cost of sales and a lower ending inventory value than does the FIFO inventory method.
12.34
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 12.1 (a) Here Today Ltd and Gone Tomorrow Ltd Condensed Income Statement for the year ended 31 December 2012 Vertical Analysis Here Today Ltd Dollars Per cent Net sales Cost of sales Gross profit Operating expenses Interest expense Profit before tax Income tax expense Profit for the period
$350,000 180,000 170,000 51,000 3,000 116,000 11,000 $105,000
Gone Tomorrow Ltd Dollars Per cent
100.0% $1,400,000 51.4% 720,000 48.6% 680,000 14.6% 278,000 .9% 10,000 33.1% 392,000 3.1% 68,000 30.0% $324,000
100.0% 51.4% 48.6% 19.9% .7% 28.0% 4.9% 23.1%
(b) Although Gone Tomorrow Ltd has more profit in dollar terms it has been less profitable than Here Today during 2012. Although the gross profit rate is the same for both companies Gone Tomorrow incurs more operating expenses, relative to sales, than does Here Today, and thus
$324, 000 a $1,550, 000
achieves a lower profit margin. Gone Tomorrow’s return on assets of 20.9%
$105, 000 b . $452,500
is lower than Here Today’s return on assets of 23.2%
$324, 000 $1,112,500
Also, Gone Tomorrow’s return on ordinary shareholders’ equity of 29.1%
$105, 000 d . $337,500
lower than Here Today’s return on ordinary shareholders’ equity of 31.1% $1,550,000 is Gone Tomorrow’s 2012 average assets:
a
Current assets Non current assets Total assets
2012 $700,000 1,000,000 $1,700,000
12.35
2011 $650,000 750,000 $1,400,000
=
$3,100, 000 2
c
is
Chapter 12: Financial statement analysis
b
$452,500 is Here Today’s 2012 average assets:
Current assets Non current assets Total assets c
2011 $100,000 270,000 $370,000
=
$905, 000 2
$1,112,500 is Gone Tomorrow’s 2012 average shareholders’ equity:
Share capital Retained earnings Shareholders’ equity d
2012 $130,000 405,000 $535,000
2012 $950,000 300,000 $1,250,000
2011 $700,000 275,000 $975,000 =$2,225,000/2
$337,500 is Here Today’s 2012 average shareholders’ equity:
Share capital Retained earnings Shareholders’ equity
2012 $360,000 65,000 $425,000
12.36
2011 $210,000 40,000 $250,000
=
$675, 000 2
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 12.2 Classic Rock Ltd (a)
(b)
(c)
(d)
(e)
Gross profit rate =
$340,000 = 43.6% $780,000
Return on ordinary shareholders’ equity =
$157, 200 = 39.0% $410,300 + $396, 000 2 $157, 200 = 22.3% $735,800 + $672, 000 2 $280,500 = 1.45 :1.0 $193,500
Return on assets =
Current ratio =
Receivables turnover =
$780, 000 = 7.8 times $106, 200 + $93,800 2 (f)
Average collection period =
(g)
Inventory turnover =
365 ÷ 7.8 = 46.8 days
$440, 000 = 4.9 times $116, 400 + $64, 000 2 (h) (i)
(j)
Average days in inventory =
365 ÷ 4.9 = 75 days
Times interest earned =
$186, 200 + $9,920 $9,920
Asset turnover =
$780, 000 = 1.1 times $735,800 + $672, 000 2 (k)
$325,500 = 44.2% $735,800
Debt to total assets =
12.37
= 19.8 times
Chapter 12: Financial statement analysis
(l)
Current cash debt coverage =
$41, 000 = 0.235times $193, 500 + $156, 000 2 (m)
Cash debt coverage =
$41, 000 = 0.136times $325,500 + $276, 000 2
12.38
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 12.3 Flower Ltd (a)
2013 (1)
2012
Profit margin ratio:
$100, 000 = 15.2% $660, 000
$120, 000 = 16.2% $740, 000 (2)
Gross profit ratio:
$320, 000 = 43.2% $740, 000 (3)
$210, 000 = 31.8% $660, 000
Asset turnover.
$740, 000 = 1.0 times $795, 000 + $665, 000 2 (4)
Earnings per share.
$120, 000 = $3.75 per share 31,984 (5)
$100, 000 = $3.33 per share 30, 000
Price-earnings ratio.
$10.00 = 3.0 times $3.33
$15.00 = 4.0 times $3.75 (6)
Cash dividend payout ratio.
$20, 000** = 17% $120, 000
$13, 000* = 13% $100, 000
**($200,000 + $120,000 - $300,0000)
*($113,000 + $100,000 - $200,000)
(7)
Debt to total assets.
$165, 000 = 24.8% $665, 000
$155, 000 = 19.5% $795, 000 (b)
$660, 000 = 1.1 times $533, 000 + $665, 000 2
The underlying profitability of the company appears to have improved. For example, profit margin and gross profit ratio have both increased. The earnings per share has increased even though there are more shares in the denominator. In addition, the company’s price-earnings ratio has increased, which suggests that investors may be looking more favourably at the company. Also, the company appears to be involved in attempting to reduce its debt burden as its debt to total assets has decreased.
12.39
Chapter 12: Financial statement analysis (c ) The usefulness of analytical tools is limited by the use of estimates, the cost basis, the
application of alternative accounting methods, atypical data at year-end, and the diversification of entities.
12.40
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 12.4
(a) M L Kurt Ltd Liquidity 2014 Current
Quick
Receivables turnover
Inventory turnover
2013
Change
$695,000 = 2.1: 1.0 $335,000
$510,000 = 3.1:1.0 $165,000
Decrease
$230,000 = 0.7: 1.0 $335,000
$179,000 = 1.1: 1.0 $165,000
Decrease
$1,000,000 = 10.7 times $93,500
$940,000 = 11.3 times $83,500
Decrease
$650,000 = 1.8 times $370,000
$635,000 = 2.0 times $325,000
Decrease
The current ratio and the quick ratio declined indicating lower liquidity. There are relatively fewer current assets for every dollar of current liabilities in 2014 than there were in 2013. This decline is exacerbated by the slower turnover of both receivables and inventory. 2014
2013
Change
$115,000 = 11.5% $1,000,000
$80,000 = 8.5% $940,000
Increase
$1,000,000 = 0.9 times ($1,340,000+$985,000)/2
$940,000 _ = 0.9 times ($985,000+$1,175,000)/2
Stable
Return on assets
$115,000 = 9.9% ($1,340,000+$985,000)/2
$80,000 _ = 7.4% ($985,000+$1,175,000)/2
Earnings per share
$115,000 = $1.15 per share 100,000
$80,000 = $0.80 per share 100,000
Profitability Profit margin
Asset turnover
Increase
Increase
Profitability has improved. The improved profitability was driven by the greater profitability of each dollar of sales, rather than efficiency in asset turnover, which remained stable.
12.41
Chapter 12: Financial statement analysis
(b) Current Ratio is Current Asset divided by Current Liabilities. Higher ratio means better shortterm liquidity. Current Ratio of 2.1 means, for every dollar of current liabilities, there is $2.10 of current assets in the company’s statement of financial position. Quick Ratio is calculated as follows: (Cash + Marketable Securities + Net Receivables)/Current Liabilities Like Current Ratio, higher ratio means better short-term liquidity. Quick Ratio calculation, however, does not include inventory and prepaid expense. For this reason, Quick Ratio is considered better than Current Ratio. Cash, marketable securities and net receivables are more liquid when compared with inventory and prepaid expenses. The inventory may not be readily saleable and the prepaid expenses may not be transferable to others. Receivables Turnover is Net Credit Sales divided by Average Net Trade Receivables. Receivables Turnover measures the number of times, on average, that receivables are collected during the period. The higher the receivables turnover, the shorter the period of time between an entity making a credit sale and collecting the cash for the receivable. The higher the receivables turnover, the more liquid the receivables of an entity. Inventory Turnover is Cost of Sales divided by Average Inventory. Inventory Turnover measures the number of times on average the inventory is sold during the period. Its purpose is to measure the liquidity of the inventory. Further, the higher the turnover, the less chance inventory will be slow moving or become obsolete and un-saleable. Profit Margin is a measure of the amount of each dollar of sales that results in profit. It is calculated by dividing profit by net sales for the period. A Profit Margin of 11.5% means that net sales of $1 results in profit of 11.5 cents. Asset Turnover measures how efficiently an entity uses its asset to generate sales. The higher the number, the more efficient. Asset Turnover is calculated by dividing net sales by average total assets for the period. Return on Assets is Profit divided by Average Total Asset. Return on Assets measures the overall profitability of assets in terms of the rate earned on each dollar invested in assets. Earnings per share is a measure of the profit earned on each ordinary share. It is calculated by dividing profit available to ordinary shareholders by the weighted average number of ordinary shares issued.
12.42
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 12.5 Ausco Ltd and Zealand Ltd (a) Ratio
Ausco Ltd
Zealand Ltd
(1)
Current
1.6:1
($9,187 ÷ $5,626)
1.5:1
($15,338 ÷ $9,973)
(2)
Receivables turnover
21.7 times
($34,025 ÷ $1,570)
118.7 times
($82,494 ÷ $695)
(3)
Average collection period
16.8 days
(365 ÷ 21.7)
3.1 days
(365 ÷ 118.7)
(4)
Inventory turnover
3.6 times
($25,992 ÷ $7,317)
5.2 times
($65,586 ÷ $12,539)
(5)
Average days in inventory
101.4 days
(365 ÷ 3.6)
70.2 days
(365 ÷ 5.2)
(6)
Profit margin
0.9%
($296 ÷ $34,025)
3.2%
($2,681 ÷ $82,494)
(7)
Asset turnover
2.0
($34,025 ÷ $17,267)
2.8
($82,494 ÷ $29,630)
(8)
Return on assets
1.7%
($296 ÷ $17,267)
9.0%
($2,681 ÷ $29,630)
(9)
Return on ordinary shareholders’ equity
4.9%
($296 ÷ $6,063)
22.8%
($2,681 ÷ $11,740
(10)
Debt to total assets
64.6%
($10,997 ÷ $17,029)
61.2%
($20,093 ÷ $32,819)
(11)
Times interest earned
1.8 times
($904 ÷ $494)
7.0 times
($4,968 ÷ $706)
(12)
Current cash debt coverage*
.062
($351 ÷ $5,626)
.311
($3,106 ÷ $9,973)
(13)
Cash return on sales
1%
($351 ÷ $34,025)
3.8%
($3,106 ÷ $82,494)
(14)
Cash debt coverage**
.032 $5,371)]
[$351 ÷ ($5,626 +
.155
[$3,106 ÷ ($9,973 + $10,120)]
* **
using year-end amounts because beginning of year data is not available. using year-end amounts. Alternatively, beginning of the year total liabilities can be determined from beginning-of-year figures for total assets and shareholders’ equity as for Ausco: $11,411 ($17,504 - $6,093): [$351 ÷ ($10,997 + $11,411)/2] = .031; and for Zealand $15,688 ($26,441 - $10,753): [$3,106 ÷ ($20,093 + $15,688)/2] = .174.
12.43
Chapter 12: Financial statement analysis
PROBLEM SET B 12.6 Salty Surf Ltd (a)
Current ratio =
$250,800 = 1.5 ∶ 1.0 162,000
(b)
Quick ratio =
($18,000 + 21,600 + 110,400) = .8 ∶ 1.0 162,000
(c)
Receivables turnover =
(d)
Average collection period = 365 ÷ 7.0 = 52 days
(e)
Inventory turnover =
(f)
Average days in inventory = 365 ÷ 5.2 = 70 days
(g)
Profit margin ratio =
$40,800 = 5.9% $696,000
(h)
Asset turnover =
[$696,000/($758,400 + $672,000)] = 1.0 times 2
(i)
Return on assets =
$40,800 = 5.7% [(758,400 + 672,000)/2]
(j)
Return on ordinary shareholders’ equity =
(k)
Earnings per share =
$40,800 = $1.36 per share (180,000/6)
(l)
Price-earnings ratio =
$23.40 = 17.2 times 1.36
(m)
Cash dividend payout ratio = ($240,000 + $40,800 − $260,400) = 50% $40,800
(n)
Debt to total assets =
(o)
Times interest earned =
$696,000 = 7.0 [$110,400 + 88,800/2]
$480,000 = 5.2 [$100,800 + 84,000/2]
$40,800 = 9.5% [(440,400 + 420,000) / 2]
$318,000 = 41.9% $758,400
($40,800 + 21,600 + $8,640) = 8.2 $8,640
12.44
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 12.7 Crazy Craft Ltd Receivables turnover = 10 =
$5,500,000 Average receivables
Average receivables =
$5,500,000 10
(Receivables 30/6/12 + $475,000) 2
= 550,000
= $550,000
Receivables 30/6/12 = $1,100,000 - $475,000 = $625,000 Profit
Profit margin = 14.5% = .145 =
$5,500,000
Profit = $5,500,000 x .145 = $797,500 Profit before income taxes = $797,500 + $280,000 = $1,077,500 Return on assets = 22% = .22 =
Average assets =
$797,500 average assets
$797,500 .22
(Assets (30/6/12) + $3,500,000) 2
= $3,625,000
= $3,625,000
Assets (30/6/12) = $7,250,000 - $3,500,000 = $3,750,000 Total current assets = $3,750,000 - $2,310,000 = $1,440,000 Inventory = $1,440,000 - $625,000 - $225,000 = $590,000 Total liabilities and shareholders’ equity = $3,750,000 Total liabilities = $3,750,000 - $1,700,000 = $2,050,000 Current ratio = 3:1 =
$1,440,000 current liabilities
Current liabilities =
$1,440,000 3
= $480,000
Non-current liabilities = $2,050,000 - $480,000 = $1,570,000 Inventory turnover = 4.8 =
COGS [(860,000 + 590,000) / 2]
Cost of sales = $725,000 x 4.8 = $3,480,000 Gross profit = $5,500,000 - $3,480,000 = $2,020,000 Gross profit - operating expenses – interest expense = profit before income tax $2,020,000 - $832,500 – interest expense = $1,077,500 Interest expense = $1,187,500 - $1,077,500 = $110,000
12.45
Chapter 12: Financial statement analysis
PROBLEM SET B 12.8 Cold Pressed Olive Ltd a). Receivables turnover = 10 =
Average receivables =
$2,750,000 Average receivables $2,750,000 = 275,000 10
(Receivables 30/6/15 + $237,500) = $275,000 2
Receivables 30/6/15 = $550,000 - $237,500 = $312,500 Profit
Profit margin = 14.5% = .145 = $2,750,000 Profit = $2,750,000 x .145 = $398,750 Profit before income taxes = $398,750 + $140,000 = $538,750 Return on assets = 22% = .22 =
Average assets =
$398,750 average assets
$398,750 = $1,812,500 .22
(Assets (30/6/15) + $1,750,000) = $1,812,500 2
Assets (30/6/15) = $3,625,000 - $1,750,000 = $1,875,000 Total current assets = $1,875,000 - $1,155,000 = $720,000 Inventory = $720,000 - $312,500 - $112,500 = $295,000 Total liabilities and shareholders’ equity = $1,875,000 Total liabilities = $1,875,000 - $850,000 = $1,025,000 Current ratio = 3:1 =
$720,000 current liabilities
Current liabilities =
$720,000 3
= $240,000
Non-current liabilities = $1,025,000 - $240,000 = $785,000 COGS
Inventory turnover = 4.8 = [(430,000 + 295,000)÷ 2] Cost of sales = $362,500 x 4.8 = $1,740,000 Gross profit = $2,750,000 - $1,740,000 = $1,010,000 12.46
Solutions manual to accompany Accounting: building business skills 4e
Gross profit - operating expenses – interest expense = profit before income tax $1,010,000 - $416,250 – interest expense = $538,750 Interest expense = $593,750 - $538,750 = $55,000 (b)
Based on the ratios provided above, Cold Pressed Olive Ltd would appear to be a reasonable investment. The profitability ratios appear strong. And the current ratio suggests that the entity does not have a liquidity problem. The only ratio of concern is the inventory turnover which suggests that inventory is slow to sell. Before making any investment decision, comparisons with industry averages and trend analysis would be advisable.
12.47
Chapter 12: Financial statement analysis
PROBLEM SET B 12.9 RAZOR BACK LTD (a) 1. Free cash flow = net cash from operating activities – capital expenditure = 202,688 – 65,120 = 137,568 2. Capital expenditure ratio =
Net cash flow from operating activities
=
capital expenditure 202,688 65,120
3. Current cash debt coverage = = 4. Cash debt coverage = =
= 3.1: 1
net cash flow from operating activities average current liabilities 202,688 [(403,000 + 406,500) ÷ 2]
= 0.5 times
net cash flow from operating activities average total liabilities 202,688 [(990,800 + 608,500) ÷ 2]
5. Cash return on sales ratio = =
/
/
= 0.25 times
net cash flow from operating activities 202,688 1,216,000
net sales
= 0.17 times
(b) Traditionally, to evaluate an entity, the ratios most commonly used by investors and creditors have been based on accrual accounting. In this question some cash-based ratios are explored that are gaining increasing acceptance among analysts. FREE CASH FLOW In the statement of cash flows, cash provided by operating activities is intended to indicate the cash-generating capability of the entity. Analysts have noted, however, that net cash provided by operating activities fails to take into account that an entity must invest in new property, plant and equipment just to maintain its current level of operations, and it may need to maintain dividends at current or minimum levels to satisfy investors. Free cash flow is the term used to describe the cash from operations available for expansion or the payment of dividends. It is the amount of cash flow from operating activities remaining after deducting investing expenditure necessary to maintain the current level of operations. For Razor Back Ltd Free cash flow of $137 568 is available for the acquisition of new assets, the retirement of debt, or the payment of dividends.
CAPITAL EXPENDITURE RATIO Another indicator of an entity’s ability to generate sufficient cash to finance the purchase of new property, plant and equipment is the capital expenditure ratio — net cash provided by operating activities divided by capital expenditures. This measure is similar to free cash flow, except that free cash flow reveals the amount of cash available for discretionary use by management, whereas the capital expenditure ratio provides a relative measure of cash provided by operations compared with cash used for the purchase of productive assets. Amounts spent on capital expenditures are listed in the investing activities section of the statement of cash flows. Using the information from Razor Back Ltd the calculations reveal its capital expenditure ratio 3.1: 1 The ratio of 3.1:1 suggests that Razor Back Ltd could have purchased more than three times as much property, plant and equipment as it did without requiring any additional outside financing. This ratio will vary across industries depending on the capital intensity of the industry. That is, we would expect a manufacturing entity to have a lower ratio (because it has higher capital expenditures) than a software entity, which spends less of its money on non-current assets and more on ‘intellectual’ capital. The phase of an entity’s life cycle will also affect the expected capital expenditure ratio. It is likely to be lower in the introductory and growth phases and higher in the maturity and decline phases. 12.48
Solutions manual to accompany Accounting: building business skills 4e
LIQUIDITY Liquidity is the ability of an entity to meet its immediate obligations. One measure of liquidity is the current ratio: current assets divided by current liabilities. A disadvantage of the current ratio is that it uses year-end balances of current asset and current liability accounts, and these year-end balances may not be representative of the entity’s position during most of the year. CURRENT CASH COVERAGE A measure that partially corrects this problem is the current cash debt coverage which is the net cash provided by operating activities divided by average current liabilities. Because net cash provided by operating activities involves the entire year rather than a balance at one point in time, it is often considered a better representation of liquidity. Razor Back Ltd net cash provided by operating activities in 1 year is 0.5:1. That is, it generates 50 cents of net cash provided by operating activities for every $1 of current liabilities. It generates enough cash from operating activities in 1 year to meet 50% of the obligations that are due within 1 year. A ratio closer to 1:1 would indicate that it generates 100 cents of net cash provided by operating activities for every $1 of current liabilities. SOLVENCY Solvency is the ability of an entity to survive over the long term. CASH DEBT COVERAGE A measure of solvency that uses cash figures is the cash debt coverage which is measured as the net cash provided by operating activities divided by total debt as represented by average total liabilities. This measure indicates an entity’s ability to repay its liabilities from cash generated from operations, i.e. without having to liquidate productive assets such as property, plant and equipment. The cash debt coverage for Razor Back Ltd is 0.25 times. Razor Back Ltd’s net cash provided by operating activities is 0.25:1. This means that the entity has 25 cents net cash provided by operating activities for every $1 of average total liabilities. Hence, Razor Back Ltd net cash provided by operating activities is 25% of its total liabilities. Another way to consider this measure is to look at the reciprocal, which is 4. It would take Razor Back Ltd 4 years to repay all of its liabilities from cash provided by operating activities at the current level. PROFITABILITY Profitability refers to an entity’s ability to generate a reasonable return. In chapter 14 accrual-based ratios that measure profitability are discussed, such as gross profit rate, profit margin and return on assets. In measures of profitability the potential differences between cash accounting and accrual accounting are most pronounced. Although some differences are expected because of the difference in the timing of revenue and expense recognition under cash versus accrual accounting, significant differences should be investigated. A cash-based measure of performance is the cash return on sales ratio. CASH RETURN ON SALES RATIO The cash return on sales ratio is calculated as net cash provided by operating activities divided by net sales. This ratio indicates the entity’s ability to turn sales into dollars. The cash return on sales ratio can be compared with the corresponding accrual-based ratio. A lower cash return on sales ratio should be investigated because it might indicate that the entity is recognising sales that are not really sales (i.e. sales it will never collect), or incurring a lot of expenditure relative to revenue. Alternatively, it may reflect payments for increased inventory and other lags occurring in the growth phase. The cash return on sales ratio for Razor Back Ltd is 0.17. 0.17:1, or 17%. This means the entity generates 17 cents in cash for every $1 of sales. When this ratio is compared to Nick Scali’s ratio of .16 or 16% in chapter 11 – we see that Razor Back Ltd has a slightly higher cash return on sales ratio. Overall it appears that Razor Back Limited ratios indicate the business is profitable and solvent, can replace its assets as needed and has free cash flow. However, further investigation is needed into the liquidity of the business to ensure that there is adequate cash flow to met short term debts as they fall due. 12.49
Chapter 12: Financial statement analysis
PROBLEM SET B 12.10 Fido Ltd and Dido Ltd (a) Ratio
Fido Ltd
Dido Ltd
(1)
Return on assets
39.0%
$138,000 ÷ 354,000
30.3%
($94,000 ÷ $310,000)
(2)
67.6%
($138,000 ÷ $204,000)
58.7%
($94,000 ÷ $160,000)
(3)
Return on ordinary shareholders’ equity Profit margin
27.6%
($138,000 ÷ $500,000)
18.8%
($94,000 ÷ $500,000)
(4)
Current ratio
4.1:1
($244,000 ÷ $60,000)
3.7:1
($220,000 ÷ $60,000)
(5)
Receivables turnover
5 times
($500,000 ÷ $100,000)
5 times
($500,000 ÷ $100,000)
Inventory turnover
2.7 times
($276,000 ÷ $104,000)
3.8 times
($300,000 ÷ $80,000)
Debt to equity
73.5%
($150,000 ÷ $204,000)
93.8%
($150,000 ÷ $160,000)
(7)
(b)
Using different accounting methods has affected all measures except the receivables turnover ratio. The use by Dido Ltd of weighted average valuation and reducing balance depreciation has increased their expenses, reduced their profit and therefore decreased their total asset and equity values. This in turn causes their return on assets, return on equity, profit margin, current ratio, and debt to equity ratio to be considerably lower than Fido Ltd; however, Dido Ltd’s inventory turnover was better because the weighted average inventory method (in a period of rising prices) results in a higher cost of sales and a lower ending inventory value than does the FIFO inventory method.
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BUILDING BUSINESS SKILLS 12.1
FINANCIAL REPORTING PROBLEM
(a) Diversified Investments Limited (DIL) Trend analysis for the five years ended 2013 Base Period 2009 – (in millions) 2013
2012
2011
2010
2009
Revenue
$2,600.0
$2,438.8
$1,675.8
$1,263.4
$1,000.0
Trend
260.0%
243.9%
167.6%
126.3%
100%
Change in revenue since 2012
$161.2
12.50
Solutions manual to accompany Accounting: building business skills 4e
Depreciation and amortisation exp
$198.2
$151.9
$108.8
$86.3
$75.0
Trend
264.3%
202.5%
145.1%
115.1%
100%
Change in depn and amort since 2012
$46.3
Other selling and admin exp
$1882.4
$1757.9
$1204.5
$872.1
$675
Trend
278.9%
260.4%
178.4%
129.2%
100.0%
Change in selling and adm since 2012
$124.5
Finance costs
$181.9
$152.0
$91.4
$57.5
$40.0
Trend
454.8%
380.0%
228.5%
143.8%
100%
Change in finance costs since 2012
$29.9
Profit after tax
228.8
450.0
207.9
178.1
150.0
152.5%
300.0%
138.6%
118.7%
100%
228.8
261.7
207.9
178.1
150.0
Trend
152.5%
174.5%
138.6%
118.7%
100%
Change in profit (cont) since 2012
($32.9)
Trend Profit from continuing operations
12.51
Chapter 12: Financial statement analysis
This trend analysis of DIL shows a favourable trend in revenue over the past five years. However, the growth in profit has generally not kept pace with the growth in revenue. In fact, with the exception of profit after tax in 2012, the growth in revenue exceeds the growth in profit. In 2012 profit after tax included profit from discontinued operations. The trend analysis raises questions about the composition of the contribution from discontinued operations which are important to assessments about future prospects of DIL. Profit from continuing operations would have been restated from 2009 – 2011. A comparison of profit after tax and profit from continuing operations in each of those three years indicates a small loss from the discontinued operations in 2009 and no contribution in 2010 and 2011. Thus the difference between profit after tax and profit from discontinued operations is likely to have arisen from a gain on disposal of the discontinued operations included in profit after tax. This should be confirmed by examining the note disclosures (not reported here). Profit actually declined in 2013, although revenue increased slightly. To assist with this analysis, the dollar change in each item since 2012 has been included in the table above. Profit after tax is excluded from the analysis because the 2012 figure includes an unusual item (gain from disposal of discontinued operations). The individual expense items shed some light on the decline in profitability. One cause of the lower profit in 2013 is the increased selling and administrative expenses (124.5m). However, the growth in selling and administrative expenses in 2010 is 7.1% compared with a 6.6% growth in sales. Although the difference in percentages is small the effect on profit is significant because selling and administrative expenses are large items in dollar terms. A small % increase in a large dollar item can flow through to a significant effect on profit. The finance costs have grown by $29.9m (19,7%) since 2012. While this is significant in itself and warrants further analysis, its impact on declining profitability in 2013 is minor because of the relatively smaller dollar amounts involved. The depreciation and amortisation expenses have increased by $46.3m (30.5%). This has contributed to the declining profitability. It appears that DIL has expanded its asset base and this may have also contributed to the increasing finance costs. (b)
All $ amounts are in millions. (1)
Debt to Total Assets: 2013: ($5500.0 - $1905.9) ÷ $5500.0 = 65.3% (Liabilities = $3594.1) 2012: ($4600.0 - $1785.6) ÷ $4600.0 = 61.2% ((Liabilities = $2814.4)
(2)
Times Interest Earned: 2013: ($228.8 +$108.7+$181.9) ÷ $181.9 = 2.9 times 2012: ($261.7+$115.3+$152) ÷ $152.0 = 3.5 times
DIL has high leverage which increased in 2013. (In fact, leverage has increased every year from 2009 to 2013.) DIL’s ability to pay interest payments when they become due declined as indicated by the decrease in the times interest earned ratio from 3.5 to 2.9.
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(c)
Profit from continuing operations is used to provide a consistent comparison and better indication of future profitability. All $ amounts are in millions. (1)
Profit Margin: 2013: $228.8 ÷ $2600.0 = 8.8% 2012: $261.7 ÷ $2438.8 = 10.7%
(2)
Asset Turnover: 2013: $2600.0 ÷ [($5500.0 + $4600.0) ÷ 2] = 0.51 times 2012: $2438.8 ÷ [($4600.01 + $3616.0) ÷ 2] = 0.59 times
(3)
Return on Assets: 2013: $228.8 ÷ [($5500.0 + $4600.0) ÷ 2] = 4.5% 2012: $261.7 ÷ [($4600.01 + $3616.0) ÷ 2] = 6.4%
(4)
Return on Ordinary Shareholders’ Equity: 2013: $228.8 ÷ [($1905.9 + $1785.6) ÷ 2] = 12.4% 2012: $261.7 ÷ [($1785.6 + $1600.4) ÷ 2] = 15.5%
The four measures of profitability declined. The increase in revenue has not kept pace with the increase in total assets in 2013. Each dollar of sales revenue generated less profit in 2013 than in 2012. These two factors combined to cause a substantial decline in the return on assets. (d)
DIL has invested significantly in 2013 with no resulting improvement in profit. Further information about the nature of the investment would be helpful in understanding the 2013 performance and assessing potential for profitability in future. Further, substantial amounts of important information about a company are not in its financial statements. Events involving such things as industry changes, management changes, competitors’ actions, technological developments, governmental actions, and union activities are often critical to the successful operations of a company. Financial reports in the media, disclosures to the Stock Exchange and publications of financial service firms (Standard & Poor’s, Dun & Bradstreet) will provide additional relevant information not usually found in the annual report.
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Chapter 12: Financial statement analysis
BUILDING BUSINESS SKILLS 12.2
INTERPRETING FINANCIAL STATEMENTS
Zhang Ltd Financial Statement Analysis (a)
(1)
$’000 omitted. 2013 Profit margin:
2012
$6723 = 1.1% $624,576
$3119 = 0.6% $548,864
Sales revenue = $627,708 - $39-$470-$823$1800 = $624,576
Sales revenue = $550324 - $60-$600-$300-$500 = $548,864
(2) Return on Shareholders’ Equity – profit from continuing operations:
$6,723
( ($123,874 + $125,623) ) /2
$3,119 = 2.5% ($125,623 + 124,000 )/2
= 5.4%
Return on Shareholders’ Equity using profit for the period:
$2,619
$1,500 = 1.2% ($123,874 + $125,623 )/2
( $125,623 +$124,000 ) /2
(3) Return on Assets using profit after tax from continuing operations: $6,723 = 2.2% ( ($291,680 + $333,352 ) /2
= 2.1%
$3,119 = 0.9% (($333,352 + $330,000 )/2
Return on Assets using profit for the period:
$1,500
( ($291,680 + $333,352 ) /2
$2,619
= 0.5%
( ($333,352 + $333,000 ) /2
= 0.8%
(4) Times Interest Earned using profit from continuing operations before finance cost and tax expense:
$11,723 + $8,529 = 2.4 times $8,529
$5,830 + $6,440 = 1.9 times $6,440
A comparison of Zhang Ltd’s profitability ratios for 2012 and 2013 could be quite misleading if the effect of the discontinuing operations were not taken into account. Using profit for the period gives the impression that Zhang’s profitability is declining as the return on shareholders’ equity and return on assets decline. However, when profit from continuing operations is used the reverse trend is observed, that is, profitability is improving as evidenced by the increase in the return on shareholders’ equity and the return on assets. The profit margin also shows improvement during this period.
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(b)
$’000 omitted. (1)
Inventory Turnover:
$279,519 = 3.9 times ($55,117 + $88,853)/2
(2)
Receivables Turnover:
$624,576 = 11.2 times ($47,583 + $63,908)/2 (3)
Gross Profit Rate
$548,864 − $233,313 = 57.5% $548,864
$624,576 − $279,519 = 55.2% $624,576
(c) Profitability has been improving and this has contributed to an improvement in Zhang Ltd’s ability to cover its interest expense. Although the gross profit rate decreased in 2013, this was offset by an increase in sales revenue which resulted in an increase in the dollar amount of gross profit. Zhang Ltd has discontinued some operations that appear to have been draining profitability. Although improved, interest cover is still low and should be monitored closely. Also, the inventory turnover is slow, indicating that Zhang has enough inventory in stock to cover approximately three months sales. Unless there is a long lead time for inventory acquisition or uncertainties about sources of supply, there may be scope for more efficient inventory policies.
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Chapter 12: Financial statement analysis
BUILDING BUSINESS SKILLS 12.3
MANAGERIAL ANALYSIS
Charles Ltd - Sturt Pty Ltd (a)
Sturt Pty Ltd’s customers are paying their invoices faster in 2015 than in 2013. The evidence for this is the accounts receivable turnover of 7.2 times in 2015, compared with only 6.8 times in 2013. The average collection period in 2015 was 50.7 days compared with 53.7 days in 2013.
(b)
It is becoming harder for Sturt Pty Ltd to pay its invoices as they come due. Although the current ratio has improved from 1.3 to 2.0 to 2.5 over the three years, the quick ratio has deteriorated steadily from 1.4 to 0.9 to 0.5. Additionally, inventory is turning over more slowly (inventory turnover decreased from 7.6 times to 6.1 times), indicating that a greater proportion of current assets is tied up in inventory, thus increasing reliance on creditors to finance current assets.
(c)
The balance in accounts receivable is increasing. This is a result of increasing sales (121% in 2014; 142% in 2015) at a greater rate than the increasing receivables turnover. In 2013 receivables were 14.7% of sales revenue (inverse of the turnover). In 2015 the receivables were only 13.9% of the sales revenue. As sales in 2015 were 1.42 times the sales in 2013, receivables in 2015 must be 19.7% (13.9% x 1.42 times) of the 2013 sales revenue. This is an increase over the 2010 level of receivables, which was only 14.7% of 2013 sales revenue.
(d)
The amount carried in inventory must be increasing. Inventory turnover is decreasing and sales (along with cost of sales) are increasing. Cost of sales has remained at 60% of sales each year. This combination has to result in a larger amount of inventory.
(e)
The amount of earnings per share is increasing. The dividends per share have remained the same ($3.00) for the three-year period, while the dividend payout ratio is decreasing. For the dividend payout ratio to be decreasing, the earnings per share must be increasing as there has been no change in the number of shares outstanding.
(f)
In 2015 and 2014, Sturt Pty Ltd used leverage to the advantage of its shareholders because it was able to achieve a before-tax return on assets in excess of the rate of interest paid on borrowed funds. However, in 2013 Sturt Pty Ltd traded on the equity at a loss as the before tax return on total assets was less than the rate of interest paid on borrowed funds.
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BUILDING BUSINESS SKILLS 12.4
FINANCIAL ANALYSIS ON THE WEB
For consistency with IBM’s Guide, the US terminology is retained. (a)
The purpose of the annual report is to provide a means by which a company can report on its performance to its shareholders and others. Any of the following could be answered as an optional element of US annual reports: financial highlights; letter to stockholders; corporate message; report of management; Board of Directors and management; and stockholder information.
(b)
The auditor’s report is a summary of the findings of an independent firm of certified public accountants (US), showing whether the financial statements are complete, reasonable and prepared in accordance with generally accepted accounting principles.
(c)
The required elements are the Statement of Earnings, which summarises revenues, expenses and results; statement of financial position, which reports on assets, liabilities and stockholders’ equity; and statement of cash flows. Key numbers in the statement of earnings are revenue, gross profit, operating income (operating profit), net earnings (net income or net profit) and earnings per share.
(d)
Students may choose any two of the following (1–6 are suggestion by a business school dean, and 7-11 are suggestions by a business executive, and 12-14 were suggested by a high-school economics teacher, and some suggestions were made by more than one person but not duplicated below): 1.
Look at changes from year to year in terms of raw changes and percentages to identify trends that are useful in assessing a company. Most large companies report up to three years historic data but a longer period is recommended for analysis.
2.
Find out information about the company’s products, people and technology and other resources that may give it a competitive advantage in the market place.
3.
Look at the ratio of operating income to total revenue (sales). Ideally this should be growing in absolute and percentage terms.
4.
Look at total stockholders’ equity and the ratio of total liabilities to total stockholders. Generally a lower ratio means a lower risk for creditors and lower borrowing costs.
5.
Check the notes for liabilities. You may find environmental liabilities, contingencies and additional lease liabilities. Not all liabilities can be measured in financial terms. Statements of financial position may also omit certain assets, such as those that do not result from transactions.
6.
Look at cash provided/used by operating activities. This is the most critical number and represents the most basic business of the company.
7.
For young companies, particularly technology companies, speak to experts who understand the technology and markets.
8.
Look at sales and sales growth and compare it to inflation.
9.
Look at earnings, earnings growth, earnings growth compared with growth in sales. 12.57
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10.
Look at the Price Earnings ratio. Some companies include this in the annual report. Compare this ratio to that of the company’s major competitors. Comparison should be at the same point in time.
11.
Look at the year-end figure for ‘backlog’. This is the dollar amount of unshipped customer orders for sales in the coming year. This can be a good indicator of what might happen in the next year.
12.
Analyse why profit has been made (this may involve looking at its website), e.g. new product, management style, which would indicate it is a healthy growing company. Profit made from cost-cutting may have serious long-term consequences if it is at the expense of quality.
13.
Investigate losses. A loss may have explanations that indicate future profitability, such as expenses on research and development that can benefit future years.
14.
Look at the movement in owners’ equity. If a large percentage of profits is declared as dividends, it could indicate that the company is not planning for expansion and innovation. It could indicate that the company will not grow in the future.
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BUILDING BUSINESS SKILLS 12.5 COMPREHENSIVE FINANCIAL ANALYSIS EXERCISE WITH WEB SEARCH (a) Ratio Liquidity 1. Current Ratio 2. Quick Ratio
3. Current Cash Debt Coverage 4. Receivables Turnover 5. Average Collection Period 6. Inventory Turnover 7. Average Days in Inventory Solvency 8. Debt to Total Assets 9. Times Interest Earned 10. Cash Debt Coverage
11. Free Cash Flow Profitability 12. Return on Ordinary Shareholder Equity 13. Return on Assets 14. Profit Margin
Formula
Calculation
2009
2008
Current Assets/Current Liabilities (Cash + Marketable Securities + Net Receivables)/Current Liabilities Net cash provided by operating activities/Average current liabilities Net credit sales/Average net trade receivables 365 days/Receivables Turnover
17,551/13,721
1.28:1
0.94:1
12,971/13,721
0.95:1
0.62:1
8,186/[(13,721 + 12,988)/2]
0.61:1
0.58:1
30,990/[(3,758 + 3,090)/2]
9.05 times
9.97 times
365/9.05
40.33 days
36.61 days
Cost of Sales /Average Inventory 365 days/Inventory Turnover
11,088/[(2,354 + 2,187)/2] 365/4.88
4.88 times
5.16 times
74.80 days
70.74 days
Total Liabilities/Total Assets
23,325/48,671
0.48:1
0.49:1
(Profit before income tax + Interest Expense)/Interest Expense Net cash provided by operating activities/Average Total Liabilities Net cash provided by operating activities – Capital expenditures
(6,906 +2,040 + 355)/355
26.20 times
18.14 times
8,186/[(23,325 +19,657)/2]
0.38:1
0.37:1
8,186,000 – 1,993,000
$6,193,00 0
$5,603,00 0
Profit available to ordinary shareholders/Average ordinary shareholders’ equity Profit/Average Total Assets Profit/Net Sales
6,824/[(25,346 + 20,862)/2]
30 cents
27 cents
6,906/[(48,671 + 40,519)/2] 6,906/30,990
15 cents
14 cents
22 cents
18 cents
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Chapter 12: Financial statement analysis
15. Asset Turnover 16. Gross Profit Rate 17. Operating Expenses to Sales 18. Cash Return on Sales 19. Earnings per share
20. Priceearnings Ratio 21. Dividend Payout Rate
Net Sales/Average Total Assets Gross Profit/Net Sales
30,990/[(48,67 1 + 40,519)/2] 19,902/30,990
69 cents
76 cents
64%
64%
Operating Expenses/Net Sales
11,671/30,990
0.38:1
0.38:1
Net cash provided by operating activities/Net Sales Profit available to ordinary shareholders/Weighte d average number of ordinary shares Share price/Earnings per share
8,186/30,990
0.26:1
0.24:1
6,824/2,303
$2.96
$2.52
73.51/2.96
24.83 times
25.23 times
Dividends/Profit
3,777/6,906
55%
60%
(b) LIQUIDITY The Current Ratio indicates that The Coca Cola Company is more liquid in 2009 when compared to 2008 figures. There are only 94 cents of current assets for every dollar of current liabilities in 2008 when compared with the 128 cents of current assets for every dollar of current liabilities in 2009. A similar trend is apparent for the Quick Ratio of 95:1 in 2009 which is a substantial improvement on the 2008 ratio of 062:1 Taking these two ratios into account, it appears that The Coca Cola Company’s liquidity has improved between 2008 and 2009. General rules of thumb for the current and quick ratios are 1.5:1 and 1:1 respectively. In both cases as The Coca Cola Company’s ratios are below the suggested rules of thumb, the company should monitor its liquidity to ensure debts can be met when they fall due. However, the current ratio is greater than 1:1 and the quick ratio is almost 1:1 suggesting the company can meet its debts as they fall due. The slight increase in the Current Cash Debt Coverage is consistent with the trends discussed above - suggesting The Coca Cola Company is slightly more liquid in 2009 when compared to 2008. Overall these 3 ratios indicate that there has been an improvement in liquidity. The Receivables Turnover declined slightly from 9.97 times per year in 2008 to 9.05 times per year in 2009. This is to be expected given the global financial crisis and declining economic trends over the last few years. To assess the effectiveness of an entity’s credit and collection policies, the average collection period should be calculated. The general rule is that the collection period should not greatly exceed the credit term period (i.e. the time allowed for payment). The Coca Cola Company’s average collection period increased slightly from 36.61 days in 2008 to 40.33 days in 2009. The 10-K report does not reveal the company’s credit terms so we cannot comment on the adequacy of their collection. However, we can compare it to PepsiCo’s credit policy. In the ‘Management discussion and analysis’ section of PepsiCo’s 2009 annual report, we see that credit terms vary between local and international sales. Payment is required within 30 days of delivery in the United States and within 60–90 days internationally. To evaluate the entity’s credit and collection 12.60
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policies more accurately we would need the break-up between international and local receivables. As this data is not available in the information provided above, we need to evaluate the results with caution. PepsiCo’s average collection period of 39.29 days in 2009 is similar to The Coca Cola Company’s 40.33 days, which is close to the 30-day credit terms for its US customers, indicates the company’s credit policy is appropriate and its monitoring of receivables collection is effective. Furthermore the slight increase in average collection period needs to be viewed in light of the difficult economic conditions arising from the recent global financial crisis, which included volatile commodity costs, frozen credit markets, fluctuating currencies and negative GDP rates as explained in the 2009 PepsiCo annual report. However, as the trend is increasing The Coca Cola Company’s should be careful to continue to monitor this ratio to ensure it doesn’t go too high and affect cash flow. The Inventory Turnover measures the number of times on average the inventory is sold during the period. Its purpose is to measure the liquidity of the inventory. The higher the turnover the less chance inventory will be slow moving or become obsolete or spoiled and unsaleable. It is important to monitor the amount of resources invested in inventory as part of managing the business. Entities do not want to unnecessarily have too much cash tied up in inventories. At the same time, they do not want to be understocked and miss out on sales because of a lack of stock. The Coca Cola Company’s inventory turnover decreased slightly from 5.16 times in 2008 to 4.88 times in 2009. Overall there has not been a significant change. Average Days in Inventory measures the average number of days it takes to sell the inventory. The Coca Cola Company’s average days in inventory has increased slightly from 70.74 days in 2008 to 74.80 days in 2009. These figures are quite acceptable when we consider the goods that the Coca Cola Company sells. Soft drinks, juices, energy drinks and water are items that normally have expiry dates longer than 1 year. If the Coca Cola Company can sell its inventories in around 70 days, the Coca Cola Company manages its inventory well. Overall - taking all of the liquidity ratios into account, The Coca Cola Company does not appear to have liquidity issues which suggests that it is in a good position to pay its debts as they fall due. SOLVENCY Solvency ratios measure the ability of the entity to survive over a long period of time. The Debt to Total Assets ratio (Total Liabilities divided by Total Assets) of the Coca Cola Company has decreased slightly from 0.49 in 2008 to 0.48 in 2009. Currently half of the assets are funded by debt and half by equity. As the amount of debt increases, long-term creditors become more concerned that The Coca Cola Company is less able to repay their long term obligations. In addition to Debt to Total Assets ratio, we also need to see the Time Interest Earned ratio. With Times Interest Earned, we can assess whether profits are adequate to meet interest payments. In 2008, The Coca Cola Company’s Times Interest Earned was 18.14 times. The ratio increased to 26.20 times in 2009. This is a significant increase and the 2008’s figure is well above the general rule of thumb that profits should be approximately 3–4 times interest expense. The Coca Cola Company’s profits are more than adequate to meet its interest repayments. To explore this further, we can calculate the entity’s cash debt coverage, which indicates an entity’s ability to repay its liabilities from cash generated from operating activities without having to liquidate the assets used in its operations. It is another indicator of the entity’s ability to generate sufficient cash to meet its long-term needs. The Coca Cola Company’s cash debt coverage increased from 0.37 in 2008 to 0.38 in 2009. The 2008 and 2009 ratios are well above what is considered appropriate as a general rule of thumb. A ratio below 0.20 times is considered cause for additional investigation. 12.61
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Free cash flow provides information about the company’s solvency and its ability to pay dividends or invest in new projects. The free cash flow has increased substantially from $5,603,000 in 2008 to $6,193,000 in 2009. It increased despite the company’s acquisition and investment activities which totalled approximately $300 million in 2009. From The Coca Cola Company’s 2009 Annual Report, we see that the Coca Cola Company acquired and invested vast amounts of funds into bottling entities. See for example investing activities in the consolidated statements of cash flows. The acquisitions and investments were principally beverage and bottling companies and trademarks. The intention was that the newly acquired investments will generate future profits for the Coca Cola Company. Overall, based on these ratios it appears that the company is solvent. PROFITABILITY Profitability ratios measure the profit or operating success of an entity for a given period of time. An entity’s profit, or the lack of it, affects its ability to obtain debt and equity financing, its liquidity position and its ability to grow. As a consequence, creditors and investors alike are interested in evaluating profitability. Profitability is frequently used as the ultimate test of management’s operating effectiveness. If we look at the Coca Cola Company’s profitability ratios in 2009, we can see that there few changes between 2009 figures and 2008 figures. The profit margin for year 2008 is 18 cents and for 2009 is 22 cents – a slight increase. The gross profit rate is the same for both years which is 64%. Operating Expenses to Sales ratios is the same for both years which is 0.38. Asset Turnover (Net Sales/Average Total Assets) has decreased by 7 cents. Cash Return on Sales ratio in 2008 is only slightly higher in 2009 moving from 24:1 in 2008 to 26:1 in 2009. The return on ordinary shareholders’ equity (ROE) shows how many dollars of profit are earned for each dollar invested by owners. For The Coca Cola Company, the figures show a slight increase from 27 cents in 2008 to 30 cents in 2009. The return on assets has also slightly increased by 1 cent since 2008. Price-earnings ratio is only slightly lower (25.23 times in 2008 and 24.83 times in 2009). The Dividend Payout Rate is lower by 5% in 2009 but this does not necessarily translate to poor performance. When management decides to keep profits in the company for acquisition or investment purpose, as is evident in 2009, dividends declared are not increased. Earnings per share is significantly higher in 2009 ($2.52 in 2008 and $2.96 in 2009). This is due to primarily higher profit. Overall, while the changes to ratios have only been slight for many of the profitability ratios they have moved in the correct direction. Overall it appears that The Coca Cola Company is providing a good return to its shareholders and is profitable. It is important to also note the sizable increase in profit between 2008 and 2009 from 5874000 to 6906 000.
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(c)
Ratio Liquidity 1. Current Ratio 2. Quick Ratio
3. Current Cash Debt Coverage 4. Receivables Turnover 5. Average Collection Period 6. Inventory Turnover 7. Average Days in Inventory Solvency 8. Debt to Total Assets 9. Times Interest Earned 10. Cash Debt Coverage 11. Free Cash Flow
Profitability 12. Return on Ordinary Shareholder Equity 13. Return on Assets 14. Profit Margin 15. Asset Turnover 16. Gross Profit Rate 17. Operating Expenses to Sales 18. Cash Return on Sales 19. Earnings per share
20. Price-earnings Ratio 21. Dividend Payout Rate
Formula
Coca Cola
Pepsi
Current Assets/Current Liabilities (Cash + Marketable Securities + Net Receivables)/Current Liabilities Net cash provided by operating activities/Average current liabilities Net credit sales/Average net trade receivables 365 days/Receivables Turnover Cost of Sales/Average Inventory 365 days/Inventory Turnover
1.28:1
1.44:1
0.95:1
1.00:1
0.61:1
0.77:1
9.05 times
9.29 times
40.33 days
39.29 days
4.88 times
7.82 times
74.80 days
46.68 days
Total Liabilities/Total Assets
0.48:1
0.56:1
(Profit before income tax + Interest Expense)/Interest Expense Net cash provided by operating activities/Average Total Liabilities Net cash provided by operating activities – Capital expenditures
26.20 times
21.35 times
0.38:1
0.30:1
$6,193,000
$4,668,000
Profit available to ordinary shareholders/Average ordinary shareholders’ equity
30 cents
40 cents
Profit/Average Total Assets Profit/Net Sales Net Sales/Average Total Assets Gross Profit/Net Sales Operating Expenses/Net Sales
15 cents 22 cents 69 cents
16 cents 14 cents $1.14
64% 0.38:1
54% 0.35:1
Net cash provided by operating activities/Net Sales Profit available to ordinary shareholders/Weighted average number of ordinary shares Share price/Earnings per share
0.26:1
0.16:1
$2.96
$3.82
24.83 times
Dividends/Profit
55%
15.87 times 46%
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Chapter 12: Financial statement analysis
LIQUIDITY Pepsi looks more liquid when we simply look at current ratio, quick ratio and current cash debt coverage. The receivables turnover and average collection period are similar for both companies. Coca Cola has higher average days in inventory (74.80 days for Coca Cola and 46.68 days for Pepsi). This suggests that Pepsi can sell its inventory about significantly faster than its competitor. Overall both companies are in a good position to pay their debts as they fall due. SOLVENCY Pepsi has a slightly higher debt to total assets ratio that Coca Cola so Pepsi has more debt funding. It follows that the Cash debt coverage ratio is higher for Coca Cola as it has less debt. Coca Cola’s Times Interest Earned is also higher than Pepsi’s. However, the both Pepsi’s and Coca Cola’s figures are still well above the general rule of thumb that profits should be approximately 3–4 times interest expense. Finally both companies have significant free cash flow with Coca Cola higher by 1 525 000. Overall, based on these ratios it appears that the companies are solvent.
PROFITABILITY Gross Profit Rate is 64% for Coca Cola and 54% for Pepsi. These gross profit rate figures suggest that Coca Cola has higher Cost of Sales compared to Pepsi. When we compare Profit margin of 22 cents for Coca Cola and 14 cents for Pepsi. We again find Coca Cola is more profitable. However, return on ordinary shareholders’ equity is only 30 cents for Coca Cola and 40 cents for Pepsi. Hence more profit is available to ordinary shareholders for Pepsi When we compare the ability of the companies to generate profits and sales by using assets we find that the Asset turnover is much higher for Pepsi at 1.14 in 2009 when compared to .69 for Coca Cola, however, the difference is lost when we look at return on assets as they are very similar at 15 cents Coca Cola and 16 cents Pepsi. Both companies pay out significant amounts of profit at 46% for pepsi and slightly higher for Coca Cola at 55% Overall both companies appear to be sound and profitable investments. See also demonstration problem for the chapter for more insights into Pepsi Co in 2009
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CRITICAL THINKING BUILDING BUSINESS SKILLS 12.6 GROUP DECISION CASE
(a)
Lenders prefer that financial statements are audited because an audit gives independent assurance that the financial statements give a true and fair representation of the company’s financial position and results of operations. With this independent assurance we feel more comfortable making a decision.
(b)
The current ratio increase is a favourable indication as to liquidity, but alone tells little about the going concern prospects of the client. From this ratio alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The decline in the quick ratio to 0.8 is an unfavourable indication as to immediate liquidity, especially when the current-ratio increase is also considered. This decline is also unfavourable because it reflects a declining cash position and raises questions as to reasons for the increases in other current assets, such as inventories. The cash debt coverage ratio is a solvency ratio that indicates a company’s ability to repay its liabilities from cash generated by operations. Since this ratio declined during 2002, it indicates that the company’s cash provided by operations decreased and/or its liabilities increased. At the current level of cash generated by operations, Growings Ltd would take 10 years to repay its existing liabilities. The asset turnover and earnings per share ratio indicate profitability. Since both ratios are higher in 2002 and profit has increased, it is most likely that the company’s sales revenue is increasing. Increases in sales and profit are favourable for goingconcern prospects. The 32 per cent increase in earnings per ordinary share, which is identical to the percentage increase in net profit, is an indication there has probably been no change in the number of issued ordinary shares. This, in turn, indicates that financing was not obtained through the issue of ordinary shares. The collective implications of these data alone are that the client entity is about as solvent at the end of the current year as it was at the beginning, although there may be a need for short-term operating cash. Creditors should however seek further information. Although a quick evaluation of a reporting entity can be made using only a few ratios and comparing these with past ratios and industry statistics, the creditors should realise the limitations of such analysis even from the best prepared statements carrying a CPA’s unqualified opinion.
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It is not possible to reach conclusions about solvency and gong-concern prospects without additional information about the nature and extent of financing. When evaluating changes in ratio or percentages, the evaluation should be directed to the nature of the item being evaluated because very small differences in ratios or percentages can represent significant changes in dollar amounts or trends. The creditors should evaluate conclusions drawn from ratio analysis in light of the current status of, and expected changes in, such things as general economic conditions, the client’s competitive position, the public’s demand (for the product itself, increased quality of the product, control of noise and pollution, etc.), and the client’s specific plans. (c)
(1)
Current cash debt coverage ratio – indicates liquidity.
(2)
Debt to total assets ratio – indicates insolvency.
(3)
Times interest earned ratio – indicates ability to repay interest when due.
Other answers are possible. (d)
The usefulness of analytical tools is limited by the use of estimates, the cost basis, the application of alternative accounting methods, atypical data at year-end, and the diversification of companies, making industry comparisons difficult. Different accounting methods affect the analysis of trends and comparisons with industry statistics or other companies within the industry.
BUILDING BUSINESS SKILLS 12.7
COMMUNICATION ACTIVITY
Hi-Tech Electronics
To:
LR Stanton
From:
Accounting Student
Re:
Financial Statement Analysis
Date:
DD/MM/YY
There are two fundamental considerations in financial statement analysis: (1) (2)
the bases of comparison and the limitations of financial statement analysis. Each of these considerations is explained below.
1.
Bases of Comparison. The bases of comparison are:
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(a)
(b)
(c)
2.
Intracompany – this basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years. Intercompany – this basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. Industry averages – this basis compares an item or financial relationship of a company with industry averages (or norms).
Limitations in financial statement analysis are: (a) (b)
(c)
(d)
(e)
Estimates – financial statements contain estimates that may be inaccurate. Cost – financial statements are based on cost, which may be affected by significant inflation or deflation. This affects comparisons over time and between companies with assets purchased in different periods. Alternative accounting methods – variations among companies in the application of generally accepted accounting principles may hamper comparability. Atypical data – fiscal year-end data may not be typical of the financial condition during the year. For instance, if the company’s year-end falls immediately after the peak of its sales (e.g. after Christmas sales in a department store), its inventory in the statement of financial position may be below normal levels. Diversification of firms – many firms are so diversified they cannot be classified by industry.
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BUILDING BUSINESS SKILLS 12.8
ETHICS CASE
Lookin’ Good Ltd (a)
The stakeholders in this case are: managing director of Lookin’ Good Ltd; other directors of Lookin’ Good Ltd; public relations officer of Lookin’ Good Ltd; you, as chief accountant of Lookin’ Good Ltd; shareholders of Lookin’ Good Ltd; potential investors in Lookin’ Good Ltd; creditors of Lookin’ Good Ltd; potential creditors of Lookin’ Good Ltd; and any readers of the press release.
(b)
The managing director’s press release is deceptive and incomplete and to that extent, his action is unethical. While inflating the share price may provide a benefit to existing shareholders if they are selling their shares, this is at the expense of a stakeholder who buys the shares at an overstated price. Further, the biased press release may cause investors to make decisions (such as retaining their shares or buying more shares) that would be different if they were provided with unbiased and complete information.
(c)
As chief accountant, you should at least inform the public relations (PR) officer, about the biased content of the release. The PR officer should be aware that the information to be released, while factually accurate, is deceptive and incomplete. The chief accountant has the responsibility to inform the managing director (and other directors) of the bias of the about-to-be-released information.
(d)
Immediately, it would be appropriate to speak/write to the PR officer and then the managing director. Students may be encouraged to discuss how this should be done (whether in writing) and what could and/or should be done if the managing director refuses to alter the press release. Suggestions include: other directors; the recipient of the press release; and the audit committee (if one exists).
BUILDING BUSINESS SKILLS 12.9
SUSTAINABILTY
Extracts from PepsiCo’s 2009 annual report Broad goals Page 3: “At PepsiCo, Performance with Purpose means delivering sustainable growth by investing in a healthier future for people and our planet. As a global food and beverage company with brands that stand for quality and are respected household names—Quaker Oats, Tropicana, Gatorade, Lay’s and Pepsi-Cola, to name a few—we will continue to build a portfolio of enjoyable and wholesome foods and beverages, find innovative ways to reduce the use of energy, water and packaging, and provide a great workplace for our associates. Additionally, we will respect, support and invest in the local communities where we operate, by hiring local people, creating products designed for local tastes and partnering with local farmers, governments and community groups. Because a healthier future for all people and our planet means a more successful future for PepsiCo. This is our promise.”
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Specific goals on Human sustainability Page 10 “Products: Provide more food and beverage choices made with wholesome ingredients that contribute to healthier eating and drinking. • increase the amount of whole grains, fruits, vegetables, nuts, seeds and low-fat dairy in our global product portfolio. • reduce the average amount of sodium per serving in key global food brands by 25 percent. • reduce the average amount of saturated fat per serving in key global food brands by 15 percent. • reduce the average amount of added sugar per serving in key global beverage brands by 25 percent. MarketPlace: Encourage people to make informed choices and live healthier. • display calorie count and key nutrients on our food and beverage packaging by 2012. • advertise to children under 12 only products that meet our global science-based nutrition standards. • eliminate the direct sale of full-sugar soft drinks in primary and secondary schools around the globe by 2012. • increase the range of foods and beverages that offer solutions for managing calories, like portion sizes. Community: • actively work with global and local partners to help address global nutrition challenges. • invest in our business and research and development to expand our offerings of more affordable, nutritionally relevant products for underserved and lower-income communities. • expand Pepsico Foundation and Pepsico corporate contribution initiatives to promote healthier communities, including enhancing • diet and physical activity programs integrate our policies and actions on human health, agriculture and the environment to make sure that they support each other.
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CHAPTER 13 – ANALYSING AND INTEGRATING GAAP ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
1, 2, 3
1, 2, 3, 4, 5
Problems
1.
Explain and apply the concepts and principles underlying the recording of accounting information.
2.
Describe the Conceptual Framework for Financial Reporting (the Conceptual Framework).
3.
Explain the objective of general purpose financial reporting.
4.
Identify the primary and other users, and their uses of financial reports.
5, 6
5.
Explain the nature of a reporting entity.
7
6.
Identify and apply the qualitative characteristics and constraint on financial reporting.
9
3, 4, 5
2A, 7A
7.
Define assets, liabilities, equity, income and expenses and apply recognition criteria.
10
3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13
2A, 8A, 9A
8.
Integrate principles, concepts, standards and the Conceptual Framework.
9.
Appreciate, at an introductory level, various future developments in financial reporting.
2
1A, 2A
3A
4A, 5A
6A, 9A
10A
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CHAPTER 13 – ANALYSING AND INTEGRATING GAAP Note to Instructors Students are invited to discuss their own views in the questions throughout the end of chapter activities. For example, question 4 requires students discuss the advantages of a conceptual framework. The question also asks students to discuss if they believe these advantages can actually be achieved. As there are no correct or recommended answers for these types of questions, the solution manual states “student’s personal views and discussion required” in these instances. ANSWERS TO QUESTIONS 1.
There are 2 concepts and 4 principles that underlie the recording of accounting information. In many cases, more than one principle or concept can apply to each transaction. For example, the monetary principle requires that only those things that can be expressed in monetary terms be included in the accounting records. Hence, all accounting transactions will be based on the monetary principle, but may also be based on others. Accounting Entity Concept This concept states that every entity can be separately identified and accounted for. Accounting Period Concept The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. Monetary Principle This principle requires that the items included in the accounting records must be able to be expressed in monetary terms. Going Concern Principle This principle states that financial statements are prepared on a going concern basis unless management either intends to or must liquidate the business or cease trading. Cost Principle The cost principle states that all assets are initially recorded in the accounts at their purchase price or cost. This is applied not only at the time the asset is purchased but also over the time the asset is held. Full Disclosure Principle The full disclosure principle requires that all circumstances and events that could make a difference to the decisions financial statement users might make should be disclosed in the financial statements.
2.
Accounting concepts, principles and recognition criteria are interrelated and provide guidance when recording certain transactions. An example is the best way to illustrate this point. Consider the payment of a 2 year insurance policy for $24,000 on 1 January 2009. The initial recording and subsequent adjustments related to this transaction are informed by 13.2
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both the accounting period concept and recognition criteria. The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. The recognition criteria inform when a transaction is to be recorded – that is when it is probable and can be reliably measured. On January 1, the payment can be recorded as: Dr Prepaid Insurance $24,000 Cr Cash $24,000 If the year end is 30 June 2013, in order to provide useful information to our users about the accounting period, we can use the expense recognition criteria and the period assumption to inform the following adjusting entry: Dr Insurance Expense $6,000 Cr Prepaid Insurance $6,000 That is $6,000 of future economic benefits in relation to insurance have expired and are recorded as an expense in the period in which it expired. 3.
A conceptual framework consists of a set of concepts defining the nature, purpose and content of general purpose financial reporting to be followed by preparers of general purpose financial reports and standard setters. In Australia, the conceptual framework has 4 main components: [1] the objective of general purpose financial reporting, [2] the reporting entity (SAC 1), [3] the qualitative characteristics [4] and the definition of elements in financial statements.
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4.
A conceptual framework consists of a set of concepts defining the nature, purpose and content of general purpose financial reporting to be followed by preparers of general purpose financial reports and standard setters. The advantages or benefits of a conceptual framework are that it improves the standard setting process and consistency in accounting practice. To illustrate, prior to the late 1970s there was no generally accepted theory of financial accounting. This meant that the development of accounting standards for financial accounting practice was piecemeal as the standards were not based on any particular theory. This resulted in some inconsistencies between standards and therefore inconsistencies in accounting practice. The development of a conceptual framework in relation to financial reporting is beneficial in that it outlines the objectives of financial reporting, the required qualitative characteristics for financial information and to provide clear guidance on how to measure and account for economic events when recording transactions and preparing financial information. Question part 2 – do you believe that these benefits can actually be achieved? Student’s personal views and discussion required
5.
As defined in Paragraph 2 “a reporting entity is a circumscribed area of economic activities whose financial information has the potential to be useful to existing and potential equity investors, lenders and other creditors who cannot directly obtain they information they need in making decisions about providing resources to the entity in assessing whether management and the governing board of that entity have made efficient and effective use of the resources provided.” This definition is consistent with the definition in the Framework and is linked to the objective of general purpose financial reporting in the Conceptual Framework. The exposure draft identifies the three features as necessary but not always sufficient conditions to identify a reporting entity. First, a reporting entity conducts, has conducted or will conduct economic activities. Second the economic activities can be distinguished from other entities and the economic environment. Third, linking back to the objective of financial reporting, financial information about the economic entities will be useful in making decisions about providing resources to the entity and in assessing the efficiency and effectiveness of management and the governing board. A related concept to the reporting entity is the accounting entity concept. While the accounting entity concept applies to all accounting entities, not all entities are reporting entities. The Accounting Entity Concept states that every entity can be separately identified and accounted for. In particular for sole traders and partnerships, it is extremely important that the owners do not confuse the entity’s transactions with their personal transactions, or the transactions of any other entity. Accounting entity must be identified and reported as separate from its owners. Question part 2 - Do you believe the accounting entity concept is helpful? Once the entity concept is explained as above, then student’s personal views and discussion required 13.4
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6.
The Conceptual Framework identifies the objective of general purpose financial reporting as the provision of financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making their decisions about providing resources to the entity. Why is it necessary to have an objective? This is best explained with reference to the building analogy given in the text on p 775. We see that understanding who the primary users of a building are, as well as details of their needs would more likely result in a building that would satisfy their needs and achieve the purpose the building was constructed to fulfill. The same is true for financial reporting – if we know the objective of financial reporting is the provision of information to users for decision making and we know who the users are and their decision making needs – the reports are more likely to fulfill their purpose! Furthermore we can also consider how that objective is best served and in what format the financial information should be presented to meet the objectives. These issues are addressed by chapter 3 of the Conceptual Framework. The Conceptual Framework provides guidance on the qualitative characteristics that information contained in general purpose financial reports should have to achieve the objective of providing useful information for decision making. That is, the qualitative characteristics are the attributes that make the information in financial statements useful.
7.
Figure 13.3 sets out the primary users of the general purpose financial reports being those users who provide resources to the entity and therefore require information to make decisions concerning the provision of those resources. (1) Equity investors provide resources to an entity usually by investing cash for the purpose of receiving a return and include shareholders, holders of partnership interests and other equity owners. (2) Lenders provide resources to an entity by lending cash for the purpose of receiving a return in the form of interest. (3) Other creditors including employees, suppliers and customers (but only in their capacity to provide resources to the entity are they considered primary users). Some questions that may be asked by investors and lenders about a company include: • Is the company earning satisfactory profit? • How does the company compare in size and profitability with its competitors? • Will the company be able to pay its debts as they fall due? • Is the company paying regular dividends to its shareholders? • What is the company’s potential for generating future cash flows? • Should I invest in the company? • Should I lend funds to this company?
8.
The conceptual framework sets out both the primary and other users. The primary users of the general purpose financial reports being those users who provide resources to the entity and therefore require information to make decisions concerning the provision of those resources. (1) Equity investors provide resources to an entity usually by investing cash for the purpose of receiving a return and include shareholders, holders of partnership interests and other equity owners. (2) Lenders provide resources to an entity by lending cash for the 13.5
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purpose of receiving a return in the form of interest. (3) Other creditors including employees, suppliers and customers (but only in their capacity to provide resources to the entity are they considered primary users). Suppliers are considered to be other creditors when they extend credit to facilitate a sale, employees are considered to be other creditors when they provide their services (human resources) in exchange for remuneration and customers are considered to be other creditors when they prepay for goods or services which are to be provided in the future. These parties are only considered resource providers to the extent that they provide the entity with resources in the form of credit or services, and they make decisions based on providing such resources. When they are not in this capacity they are referred to as other users. Figure 13.3 summarises the three main categories of users. In addition to ‘primary users’ there are also ‘other users’. Other users include government agencies, members of the public as well as suppliers, customers and employees (when not resource providers as explained above). The information needs and questions of other users vary considerably. For example, taxation authorities such as the ATO want to know whether the entity complies with the tax laws. Regulatory agencies such as the Australian Securities and Investments Commission (ASIC) or the Australian Competition and Consumer Commission (ACCC) want to know whether the entity is operating within prescribed rules.
While these other users have specialised information needs, they may find the financial information that meets the needs of resource providers useful. Like the primary users, the common information needs of other users include an assessment of the entity’s future cash flows (amount, timing and uncertainty) and evidence that management has discharged its responsibilities to use the entity’s resources efficiently and effectively. However, it is made clear that financial reporting is not primarily directed to other users but rather to equity investors, lenders and other creditors.
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9. According to the Conceptual Framework, the qualitative characteristics are classified as either fundamental or enhancing depending on how they affect the usefulness of financial information. Enhancing qualitative characteristics and fundamental qualitative characteristics are complementary. Fundamental qualitative characteristics For the information in general purpose financial reports to be useful, it must be relevant and provide a faithful representation of the economic phenomena it represents. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. Relevance Information is considered relevant if it is capable of making a difference in the decisions made by users. Information that has predictive value and/or confirmatory value is considered to be relevant. Faithful representation Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. Relevance and faithful representation work together in enhancing the decision usefulness of information. Relevance is applied to determine which economic phenomena to represent and then faithful representation is applied to determine which depictions best represent the underlying economic phenomena. Enhancing qualitative characteristics Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability. These characteristics are called enhancing characteristics as they enhance the decision usefulness of relevant information faithfully represented in financial statements. The enhancing qualitative characteristics are summarised in Figure 13.4 Comparability Information that is comparable facilitates users identifying similarities and differences between different economic phenomena. Consistency refers to the use of the same accounting policies between entities, at the same point in time, or the same entity over time. Consistency supports the achievement of comparability. Verifiability Information is verifiable if it faithfully represents the economic phenomena it is meant to represent. Verifiability means that independent observers could reach a consensus – but not necessarily one hundred percent agreement- that a particular depiction is a faithful representation. Direct verification is through direct observation like counting cash to verify cash balance reported on the statement of financial position or counting inventory to determine quantities in stock. Indirect verification is where techniques or calculations are used to check the representation. For example verifying the ending inventory balance in the statement of financial position by checking quantities and costs using the same cost flow assumption. See chapter 5 for more information on calculating ending inventory using different cost flow assumptions. Timeliness Timeliness is measured by whether the information is available to users before it ceases to 13.7
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be relevant; that is, the information is received while it is still capable of influencing the decisions users make based on the information. Financial information may lose its relevance Understandability Understandability is the last of the enhancing qualitative characteristics and relates to the quality of information that assists users to understand the meaning of the information provided Constraint on financial reporting There is only one constraint on financial reporting namely cost. Providing decision-useful information imposes costs, and the benefits of providing the information should outweigh the costs. Costs can include those associated with collecting, processing, verifying and disseminating information. Assessing whether benefits outweigh costs is usually more qualitative than quantitative and is often incomplete. In an attempt to ensure benefits outweigh costs, it is important to consider whether one or more enhancing qualitative characteristics may be sacrificed to reduce costs. Figure 13.5 summarises the fundamental and enhancing qualitative characteristics of financial information and the constraint of providing financial information as outlined in the in the Conceptual Framework.
10.
Accounting information is deemed to be relevant if it would make a difference in a business decision. Users of financial information need to make many decisions based on the information contained in general purpose financial reports. Decisions such as “shall I invest in this entity?” or “should I lend money to this entity?” require information on the entity’s future profitability and ability to pay its debts as they fall due. It seems then that, for information to be relevant, it must have predictive value, to help users make predictions about the future, or provide feedback, to help users assess the accuracy of their past predictions and decisions. Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. It is important that the information depicts the economic substance of the transactions, events or circumstances. At times, economic substance may not be the same as the legal form. To be complete, all of the information needed to represent the economic phenomena faithfully is included and there is no omission which could make the information misleading. Hence, like relevance, faithful representation is also linked to the full disclosure principle. Question part 2 – Discuss whether you believe one is more important than the other, or if they are equally important? Student’s personal views and discussion required
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Relevance and faithful representation are both important however, they can involve some trade-offs. For example, information about future profits is very relevant. However, as we are unable to tell the future with certainty, such information may not be faithful represented. While they are both important to answer which one is more important in a particular instance it is helpful to consider the information needs of the user. For example, if the user is a capital provider then relevance and faithful representation could be considered equally important. However, if the user is a government agency performing a review or oversight function, faithful representation could be considered more important than relevance if relevance relates to future information, rather than relevance of the information to the oversight function.
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11.
Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. To be complete, all of the information needed to represent the economic phenomena faithfully is included and there is no omission that could make the information misleading. Information that is considered to be neutral is free from bias. Information is biased if it is intended to attain or induce a particular behavior or result. Some of the information in general purpose financial reports is measured using estimates in conditions of uncertainty. Question part 2 – Do you believe that financial information can, in reality, be neutral and representationally faithful? Explain your answer. Student’s personal views and discussion required Ruth Hines explores this very question in R. Hines 1991, ‘The FASB’s Conceptual framework, financial accounting and the maintenance of the social world’, Accounting Organizations and Society, vol. 16, no. 4, pp. 313–2. Some time ago in this journal article she wrote about the FASB’s conceptual framework. She suggested that it appears that the ‘assumption underpinning the Conceptual Framework is that the relationship between financial accounting and economic reality is a unidirectional, reflecting or faithfully reproducing relationship: economic reality exists objectively, intersubjectively, concretely and independent of financial accounting practices; financial accounting reflects, mirrors, represents or measures the pre-existent reality’. This is an objectivist’s view of the world. If this was our world view then we would answer the question by stating “Yes it is possible for information to be represented faithfully and neutral.” On the other hand, if we held a subjectivists view of the world, we would assume there is no such phenomena as an economic reality to be measured objectively that exists independent of people’s perceptions. That is, reality is subjective and the result of personal interpretation. Based on this assumption, accounting information is subjective and it requires judgements, estimates and interpretations and must, therefore, be biased and cannot be representationally faithful.
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12.
Cost is a constraint that limits the information provided by financial reporting. Cost Preparers and standard setters seek to ascertain that the costs of preparing certain financial information are not greater than the benefits to be derived from using that information. The costs and particularly the benefits of financial information are difficult to measure; consequently, it is a subjective measure. Assessing whether benefits outweigh costs is usually more qualitative than quantitative and is often incomplete. In an attempt to ensure benefits outweigh costs, it is important to consider whether one or more enhancing qualitative characteristics may be sacrificed to reduce costs.
13.
General purpose financial statements of an entity can provide valuable information about an entity. However, this information is more meaningful if it is supplemented with additional information including general economic conditions, political climate, industry trends or averages, information from directors’ reports and media releases. For example, in times of increasing interest rates, pressures on the housing markets have affected the demand for other sales such as building materials and furniture sales. These general economic conditions make it more difficult for entities to increase their prices without potentially losing sales to competitors and might explain decreases in sales for the period. Investing in a government project in a country which is politically unstable might explain financial losses if the government has changed. Industry averages or competitors’ ratios for a variety of ratios – e.g. return on assets, debt to equity, dividend payout etc…allow us to determine how effective a particular entity is in relation to its competitors.
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14.
General purpose financial reports should be seen more as models of transactions rather than exact depictions of transactions and events given the information contained in general purpose financial reports is, to a significant extent, based on estimates and judgements. Many types of judgements have been explored throughout the book. For example, we calculated estimates to accrue expenses in chapter 3, estimates for bad and doubtful debts in chapter 7, and estimates for warranties in chapter 9. The Conceptual Framework outlines the concepts that underlie the estimates and judgements necessary for financial reports. For this reason, general purpose financial reports can be seen as models of the transactions and events that have occurred in relation to an entity rather than an exact depiction.
13.
The conceptual framework identifies qualitative characteristics as either fundamental or enhancing depending on how they affect the usefulness of financial information.
Fundamental qualitative characteristics For the information in general purpose financial reports to be useful, it must be relevant and provide a faithful representation of the economic phenomena it represents. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. Information is considered relevant if it is capable of making a difference in the decisions made by users as capital providers. Information that has predictive value and/or confirmatory value is considered to be relevant. Information is considered to have predictive value if it can be used by capital providers to develop their expectations for the future. Information is considered to have confirmatory value if it confirms or disconfirms users’ past or present expectations. Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. It is important that the information depicts the economic substance of the transactions, events or circumstances. To be complete, all of the information needed to represent the economic phenomena faithfully is included and there is no omission that could make the information misleading. Hence, faithful representation is linked to the full disclosure principle. Information that is considered to be neutral is free from bias. Information is biased if it is intended to attain or induce a particular behaviour or result. Some of the information in general purpose financial reports is measured using estimates in conditions of uncertainty. Hence, it is not reasonable to expect that reports will be completely error free. However, despite this limitation, faithful representation is achieved when the inputs used to make the judgements and estimate reflect the best available information at the time. Relevance and faithful representation work together in enhancing the decision usefulness of information as follows. First, relevance is applied to determine which economic phenomena to represent. Then, faithful representation is applied to determine which depictions best represent the underlying economic phenomena. Enhancing qualitative characteristics and fundamental qualitative characteristics are complementary. 13.12
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Enhancing qualitative characteristics Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability, and are used to distinguish more useful information from less useful information. They are called enhancing characteristics as they enhance the decisionusefulness of relevant information faithfully represented in financial reports. Information that is comparable facilitates users’ identification of similarities and differences between different economic phenomena. Consistency refers to the use of the same accounting policies between entities, at the same point in time, or by the same entity over time. Consistency supports the achievement of comparability. Information is verifiable if the information presented represents the economic phenomena without bias or material error and has been prepared with appropriate recognition and measurement methods. Timeliness is measured by whether the information is available to users before it ceases to be relevant; that is, the information is received while it is still capable of influencing the decisions that users make. Understandability is the last of the enhancing qualitative characteristics and relates to the quality of information that facilitates users to comprehend the meaning of the information provided. It is important to recognise that it is highly dependent upon the capabilities of users of financial reports and that users are assumed to have a reasonable knowledge of business activities and economic phenomena. However, classifying, characterising and presenting comparable information clearly and concisely will enhance understandability. What makes a qualitative characteristic fundamental or enhancing depends on how it affects the usefulness of financial information. Given the aim of general purpose financial reports is to be useful, it must therefore be relevant and provide a faithful representation of the economic phenomena it represents. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. While enhancing qualitative characteristics improve the usefulness of financial information and should be maximised where possible, they cannot make information decision useful if the information is irrelevant or not faithfully represented. Question part 2 What makes a qualitative characteristic fundamental or enhancing?
For the information in general purpose financial reports to be useful, it must be relevant and provide a faithful representation of the economic phenomena it represents. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability, and are used to distinguish more useful information from less useful information. They are called enhancing characteristics as they enhance the decisionusefulness of relevant information faithfully represented in financial reports. 13.13
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Question part 3 – Do you believe this is an important distinction? Student’s personal views and discussion required
16.
Cost is the constraint that limits the information provided by financial reporting. Providing decision-useful information imposes costs, and the benefits of providing the information should outweigh the costs. Costs can include the costs of collecting, processing, verifying and disseminating information. Assessment of benefits and costs is usually more qualitative than quantitative and is often incomplete. When attempting to ensure that the benefits of providing the information outweigh the costs, it may be necessary to sacrifice one or more enhancing (rather than fundamental) qualitative characteristics in order to reduce costs. This is justified by the fact that for the information in general purpose financial reports to be useful, it must be relevant and provide a faithful representation of the economic phenomena it represents. Therefore, relevance and faithful representation cannot be compromised to save costs. Enhancing qualitative characteristics on the other hand are used to distinguish more useful information from less useful information. Given they are only ‘enhancing’ characteristics as they enhance the decision-usefulness of relevant information they can be sacrificed and users can still have faithfully represented and relevant information in financial reports.
17.
A liability is defined in the Conceptual Framework as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’ (paragraph 4.4b). Recognition criteria As outlined in the Conceptual Framework, a liability is recognised in the statement of financial position when: (a) it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation (b) the amount at which the settlement will take place can be measured reliably ( paragraph 4.46).
18.
Income is defined in the Conceptual Framework as ‘increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from 13.14
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equity participants’(paragraph 4.25a). It is important to note that, like the definition of equity, the definition of income is linked to the definitions of assets and liabilities. As defined in the Conceptual Framework expenses are ‘decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants’(paragraph 4.25b). It is important to note that, like the definitions of equity and income, the definition of expenses is linked to the definitions of assets and liabilities.
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19.
Assets are defined in the Conceptual Framework as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.” (para 4.4a). First, the entity must have control over the asset. While control often means ownership of the asset, ownership is not an essential characteristic. A second essential characteristic is that the control of the future economic benefits must be as a result of a past transaction or event. Generally, this is after the purchase of the asset has taken place. It is important to note that resources to be purchased in the future are not considered an asset of the entity until the exchange takes place. However, to further complicate matters, payment is not an essential characteristic of an asset; a donated resource, once the entity has control of the future economic benefits, meets the definition of an asset as well. Finally, the resource must be able to provide future economic benefits or service potential, such that it can contribute directly or indirectly to the future cash flows or cash equivalents of the entity. The definition of an asset identifies its essential features but does not attempt to specify the criteria that need to be met before it can be recognised in the statement of financial position. Hence, it is not sufficient to record assets based only upon the definition of assets. We also need the recognition criteria. Recognition is the process of recording in the financial statements any item that meets the definition of an element and satisfies the criteria for recognition. Assets that satisfy the recognition criteria should be incorporated in the statement of financial position when: [1] it is probable that the future economic benefits will flow to the entity, and [2] the asset has a cost or value that can be measured with reliability. The first recognition criterion results from the fact that business entities operate in uncertain environments. We use the concept of probability to refer to the degree of uncertainty that surrounds whether the future economic benefits will flow to or from the entity in relation to a transaction or event. To assess the degree of probability of the future economic benefits, all of evidence available when the financial statements are prepared is used. For example, when it was probable that a receivable would be collected, it was recognised as an asset. When it was probable that a receivable would not be collected, we incurred doubtful debts expense. The second recognition criterion requires that each item possesses a cost or value that can be measured with reliability. Some items are recorded at cost and very straight forward. Some items such as provision for warranties must be estimated. Items that cannot be reasonably estimated are not recognised in the financial statements.
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20.
Equity is defined in the Conceptual Framework as “the residual interest in the assets of the entity after deducting all its liabilities.” Equity is what remains when we subtract liabilities from assets. The accounting equation can be restated from: Assets = Liabilities + Equity to: Equity = Assets – Liabilities. The above equation shows that equity cannot be defined independently of the other elements in the statement of financial position. Equity is the residual. Examples of transactions that affect equity are sale of equipment that results in gain or loss, capital injection into a business or withdrawals by owners, and asset valuations. Examples of transactions that do not affect equity are purchase of equipment, payment of debts, purchase of an insurance policy and receipt of cash for existing receivables.
21.
Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. To illustrate, a sale of goods on credit results in an increase in Accounts Receivable (asset) and a corresponding increase in Sales Revenue (income). Another illustration, the provision of goods or services in relation to a customer who has paid in advance would be recorded as a decrease in Revenue Received in Advance (liability) and an increase in Revenue (income). AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14). 13.17
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AASB 118 prescribes tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (paragraph 20).
22.
The 2 basic common recognition criteria that are applied to assets, liabilities, revenues and expenses are: [1] Increase or decrease in economic benefits is probable, and [2]The amount of assets, liabilities, revenues or expenses can be measured reliably.
23.
The four bases of measurement as outlined in the Conceptual Framework are: [1] Historical Cost Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation, or in some circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. [2] Current Cost Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently. [3] Realisable (Settlement) Value Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in orderly disposal. Liabilities are carried at their settlement 13.18
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values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business. [4] Present Value Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. Liabilities are carried at the present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business. There are some common alternative measurement bases that can be found in general purpose financial reports. Some assets that are originally recorded at cost are reported on a revalued basis in statement of financial position. This means the assets were revalued either upward or downward to their fair value. Fair value is a subset of the realisable (settlement) value in the Conceptual Framework. Another alternative measurement base is the fair value less any costs incurred in selling the asset. For example, inventories are usually reported at the lower of cost and net realisable value.
24.
GAAP consists of accounting standards, underlying accounting concepts and principles and the Conceptual Framework. The Conceptual Framework defines which entities are required to prepare general purpose financial reports, explains the objective of general purpose financial reports, outlines what is reported in general purpose financial reports, and provides guidance on how items are reported. In addition to the Conceptual Framework, other aspects of GAAP outline what is reported in general purpose financial reports as well as how those items are reported in general purpose financial reports. The various other aspects include the concepts and principles, the accounting standards backed by legislation, as well as the measurement rules as outlined in the standards and the Conceptual Framework. After the Corporations Act, accounting standards are the first point of guidance for preparers. Accounting standards and authoritative interpretations of accounting standards must be followed as they have legislative backing. If the standards are silent on an accounting issue, preparers can seek guidance from the conceptual framework (the Conceptual Framework plus SAC 1 and SAC 2). The concepts and principles that traditionally underlie accounting are applied where there is no guidance on an issue in the conceptual framework. To summarise, GAAP is applied as follows: first the Corporations Act, then accounting standards and interpretations are consulted, then the conceptual framework and finally the underlying concepts and principles.
25.
Three future developments in financial reporting are:
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[1] International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) are currently conducting a joint project to develop the Conceptual Framework. This will impact financial reporting in many ways including what transactions and events will be reported and how. As this is a comprehensive project, it has been divided into eight phases that will take many years to complete and will involve consultation with many and varied stakeholders at all stages of the project. [2] Sustainability Reporting: Mining, deforestation, toxic wastes in river and oceans, and natural resource consumption are some of many negative impacts that businesses all around the world have on natural environment. Currently, many companies disclose information on the impact of their businesses on the environment, however these social and environmental disclosures are voluntary. There are increasing pressures on companies from shareholders and other stakeholders to measure, report on and reduce their environmental impact. There are also increasing pressures on governments to take appropriate actions. For example, in Australia, at the time of writing the text book, the Australian government released its climate change plan – Securing a clean energy future - outlining its new carbon policy. The comprehensive plan is scheduled to commence 1 July 2012 as part of a two staged process. The first stage is a fixed price carbon period of three years which transitions into the second stage with an emissions trading scheme commencing 1 July 2015. In the first year, businesses will pay a fixed price of $23 per tonne of carbon dioxide equivalent and the price will rise 2.5% per year during the fixed price period. Then companies will need to transition into an emissions trading scheme The legislation is currently being drafted and is intended to be submitted to parliament in September. [3] Business entities use their accounting information systems to record, analyse and communicate the economic transactions of a business. While businesses collect similar information in the main, they can vary widely in the format and level of detail of the information they collect. These differences make it difficult for organisations to share information reliably or cost effectively. To further complicate matters, elements of financial information can be defined differently, different accounting methods can be used, and in different countries reporting requirements can vary. This creates difficulties for multinational companies that operate and report all over the world. There is something called eXtensible Business Reporting Language (XBRL) which can help solving these problems. XBRL is a language for describing exactly which information is included in a report. It can even take into account differences in definitions and measurements of elements in other countries. The goal of XBRL is to make the analysis and reporting financial information more consistent and reliable, and easier to facilitate. The financial information based on XBRL can be used to report to shareholders, banks, regulators and other parties. To report financial information in a consistent form, the creators of XBRL have developed a taxonomy or vocabulary that can affect the format of financial information throughout the complete life cycle of that information. XBRL will also facilitate the completion of reports required by regulatory agencies and the preparation of financial reports.
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SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 13.1 (a) False The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. This concept does not include “smoothing out seasonal fluctuations between periods”. (b) False The cost principle states that all assets are initially recorded in the accounts at their purchase price or cost. This is applied not only at the time the asset is purchased but also over the time the asset is held. (c) False The going concern principle states that financial statements are prepared on a going concern basis unless management either intends to or must liquidate the business or cease trading. Following that, the going concern assumption is that the business will remain in operation for the foreseeable future.
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BRIEF EXERCISE 13.2
(a) In this case the accounting entity concept has been incorrectly applied. This concept states that every entity can be separately identified and accounted for. The owner’s personal transactions should not be recorded as part of the business transactions and they should be kept separate. Hence, recording personal vehicle expenses in the entity’s income statement is a violation of accounting entity concept. (b) In this case, no amount would be reported in the financial statements but would be disclosed in the notes, as a law suit of this nature is classified as a contingent liability. Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. Contingent liabilities are not recognised in the financial statements. However, information about contingent liabilities must be disclosed in the notes to the financial statements if they are material. If the children’s toy manufacturer does not disclose the lawsuit and probable loss, there is a violation of full disclosure principle. The full disclosure principle requires that all circumstances and events that could make a difference to the decisions financial statement users might make should be disclosed in the financial statements. (c) The cost principle states that all assets are initially recorded in the accounts at their cost. This is applied not only at the time the asset is purchased but also over the time the asset is held. The going concern principle states that financial statements are prepared on a going concern basis unless management either intends to or must liquidate the business or cease trading. So, unless the business is to cease trading or is to be liquidated, recording land and buildings at their estimated selling price is a deviation from the cost principle.
BRIEF EXERCISE 13.3 (a) The going concern principle states that financial statements are prepared on a going concern basis unless management either intends to or must liquidate the business or cease trading. (b) The full disclosure principle requires that all circumstances and events that could make a difference to the decisions financial statement users might make should be disclosed in the financial statements. (c) The accounting entity concept states that states that every entity can be separately identified and accounted for. Under this concept, the personal transactions of the owners (regardless of entity form i.e. sole trader, partnership or company) should be accounted for separately from the entity’s transactions.
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BRIEF EXERCISE 13.4
(a) (b) (c)
(d)
(e)
True. Prior to 1970 there was no generally accepted theory of accounting. False. While there are many financial accounting theories with a variety of aims, the capitalist theory is not one of them. True. Prior to the late 1970s there was no generally accepted theory of financial accounting. This meant that the development of accounting standards for financial accounting practice was piecemeal as the standards were not based on any particular theory. This resulted in some inconsistencies between standards and therefore inconsistencies in accounting practice. True. In Australia, the conceptual framework (the Framework) consists of a set of concepts defining the nature, purpose and content of general purpose financial reporting to be followed by preparers of general purpose financial reports and standard setters. False. Currently, the authoritative status of the Conceptual Framework is that entities that prepare financial statements in accordance with IFRSs are required to consider the Conceptual Framework when there is no particular standard or interpretation that applies to a transaction or event. The IASB and FASB have not decided upon the authoritative status of the proposed improved conceptual framework; however, it will not have the same status as financial reporting standards, nor will it override standards.
BRIEF EXERCISE 13.5
User Category Primary users Other users Potential equity X investors Regulators X Existing equity X investors Lenders X Members of the public X Other creditors X* Financial advisers X Customers X** X • Include employees, suppliers and **customers in their capacity as resource providers otherwise they are not considered primary users
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BRIEF EXERCISE 13.6 Users
Information needs
1. Managers
6. Information to calculate the amount of tax owing and whether the entity complies with tax laws
2. Investors
4. Information on whether an entity will continue to honour product warranties and support its product lines
3. Creditors
7. Information to determine whether the entity is operating within prescribed rules
4. Customers
5. Information on whether the entity has the ability to pay increased wages and benefits, and offer job security
5. Employees and trade unions
3. Information to determine whether to grant credit based on risks and ability of the entity to repay debts
6. Government authorities
2. Information to determine whether to invest based on future profitability, return on capital growth
7. Regulatory agencies
1. Information to plan, organise and run a business
BRIEF EXERCISE 13.7 There are three main indicators used to decide whether a business organisation is a reporting entity. An entity is more likely to be classified as a reporting entity if: •
the entity is managed by individuals who are not owners of the entity;
•
the entity is politically or economically important; and
•
the entity is considered large when measured in terms of sales, assets, borrowings, customers and employees.
Based on these criteria, reporting entities include public companies and some large private companies as well as government authorities, as these entities have external users with a 13.24
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significant stake or interest in the organisation but are unable to command the preparation of specialised reports to satisfy their information needs. Hence: (a) Less likely (b) More likely (c) Not clear…need more information (if it had a small customer base it is less likely than if it has a large customer base, regardless of satisfaction) (d) More likely (e) Less likely (f) More likely
BRIEF EXERCISE 13.8
(a) Constraint (b) Neither constraint nor qualitative characteristic (c) Qualitative characteristic (d) Qualitative characteristic (e) Neither constraint nor qualitative characteristic (f) Neither constraint nor qualitative characteristic (g) Qualitative characteristic (h) Qualitative characteristic
BRIEF EXERCISE 13.9 (a) Fundamental (b) Neither fundamental or enhancing * (c) Enhancing (d) Enhancing (e) Neither fundamental or enhancing but a constraint (f) Enhancing (g) Neither fundamental or enhancing (h) Fundamental (i) Enhancing * While materiality is not explicitly mentioned as a fundamental or enhancing characteristic - the
relevance of the information is affected by its materiality. Information is material if its omission or misstatement could affect users’ decisions. BRIEF EXERCISE 13.10 (a) Assets are defined in the Conceptual Framework as a resource controlled by the entity as a result of past events and from which ‘future economic benefits’ (not resources) are expected to flow ‘to’ (not ‘from’) the entity. (b) Expenses are defined in the Conceptual Framework as ‘decreases’ (not ‘increases’) in economic benefits during the accounting period in the form of outflows or depletions of assets 13.25
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or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. (c) Equity is defined in the Conceptual Framework as the residual interest in the ‘assets’ (not ‘equity’) of the entity after deducting all its liabilities. (d) Income is defined in the Conceptual Framework as increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, ‘other than those relating to’ contributions from equity participants (not ‘as well as’ contributions from equity participants).
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SOLUTIONS TO EXERCISES
EXERCISE 13.1 Accounting Entity Concept: Tony is the sole owner of Tony’s Pizza Palace. Recently, he purchased a bicycle for his own personal use from his business bank account. He never delivers pizza using the bicycle. At the time of purchase, Tony recorded the transaction in his business accounts as: Dr Withdrawals Cr Bank
Accounting Period Concept: A company with a December year end purchased a 1-year fire insurance policy for $12,000 on October 1, 2009. In order to report the correct income and asset figures in the financial statements ending December 2009, the transaction was recorded as: Dr Prepaid Insurance $9,000 Dr Insurance Expense $3,000 Cr Cash $12,000 This transaction recognises a $3000 expense in period one and a 9,000 expense in the following accounting period. Alternatively the $12,000 could have been initially recorded using either the asset method or the expense method and then adjusted at year end. Note that asset and expense definitions and recognition criteria are also relevant and related.
Going Concern Principle: Company A purchased equipment for $1 million. A year later, the equipment is still reported at its book value (purchase price minus accumulated depreciation), not liquidation value.
Cost Principle: Company A purchased a piece of land for $ 1,000,000 after obtaining a loan. At the time of purchase, the company was considered to be a going concern and the land was recorded in the statement of financial position at $ 1,000,000. Dr Land $ 1,000,000 Bank Loan $ 1,000,000 13.27
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In the next reporting period, the land will still be recorded at $1,000,000 under the cost principle, although the price of the land may have increased to $1,200,000.
Full Disclosure Principle: Company A was sued for defective products that resulted in customer injuries. The legal representation for the company assessed that the company is likely to lose the case and will be required to pay a large amount of money as compensation. While the payment is probable, however at this stage it cannot be reliably estimated. While no amount is recorded in the financial statements, Company A discloses information about the law suit and likely losses in its notes to the financial statements.
EXERCISE 13.2 FISHY TAILS (a) (i) The purchase of motor vehicle transaction was recorded incorrectly. The purchase of plant and equipment was recorded correctly. (ii)The entry for the purchase of motor vehicle was incorrectly recorded as it violates the accounting entity concept. The accounting entity concept states that every entity can be separately identified and accounted for. In this case the personal transactions of the owner were not recorded separately from the transactions of the entity. The purchase of the motor vehicle for personal use out of company funds should be recorded as a withdrawal of capital. (iii) Correcting entry: Drawings $20,000 Motor Vehicles
$20,000
Correct entry that should have been recorded in the first instance: Drawings $20,000 Cash $20,000 (b) If the car were to be used for business purposes, then the initial entry of debit to Motor Vehicles and credit Cash would have been correct. If the vehicle is purchased solely for business use, it is correct to report the vehicle as a company asset and accounting entity concept is not violated.
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EXERCISE 13.3 (a) 7. (Going Concern Principle) This principle states that financial statements are prepared on a going concern basis unless management either intends to or must liquidate the business or cease trading. (b) 1. (Accounting Entity Concept) This concept states that every entity can be separately identified and accounted for. (c) 6. (Full Disclosure Principle) The full disclosure principle requires that all circumstances and events that could make a difference to the decisions financial statement users might make should be disclosed in the financial statements. (d) 2. (Monetary Principle) This principle requires that the items included in the accounting records must be able to be expressed in monetary terms. (e) 5. (Materiality) The relevance of information is affected by its materiality. Information is material if its omission or misstatement could affect users’ decisions. (f) 3. (Accounting Period Concept) The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. (g) 9. (Expense recognition criteria) The Conceptual Framework provides expense recognition criteria. Expenses should be recognised when ‘a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably’ (paragraph 94). (h) 4. (Cost Principle) The cost principle states that all assets are initially recorded in the accounts at their purchase price or cost. This is applied not only at the time the asset is purchased but also over the time the asset is held.
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EXERCISE 13.4 (a) A violation of revenue recognition criteria has occurred. AASB 118 and NZ IAS 18 ‘Revenue’ prescribe principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (1) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (2) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (3) the amount of revenue can be measured reliably; (4) it is probable that the economic benefits of the revenue will flow to the entity; and (5) the associated costs can be measured reliably (paragraph 14). In this case no sale has occurred however, revenue has been recognised. Normally, the transfer of significant risks and rewards of ownership occurs when legal title passes to the buyer. Further, in the question we are also told that the amount cannot be reliably measured at this stage – a further violation of the recognition criteria. (b) A violation of Accounting Period Concept has occurred. The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. In this case no reports have been prepared. (c) In this case no violation is evident as the inventory is being carried at the lower of cost or net realisable value. Although the cost principle states that assets are to be recorded at their cost, AASB 102 Inventories mandates that ‘inventories shall be measured at the lower of cost and net realisable value’ (para.9). Furthermore, the Conceptual Framework also provides expense recognition criteria. Expenses should be recognised when ‘a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably’ (paragraph 94). In this case the net realisable value is lower than the cost of inventory so there has been a decrease in an asset (inventory) and an increase in an expense (inventory write-down expense).
(d) A violation of going concern principle is evident in this case. The going concern principle states that financial statements are prepared on a going basis unless management either intends to or must liquidate the business or cease trading. In this case, liquidation is unlikely, so property plant and equipment should not be reported at the amount for which it could be sold at short notice, but either cost or revalued basis. In addition, property, plant and equipment and bills payable also need to be classified as non-current assets and liabilities respectively. (e) A violation of cost principle in this case. The cost principle states that all assets are initially recorded in the accounts at their purchase price or cost. This is applied not only at the time
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the asset is purchased, but also over the time the asset is held. If the net realisable value is lower than cost, then Full of Beans Ltd should report the inventory at net realisable value. (f) A violation of accounting entity concept is evident in this case. This concept states that every entity can be separately identified and accounted for. In other words, owner’s personal transactions must be clearly separated from the entity’s transactions. Hence a computer that is purchased for personal use should not be included in the company records.
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EXERCISE 13.5 (1) Drawings Cash
3,000 3,000
(Purchase of a computer from entity funds for personal use) Accounting Entity Concept states that every entity can be separately identified and accounted for. Hence personal transactions of the owner should be recorded separately from the transactions of the entity. Therefore, the purchase of computer for personal use using company funds is recorded as a withdrawal of capital rather than an asset of the entity. (2) Paintings Cash
50,000 50,000
(Purchased paintings for $50,000 in cash) The monetary principle requires that the items included in the accounting records must be able to be expressed in monetary terms. This principle underlies all recorded transactions. Hence the purchase of paintings for use within the business is recorded in monetary terms at cost as indicated above. (3) 1 Jan 2011 Dr Prepaid Insurance 24,000 Cr Cash 24,000 (Company purchased a 1-year insurance policy for $24,000 on 1 January 2011) The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. If the company’s year end is 30 June, in order to provide useful reports at the end of each accounting period, the company must make adjusting entries to ensure assets, liabilities, revenues and expenses are reported correctly. The adjusting entry is: 30 June 2011 Insurance Expense Prepaid Insurance
12,000 12,000
(Adjusting entry for Insurance) (4) Building Cash
1,000,000 1,000,000
(Purchased a building for $1,000,000)
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Cost principle states that all assets are initially recorded in the accounts at their purchase price or cost. In the above example, the company recorded the purchase of its new building at cost. (5) Notes to the financial statements: Our company is currently involved in a law suit in relation to damages caused by one of our products. While the exact amount of the possible payout is currently unknown, it is expected that a payout will be awarded and could be in the vicinity of $500,000 to $1,000,000. In this case, no amount would be reported in the financial statements but would be disclosed in the notes as shown above, as a law suit of this nature is classified as a contingent liability. Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. Contingent liabilities are not recognised in the financial statements. However, information about contingent liabilities must be disclosed in the notes to the financial statements if they are material. If this company did not disclose the lawsuit and probable loss, there is a violation of full disclosure principle. The full disclosure principle requires that all circumstances and events that could make a difference to the decisions financial statement users might make should be disclosed in the financial statements. (6) 31 December 2010 Depreciation Expense 20,000 Accumulated Depreciation – Building
20,000
(Depreciation expense for the year - Cost $1,000,000 / 50 years no residual value = $20,000) On January 1 2010, Dido Ltd purchased a building for $1,000,000. The building is to be depreciated with straight line method over 50 years with no residual value. On December 31 2010, the company recorded the above journal entry. Dido Ltd is in a strong financial position and has no liquidation plans. The going concern principle states that financial statements are prepared on going concern basis unless management either intends to or must liquidate the business or cease trading. As the company is a going concern the building is not reported at liquidation value. The above journal entry records the annual depreciation charge. The building cost $1,000,000 less the accumulated depreciation charge $20,000 will be reported in the statement of financial position in the non-current asset section.
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(7) 25 June 2009 Accounts Receivable Service Revenue
1,000 1,000
(Billed customer for services performed) Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. Revenue is a subset of income. To illustrate, a sale of goods on credit results in an increase in Accounts Receivable (asset) and a corresponding increase in Sales Revenue (income). Another illustration, the provision of goods or services in relation to a customer who has paid in advance would be recorded as a decrease in Revenue Received in Advance (liability) and an increase in Revenue (income). Revenue recognition criteria - AASB 118 prescribes tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (paragraph 20). Once the services have been performed, the inflow of economic benefits during the accounting period in the form of inflows or enhancements of assets that result in increase in equity, other than those relating to contributions from equity participants, is probable and can be reliably measured.
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(8) Dec 31 2011 Rent Expense 1,000 Prepaid Rent 1,000 (Year end adjusting entry for rent expense) Expenses are defined in the Conceptual Framework as ‘decreases’ in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. The Conceptual Framework provides expense recognition criteria. Expenses should be recognised when ‘a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably’ (paragraph 94). The 2 basic common recognition criteria that are applied to assets, liabilities, revenues and expenses are: [1] Increase or decrease in economic benefits is probable, and [2]The amount of assets, liabilities, revenues or expenses can be measured reliably In this case, the asset in the form of Prepaid Rent has expired as the service has been provided. The depletion of assets has arisen and can be reliably measured. The company paid $2,000 for 2 months rent in advance on 1 December 2011. The initial entry was recorded as a debit to prepaid rent. The adjusting entry above was made on 31 December 2011 to recognise that an expense had been incurred based on the expense recognition criteria, that is a decrease in assets that can be measured reliably.
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EXERCISE 13.6 Provisions are defined as liabilities for which the amount of the future sacrifice is uncertain. That is, whether a liability is a provision or some other type of liability (e.g. borrowings, trade creditors, accruals) depends upon the extent of uncertainty associated with the amount of the future sacrifice. For borrowings such as debentures, leases, unsecured notes and mortgages, the amount of the future sacrifice (i.e. the repayment) can be predicted with a high level of certainty. Similarly, the amount of the future sacrifice for trade creditors can be measured with a high level of certainty because it is quantified on the supplier’s invoice. The uncertainty associated with the amounts of future sacrifice varies along a continuum ranging from very low uncertainty to very high uncertainty. Provisions are liabilities for which there is significant uncertainty about the amount of the future sacrifice but which are considered able to be measured reliably by estimation. Examples include provisions for warranties, and provisions for employee entitlements such as long service leave. A warranty is an obligation of the supplier of goods or services to the purchaser that the product will be functional or that the work performed will remain satisfactory for a stated period after the sale of goods or the provision of services. There is significant uncertainty in the measurement of the future sacrifices that will be needed to satisfy existing warranties. This is due to two reasons: 1. The future sacrifice is conditional upon the customer making a claim. 2. The costs of satisfying claims vary with the nature of the fault. Some warranty claims may require the replacement of a small part, while other warranty claims may require replacement of the goods sold to the customer. There is significant uncertainty about the future sacrifice required for employee entitlements, such as long service leave, because the amount payable is affected by the following: • whether employees stay with the employer long enough to become entitled to long service leave • when employees take long service leave • the extent to which the employee is promoted before taking long service leave • increases in general salaries between the time the liability is recorded and when it is paid. Other liabilities such as accruals are liabilities to pay for goods or services that have been provided but for which a supplier’s invoice has not yet been recorded as an account payable. Accruals often involve estimation, such as the amount of the next electricity bill or telephone account. Although higher than borrowings and trade creditors, the level of uncertainty of accruals is typically low because they are often for recurring services such as telephone connections, electricity usage and interest.
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Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably. Liabilities are also classified as contingent if they do not satisfy the probability criterion, or if they are dependent upon the occurrence of an uncertain future event outside the control of the entity. Examples include an unresolved lawsuit brought against the entity and the potential liability resulting from a tax audit in progress. Contingent liabilities are not recognised because they are not probable or are unable to be measured reliably, or both, i.e. they do not satisfy the probability criterion and the measurement criterion for the recognition of liabilities. Based on these definitions, the liabilities are classified as follows: (a) Contingent liabilities (b) Other liabilities (c) Other liabilities (d) Provisions (e) Other liabilities (f) Provisions (g) Other liabilities (h) Other liabilities (i) Contingent liabilities
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EXERCISE 13.7 THRIFTY TYRES
(1) Revenue recognition criteria were not followed. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Further, in the context of revenue recognition (income) AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14). In this case part (a) has not been satisfied and revenue should not be recorded until the tyres are delivered in March. The effect of this error is an overstatement of revenue and hence an overstatement of profit and also an understatement of liabilities in the form of Revenue Received in Advance by $20,000. The correcting entry would be: Dr Service Revenue 20,000 Cr Revenue Received in Advance 20,000 (To adjust the Service Revenue account for revenue received in advance) (2) Expense recognition criteria were not followed. Expenses are recorded when there is a decrease in future economic benefits related to a decrease in an asset or an increase in liability. In this case there was no decrease in assets as the advertising supplies (asset) were still on hand and have not been used. The entry to correct this error: Dr Supplies Inventory 2,300 Cr Supplies Expense 2,300 (To adjust the supplies expense account for supplies still on hand) The effect of the error is an overstatement of the company’s expenses, an understatement of the company’s assets and therefore an understatement of the company’s profit by $2,300.
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(3) Expenses are recorded when there is a decrease in future economic benefits related to a decrease in an asset or an increase in liability. In this case the expense recognition criteria were not followed as there was a decrease in assets (prepaid insurance which had expired) which could be reliably measured. The prepaid insurance should amount to $9,000 as of 31 December 2013, hence the company should record an adjusting entry at year end to account for the decline in the asset and increase in insurance expense. The adjusting journal entry would be a debit of $3,000 for Insurance Expense and a credit of $3,000 for Prepaid Insurance. In this case the decrease in future economic benefits related to a decrease in an asset and the amount of that decrease can be measured reliably, and so the expense must be recorded. The effect of this error is an understatement of expenses, an overstatement of assets and an overstatement of profit by $3,000.
(4) Expenses were not recorded correctly and the company did not follow expense recognition criteria. In these cases there have been decreases in future economic benefits related to increases in liabilities and the amounts can be measured reliably, and so the expenses must be recorded. The expenses should be recorded (accrued) as follows: Dr Advertising Expense Cr Advertising Payable Dr Repairs Expense Cr Repairs Payable Dr Electricity Expense Cr Electricity Payable
2,500 2,500 2,000 2,000 800 800
The effect of not recording the expenses correctly is an understatement of expenses and an understatement of liabilities by $5,300. Therefore, profit is also overstated by $5,300. (5) Expenses were not recorded correctly and the company did not follow expense recognition criteria. In this case there has been a decrease in future economic benefits related to an increase in liabilities and the amount can be measured reliably, and so the expense must be recorded. Once employees have performed their duties, wages expenses have been incurred. Therefore, the company must record the wages expenses and corresponding liabilities. In this case, the journal entry: Dr Wages Expense 400 Cr Wages Payable 400 The impact of this error is an understatement of expenses and liabilities and an overstatement of profit by $400. 13.39
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(6) Expenses were not recorded correctly and the company did not follow expense recognition criteria. In this case there has been a decrease in future economic benefits related to an increase in liabilities and the amount can be measured reliably, and so the expense must be recorded. The interest for 1 year is $24,000. As the amount for December has not been recorded, expenses and liabilities are understated and the profit is overstated by $2,000. The journal entry to record the expense and corresponding liability is: Interest Expense 2,000 Interest Payable 2,000
EXERCISE 13.8 (a) (1) The correcting entry would be: Dr Service Revenue 20,000 Cr Revenue Received in Advance 20,000 (To adjust the Service Revenue account for revenue received in advance) (2) The entry to correct this error: Dr Supplies Inventory 2,300 Cr Supplies Expense 2,300 (To adjust the supplies expense account for supplies still on hand) (3) The adjusting entry is as follows: Dr Insurance Expense $3,000 Cr Prepaid Insurance $3,000 (To adjust the prepaid insurance to recognise the amount expired) (4) The adjusting entry would be: Dr Advertising Expense Cr Advertising Payable Dr Repairs Expense Cr Repairs Payable Dr Electricity Expense Cr Electricity Payable (To record various accrued expenses)
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(5) The adjusting entry would be: Dr Wages Expense Cr Wages Payable (To recorded accrued wages)
400 400
(6) The adjusting entry would be: Dr Interest Expense Cr Interest Payable (To record accrued interest)
(b)
2,000 2,000
Initial Reported Profit
50,560
Revenue that should have not been recorded
(20,000)
Supplies expense that should have not been recorded
2,300
Insurance expense that was not recorded
(3,000)
Advertising expense that was not recorded
(2,500)
Repairs expense that was not recorded
(2,000)
Electricity expense that was not recorded
(800)
Wages expense that was not recorded
(400)
Interest expense that was not recorded
(2,000)
Revised Profit
(28,400) 22,160
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EXERCISE 13.9 (a) Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (1) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (2) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (3) the amount of revenue can be measured reliably; (4) it is probable that the economic benefits of the revenue will flow to the entity; and (5) the associated costs can be measured reliably (paragraph 14). In this case the entity has NOT transferred to the buyer the significant risks and rewards of ownership of the goods (i.e. the machinery is yet to be manufactured and shipped), hence revenue cannot be recognised. As outlined in the Conceptual Framework, a liability is recognised in the statement of financial position when: (a) it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation (b) the amount at which the settlement will take place can be measured reliably (paragraph 91). In this case there is a present obligation to manufacture and ship the machinery, and therefore a liability should be recognised as follows: Cash
200,000 Revenue Received in Advance 200,000 (To record revenue received in advance form a customer for goods to be shipped in Feb 2014)
(b) Assets are defined in the Conceptual Framework as ‘a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’ (paragraph 49(a)). Assets that satisfy the recognition criteria should be incorporated in the statement of financial position when: (1) it is probable that the future economic benefits will flow to the entity (2) the asset has a cost or value that can be measured with reliability (paragraph 89). In this case, the equipment is a result of a past transaction (settlement for goods sold), is controlled by Playing Guitars, and provides the business with future economic benefits (generating revenue). Hence one asset account has increased (equipment) and another decreased (accounts receivable). Journal Entry: 13.42
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Equipment Accounts Receivables
3,000 3,000
As an asset account is increased by $3,000 and another asset account is decreased by $3,000, the total amount of assets does not change.
(c) Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. Contingent liabilities are not recognised in the financial statements. However, information about contingent liabilities must be disclosed in the notes to the financial statements if they are material. In this case the amount cannot be measured with reliability, and cannot be reported on the face of the financial statements (no journal entry). However, while the amount is unknown a future obligation is certain as the courts have ordered the repairs. Hence, this must be disclosed in the notes to the financial statements as a contingent liability.
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EXERCISE 13.10 Assets are defined in the Conceptual Framework as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Assets that satisfy the recognition criteria should be incorporated in the statement of financial position when [1] it is probable that the future economic benefits will flow to the entity and [2] the asset has a cost or value that can be measured with reliability. (a) Saleable inventory is an asset (as opposed to old and obsolete inventory which has no expected future economic benefit). It is it is probable that the future economic benefits will flow to the entity through the sale of inventory in the form of receivables and then cash and this can be measured with reliability (i.e. known selling price and cost price). (b) Not an asset. While the antique boot is an interesting talking point and meets some of the elements in the definition and recognition criteria of an asset (e.g. it is controlled by the entity), we are told that it has no commercial value (cannot provide future economic benefits in the form of sale). An asset needs to provide a future economic benefit and a cost or value that can be measured with reliability. (c) Consignment stock is not an asset of Shiny Shoes (the consignee); it is an asset of the consignor. Although Shiny Shoes has possession of the consigned shoes, it does not have control of the shoes as the ownership still belongs to the consignor. (d) While in colloquial terms we often hear ‘employees are the greatest assets of a company’, in terms of the definition of an asset in accounting, staff members are not the company’s assets. Shiny Shoes does not have control of the three staff members, which is essential to the definition of an asset. While staff members may provide future economic benefits to the company, they are not controlled by the company as they are able to resign anytime and work elsewhere. (e) Shelving to display shoes is an asset. It is controlled by the entity as a result of past events (i.e. purchase transaction). It provides a probable future economic benefit in that displaying shoes is likely to result in shoe sales or the shelves themselves can be sold for cash. Shelves also have costs that can be measured with reliability (i.e. purchase price), and therefore should be recognised in the financial statements.
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EXERCISE 13.11 Liability is defined in the Conceptual Framework as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A liability is recognised in the statement of financial position when [1] it is probable that an outflow of resources embodying economic benefit will result from the settlement of a present obligation, and [2] the amount at which the settlement will take place can be measured reliably. (a) The purchase of concrete and steel on account should be recognised as a liability. Once the goods are received, a present obligation of Bigger Home Builders (i.e. obligation to pay for the materials) arising from past events (i.e. purchase transaction) exists, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits e.g. the payment of cash. It is probable that an outflow of resources embodying economic benefit will result from the settlement of the obligation, and the amount of the settlement can be measured reliably through the purchase price. The journal entry to recognise the liability is: Building Materials Accounts Payable
X X
(b) The receipt of $100,000 as a deposit for homes to be built is recognised as a liability. The deposit received, cannot be recorded as Revenue as the work to build home has not been completed. Once the deposit is received, a present obligation of the company to build homes for its clients has risen from a past event (i.e. receipt of the deposit)., The settlement of the obligation is expected to result in an outflow from the company of resources embodying economic benefits e.g. resources used to build homes or the repayment of the deposit. The journal entry to recognise the liability is: Cash 100,000 Revenue Received in Advance
100,000
It is probable that an outflow of resources embodying economic benefit will result from the settlement of the obligation to build homes, and the amount of the settlement can be measured reliably through the amount of deposit received.
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(c) An agreement to employ new staff is not recorded as liability as no present obligation exists and there is no transaction from past event (the new staffs have not commenced working). Once the new staff members start working, a present obligation to pay them will exist. The journal entry to recognise the liability after the work has been completed will be: Wages Expense X Wages payable X
(d) No liability should be recorded, however in this case there may be a contingent liability. Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. Although the amount of the lawsuit can be measured reliably ($13,000), whether or not an outflow of resources embodying economic benefit resulting from the settlement of the lawsuit occurs would depend on the court’s decision, which is outside the control of Bigger Home Builders. While the company believes that it might lose the case, the result cannot be determined until court decisions are made. Given that the lawsuit does not satisfy the probability criterion and are dependent upon the court’s decision, it should be disclosed in the notes to the financial statements as a contingent liability.
(e) No liability recorded as the amount of damages cannot be measured reliably. However, given that the company has been ordered by the court to pay damages even though the amount is uncertain, it must be disclosed in the notes of the financial statement as a contingent liability. Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. In this case there is an obligation but the amount is uncertain.
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EXERCISE 13.12 Revenue is a subset of income. Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. To illustrate, a sale of goods on credit results in an increase in Accounts Receivable (asset) and a corresponding increase in Sales Revenue (income). Another illustration, the provision of goods or services in relation to a customer who has paid in advance would be recorded as a decrease in Revenue Received in Advance (liability) and an increase in Revenue (income). Further, in the context of revenue recognition (income), AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: [1] the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; [2] the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; [3] the amount of revenue can be measured reliably; [4] it is probable that the economic benefits of the revenue will flow to the entity; and [5] the associated costs can be measured reliably.
For the revenue arising from the provision of services, the following must be satisfied for it to be recognised: [1] the amount of revenue can be measured reliably; [2] it is probable that the economic benefits associated with the transaction will flow to the entity; [3] the stage of completion of the transaction at the reporting date can be measured reliably; and [4] the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.
(a) Revenue is not recognised as the magazines have yet to be delivered, hence the transaction doesn’t meet the revenue recognition criteria as “the entity has NOT transferred to the buyer the significant risks and rewards of ownership of the goods”. Currently Surfin’ Magazines has an obligation to either refund the money or to deliver the magazines, hence the $24,000 is recorded as a liability (Revenue Received in Advance) 13.47
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and not a revenue. Revenue will be recognised once the magazines have been delivered to subscribers.
(b) Dividend received is recognised as income because it is an increase in economic benefit during the accounting period in the form of inflow or enhancement of assets (i.e. cash) that results in increase in equity, other than those relating to contribution from equity participants. Since the dividend has already been received, the economic benefits associated with the transaction have flown to Surfin’ Magazines and the amount of dividends can be measured reliably. In this case the transaction would be recorded as follows: Cash
X Dividend Income
X
(c) Payment of interest on a loan is not recognised as revenue. Rather, it is recognised as an expense as it involves a decrease of future economic benefits in the form of outflows of assets (cash). The journal entry would be: Interest expense Cash
X X
(d) Discount Received is recorded as revenue. Discount Received is revenue as the discount represents a saving in outflows of economic resources - a consequential reduction in liabilities and also an increase in equity other than those relating to contributions from equity participants. Furthermore, the increase in future economic benefits related to the decrease in liability (account payable) has arisen and can be measured reliably. The journal entry should be: Accounts Payable Cash Discount Received
X X X
(e) Once the magazines are delivered, revenue can be recognised as Surfin’ Magazines has fulfilled all of the recognition criteria including transfer of the significant risks and rewards of ownership of the goods to the customers. The amount of revenue can be measured reliably as reflected in the subscription price. Hence the amount previously recorded as Revenue Received in Advance can now be recorded as Revenue.
The journal entry: 13.48
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Revenue Received in Advance Revenue
X X
(f) Once the magazines are delivered, revenue can be recognised as Surfin’ Magazines has fulfilled all of the recognition criteria including transfer of the significant risks and rewards of ownership of the goods to the customers. Since the customers have not yet paid the subscription fees, the revenue is recognised with a corresponding receivable account to record payments owed by the customers. The journal entry: Accounts Receivable Revenue
X X
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EXERCISE 13.13 ROSEVILLA GOLF COURSE LTD
As defined in the Conceptual Framework expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Expenses should be recognised when a decrease in future economic benefits related to a decrease in an asset or an increase of liability has arisen that can be measured reliably. (a) A payment of public liability insurance 1 year in advance does not meet the definition criteria of an expense. No expense is recognised because no depletion of assets or incurrence of liabilities that result in decreases in equity has occurred. Instead, an asset account has decreased (cash) and another asset account has increased (prepaid insurance) by the same amount (hence there is no change in total assets). Insurance expense will start to be recognised next month when the insurance fee for the 1st month expires. The journal entry is: Prepaid Insurance Cash
240,000 240,000
(b) A payment of dividends is a distribution of profit and not an expense. Expenses are outflows or depletions of assets (cash) or incurrence of liabilities that result in decreases in equity other than those relating to distributions to equity participants. In this case the depletion of assets relates to equity participants in the form of dividend payments. (c) Interest payment is an expense. There is a decrease in economic benefit in the form of a depletion of assets (cash) and the amount can be measured reliably. The journal entry: Interest Expense Cash
X X
(d) Discount allowed is recorded as an expense. There is a decrease in future economic benefit in the form of depletion of assets (i.e. reduction in the amount of cash received from customers) that result in decreases in equity. If no discount was allowed more cash would have been received. The journal entry: Cash Discount Allowed Accounts Receivable
X 2000 XX
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(e) Fees paid in advance by members are not recorded as expenses. There has been no decrease yet in economic benefit i.e. outflows or depletions of assets (cash) or incurrence of liabilities that result in decreases in equity. Rather, Rosevillia Golf Course should recognise the fees received in advance as a liability, because the fees have created a present obligation for Rosevillia to provide facilities/services to its members, which will result in outflows of its resources or future economic benefits. The transaction should be recorded as: Cash 3,000,000 Revenue Received in Advance 3,000,000 An asset account (cash) is increased by $3 million and a liability account (Revenue Received in Advance) is increased by $3 million. (f) The electricity bill is recorded as an accrued expense. The company has used the electricity for the period and incurred a liability to pay for the electricity used that results in a decrease in equity other than those relating to distributions to equity participants and the amount can be measured reliably. The journal entry: Electricity Expense Electricity Payable
X X
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SOLUTIONS TO PROBLEM SET A
PROBLEM SET A 13.1 BETTA BALLS LTD
(a) a) In this case reporting inventory at net realisable value is violation of cost principle. b) In this case recording the computer as an asset of the business is a violation of accounting entity concept. c) In this case, including 2013 sales in the 2014 period to increase profit violates both the accounting period concept and revenue recognition criteria. d) In this case, excluding incurred yet not paid expenses to increase profit violates both the accounting period concept and expense recognition criteria. e) Non disclosure of the law suit is a violation of the full disclosure principle and the definition and recognition criteria for liabilities. (b) a) The cost principle states that all assets are initially recorded in the accounts at their purchase price or cost. This is applied not only at the time the asset is purchased but also over time the asset is held. Under the lower of cost or net realisable value rule, inventory should be reported in the statement of financial position at cost, unless the net realisable value is less than cost. Hence, merchandise inventory with a cost of $68,000 and a realisable value of $100,000 should not be recorded at its net realisable value but at its cost. b) Accounting Entity Concept states that every entity can be separately identified and accounted for. Hence, the personal transactions of the owner should be recorded separately from the transactions of the entity. The purchase of a computer for personal use out of company funds should be recorded as a withdrawal of owner’s capital (i.e. a debit to Drawings and a credit to Cash), not an increase in the company’s assets (i.e. a debit to office equipment). c) The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. This implies that only transactions that occur in one period can be included in the report for that particular period. Therefore, the manager of Betta Balls should not include the sales figure for the first two days of 2013 in the 2014 income statement. Income (e.g. revenue) is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants”. Recognition criteria require the inflow 13.52
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of resources to be probable and measured reliably. Revenue is recognised on the sale of goods when a number of conditions are satisfied, including that “the entity has transferred to the buyer the significant risks and rewards of ownership of the goods”. Clearly the sales made during the first two days of 2013 (when the goods were delivered) must be excluded from 2014 revenue since the ownership of goods has not yet been transferred to customers in 2014 and thus revenue should not be recognised at that point. d) The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. This implies that an interest payment incurred in 2014 should be recorded in 2014 period even though payment has not yet been made. Expenses are defined in the Framework as decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. The $13,000 interest payment incurred by Betta Balls in 2014 satisfies the definition of an expense, as there was a decrease in economic benefits in the form of incurrence of a liability (i.e. interest payable) that result in a decrease in equity other than those relating to distributions to equity participants. In addition, the decrease in economic benefits was incurred in 2014 and can be measured reliably. Hence, the manager should have recorded $13,000 interest expense during 2014. e) The definition and recognition criteria for liabilities and the full disclosure principle are relevant to this case. Full disclosure requires that all circumstances and events that could make a difference to the decision financial statement users might make should be disclosed in the financial statements. In this case there is a lawsuit for which there is a probable payout. This circumstance could cause financial statement users to make a different decision, for example by not investing as much to the company if they found out about the lawsuit. Therefore, the accountant should disclose this information in the notes to the financial statements. In the case of Betta Balls, although the lawsuit damages satisfies the definition of liabilities, it fails the recognition criteria due to the uncertainty of the amount to be paid. Following that, the damages is not a liability, but a contingent liability. Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. Contingent liabilities are not recognised in the financial statements. However, information about contingent liabilities must be disclosed in the notes to the financial statements if they are material. Hence, Betta Balls must disclose information about the lawsuit in the notes of financial statement so as to provide all the relevant data needed for financial statement users in making decisions. (c) a) Statement of Financial Position Current Assets: 13.53
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Inventory
68,000
Inventory should be reported in the statement of financial position at cost as the net realisable value is greater than cost. b) The correct journal entry should be: Drawings – Betty Baldrin 2,500 Cash 2,500 Given the computer was purchased for personal use, it should not be recorded as the company’s transactions. Rather, the transaction should be recorded as a withdrawal of Betty’s capital. c) No sales occurred in 2013 should be recorded in the income statement for the year ending 2014. For the income statement for the year ending 2013, record the first two days sales: Accounts Receivable or Cash X Sales X d) Interest expense of $13,000 should be recorded in 2014 as follows: Interest Expense 13,000 Interest Payable 13,000 Interest expense is recorded when there is as decrease in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities (interest payable). Beta Balls has incurred $13,000 of interest expense in the year ended 31 December 2014. e) No journal entry recorded since the amount of damages cannot be measured reliably. However, given Betta Balls is likely to pay damages, information about the lawsuit must be disclosed in the notes to the financial statements as the lawsuit could make a difference to the decisions made by financial statement users. Notes to the financial statements: Currently Betta Balls is being sued by a customer in relation to one of the company’s products. While the amount of damages to be paid is unknown at this stage, it is expected that the company will have to pay damages in the vicinity of $XX-$XX.
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PROBLEM SET A 13.2 MOO COW FARM LTD Please note that under REQUIRED that part (j) refers to the cost principle and for part (h) cost refers to the cost constraint on financial reporting.
(a) In this situation, the concept of materiality has been correctly applied. The relevance of information is affected by its materiality. Information is material if its omission or misstatement could affect users’ decisions. In this case, as the fence repair tools are immaterial they are expensed immediately rather than being capitalised and depreciated over the life of the asset. (b) In this situation, the expense recognition criteria have been correctly applied. Expenses should be recognised when a decrease in future economic benefit related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. Clearly, unpaid farm hand salaries are decreases in future economic benefits in the form of incurrence of liabilities (i.e. salaries payable) that result in decreases in equity, other than those relating to distributions to equity participants. The decrease in future economic benefits has arisen when the workers complete their work, and the amount can be measured reliably through the salary rate. Therefore, the salaries incurred but unpaid should be recognised as expenses in the period when they were incurred. (c) In this situation, the monetary principle has been correctly applied. The monetary principle requires that the items included in the accounting records must be able to be expressed in monetary terms, such as dollar, pound, or euro. (d) In this situation, the accounting period concept has been correctly applied. The accounting period concept states that the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity. Consequently, financial information must be separated into time periods for reporting purposes. (e) In this situation, the cost principle has been correctly applied. The cost principle states all assets are initially recorded in the accounts at their purchase price or cost. This can be applied not only at the time the asset is purchased but also over the time the asset is held. However, assets can be re-valued as appropriate. (f) In this situation, the accounting entity concept has been correctly applied. This concept states that every entity can be separately identified and accounted for. Therefore the personal transactions of owners should be recorded separately from the transactions of the business entity. (g) In this situation, the full disclosure principle has been correctly applied. The full disclosure principle requires that all circumstances and events that could make a difference to the decision financial statement users might make should be disclosed in the financial statements.
(h) In this situation, the revenue recognition criteria have been correctly applied. Revenue is recognised in the income statement when an increase in future economic benefit related to 13.55
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an increase in an asset or a decrease of a liability has arisen that can be measured reliably. The increase in asset or decrease in liability must result in increase in equity, other than those relating to contributions from equity participants. (i) This situation illustrates the cost versus benefits constraint. Preparers and standard setters seek to ascertain that the costs of preparing certain financial information are not greater than the benefits to be derived from using that information.
PROBLEM SET A 13.3
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(a) “The Conceptual Framework looks like a window that you can see the world through” (In the text book, the analogy of the window is used to help students understand how the Conceptual Framework works. That is, the Conceptual Framework is likened to a window because it allows users, standard setters and preparers to view the economic world in a particular way. The Conceptual Framework itself does not look like a window; this student has not understood or discussed the analogy used in the book correctly). “and has four sections”. (There are 4 sections in the Conceptual Framework. This is correctly pointed out). “It talks about accounting concepts”. (A conceptual framework indeed outlines accounting concepts, so this is correct). “It talks about what accounting is about”. (More specificity is required in the answer, the Conceptual Framework identifies the objective of financial reporting rather than ‘what it is about’.) “It tells accountants how to prepare financial statements”. (Correct, the Conceptual Framework. provides guidance for standard setters and preparers). “It is helpful to standard setters”. (Correct, see comments above). “The four parts are: (a) the accounting entity, which states that the transactions of the owners should be separate from that of the business”. (Incorrect. The student should refer to “the reporting entity”, not the accounting entity. The reporting entity is an entity in which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions). (b) “the objective of businesses, which states the objective of a business, is to make profit to be able to pay dividends to the owners”. (Incorrect. The Conceptual Framework explains “the objective of general purpose financial reporting.” The objective of general purpose financial reporting is to provide information to users that is useful for making and evaluating decisions about the allocation of scarce resources). (c) “the qualitative characteristics, which include the monetary principle, the accounting period concept and the going concern and cost principles”. (Incorrect. According to the Conceptual Framework, the qualitative characteristics are classified as either fundamental or enhancing depending on how they affect the usefulness of financial information. Enhancing qualitative characteristics and fundamental qualitative characteristics are complementary. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability.). (d) “the definition of elements in the financial statements, which is the last window. For example, accounts receivable is defined as ‘the right to receive cash upon the sale of goods or provision of services to a customer.’” (Incorrect. The Conceptual Framework defines the major elements of general purpose financial reports namely assets, liabilities, equity, income and expenses). 13.57
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(b) A possible model or correct answer: The conceptual framework consists of a set of concepts defining the nature, purpose and content of general purpose financial reporting to be followed by preparers of general purpose financial reports and standard setters. The conceptual framework in Australia, also known as the Conceptual Framework, has 4 main components: [1] the reporting entity (SAC 1), [2] the objective of general purpose financial reports (SAC 2), [3] the qualitative characteristics, and [4] the definition of elements of financial statements.
The reporting entity is defined in the Conceptual Framework as an entity for which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions (SAC 1). The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making their decisions about providing resources to the entity. Decisions include: buying, selling or retaining shares and providing loans or settling amounts owed to the entity. To make those decisions, users need information to help them assess the prospects for future net cash inflows to an entity. This will allow them to estimate the return they can expect from the resources they provide to the entity. This definition highlights the primary users of general purpose financial reports to be existing and potential investors, lenders and other creditors, however, these users cannot generally require a reporting entity to provide information directly to them so they rely on general purpose financial reports. It is acknowledged that general purpose financial reports cannot provide all of the information that each of the primary users may need, neither do they provide a valuation of an entity. However, they seek to provide information set that will meet the needs of the maximum number of primary users. Hence, financial reports, together with other sources of information such as general economic conditions, political climate and industry conditions, allow primary users to estimate the value of the reporting entity and assess the prospects for future net cash inflows to an entity. It is, however, acknowledged that other groups may also be interested in the financial information. For example, the management of the reporting entity is one such group but it was decided that management does not need to rely on general purpose financial reports because managers can obtain the financial information they needs internally. Other parties such as regulators and members 13.58
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of the public may also find general purpose financial reports useful. However, it is made clear that financial reporting is not primarily directed to other users but rather to equity investors, lenders and other creditors. According to the Conceptual Framework, the qualitative characteristics are classified as either fundamental or enhancing depending on how they affect the usefulness of financial information. Enhancing qualitative characteristics and fundamental qualitative characteristics are complementary. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. Relevance - information is considered relevant if it is capable of making a difference in the decisions made by users. Information that has predictive value and/or confirmatory value is considered to be relevant. Information is considered to have predictive value if it can be used to develop expectations for the future. Information is considered to have confirmatory value if it confirms or contests users’ past or present expectations. Information can often be both predictive and confirmatory.
Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. It is important that the information depicts the economic substance of the transactions, events or circumstances. At times, economic substance may not be the same as the legal form. To be complete, all of the information needed to represent the economic phenomena faithfully is included and there is no omission which could make the information misleading. Hence, like relevance, faithful representation is also linked to the full disclosure principle.
Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability. These characteristics are called enhancing characteristics as they enhance the decision usefulness of relevant information faithfully represented in financial statements. Comparability Information that is comparable facilitates users identifying similarities and differences between different economic phenomena. Consistency refers to the use of the same accounting policies between entities, at the same point in time, or the same entity over time. Consistency supports the achievement of comparability. Verifiability Information is verifiable if it faithfully represents the economic phenomena it is meant to represent. Verifiability means that independent observers could reach a consensus - but not necessarily one hundred percent agreement- that a particular depiction is a faithful representation. Direct verification is through direct observation like counting cash to verify cash balance reported on the balance sheet or counting inventory to determine quantities in stock. Indirect verification is where techniques or calculations are used to check the representation. Timeliness is measured by whether the information is available to users before it ceases to be relevant; that is, the information is received while it is still capable of influencing the decisions users make based on the information. Financial information may lose its relevance if it is not reported in a timely manner, however, some information may remain timely even long after the reporting period as the information is used to determine trends. 13.59
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Application of timeliness means that the preparer should not take so long to collect and prepare financial information that the reported information loses its relevance. Application of this principle may mean that some transactions and events are reported before all the facts are known. Understandability refers to the extent to which information can be understood by proficient users; that is, users who have reasonable knowledge of accounting and business activities. It is not practicable to require financial statements to be understandable to novices. The definitions of asset, liability, equity, income and expense are also outlined in the Conceptual Framework. Assets are defined in the Framework as ‘a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’ (paragraph 49(a)). A liability is defined in the Framework as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’ (paragraph 49(b)). Equity is defined in the Framework as ‘the residual interest in the assets of the entity after deducting all its liabilities’ (paragraph 49(c)). Income is defined in the Framework as ‘increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants’ (paragraph 70(a)). Finally, expenses are ‘decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants’ (paragraph 70(b)).
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PROBLEM SET A 13.4 STATIONERY MOVERS LTD
(a) A number of different objectives or purposes of financial reporting have been suggested, for example, the stewardship or accountability objectives (or perspectives) of financial reporting. These perspectives suggest that for entities where there is a separation of ownership from control (e.g. in a company where shareholders do not manage the business), general purpose financial reports can support the stewardship or accountability function. Managers can use general purpose financial reports to show the owners they are fulfilling their stewardship function effectively and that the resources are being managed effectively and appropriately, and shareholders can use the reports to check on managers and make them accountable. An alternative purpose or objective of financial reporting is the decision usefulness perspective where the objective of general purpose financial reports is to provide information to users that is useful for making and evaluating decisions about the allocation of scarce resources.
(b) The Conceptual Framework states that the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making their decisions about providing resources to the entity. Decisions include: buying, selling or retaining shares and providing loans or settling amounts owed to the entity. To make those decisions, users need information to help them assess the prospects for future net cash inflows to an entity. This will allow them to estimate the return they can expect from the resources they provide to the entity. (c) It is acknowledged that general purpose financial reports cannot provide all of the information that each of the primary users may need, neither do they provide a valuation of an entity. However, they seek to provide information set that will meet the needs of the maximum number of primary users. Hence, financial reports, together with other sources of information such as general economic conditions, political climate and industry conditions, allow primary users to estimate the value of the reporting entity and assess the prospects for future net cash inflows to an entity. Furthermore, financial information about the economic entities will be useful in assessing the efficiency and effectiveness of management and the governing board.
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PROBLEM SET A 13.5
(a)
In the Conceptual Framework, the primary categories of users include: - Equity investors: ⚫ ⚫ ⚫ - Lenders ⚫ ⚫ - Other creditors ⚫ ⚫ ⚫ ⚫
Shareholders Holders of partnership interests Other equity owners Lenders (e.g. banks) Purchasers of traded debt instruments (e.g. debentures) Employees* Suppliers* Customers* Other groups*
*Only in their capacity as resource providers, otherwise they are not considered primary users. (b)
Other users include government agencies, members of the public as well as suppliers, customers and employees (when not resource providers as explained above). The information needs and questions of other users vary considerably. For example, taxation authorities, such as the Australian Taxation Office (ATO), want to know whether the entity complies with taxation laws. Regulatory agencies, such as the Australian Securities and Investments Commission (ASIC) or the Australian Competition and Consumer Commission (ACCC), want to know whether the entity is operating within prescribed rules.
(c )The Conceptual Framework distinguishes between primary and other users because the objective of general purpose financial reporting is to satisfy the needs of primary users – that is to provide financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making their decisions about providing resources to the entity. Given it is also acknowledged that other groups may also be interested in the financial information such as government agencies, members of the public as well as suppliers, customers and employees (when not resource providers as explained above). may also find general purpose financial reports useful. Hence it is useful to distinguish who the primary and other users are.
PROBLEM SET A 13.6 13.62
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(a) Accounting entity concept states that every entity can be separately identified and accounted for. For example, if a sole trader purchased a car for personal use by obtaining the funds from their personal bank account, the accounting entity concept implies that the transaction should not be recorded in the accounts of the entity. However, if the owner purchased a car from their personal bank account for use within the business, then, based on the accounting entity concept, this transaction would be recorded as a debit to an asset account (Motor Vehicles) and a credit to an equity account (Owner’s Capital). (b) At the time of writing the book the section on the reporting entity was not available in Conceptual framework. Hence, Australian business entities and standard setters use that section form the previous conceptual framework known as the Framework. The Framework (in SAC1) defines a reporting entity as “an entity in which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions”. (c) The statement “all accounting entities are reporting entities” is incorrect. The accounting entity concept states that every entity can be separately identified and accounted for. This is particularly important for sole proprietorships and partnerships as they are not separate legal entities. It is important that the owners do not confuse the entity’s transactions with their personal transactions, or the transactions of any other entity. There are many different forms of business organisation, including the sole trader, partnerships, companies and not-forprofit organisations. While each of these businesses records accounting transactions based on the accounting entity concept and is likely to prepare financial information for a variety of users, not all businesses are defined as reporting entities. Hence, while the accounting entity concept applies to all entities, not all entities are reporting entities. The Framework defines the reporting entity “as an entity in which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions” (SAC 1). Based on this definition, there would be little point in requiring a small business to prepare general purpose financial reports if the owner is also the manager of the business and there are no external users who would be dependent on the reports to make decisions. Therefore the statement is incorrect, as not all accounting entities are reporting entities. (d) A business organisation is more likely to be classified as a reporting entity if (1) the entity is managed by individuals who are not owners of the entity, (2) the entity is politically or economically important, and (3) the entity is considered large when measured in terms of sales, assets, borrowings, customers and employees. (e) Based on the indicators, publicly listed companies, some large private companies and government authorities are generally classified as reporting entities.
(f) It is important to link the definition of a reporting entity to the objective of financial reporting because what classifies an entity as a reporting entity would be dependent on whether there are users who rely on general purpose financial reports to make and evaluate decisions about the allocation of scarce resources (which is the objective of financial reporting). In 13.63
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other words, if there is no user who needs the report to make economic decisions, then most likely the entity is not a reporting entity.
PROBLEM SET A 13.7 BUSY B CLEANING LTD
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(a) Relevance and faithful representation as defined in the Conceptual Framework: Accounting information is deemed to be relevant if it would make a difference in a business decision. Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. (b) Relevance and reliability are both important qualitative characteristics of financial information. Accounting information that is not relevant is not useful in decision making because it does not help users to predict the future or assess the accuracy of their past predictions. Accounting information that is not reliable is also not useful because users cannot depend on the information to make decisions. Relevance and reliability can involve some trade offs. For example, information about future profits is very relevant. However, as we are unable to tell the future with certainty, such information lacks reliability. (c) Based on GAAP, the alternative ways land can be reported is at cost (based on the cost principle) or at fair value. In chapter 8 we discussed the recording and reporting of non-current assets. In that chapter, examples of asset revaluations were provided. Recall that after the initial recognition of an asset at cost (which is its fair value at the time of acquisition), an entity may choose to revalue its non-current assets to fair value. A revaluation is a reassessment of the fair value of a non-current asset at a particular date. After the initial recognition of a property, plant and equipment (PPE) asset at cost, AASB 116 requires each class of PPE to be measured on either the cost basis or the revalued basis. Assets can be revalued upwards or downwards as relevant. When the PPE asset is measured using the revaluation basis, any impairment loss is treated as a revaluation decrement. You can review chapter 8 if you cannot recall how to record non-current assets. (d) Your recommendation as to the land should be reported, including justification for your answer. The decision should be based on providing the information that will best serve the objective for financial reporting – that is the objective of general purpose financial reporting is to satisfy the needs of primary users – that is to provide financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making their decisions about providing resources to the entity. Student’s personal views and discussion required
(e) Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. To be complete, all of the information needed to represent the economic phenomena faithfully is included and there is no omission that could make the information misleading. Information that is considered to be neutral is free from bias. Information is biased if it is intended to attain or induce a particular behavior or result. Some of 13.65
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the information in general purpose financial reports is measured using estimates in conditions of uncertainty. Ruth Hines explores whether financial information can be neutral and representationally faithful in R. Hines 1991, ‘The FASB’s Conceptual framework, financial accounting and the maintenance of the social world’, Accounting Organizations and Society, vol. 16, no. 4, pp. 313–2. Some time ago in this journal article she wrote about the FASB’s conceptual framework. She suggested that it appears that the ‘assumption underpinning the Conceptual Framework is that the relationship between financial accounting and economic reality is a unidirectional, reflecting or faithfully reproducing relationship: economic reality exists objectively, intersubjectively, concretely and independent of financial accounting practices; financial accounting reflects, mirrors, represents or measures the pre-existent reality’. This is an objectivist’s view of the world. From this world view “it is possible for information to be free from material error and neutral.” On the other hand, if we held a subjectivists view of the world, we would assume there is no such phenomena as an economic reality to be measured objectively that exists independent of people’s perceptions. That is, reality is subjective and the result of personal interpretation. Based on this assumption, accounting information is subjective and it requires judgements, estimates and interpretations and must, therefore, be biased and cannot be representationally faithful.
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PROBLEM SET A 13.8 BRAIDWOOD HAIR LTD
Reporting assets - leased and purchased. (a and b) Assets are defined in the Conceptual Framework as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity” (paragraph 49(a)). The entity must have control over the asset. Ownership is not necessary. An asset is recognised when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured with reliability. A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. A liability is recognised when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably. (c) An operating lease is where the lessor effectively retains the risks and rewards of owning an asset and, consequently, operating leases are reported in the statements of financial position of the lessor. A finance lease is where the substantial risks and rewards of ownership of the asset are effectively transferred to the lessee even though the ownership remains with the lessor. In essence, a finance lease is simply another way to finance the purchase of an asset and hence, the asset and the liability should be reported on the statement of financial position of the lessee as they would have been if the entity had borrowed funds to finance the asset’s purchase. Consequently, finance leases are reported on the lessee’s statement of financial position. (d) A finance lease meets the definition and recognition criteria for assets and liabilities. First, the lessee has control over the asset as the lease contract transfers all the benefits and risks of ownership to the lessee. The control is a result of past events, which is the lease agreement. The leased asset also provides future economic benefits to the lessee, as the lessee is able to use the asset to generate future income. In relation to the lessee’s liability, there is a present obligation to make lease payments. The present obligation is a result of past events (i.e. the lease agreement) and there will be outflows of resources embodying economic benefits (cash outlays for lease payments). In conclusion, Braidwood Hair Ltd would record asset and liability in its statement of financial position if the assets are acquired under a finance lease. Under a finance lease, the substantial risks and rewards of ownership of the asset are effectively transferred to the lessee; hence the asset and liability must be recorded in the lessee’s statement of financial position. 13.67
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PROBLEM SET A 13.9 WOOD BOXES LTD
(a) a) Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. To illustrate, a sale of goods on credit results in an increase in Accounts Receivable (asset) and a corresponding increase in Sales Revenue (income). Another illustration, the provision of goods or services in relation to a customer who has paid in advance would be recorded as a decrease in Revenue Received in Advance (liability) and an increase in Revenue (income). AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14). In the case of Wood Boxes, revenue cannot be recognised on the sale of goods as Wood Boxes has not transferred to the buyer the significant risks and rewards of ownership of the goods (i.e. the goods have not been delivered to the buyer). Therefore, no revenue can be recorded. Instead, a liability is recorded (Revenue Received in Advance) as Wood Boxes has a present obligation to the buyer resulting in an outflow of resources – either in the form of the good to be delivered or the payment refunded. Once the goods are delivered, then sales revenue can be recognised. b) In this case Wood Boxes needs to record an expense. An expense should be recognised when decreases in future economic benefits related to decreases in assets or increases in liabilities have arisen that can be measured reliably. Based on past experience, it is expected that $16,000 of the $400,000 recorded as accounts receivable will not be 13.68
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collected, so there has been a decrease in future economic benefits for Wood Boxes in the form of forgone cash receipts from payments of receivables. The amount of bad debts cab be measured reliably based on the receivable collection history of the company. The expense is called bad debts expense. As Wood Boxes does not know which debts will go bad, it should credit an account called Allowance for Doubtful Debts which is a contra asset account to account receivables and reduces the net receivables reported in the statement of financial position. c) Expense should be recognised when a decrease in future economic benefit related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably. In this case, Wood Boxes has $3,000 of inventory which is no longer saleable as it had been damaged by water. There is a decrease in future economic benefits related to the asset as the inventory can no longer be sold to generate income. The amount of damaged inventory can be measured reliably during the stocktake. Wood Boxes must record an expense of $3,000 (Inventory Write-Down Expense) and a decrease in Inventory of $3,000. d) Assets are resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Wood Boxes, the consignee, has possession of goods on consignment. However, Wood Boxes does not have control of the assets, since the ownership of the assets still belongs to the consignor. If Wood Boxes does not sell the consigned goods within the agreed consignment period, the goods will be returned to the consignor. Hence, the consigned goods should not be included in the stocktake as inventory. The stocktake figures should be adjusted to exclude the consignment stock to ensure the correct inventory figures are reported in the statement of financial position. e) Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability can be measured reliably.” In this case, Wood Boxes should record a Discount Received of $100. Discount Received is recorded by the buyer as income, as a discount represents a saving in outflows and a consequential reduction in liabilities and an increase in equity other than those relating to contributions from equity participants. f) Liability is recognised in the statement of financial position when [1] it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and [2] the amount at which the settlement will take place can be measured reliably. It is probable that Wood Boxes will need to pay for the damages. However, as the amount is yet to be determined it cannot be measured reliably. In this case, no amount would be reported in the financial statements but would be disclosed in the notes to the financial statements. A lawsuit of this nature is classified as a contingent liability. Contingent liabilities are liabilities for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably, that do not satisfy the probability 13.69
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criterion, or are dependent upon the occurrence of an uncertain future event outside the control of the entity. Contingent liabilities are not recognised in the financial statements. However, information about contingent liabilities must be disclosed in the notes to the financial statements if they are material. In this case, the estimated $500,000 is considered a material amount. g) Assets are resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. On 1 November 2014, Wood Boxes purchased a one-year prepaid insurance of $12,000. This prepaid insurance is recognised as an asset, because it is owned by Wood Boxes as a result of a past event (i.e. the purchase) and from which future economic benefits in the form of payments for unexpected damages/losses are expected to flow to Wood Boxes. As of 31 December 2014, the value of the prepaid insurance is only $10,000 because the 2-month prepaid insurance for November and December has expired. Expense should be recognised when a decrease in future economic benefit related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably. Therefore, $2,000 worth of prepaid insurance that has expired should be recognised as an expense, as there is a decrease in future economic benefit related to a decrease in the prepaid insurance and the amount can be measured reliably. Wood Boxes must record an insurance expense of $2,000. h) An expense should be recognised when a decrease in future economic benefit related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably. Wood Boxes has used the electricity for the period and a liability has arisen to pay for the use of electricity to the electricity company, which can be measured reliably based on the electricity bill. Therefore, Wood Boxes must record $2,500 of Electricity Expense and $2,500 of Electricity Payable.
(b) a)
Cash
2,500 Revenue Received in Advance
b) At the time of sales, the journal entry is as follows: 13.70
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Accounts Receivable
400,000
Revenue
400,000
The journal entry to record collection of receivables would be: Cash
300,000 Accounts Receivable
300,000
The journal entry to record bad debt expense is: Bad Debts Expense
16,000
Allowance for Doubtful Debts
c)
Inventory Write-down Expense
16,000
3,000
Inventory
3,000
d) No journal entry recorded if Wood Boxes inventory has not been adjusted to include the consignment stock. In that case the stocktake figures should be adjusted to exclude the consignment stock to ensure the correct inventory figures are reported in the statement of financial position.
e)
Accounts Payable
10,000
Cash
9,900
Discount Received
100
f) No journal entry is recorded, but information about the contingent liability (lawsuit) must be disclosed in the notes to the financial statements. g) At the time of purchase of insurance, the journal entry is as follows: Prepaid Insurance
12,000
Cash
12,000
At the end of year, the adjusting journal entry is as follows: Insurance Expense
2,000
Prepaid Insurance
2,000
h) Electricity expense
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Electricity Payable
2,500
(c ) Wood Boxes is considered to be a reporting entity if it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions. Using the indicators of a reporting entity, Wood Boxes would be classified as a reporting entity if: •
Wood Boxes is managed by individuals who are not its owners;
•
the company is politically or economically important; and
•
the company is considered large when measured in terms of sales, assets, borrowings, customers and employees.
PROBLEM SET A 13.10
(a) GAAP consists of accounting standards, underlying accounting concepts and principles and the Conceptual Framework. In your notes you may like to use the summary table provided in Chapter 13. Figure 13.7. 13.72
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The summary of the various aspects of GAAP is as follows: GAAP Reporting question
Conceptual element of GAAP Who is required to prepare Reporting entity general purpose financial reports (preparers)? What is the purpose of Objective of financial general purpose financial reporting reporting? Who uses general purpose Users of financial reports financial reports (recipients)? What is reported in general Qualitative characteristics purpose financial reports? and constraints How are items reported in Definition of elements and general purpose financial recognition criteria reports? Concepts and principles
Source Authority Statement of Accounting Concepts 1(The Australian conceptual framework) Conceptual Framework
Conceptual Framework
Conceptual Framework Conceptual Framework
Evolved over time, Conceptual Framework , accounting standards Rules Accounting standards, Corporations Act Measurement Conceptual Framework accounting standards GAAP consists of accounting standards, underlying accounting concepts and principles and the Conceptual Framework .
The Conceptual Framework consists of a set of concepts defining the nature, purpose and content of general purpose financial reporting to be followed by preparers of general purpose financial reports and standard setters. The Conceptual Framework has 4 main components: [1] the reporting entity (SAC 1), [2] the objective of general purpose financial reports and users [3] the qualitative characteristics and [4] the definition of elements in financial statements.
The reporting entity is defined in the Framework as an entity for which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions (SAC 1). The reporting entity is defined in the Conceptual Framework as an entity for which it is reasonable to expect the existence of users who depend on general purpose financial reports for information to enable them to make economic decisions (SAC 1).
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The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential equity investors, lenders and other creditors in making their decisions about providing resources to the entity. Decisions include: buying, selling or retaining shares and providing loans or settling amounts owed to the entity. To make those decisions, users need information to help them assess the prospects for future net cash inflows to an entity. This will allow them to estimate the return they can expect from the resources they provide to the entity. This definition highlights the primary users of general purpose financial reports to be existing and potential investors, lenders and other creditors, however, these users cannot generally require a reporting entity to provide information directly to them so they rely on general purpose financial reports. It is acknowledged that general purpose financial reports cannot provide all of the information that each of the primary users may need, neither do they provide a valuation of an entity. However, they seek to provide information set that will meet the needs of the maximum number of primary users. Hence, financial reports, together with other sources of information such as general economic conditions, political climate and industry conditions, allow primary users to estimate the value of the reporting entity and assess the prospects for future net cash inflows to an entity. It is, however, acknowledged that other groups may also be interested in the financial information. For example, the management of the reporting entity is one such group but it was decided that management does not need to rely on general purpose financial reports because managers can obtain the financial information they needs internally. Other parties such as regulators and members of the public may also find general purpose financial reports useful. However, it is made clear that financial reporting is not primarily directed to other users but rather to equity investors, lenders and other creditors. According to the Conceptual Framework, the qualitative characteristics are classified as either fundamental or enhancing depending on how they affect the usefulness of financial information. Enhancing qualitative characteristics and fundamental qualitative characteristics are complementary. Relevance and faithful representation are therefore classified as fundamental qualitative characteristics. Relevance - information is considered relevant if it is capable of making a difference in the decisions made by users. Information that has predictive value and/or confirmatory value is considered to be relevant. Information is considered to have predictive value if it can be used to develop expectations for the future. Information is considered to have confirmatory value if it confirms or contests users’ past or present expectations. Information can often be both predictive and confirmatory.
Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. It is important that the information depicts the economic substance of the transactions, events or circumstances. At times, economic substance may not be the same as the legal form. To be complete, all of the information needed to represent the economic phenomena faithfully is included and there is no omission which could make the 13.74
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information misleading. Hence, like relevance, faithful representation is also linked to the full disclosure principle.
Enhancing qualitative characteristics include comparability, verifiability, timeliness and understandability. These characteristics are called enhancing characteristics as they enhance the decision usefulness of relevant information faithfully represented in financial statements. Comparability Information that is comparable facilitates users identifying similarities and differences between different economic phenomena. Consistency refers to the use of the same accounting policies between entities, at the same point in time, or the same entity over time. Consistency supports the achievement of comparability. Verifiability Information is verifiable if it faithfully represents the economic phenomena it is meant to represent. Verifiability means that independent observers could reach a consensus - but not necessarily one hundred percent agreement- that a particular depiction is a faithful representation. Direct verification is through direct observation like counting cash to verify cash balance reported on the balance sheet or counting inventory to determine quantities in stock. Indirect verification is where techniques or calculations are used to check the representation. Timeliness is measured by whether the information is available to users before it ceases to be relevant; that is, the information is received while it is still capable of influencing the decisions users make based on the information. Financial information may lose its relevance if it is not reported in a timely manner, however, some information may remain timely even long after the reporting period as the information is used to determine trends. Application of timeliness means that the preparer should not take so long to collect and prepare financial information that the reported information loses its relevance. Application of this principle may mean that some transactions and events are reported before all the facts are known. Understandability refers to the extent to which information can be understood by proficient users; that is, users who have reasonable knowledge of accounting and business activities. It is not practicable to require financial statements to be understandable to novices. The definitions of asset, liability, equity, income and expense are also outlined in the Conceptual Framework. Assets are defined in the Framework as ‘a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’ (paragraph 49(a)). A liability is defined in the Framework as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’ (paragraph 49(b)). Equity is defined in the Framework as ‘the residual interest in the assets of the entity after deducting all its liabilities’ (paragraph 49(c)). Income is defined in the Framework as ‘increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants’ (paragraph 70(a)). Finally, expenses are ‘decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants’ (paragraph 70(b)). 13.75
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In addition to the Conceptual Framework, other aspects of GAAP include the corporations act, accounting concepts and principles, accounting standards including the measurement rules as outlined in the standards.
There are 2 concepts and 4 principles that underlie the recording of accounting information: •
Accounting Entity Concept: every entity can be separately identified and accounted for.
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Accounting Period Concept: the life of a business entity can be divided into artificial periods and that useful reports covering those periods can be prepared for the entity.
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Monetary Principle: the items included in the accounting records must be able to be expressed in monetary terms.
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Going Concern Principle: financial statements are prepared on a going concern basis unless management either intends to or must liquidate the business or cease trading.
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Cost Principle: all assets are initially recorded in the accounts at their purchase price or cost. This is applied not only at the time the asset is purchased but also over the time the asset is held. Full Disclosure Principle: all circumstances and events that could make a difference to the decisions financial statement users might make should be disclosed in the financial statements.
•
It is important to identify the order in which the various aspects of GAAP must be applied. After the Corporations Act accounting standards are the first point of guidance for preparers. Accounting standards and authoritative interpretations of accounting standards must be followed as they have legislative backing, which means they are required by law. If the standards are silent on an accounting issue, preparers can seek guidance from the conceptual framework (the Conceptual Framework plus SAC 1 from the Framework). The concepts and principles that traditionally underlie accounting are applied where there is no guidance on an issue in the conceptual framework. Further, if any conflicts arise between standards, the conceptual framework or concepts and principles, the various aspects of GAAP are still applied in the order listed above. To summarise, GAAP is applied as follows: first the Corporations Act, then accounting standards and interpretations are consulted, then the conceptual framework and finally the underlying concepts and principles.
(b) The various aspects of GAAP do not operate in isolation, but are interrelated. Examples of the interrelationships include: • reporting entities are required to prepare general purpose financial reports and the objective of general purpose financial reports is to provide decision-useful information to users.
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•
•
the objective of general purpose financial reporting is to provide decision-useful information to users and usefulness is dependent upon the information’s qualitative characteristics. the accounting period concept and the revenue and expense recognition criteria are interrelated. Revenue (expense) recognition criteria require that revenues (expenses) are recognised in the period when the increase (decrease) in assets or decrease (increase) in liabilities become probable and can be measured reliably. In other words, only the increase/decrease in assets or liabilities that occur in a certain period can be recognised as revenue or expense in that period. This is consistent with the accounting period concept.
(c) (i) The Global Reporting Initiative (GRI) is a network-based organization that pioneered the world’s most widely used sustainability reporting framework. The Sustainability Reporting Framework provides guidance on how organisations can disclose their sustainability performance. It consists of the Sustainability Reporting Guidelines, Sector Supplements and the Technical Protocol - Applying the Report Content Principles. The Framework is applicable to organisations of any size or type, from any sector or geographic region, and has been used by thousands of organisations worldwide as the basis for producing their sustainability reports. GRI is committed to the Framework’s continuous improvement and application worldwide. GRI’s core goals include the mainstreaming of disclosure on environmental, social and governance performance. GRI's Reporting Framework is developed through a consensus-seeking, multi-stakeholder process. Participants are drawn from global business, civil society, labor, academic and professional institutions. Sustainability reporting is a process for publicly disclosing an organisation’s economic, environmental, and social performance. Many organisations find that financial reporting alone no longer satisfies the needs of shareholders, customers, communities, and other stakeholders for information about overall organisational performance. The term “sustainability reporting” is synonymous with citisenship reporting, social reporting, triplebottom line reporting and other terms that encompass the economic, environmental, and social aspects of an organisation’s performance. (ii). The benefits of GRI Reporting: For reporting organisations, the GRI Reporting Framework provides tools for: management, increased comparability and reduced costs of sustainability, brand and reputation enhancement, differentiation in the marketplace, protection from brand erosion resulting from the actions of suppliers or competitors, networking and communications. For report users, the GRI Reporting Framework are a useful benchmarking tool, corporate governance tool and an avenue for long term dialogue with reporting organisations. GRI promotes a standardised approach to reporting to stimulate demand for sustainability information – benefitting both reporting organisations and report users. Sustainability reports based on the GRI Framework can be used to demonstrate organisational commitment to sustainable development, to compare organisational performance over time, and to 13.77
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measure organisational performance with respect to laws, norms, standards and voluntary initiatives. Other benefits include increased comparability. Companies follow a generally accepted reporting framework for financial reporting. Without a similarly accepted framework for sustainability reports, such reports could lack the features that could make them broadly useful: credibility, consistency, and comparability. If the thousands of companies that voluntarily disclose their sustainability impacts did not refer to a generally accepted reporting framework, they would risk producing noncomparable reports, and/or reports which inadequately address the full spectrum of stakeholder interests. A generally accepted sustainability reporting framework also simplifies report preparation and assessment, helping both reporters and report users gain greater value from sustainability reporting. Because the development costs of the GRI framework is shared among multiple users, the overall transaction cost for reporters is considerably lower than costs might be should a company develop it’s ‘own company’ or ‘own sector’ reporting framework. (iii) GRI Reporting Framework The Reporting Framework sets out the principles and Performance Indicators that organisations can use to measure and report their economic, environmental, and social performance. The cornerstone of the Framework is the Sustainability Reporting Guidelines. The third version of the Guidelines – known as the G3 Guidelines - was published in 2006, and is a free public document. The Guidelines are the foundation of the Framework and are now in their third generation (G3). They feature Performance Indicators and Management Disclosures that organisations can adopt voluntarily, flexibly and incrementally, enabling them to be transparent about their performance in key sustainability areas. The G3.1 Guidelines are the latest and most complete version of GRI's G3 Sustainability Reporting Guidelines. These Guidelines are based on G3 but contain expanded guidance on local community impacts, human rights and gender. While G3-based reports are still valid, GRI recommends that reporters use G3.1, the most comprehensive reporting guidance available today.
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BUILDING BUSINESS SKILLS BBS13.1 DOMINOES (a) 3.8 REVENUE RECOGNITION Revenue is measured at the fair value of the consideration received or receivable. 3.8.1 Sale of goods Revenue from the sale of goods is recognised when the Consolidated entity has transferred to the buyer the significant risks and rewards of ownership of the goods. 3.8.2 Franchise income Franchise income is recognised on an accrual basis in accordance with the substance of the relevant agreement. 3.8.3 Rendering of services Service revenue relates primarily to store building services and is recognized by reference to the stage of completion of the contract. 3.8.4 Royalties Royalty revenue is recognised on an accrual basis in accordance with the substance of the relevant agreement (provided that it is probable that the economic benefits will flow to the Consolidated entity and the amount of revenue can be measured reliably). Royalties determined on a time basis are recognised on a straight-line basis over the period of the agreement. Royalty arrangements that are based on sales and other measures are recognised by reference to the underlying arrangement. Revenue is measured at the fair value of the consideration received 3.8.5 Dividend and interest revenue Dividend revenue from investments is recognised when the shareholder’s right to receive payment has been established (provided that it is probable that the economic benefits will flow to the Consolidated entity and the amount of revenue can be reliably measured). Interest revenue is recognised when it is probable that the economic benefits will flow to the Consolidated entity and the amount of revenue can be measured reliably. Interest revenue is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that exactly discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount on initial recognition.
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(b) Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14). AASB 118 prescribes tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (paragraph 20). Yes, Domino’s revenue recognition methods are consistent with the revenue recognition criteria discussed in the chapter.
For example: Domino’s policy on the sale of goods corresponds with part (a) of AASB 118 and NZ IAS 18 ‘Revenue’ for sale of goods (para 14) “the entity has transferred to the buyer the significant risks and rewards of ownership of the goods”;. DOMINO’S “Revenue from the sale of goods is recognised when the Consolidated entity has transferred to the buyer the significant risks and rewards of ownership of the goods”.
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Royalty revenue is recognised as they accrue, in accordance with the relevant agreement and effective yield on the financial asset. This implies that those revenues are recognised when the increase in future economic benefits have arisen (accrued) and can be measured reliably using the agreement and relevant yield, which is consistent with the income recognition criteria outlined in the Conceptual Framework. (c) 3.7 GOODS AND SERVICES TAX Revenues, expenses and assets are recognised net of the amount of goods and services tax (“GST”), except: i. where the amount of GST incurred is not recoverable from the taxation authority, it is recognised as part of the cost of acquisition of an asset or as part of an item of expense; or ii. for receivables and payables which are recognised inclusive of GST. The net amount of GST recoverable from, or payable to, the taxation authority is included as part of receivables or payables. Cash flows are included in the cash flow statement on a gross basis. The GST component of cash flows arising from investing and financing activities which is recoverable from, or payable. Revenues, expenses and assets are recognised net of the amount goods and services tax (GST) except: (1) where the amount of GST incurred is not recoverable from the taxation authority, it is recognised as part of the cost of acquisition of an asset or as part of an item of expense; or (2) for receivables and payables which are recognised inclusive of GST.
(d) Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards incidental to ownership of the leased asset to the lessee. All other leases are classified as operating leases. In relation to finance lease payments, minimum lease payments are apportioned between the finance charge and the reduction of outstanding liability. The finance charge is allocated to each period during the lease term so as to produce a constant period rate of interest on the remaining balance of the liability.
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BBS13.2 COCA-COLA AMATIL LTD
(b) Students are required to access the CCA 2010 annual report. g) Revenue Revenue is recognised and measured at the fair value of the consideration received or receivable to the extent that it is probable that economic benefits will flow to the Group and the revenue can be reliably measured. Revenue is recognised net of discounts, allowances and applicable amounts of value added taxes such as the Australian Goods and Services Tax. The following specific recognition criteria must also be met before revenue is recognised – i) Sale of goods and materials Revenue is recognised when the significant risks and rewards of ownership of the goods have passed to the buyer and the amount of revenue can be measured reliably. Risks and rewards of ownership are considered passed to the buyer at the time of delivery of the goods to customers; ii) Rendering of services Revenue from installation and maintenance of equipment is recognised when the services have been performed and the amount can be measured reliably; iii) Interest income Interest income is recognised as the interest accrues using the effective interest method; iv) Dividends Dividends are recognised when the right to receive payment is established; and v) Rental income Rental income arising from equipment hire is accounted for on a straight line basis over the term of the rental contract.
(c) AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; 13.82
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(d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14). AASB 118 prescribes tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (paragraph 20). Yes, the company’s policies of revenue recognition are consistent with the revenue recognition criteria discussed in the chapter.
For example: Coca-Cola Amatil Ltd’s policy on the sale of goods corresponds with part (a) of AASB 118 and NZ IAS 18 ‘Revenue’ for sale of goods (para. 14). Similarly, Coca-Cola’s policy on the rendering of service follows part (a) and (b) of AASB 118 and NZ IAS 18 ‘Revenue’ for rendering of services (para. 20). Furthermore, interest income is recognised when it accrues and dividend income is recognised when the right to receive the payments is established, that is when the increase in future economic benefits have arisen. This is consistent with the income recognition criteria as outlined in the Conceptual Framework.
(d) Both company’s methods of revenue recognition are consistent with the revenue recognition criteria discussed in the chapter. For example, for the sale of goods, they both recognise revenue when significant risks and rewards of ownership of the goods have passed to the buyer and the amount of revenue can be measured reliably with AASB 118 and NZ IAS 18 ‘Revenue’ (para 14). Both companies’ policies on recognising income from services are also consistent with the AASB 118 and NZ IAS 18. In terms of interest, dividend and royalty income, both companies recognise the income when they accrue, which is when the increase in economic benefits have arisen and can be measured reliably. In summary, both Domino Pizza and Coca-Cola Amatil’s policies on revenue recognition comply with what outlines in the Conceptual Framework.
BBS13.3 COCA-COLA AMATIL LTD
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(a) We recognize revenue when persuasive evidence of an arrangement exists, delivery of products has occurred, the sales price is fixed or determinable, and collectibility is reasonably assured. For our Company, this generally means that we recognize revenue when title to our products is transferred to our bottling partners, resellers or other customers. Title usually transfers upon shipment to or receipt at our customers' locations, as determined by the specific sales terms of each transaction. Our sales terms do not allow for a right of return except for matters related to any manufacturing defects on our part. Our customers can earn certain incentives, which are included in deductions from revenue, a component of net operating revenues in the consolidated statements of income. These incentives include, but are not limited to, cash discounts, funds for promotional and marketing activities, volume-based incentive programs and support for infrastructure programs. Refer to Note 1 of Notes to Consolidated Financial Statements. The aggregate deductions from revenue recorded by the Company in relation to these programs, including amortization expense on infrastructure programs, were approximately $5.0 billion, $4.5 billion and $4.4 billion in 2010, 2009 and 2008, respectively. In preparing the financial statements, management must make estimates related to the contractual terms, customer performance and sales volume to determine the total amounts recorded as deductions from revenue. Management also considers past results in making such estimates. The actual amounts ultimately paid may be different from our estimates. Such differences are recorded once they have been determined, and have historically not been significant.
(b) Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14).
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AASB 118 prescribes tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (paragraph 20).
Yes, the company’s methods of revenue recognition are consistent with the revenue recognition criteria discussed in the chapter. For example: Coca-Cola Company’s policy on the sale of goods requires that the “delivery of products has occurred” for sales revenue to be recognised. This corresponds with AASB 118 and NZ IAS 18 ‘Revenue’ part (a), that “the entity has transferred to the buyer the significant risks and rewards of ownership of the goods” (para 14). Furthermore, the Coca-Cola Company’s policy on the sale of goods requires that the “sales price charged is fixed or determinable and collectability is reasonably assured”. This implies that for sales revenue to be recognised, increase in future economic benefits in the form of cash receipts can be reliably measured, which is consistent with the income recognition criteria outlined in the Conceptual Framework.
BBS13.4 FURRY CREATURES LTD Instructor note: There is an error in the additional information 6. Bank loan should have been taken out on 1 January 2014, not 2011. (a) Correct income statement: Furry Creatures Ltd Income Statement For the year ended 31 March 2014 Revenues Service revenue Operating expenses Advertising Wages Electricity Depreciation Repairs Insurance
108,000 (1) 8,600 (2) 42,600 (3) 4,700 (4) 1,200 6,000 (5) 8,000 (6) 13.85
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Supplies Interest Total operating expenses Profit
7,700 (7) 500 (8) 79,300 28,700
Workings: (1) 120,000 - 12,000 (2) 6,100 + 2,500 (3) 42,200 + 400 (4) 3,900 + 800 (5) 4,000 + 2,000 (6) 16,000/12 months * 6 months = 8,000 (7) 10,000 – 2,300 = 7,700 (8) (20,000*0.1/12) * 3 = 500
(b) Revenue recognition criteria were not followed as revenue was recognised before Furry Creatures has transferred to the buyer the significant risks and rewards of ownership of the goods. Hence the $12,000 advanced money should be recorded as a liability (Revenue Received in Advance). The effect on the results of this error is that profit is overstated by $12,000. The $12,000 cash receipts will be recognised as revenue once the goods have been delivered to the buyer. Expenses should be recognised when a decrease in future economic benefit related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. Kalvin did not follow the expense recognition criteria as he did not record some expenses which have been incurred but not yet paid, such as advertising, electricity, repairs, wages, and interest. In addition, a portion of prepaid expenses such as advertising supplies and insurance which have expired should be recognised as expenses since the decrease in economic benefits have arisen. The effect of not recognising expenses also results in an overstatement of profits. Overall profit was overstated by $33,900.
BBS13.5 COCA-COLA AMATIL LTD
(a) Students are required to access CCA 2010 sustainability report. (b) CCA’s achievements in the areas of environment and community: ENVIRONMENT 13.86
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Three priorities in this area were water stewardship, packaging and recycling and energy and climate Water Stewardship •
Production of beverages increased yet total water usage to make the beverages dropped.
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Installation of a waste water treatment plant
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Ground water and spring water sources subject to stringent assessment procedures to ensure ongoing sustainability of sources
Packaging and Recycling •
Invested $45 million to develop lightest PET plastic bottles
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Public place recycling projects with major customers – eg The Westfield’s project alone will see decrease in 600 tonnes of bottles and cans diverted away from landfill
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Increased internal recycling across the group
Energy and Climate •
Installed 670 solar panels to deliver clean, renewable energy to the Eastern creek distribution centre
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Waste water treatment plant provides renewable energy
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Relocation of head office to a 5 star green rated building
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Measuring and reporting carbon use and emissions
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Contribution to earth hour turning off iconic Coke sign kings cross
COMMUNITY •
CCA Foundations - 2008/9 $2.4 million in community projects
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CCA 2008/9 $17.9 million in community projects
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CCA and SPCA and employees supporter Victoria bushfire victims
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Generous donations to: food banks, national breast cancer foundation, drought assistance,
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Participation in clean up days – Bali beaches, Jakarta waterways, and New Zealand
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BBS 13.6 STATISTICS R US PTY LTD
To:
Board of Directors, Statistics R Us Pty Ltd
From:
Accountant
Subject:
Accounting for Revenue
Income is recognised when income definition and income recognition criteria are met. Income is defined in the Conceptual Framework. as “increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” Income is recognised in the income statement “when an increase in future economic benefits related to an increase in an asset or a decrease of a liability can be measured reliably.” That is, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. To illustrate, a sale of goods (or the provision of services) on credit results in an increase in Accounts Receivable (asset) and a corresponding increase in Sales (or Service) Revenue (income). Another illustration, the provision of goods or services in relation to a customer who has paid in advance would be recorded as a decrease in Revenue Received in Advance (liability) and an increase in Revenue (income). AASB 118 and NZ IAS 18 ‘Revenue’ prescribes principles for the recognition of revenue for the sale of goods. Revenue is recognised on the sale of goods when all of the following conditions are satisfied: (a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods; (b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (c) the amount of revenue can be measured reliably; (d) it is probable that the economic benefits of the revenue will flow to the entity; and (e) the associated costs can be measured reliably (paragraph 14). AASB 118 also prescribes tests for determining when the outcome of a transaction involving the rendering of services can be estimated reliably. All of the following conditions must be satisfied: (a) the amount of revenue can be measured reliably; (b) it is probable that the economic benefits associated with the transaction will flow to the entity; (c) the stage of completion of the transaction at the reporting date can be measured reliably; and (d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably (paragraph 20). 13.89
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In this case the facts are as follows: 13 June 2012
Contract signed for $ 1 million – no work has been competed by the ended 2009. Hence no revenue should be recognised.
Cash to be received: Year ended 2013
$600,000
Year ended 2014
$300,000
Year ended 2015
$100,000
Total
$1,000,000
Work to be completed: Year ended 2013
50%
Year ended 2014
50%
year
AASB 118 prescribes that in order to be recognised as revenue, services must be performed, or the stage of completion at the reporting date can be measured reliably. Therefore, Statistics R Us should recognise service revenue when the research has been performed. Details of the appropriate treatment of revenue each year are reported below.
June 13, 2012 No entry – there has not been an accounting transaction - no past transaction or event has occurred. A contract has been signed but no work has been completed.
June 30, 2013 By June 2013, $600,000 cash will have been received, hence a debit of $600,000 to cash. However, given only 50% of the work would have been completed, only 50% of the revenue should be recognised (i.e. 50% of $1 million, or $500,000). The rest of the cash received ($100,000) should be recorded as Revenue Received in Advance as the cash has been received in advance of the service being performed. This is a liability account, as it represents a future obligation of Statistics R Us to either provide the service or to pay back the cash. The journal entry is as follows: Cash
600,000 Service Revenue
500,000
Revenue Received in Advance
100,000 13.91
Solutions manual to accompany Accounting: building business skills 4e
June 30, 2014 By June 2014, a further $300,000 cash will have been received, hence a debit of $300,000 to cash. Given the final 50% of the work would have been completed, then the final 50% of the revenue (i.e. $500,000) should be recognised as income and be credited to service revenue account. The $100,000 amount of revenue received in advance from the previous year can now be recognised as revenue as the work has been completed. This is recorded as a debit of $100,000 to Revenue Received in Advance. By this time, all research works would have been performed, however the last $100,000 payment has not been received. Since the work has been completed, the $100,000 should be recognised as revenue and hence a debit to Accounts Receivable for $100,000 is made. The journal entry is as follows: Cash
300,000
Revenue Received in Advance
100,000
Accounts Receivable
100,000
Service Revenue
500,000
August 2014 At this stage, the amount owed for the work completed in June 2014 has now been received. Hence, Accounts Receivable is credited for $100,000 to account for the collection. The journal entry is as follows: Cash
100,000 Accounts Receivable
100,000
I hope this report will be able to clarify your queries in regards to the appropriate treatment for the revenue arising from the research contract. Please do not hesitate to contact me if you have further questions.
Yours sincerely,
BBS13.7 GOOD FOODS LTD 13.92
Chapter 13: Analysing and intergrating GAAP
(a) The stakeholders in this situation are: •
Alf Alfa, the managing director
•
creditors of Good Foods
•
employees of Good Foods
•
shareholders of Good Foods
•
potential investors of Good Foods
•
potential customers
(b) Many stakeholders could be potentially harmed by the non disclosure. For example: shareholders may lose their investment and/or receive decreased dividends if a large payout is made. Potential investors may lose money if they have decided to invest in Good Foods without the knowledge of the lawsuit. Good Foods’ ability to repay its creditors may also be affected if it has to pay for large amount of damages. On the worst scenario, Good Foods may declare bankruptcy after paying the damages, which results in the employees losing their jobs and investors their money. Potential customers may also be disadvantaged if they are not made aware of the incident before they decide to buy the company’s products.
(c) The managing director’s actions are inappropriate as he does not follow generally accepted accounting principles. The lawsuit is classified as a contingent liability. While it is not reported in the financial statements because the amount is unknown and cannot be measured reliably, contingent liabilities must be disclosed in the notes of financial statements. Given many stakeholders could be harmed or disadvantaged by the non disclosure, the managing director’s actions are unethical.
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BBS13.8 HEALTHY LIVING LTD
(a) The stakeholders in this situation include: •
Con Puter, the business information system manager
•
Abit Crooked, the CFO
•
Alot Crooked, the CEO
•
shareholders of Healthy Living
•
potential inventors of Healthy Living
•
any reader of the press release
(b) Financial information must be reported in a timely manner; otherwise it will lose its relevance. In order to be timely, some estimates need to be made. For example, an estimated amount for doubtful debts is calculated rather than waiting until the debt goes bad. Expenses are accrued, e.g. for electricity and telephone expenses, if the expenses have been incurred but no invoice has been received or paid by year end. However, while some estimates are consistent with the timeliness constraint, it is not consistent with the timeliness constraint to estimate the revenue on health cover contracts sold. This information needs to be accurate, not estimated. It is also not consistent to estimate all other expenses if the data is not available due to a computer error. (c) No, the actions requested by Alot Crooked are not consistent with GAAP. The income and expense recognition criteria require revenues and expenses to be recognised when the increase or decrease in future economic benefits are probable and can be measured reliably. Furthermore, one of the fundamental qualitative characteristics of financial information as outlined in the Conceptual Framework. is faithful representation. Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral and free from material error. Without accurate computer records, the revenue and expense figures cannot be measured faithfully. As a result, the estimated profit figure will not be complete or free from material error. (d) Faithful representation is only achieved when the inputs used to make the judgment and estimate reflect the best available information at the time. In this case, reporting estimated fictitious figures does not result in faithful representation of the economic reality of the business, since the actual revenue and expense figures have been recorded. Further, given many stakeholders could be harmed by the disclosure of estimated figures which could result in poor information and hence poor decisions, the managing director’s action in reporting estimated profit figure is unethical. (e) A significant error in estimating profit can result in wrong decisions made by people who rely on the information. For example, shareholders may lose their investment and/or receive less 13.94
Chapter 13: Analysing and intergrating GAAP
dividends if the financial information is misrepresented in the form of an overstatement of profit. Potential investors may lose money if they decide to invest in the organisation they believe is more profitable than it actually is. Creditors may not be repaid as expected if they lend money based on overstated profits. Overstatement of profit could result in employees and trade unions trying to get higher wages and better working conditions. The general public could be harmed by the overstatement of profits if they choose to invest or purchase products from the company based on the incorrect figures. Errors and inappropriate behaviors in business decrease people’s faith in accounting and the business world.
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Solutions manual to accompany Accounting: building business skills 4e
CHAPTER 14 – INTRODUCTION TO MANAGEMENT ACCOUNTING ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1.
Explain the distinguishing features of management accounting
1
7
2.
Identify the three broad functions of management and discuss how management accounting tools assist these functions.
2
7
3.
Define the three classes of manufacturing costs.
3,4
1,2,3
1A,2A,3A, 1B, 2B, 3B
4.
Distinguish between product and period costs.
4
2,3
1A,2A,3A, 1B, 2B, 3B
5.
Explain the difference between a merchandising and a manufacturing income statement.
4,8, 9,10, 13
7A, 7B
6.
Explain the difference between a merchandising and a manufacturing balance sheet.
4,8,10,12, 13
7A, 7B
7.
Indicate how costs of goods manufactured and sold are determined.
4,5,6, 9,10, 13
3A,4A,5A, 6A,7A, 3B, 4B, 5B, 6B,7B
8.
Describe contemporary developments in management accounting.
9.
Prepare a worksheet and closing entries for a manufacturing entity.
5,6
7
7
14.1
11
8A, 8B
Chapter 14: Introduction to management accounting
ANSWERS TO QUESTIONS 1.
2.
3.
(a)
Disagree. Management accounting is a field of accounting that provides economic and financial information for managers and other internal users.
(b)
Pat is incorrect. Management accounting applies to all types of businesses – service, merchandising and manufacturing.
(a)
Financial accounting is concerned primarily with external users such as shareholders, creditors and regulatory agencies. In contrast, managerial accounting is concerned primarily with internal users such as officers, department heads, managers and supervisors in the company.
(b)
Classified financial statements are the end product of financial accounting. The statements are prepared quarterly, six monthly and annually. In management accounting, internal reports may be prepared daily, weekly, monthly, quarterly, annually, or as needed.
(c)
The purpose of financial accounting is to provide general purpose information for all users. The purpose of management accounting is to provide special purpose information for a particular user for a specific decision.
Karen should know that the management of an organisation performs three broad functions: (1)
Planning requires management to look ahead and to establish objectives.
(2)
Directing and motivating involves coordinating the diverse activities and human resources of a company to produce a smooth running operation.
(3)
Controlling is the process of keeping the activities of the entity on track.
4.
Disagree. Decision making is not a separate management function. Rather, decision making involves the exercise of good judgement in performing the three management functions explained in the answer to question three above.
5.
Since office building is not used for manufacturing purposes, its depreciation is classified as a period cost.
6. Fisher Ltd Prime costs $ Direct materials
12,000
Direct Labour
15,000
Manufacturing overhead
Conversion costs $ 15,000 9,000
Total
$27,000
14.2
$24,000
Solutions manual to accompany Accounting: building business skills 4e
7. Harn Manufacturing Raw materials opening inventory
$32,000
Raw materials purchases Total raw materials available for use
200,000 232,000
Raw materials closing inventory
29,000
Direct materials used
$203,000
8. Griggs Manufacturing (a) Direct materials used Direct labour used
$280,000 100,000
Total manufacturing overhead
220,000
Total manufacturing costs
$600,000
(b) Total cost of work in process (beginning WIP + total manufacturing costs) [$27,200 + $600,000] (c)
Cost of goods manufactured (total cost of WIP – ending WIP) [$627,200 - $36,400]
$627,200
$590,800
9.
The accounting cycle for a manufacturing entity is the same as for a merchandising entity.
10.
The typical account balances are: ▪
Work in Process Inventory
▪
Raw Materials Inventory
▪
Raw Material Purchases
▪
Direct Labour
▪
Indirect Labour; and
▪
Factory Overhead Accounts, such as power, repairs and depreciation.
14.3
Chapter 14: Introduction to management accounting
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14.1 Financial Accounting
Management Accounting
Main users
External users
Internal users
Purpose of reports
General purpose information for all users
Special purpose information for a particular user for a specific decision.
Frequency of reports
Quarterly, six monthly and annually
As the need arises
Type of reports
Classified financial statements
Internal reports
Content of reports
General-purpose, classified financial statements
Customised, internal reports
Verification process
Annual audit by registered company auditor
No independent audit.
BRIEF EXERCISE 14.2 1.
(a)
Planning.
2.
(b)
Directing and motivating.
3.
(c)
Controlling.
BRIEF EXERCISE 14.3 (a) (b) (c) (d)
Direct materials Direct materials Direct labour Manufacturing overhead
(e) (f) (g) (h)
Manufacturing overhead. Direct materials Direct materials Manufacturing overhead.
BRIEF EXERCISE 14.4 OFFICE MATE PTY LTD
Direct Material (a) (b) (c) (d)
Product Cost Direct Labour
Factory Overhead x
x
Prime Cost
Conversion Cost x
x x x
x
14.4
x x
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 14.5 SUNNY LTD
1. 2. 3.
A Direct Material Used $98,000 $44,000 $11,000
+
B + Direct Labour Used $122,000 $44,000 $30,000
C Factory Overhead $100,000 $60,000 $19,000
=
D Total Manufacturing Costs $320,000 $148,000 $60,000
=
D
BRIEF EXERCISE 14.6 SUNNY LTD
A
1. 2. 3.
+
Total Manufacturing Costs $320,000
B
-
Work in Process (1/1)
C
Work in Process (31/13)
Cost of Goods Manufactured $337,000
$110,000 $27,000
BRIEF EXERCISE 14.7 LAWNEY MANUFACTURING
Account Finished Goods Inventory Work in Process Inventory Raw Materials Purchases Direct Labour
Work Sheet Column Income statement (DR) Cost of Goods Manufactured (DR) Cost of Goods Manufactured (DR) Cost of Goods Manufactured (DR)
14.5
Chapter 14: Introduction to management accounting
SOLUTIONS TO EXERCISES EXERCISE 14.1 MAUER LTD
1. 2. 3. 4. 5.
(b) (c) (c) (c) (a)
Direct labour Manufacturing overhead Manufacturing overhead Manufacturing overhead Direct materials
6. 7. 8. 9. 10.
(b) (c) (c) (c) (a)
Direct labour Manufacturing overhead Manufacturing overhead Manufacturing overhead Direct materials
EXERCISE 14.2 OSCAR LTD
(a)
Direct materials Direct labour Prime costs
$143,400 72,100 $215,500
(b)
Factory power Depreciation on factory equipment Indirect factory labour Indirect materials Factory manager’s salary Rates and taxes on factory building Factory repairs Manufacturing overhead
$10,200 11,240 52,600 101,200 10,000 3,500 2,100 $190,840
(c)
Direct labour Manufacturing overhead Conversion costs
$72,100 190,840 $262,940
(d)
Direct materials Direct labour Manufacturing overhead Product costs
$143,400 72,100 190,840 $406,340
(e)
Depreciation on delivery trucks Sales salaries Repairs to office equipment Advertising Office supplies used Period costs
$3,000 51,700 1,500 16,000 4,000 $76,200
14.6
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 14.3 TOWER COMPUTERS
1. 2.
(c) (c)
3. 4.
(a) (c)
5. 6.
(b) (d)
7. 8.
(a) (b)
9. 10.
(c) (c)
EXERCISE 14.4 PIAZZA MANUFACTURING LTD
1. 2. 3.
(a) (a) (a), (c)
4. 5. 6.
(b) (a) (a)
7. 8. 9.
(a) (b), (c) (a)
10. 11. 12.
(a), (b) (b) (b)
13. 14. 15.
(a) (a) (a)
16.
(a)
EXERCISE 14.5 DALBY LTD Case A (a) Total manufacturing costs Less: Manufacturing overhead Direct labour Direct materials used
$180,650 (42,500) (60,000) $78,150
(b)
Total cost of work in process Less: Total manufacturing costs Work in process (1/1/13)
$221,500 (180,650) $40,850
(c)
Total cost of work in process Less: Cost of goods manufactured Work in process 31/12/13
$221,500 (185,275) $36,225
Case B (d) Direct materials used Direct labour Manufacturing overhead Total manufacturing costs
$70,000 86,000 81,600 $237,600
(e)
Total manufacturing costs Work in process 1/1/13 Total cost of work in process
$237,600 16,500 $254,100
(f)
Total cost of work in process Less: Work in process 31/12/13 Cost of goods manufactured
$254,100 (9,000) $245,100
Case C (g) Total manufacturing costs Less: Manufacturing overhead Direct materials used
$260,000 (102,000) (130,000) 14.7
Chapter 14: Introduction to management accounting
Direct labour
$28,000
(h)
Total cost of work in process Less: Total manufacturing cots Work in process 1/1/13
$327,000 (260,000) $67,000
(i)
Total cost of work in process Less: Work in process 31/12/13 Cost of goods manufactured
$327,000 (70,000) $257,000
EXERCISE 14.6 SOLOMON MANUFACTURING LTD
Raw materials inventory (1/1): Direct materials used Add: Raw materials inventory 31/12 Less: Raw materials purchases Raw materials inventory
$190,000 7,500 (158,000) $39,500
Total cost of work in process: Cost of goods manufactured Add: Work in process 31/12 Total cost of work in process
$560,000 81,000 $641,000
Total manufacturing costs: Total cost of work in process Less: Work in process (1/1) Total manufacturing costs
$641,000 (200,000) $441,000
Direct labour: Total manufacturing costs Less: Total overhead Direct materials used Direct labour
$441,000 (122,000) (190,000) $129,000
EXERCISE 14.7 (a) External auditors (b) Inventory (c) Globalisation (d) Total quality management (e) Budgets (f) Balanced scorecard (g) Creditors, shareholders (h) Management accounting
14.8
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 14.8 (a) Merchandising companies (b) Work in process inventory (c) Service company (d) Manufacturing companies (e) Finished goods inventory (f) Raw materials
14.9
Chapter 14: Introduction to management accounting
EXERCISE 14.9 BROADBEACH LTD (a) Broadbeach Ltd Cost of Goods Manufactured Schedule For the month ended 30 June 2014
Work in process 1/6/14 Direct materials used Direct labour Manufacturing overhead: Indirect labour Factory manager’s salary Indirect materials Depreciation – equipment Maintenance – equipment Factory electricity Total manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process 30/6/14 Cost of goods manufactured
$3,000 $20,000 25,000 $4,500 3,000 2,200 1,700 1,300 400 13,100 58,100 61,100 (3,500) $57,600
(b) Broadbeach Ltd Income Statement (Partial) For the month ended 30 June 2014
Net sales Cost of sales: Finished goods inventory, 1/6/14 Cost of goods manufactured [from (a)] Cost of goods available for sale Finished gods inventory 30/6/14 Cost of sales Gross profit
14.10
$98,100 $5,000 57,600 62,600 6,000 56,600 $41,500
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 14.10 SALAZAR MANUFACTURING (a) Salazar Manufacturing Cost of Goods Manufactured Schedule for the month ended 30 June 2013
Work in process 1 June Direct materials Raw materials inventory 1 June Raw materials purchases Total raw materials available for use Less: Raw materials inventory 30 June Direct materials used Direct labour Manufacturing overhead: Indirect labour Factory insurance Machinery depreciation Factory power Machinery repairs Miscellaneous factory costs Total manufacturing overhead Total manufacturing costs for the month Total cost of work in process Less: Work in process inventory, 30 June Cost of goods manufactured
$5,000 $8,800 62,000 70,800 11,000 59,800 45,000 $5,500 4,000 4,800 2,500 1,800 1,300 19,900 124,700 129,700 7,000 $122,700
(b) Salazar Manufacturing Statement of Financial Position (Partial) as at 30 June 2013
Current Assets Inventories Finished goods Work in process Raw materials
$6,000 7,000 11,000
$24,000
Note: In the external financial report of the statement of financial position, the total value of inventory $24,000 is shown, and in the notes to the financial statements the breakdown of the individual components of inventory is usually in the following order, finished goods, work in process and raw materials.
14.11
Chapter 14: Introduction to management accounting
EXERCISE 14.11 Salazar Manufacturing Partial worksheet for month ended 30 June 2013
Finished Goods Work in Process Raw materials Raw materials purchase Direct labour Indirect labour Factory insurance Machinery depreciation Machinery repairs Factory power Miscellaneous
Adjusted trial balance Dr Cr $8,000 5,000 8,800 62,000 45,000 5,500 4,000 4,800 1,800 2,500 1,300 148,700
Cost of goods manufactured Dr Cr $5,000 8,800 62,000 45,000 5,500 4,000 4,800 1,800 2,500 1,300 140,700
Cost of goods manufactured 140,700
Income statement Dr $8,000
$7,000 11,000
18,000 122,700 140,700
14.12
122,700
Cr $6,000
Statement of financial position Dr Cr $6,000 7,000 11,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 14.12 LANIER MANUFACTURING LTD
Raw materials inventory (1/1): Direct materials used Add: Raw materials inventory 31/12 Less: Raw materials purchases Raw materials inventory
$135,500 6,500 (132,000) $10,000
Total cost of work in process: Cost of goods manufactured Add: Work in process 31/12 Total cost of work in process
$560,000 87,000 $647,000
Total manufacturing costs: Total cost of work in process Less: Work in process (1/1) Total manufacturing costs
$647,000 (200,000) $447,000
Direct labour: Total manufacturing costs Less: Total overhead Direct materials used Direct labour
$447,000 (127,000) (135,500) $184,500
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Chapter 14: Introduction to management accounting
EXERCISE 14.13 FIERO MOTOR LTD
(a)
Raw Materials account: Work in Process account: Finished Goods account: Cost of Sales account: Selling Expenses account:
(b)
To: From: Subject:
(5,000 – 4,650) x $8 (4,600 x 10%) x $8 (4,600 x 90% x 20%) x $8 (4,600 x 90% x 80%) x $8 50 x $8
= = = = =
$ 2,800 $ 3,680 $ 6,624 $26,496 $400
Chief Accountant Student Statement Presentation of Accounts
Two accounts, Cost of Sales and Selling Expenses will appear in the Income statement. Cost of Sales will be deducted from net sales in determining gross profit. Selling Expenses will be shown under operating expenses and will be deducted from gross profit in determining profit. The other accounts associated with the manufacturing of headlamps are inventory accounts which contain end of period balances. Thus, they will be reported under inventories in the current asset section of the statement of financial position. In the notes to the financial statements, the breakdown of the components of inventory will be shown usually in the following order: raw materials, work in process and finished goods.
14.14
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 14.1 GALEX LTD (a)
Based on the production of 1 300 stereo systems per month
Cost Item Raw materials (1) Wages for workers (2) Rent on equipment Miscellaneous materials (3) Factory supervisor’s salary Cleaning costs Advertising Depreciation on factory building (4) Rates and taxes on factory building (5)
Direct Materials $91,000
Product Costs Direct Manufacturing Labour Overhead $97,500 $4,500 6,500 3,500 1,300
(b)
$70 x 1 300 $15 x 5 x 1 300 $5 x 1 300 $7,200/12 $6,000/12
= = = = =
Prime Conversion Costs Costs $91,000 97,500 $97,500 4,500 6,500 3,500 1,300
$8,500
$91,000 (1) (2) (3) (4) (5)
Period Costs
$97,500
$91,000 $97,500 $6,500 $600 $500
Total production costs: Direct materials Direct labour Manufacturing overhead Total production cost
$91,000 97,500 16,900 $205,400
Production cost per stereo = $205,400/1 300 = $158.00
14.15
600 500 $16,900
$8,500
$188,500
600 500 $114,400
Chapter 14: Introduction to management accounting
PROBLEM SET A 14.2 GLAZIER LTD (a)
Based on the production of 100 motorcycles per month.
Cost Item Rent on factory equipment Insurance on factory building Raw materials Power costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Maintenance factory Factory manager’s salary Miscellaneous materials Advertising for cycles Sales commissions Depreciation on factory building
Direct Materials
Total production costs Direct materials Manufacturing overhead Direct labour Total production cost
Period Costs
$30,000
Prime Costs
Conversion Costs $6,200 3,000
$30,000 800
800 $200
$45,000
45,000
45,000
400 600 5,000 600
600 5,000 600 10,000 5,000
$30,000
(b)
Product Costs Direct Manufacturing Labour Overhead $6,200 3,000
$45,000
$30,000 45,000 17,000 $92,000
Production cost per motorcycle = $92,000/100 = $920.00
14.16
800 $17,000
$15,600
$75,000
800 $62,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 14.3 LUCAS KIDS TOWN LTD (a) Lucas Kids Town Ltd Cost of Goods Manufactured Schedule For the year ended 30 June 2013 Work in process, 1/7/12 Direct materials Raw materials inventory, 1/7/12 Add: Raw materials purchased Less: Raw materials inventory, 30/6/13 Direct materials used Direct labour Manufacturing overhead Depreciation - factory machinery Factory supplies Factory power Indirect labour Total overhead Total manufacturing costs Total cost of work in process Less: Work in process, 30/6/13 Cost of goods manufactured
(b)
$3,825 $2,490 22,500 3,960 21,030 41,000 7,250 2,800 3,000 16,250 29,300 91,330 95,155 4,940 $90,215
If depreciation - office equipment was included in manufacturing overhead, it will overstate the conversion cost of overhead. The cost of goods manufactured for the current period will also be overstated.
14.17
Chapter 14: Introduction to management accounting
PROBLEM SET A 14.4 LUCAS KIDS TOWN LTD
Lucas Kids Town Ltd Income Statement For the year ended 30 June 2013 Sales revenue Cost of sales: Finished goods inventory, 1/7/12 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 30/6/13 Cost of sales Gross profit Operating expenses: Depreciation - office equipment Administrative expense Sales commissions Total operating expenses Net profit
$132,000 8,000 90,215 98,215 14,350 83,865 48,135 3,800 7,800 7,250 18,850 $29,285
(b) Cost of sales will be reduced because cost of goods available for sale would be the same as cost of goods manufactured if there was no beginning finished goods. With a reduced cost of sales, both gross and net profit would increase.
14.18
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 14.5 HAWKINSON LTD
Hawkinson Ltd Cost of Goods Manufactured Schedule for the month ended 31 August 2013
(a)
(b)
Work in process inventory, 1/8 Direct materials: Raw materials inventory, 1/8 Raw materials purchased Total raw materials available for use Less: Raw materials inventory, 31/8 Direct materials used Direct labour Manufacturing overhead: Factory rent Depreciation on factory equipment Indirect labour Factor power (10,000 x .7) Factory insurance (5,000 x .8) Total manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, 31/8 Cost of goods manufactured
$25,000 $18,000 200,000 218,000 (33,000) $185,000 150,000 60,000 40,000 20,000 7,000 4,000 131,000 466,000 491,000 (21,000) $470,000
Hawkinson Ltd Income statement for the month ended 31 August 2013
Sales (net) Cost of sales: Finished goods inventory, 1/8 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 31/8 Cost of sales Gross profit Operating expenses Advertising expenses Selling and administrative salaries Depreciation expense on sales equipment Power expense ($10,000 x .3) Insurance expense ($5,000 x .2) Total operating expenses Profit 14.19
$670,000 $40,000 470,000 510,000 62,000 448,000 222,000 80,000 70,000 55,000 3,000 1,000 209,000 $13,000
Chapter 14: Introduction to management accounting
PROBLEM SET A 14.6 (a)
Case 1 (a) Direct materials used Direct labour Manufacturing overhead Total manufacturing costs
$8,300 3,000 4,000 $15,300
(b)
Total manufacturing cost Plus: Beginning work in process Less: Cost of goods manufactured Ending work in process inventory
$15,300 1,000 (12,800) $3,500
(c)
Goods available for sale Less: Cost of goods manufactured Beginning finished goods inventory
$17,300 (12,800) $4,500
(d)
Goods available for sale Less: Ending finished goods inventory Cost of sales
$17,300 (1,200) $16,100
(e)
Sales Less: Sales discounts Cost of sales Gross profit
$21,500 (1,500) (16,100) $3,900
(f)
Gross profit Less: Operating expenses Profit
$3,900 (2,700) $1,200
Case 2 (g) Total manufacturing costs Less: Direct labour Manufacturing overhead Direct materials used
$22,000 (4,000) (5,000) $13,000
(h)
Cost of goods manufactured Ending work in process inventory Less: Total manufacturing costs Beginning work in process inventory
$21,000 2,000 (22,000) $1,000
(i)
Sales? Need to solve (k) first. Gross profit Cost of sales Sales discounts Sales
$6,000 22,500 1,200 $29,700
Beginning finished goods inventory Cost of goods manufactured Goods available for sale
$4,000 21,000 $25,000
(j)
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Solutions manual to accompany Accounting: building business skills 4e
(b)
(k)
Goods available for sale Less: Ending finished goods inventory Cost of sales
$25,000 (2,500) $22,500
(l)
Gross profit Less: Profit Operating expenses
$6,000 (2,800) $3,200
Case 1 Condensed Cost of Goods Manufactured Schedule Work in process, beginning Direct materials Direct labour Manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, ending Cost of goods manufactured
(c)
$1,000 $8,300 3,000 4,000 15,300 16,300 (3,500) $12,800
Case 1 Income statement Sales Less: Sales discounts Net sales
$21,500 (1,500) 20,000
Cost of sales: Finished goods inventory, beginning Cost of goods manufactured Cost of goods available for sale Finished goods inventory, ending Cost of sales Gross profit Operating expenses Profit
$4,500 12,800 17,300 1,200 16,100 3,900 2,700 $1,200
Case 1 Partial Statement of Financial Position Current assets: Cash Receivables Inventories: Finished goods Work in process Raw materials Prepaid expenses Total current assets
$4,300 10,000 $1,200 3,500 700
14.21
5,400 200 $19,900
Chapter 14: Introduction to management accounting
PROBLEM SET A 14.7 MAURO MANUFACTURING LTD Mauro Manufacturing Ltd Cost of Goods Manufactured Schedule for the year ended 31 December 2014 (a)
(b)
Work in process inventory, 1/1/14 Direct materials: Raw materials inventory, 1/1/14 Raw materials purchases Freight-in on materials purchased Total raw materials available for use Less: Raw materials inventory, 31/12/14 Direct materials used Direct labour Manufacturing overhead: Factory manager’s salary Indirect labour Factory power Factory machinery, depreciation Factory rates and taxes Factory insurance Factory repairs Total manufacturing overheads Total manufacturing costs Total cost of work in process Less: Work in process, 31/12/14 Cost of goods manufactured
$25,240 $43,000 206,800 5,640 255,440 (39,600) $215,840 250,600 60,000 35,410 36,000 18,090 10,100 5,400 4,500 169,500 635,940 661,180 (23,600) $637,580
Mauro Manufacturing Ltd Income statement (Partial) for the year ended 31 December 2014 Sales revenues: Sales Less: Sales discounts
$890,900
Net sales Cost of sales: Finished goods inventory, 1/1/14 Cost of goods manufactured (see schedule) Cost of goods available for sale Finished goods inventory, 31/12/14 Cost of sales Gross profit
14.22
(10,120) 880,780 76,000 637,580 713,580 83,200 630,380 $250,400
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(c)
Mauro Manufacturing Ltd Statement of Financial Position (Partial) as at 31 December 2014 Current assets Cash Accounts receivable Inventories: Finished goods Work in process Raw materials Total current assets
$15,000 45,000 $83,200 23,600 39,600
14.23
146,400 $206,400
Chapter 14: Introduction to management accounting
PROBLEM SET A 14.8 (a)
Grayson Manufacturing Ltd Work Sheet for the year ended 30 June 2012 Adjusted Trial Balance
Cash Accounts Receivable (net) Finished Goods Inventory Work in Process Inventory Raw Materials Inventory Plant Assets Accumulated Depreciation Accounts Payable Bills Payable Income Taxes Payable Share Capital Retained Earnings Sales Raw Materials Purchases Direct Labour Indirect Labour Factory Repairs Factory Depreciation Factory Manager’s Salary Factory Insurance Factory Rates and Taxes Factory Power Selling Expenses Administrative Expenses Income Taxes Expense Totals Cost of Goods Manufactured Totals Profit Totals
Dr $30,500 72,100 55,200 17,400 23,400 720,000
Cr
Cost of Goods Manufactured Dr Cr
17,400 23,400
Income Statement Dr
Cr
55,200
51,400
22,800 21,700
275,000 31,000 42,000 8,100 300,000 190,400 932,000 211,600 265,400 23,200 9,600 18,000 40,000 4,700 12,900 13,300 108,600 120,800 31,800 0
Statement of Financial Position Dr Cr $30,500 72,100 51,400 22,800 21,700 720,000 275,000 31,000 42,000 8,100 300,000 190,400
932,000 211,600 265,400 23,200 9,600 18,000 40,000 4,700 12,900 13,300
$1,778,500
639,500 $639,500
14.24
44,500 595,000 $639,500
108,600 120,800 31,800 316,400 595,000 911,400 72,000 $983,400
983,400
918,500
$983,400
$918,500
846,500 72,000 $918,500
Solutions manual to accompany Accounting: building business skills 4e
(b) Grayson Manufacturing Ltd Cost of Goods Manufactured Schedule for the year ended 30 June 2012 Work in process inventory, 1/7/11 Direct materials: Raw materials inventory, 1/7/11 Raw materials purchased Total raw materials available for use Less: Raw materials inventory, 30/6/12 Direct materials used Direct labour Manufacturing overhead: Factory manager’s salary Indirect labour Factory depreciation Factor repairs Factory power Factory rates and taxes Factory insurance Total manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, 30/6/12 Cost of goods manufactured
$17,400 $23,400 211,600 235,000 (21,700) $213,300 265,400 40,000 23,200 18,000 9,600 13,300 12,900 4,700 121,700 600,400 617,800 (22,800) $595,000
(c) Grayson Manufacturing Ltd Income Statement for the year ended 30 June 2012 Sales Cost of sales: Finished goods inventory, 1/7/11 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 30/6/12 Cost of sales: Gross profit Operating expenses Selling expenses Administrative expenses Total operating expenses Profit before income tax Income tax expense Profit
14.25
$932,000 $55,200 595,000 650,200 (51,400) 598,800 333,200 108,600 120,800 229,400 103,800 31,800 $72,000
Chapter 14: Introduction to management accounting
Grayson Manufacturing Ltd Statement of Financial Position as at 30 June 2012 Current assets Cash Accounts receivable (net) Inventories: Finished goods Work in process Raw materials Total current assets Property, plant and equipment: Plant assets Less: Accumulated depreciation Total assets Current liabilities: Accounts payable Bills payable Income taxes payable Total liabilities Net assets
$30,500 72,100 $51,400 22,800 21,700
720,000 (275,000)
95,900 198,500
445,000 643,500
31,000 42,000 8,100 81,100 $562,400
Shareholders’ Equity Share capital Retained earnings ($190,400 + $72,000) Total Shareholders’ Equity
14.26
300,000 262,400 $562,400
Solutions manual to accompany Accounting: building business skills 4e
(d) General Journal June 30
June 30
June 30
June 30
June 30
Work in process inventory, 30/6/12 Raw materials inventory, 30/6/12 Manufacturing summary
$22,800 21,700
Manufacturing summary Work in Process Inventory 1//7/11 Raw materials Inventory 1/7/11 Raw materials purchased Direct labour Indirect labour Factory repairs Factory depreciation Factor manager’s salary Factory insurance Factory rates and taxes Factory power
$639,500
Finished Goods Inventory, 30/6/12 Sales Income Summary
$51,400 932,000
Income Summary Finished Goods Inventory, 1/7/11 Manufacturing Summary Selling Expenses Administrative Expenses Income Tax Expense
$911,400
Income Summary Retained Earnings
$72,000
$44,500
$17,400 23,400 211,600 265,400 23,200 9,600 18,000 40,000 4,700 12,900 13,300
$983,400
$55,200 595,000 108,600 120,800 31,800
$72,000
(e) June 30
Closing entry
June 30 June 30
Closing entry Retained Profits
Manufacturing Summary $639,500 June 30 Closing entry June 30 Income Summary $639,500
Income Summary $911,400 June 30 72,000 $1,050,600
14.27
Closing entry
$44,500 595,000 $639,500
$983,400 $1,050,600
Chapter 14: Introduction to management accounting
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 14.1 MOLIK LTD (a)
Based on the production of 3,000 racquets per month
Cost Item Raw materials (1) Wages for workers (2) Rent on equipment Miscellaneous materials (3) Factory supervisor’s salary Cleaning costs Advertising Depreciation on factory building (4) Rates and taxes on factory building (5)
Direct Materials $84,000
(b)
$28 x 3,000 $15 x 2 x 3,000 $3 x 3,000 $19,200/12 $4,800/12
= = = = =
Total production costs: Direct materials Direct labour Manufacturing overhead Total production cost
Period Costs
$90,000
Prime Costs $84,000 90,000
$4,000 9,000 2,500 2,000
Conversion Costs $90,000 4,000 9,000 2,500 2,000
$6,000
$84,000
(1) (2) (3) (4) (5)
Product Costs Direct Manufacturing Labour Overhead
$48,000
$84,000 $90,000 $9,000 $1,600 $400
$84 000 90,000 19,500 $193,500
Production cost per racket = $193,500/3,000 = $64.50
14.28
1,600 400 $19,500
$6,000
$174,000
1,600 400 $109,500
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 14.2 MAREK ACCESSORIES (a)
Based on the production of 10,000 helmets per month.
Cost Item Rent on factory equipment Insurance on factory building Raw materials Power costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials Factory manager’s salary Rates and taxes on factory building Advertising for helmets Sales commissions Depreciation on factory building
Direct Materials
Product Costs Direct Manufacturing Labour Overhead $8,000 1,500
$80,000
Total production costs Direct materials Manufacturing overhead Direct labour Total production cost
Prime Costs
Conversion Costs $8,000 1,500
$80,000 800
800 $400
$106,000
106,000
106,000
800 1,500 5,700 800
1,500 5,700 800 11,000 6,500
$80,000
(b)
Period Costs
$106,000
$80,000 106,000 21,300 $207,300
Production cost per helmet = $207,300/10,000 = $20.73
14.29
3,000 $21,300
$18,700
$186,000
3,000 $127,300
Chapter 14: Introduction to management accounting
PROBLEM SET B 14.3 GREENSPRING LTD
Cost of Goods Manufactured Schedule for the year ended 30 June 2013
(a) Work in process, 1/7/12 Direct materials Raw materials inventory, 1/7/12 Add: Raw materials purchased Less: Raw materials inventory, 30/6/13 Direct materials used Direct labour Manufacturing overhead Depreciation - factory machinery Factory supplies Factory power Indirect labour Total overhead Total manufacturing costs Total cost of work in process Less: Work in process, 30/6/13 Cost of goods manufactured
$19,125 $12,450 112,500 19,800 105,150 205,000 36,250 14,000 15,000 81,250 146,500 456,650 475,775 24,700 $451,075
(b) If depreciation - office equipment was included in manufacturing overhead, it will overstate the conversion cost of overhead. The cost of goods manufactured for the current period will also be overstated.
14.30
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 14.4 GREENSPRING LTD
Income statement (Partial) for the year ended 30 June 2013 (a) Sales revenue Cost of goods sold: Finished goods inventory, 1/7/12 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 30/6/13 Cost of sales Gross profit Operating expenses: Depreciation - office equipment Administrative expense Sales commissions Total operating expenses Net profit
$660,000 $40,000 451,075 491,075 71,750 419,325 240,675 19,000 39,000 36,250 94,250 $146,425
(b) Cost of sales will be reduced because cost of goods available for sale would be the same as cost of goods manufactured if there were no beginning finished goods. With a reduced cost of sales, both gross and net profit would increase.
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Chapter 14: Introduction to management accounting
PROBLEM SET B 14.5 NOONAN LTD
Cost of Goods Manufactured Schedule for the month ended 31 October 2013
(a)
(b)
Work in process inventory, 1/10 Direct materials: Raw materials inventory, 1/10 Raw materials purchased Total raw materials available for use Less: Raw materials inventory, 31/10 Direct materials used Direct labour Manufacturing overhead: Factory rent Depreciation on factory equipment Indirect labour Factory power (12,000 x .7) Factory insurance (8,625 x .8) Total manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, 31/10 Cost of goods manufactured
$13,000 $20,000 271,000 291,000 (25,000) $266,000 210,000 72,000 30,000 32,000 8,400 6,900 149,300 625,300 638,300 (16,000) $622,300
Noonan Ltd Income statement for the month ended 31 October 2013 Sales (net) Cost of sales: Finished goods inventory, 1/10 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 31/10 Cost of sales Gross profit Operating expenses Advertising expenses Selling and administrative salaries Depreciation expense on sales equipment Power expense ($12,000 x .3) Insurance expense ($8,625 x .2) Total operating expenses Profit
14.32
$840,000 $30,000 622,300 652,300 (48,000) 604,300 235,700 85,000 81,000 43,000 3,600 1,725 214,325 $21,375
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 14.6 (a)
Case 1 (a) Direct materials used Direct labour Manufacturing overhead Total manufacturing costs
$8,000 6,000 5,000 $19,000
(b)
Total manufacturing cost Plus: Beginning work in process Less: Cost of goods manufactured Ending work in process inventory
$19,000 1,000 (16,500) $3,500
(c)
Goods available for sale Less: Cost of goods manufactured Beginning finished goods inventory
$18,000 (16,500) $1,500
(d)
Goods available for sale Less: Ending finished goods inventory Cost of sales
$18,000 (3,000) $15,000
(e)
Sales Less: Sales discounts Cost of sales Gross profit
$24,500 (2,500) (15,000) $7,000
(f)
Gross profit Less: Operating expenses Profit
$7,000 (2,500) $4,500
Case 2 (g) Total manufacturing costs Less: Direct labour Manufacturing overhead Direct materials used
$21,000 (8,000) (4,000) $9,000
(h)
Cost of goods manufactured Ending work in process inventory Less: Total manufacturing costs Beginning work in process inventory
$22,000 3,000 (21,000) $4,000
(i)
Sales? Need to solve (k) first. Gross profit Cost of sales Sales discounts Sales
$7,000 23,000 1,400 $31,400
Beginning finished goods inventory Cost of goods manufactured Goods available for sale
$3,500 22,000 $25,500
(j)
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Chapter 14: Introduction to management accounting
(b)
(k)
Goods available for sale Less: Ending finished goods inventory Cost of sales
$25,500 (2,500) $23,000
(l)
Gross profit Less: Profit Operating expenses
$7,000 (2,800) $4,200
Case 1 Condensed Cost of Goods Manufactured Schedule Work in process, beginning Direct materials Direct labour Manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, ending Cost of goods manufactured
(c)
$1,000 $8,000 6,000 5,000 19,000 20,000 (3,500) $16,500
Case 1 Income Statement Sales Less: Sales discounts Net sales
$24,500 (2,500) $22,000
Cost of sales: Finished goods inventory, beginning Cost of goods manufactured Cost of goods available for sale Finished goods inventory, ending Cost of sales Gross profit Operating expenses Profit
$1,500 16,500 18,000 3,000 15,000 7,000 2,500 $4,500
Case 1 Partial Statement of Financial Position Current assets: Cash Receivables Inventories: Finished goods Work in process Raw materials Prepaid expenses Total current assets
$4,000 15,000 $3,000 3,500 600
14.34
7,100 400 $26,500
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 14.7 SCHEVE MANUFACTURING LTD (a) Scheve Manufacturing Ltd Cost of Goods Manufactured Schedule for the year ended 30 June 2013 Work in process inventory, 1/7/12 Direct materials: Raw materials inventory, 1/7/12 Raw materials purchases Freight-in on raw materials purchased Total raw materials available for use Less: Raw materials inventory, 30/6/13 Direct materials used Direct labour Manufacturing overhead: Factory manager’s salary Factory electricity Indirect labour Factory depreciation - machinery Factor property rates Factory insurance Factory repairs Total manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, 30/6/13 Cost of goods manufactured
$21,000 $46,500 89,800 8,600 144,900 (39,600) $105,300 147,250 29,000 24,600 24,460 15,000 9,600 4,600 1,400 108,660 361,210 382,210 (18,700) $363,510
(b) Scheve Manufacturing Ltd Income Statement (Partial) for the year ended 30 June 2013
Sales revenues Sales Less: Sales discounts Net sales Cost of sales: Finished goods inventory, 1/7/12 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 30/6/13 Cost of sales Gross profit
14.35
$547,000 3,300 543,700 $96,000 363,510 459,510 (95,900) 363,610 $180,090
Chapter 14: Introduction to management accounting
(c) Scheve Manufacturing Ltd Statement of Financial Position (Partial) as at 30 June 2013
Current assets Cash Accounts receivable (net) Inventories: Finished goods Work in process Raw materials Total current assets
$32,000 27,000 $95,900 18,700 39,600
14.36
154,200 $213,200
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 14.8 (a)
Everheart Manufacturing Ltd Work Sheet for the year ended 30 June 2012 Adjusted Trial Balance
Cash Accounts Receivable (net) Finished Goods Inventory Work in Process Inventory Raw Materials Inventory Plant Assets Accumulated Depreciation Accounts Payable Bills Payable Income Taxes Payable Share Capital Retained Earnings Sales Raw Materials Purchases Direct Labour Indirect Labour Factory Repairs Factory Depreciation Factory Manager’s Salary Factory Insurance Factory Rates and Taxes Factory Power Selling Expenses Administrative Expenses Income Taxes Expense Totals Cost of Goods Manufactured Totals Profit Totals
Dr $16,700 62,900 56,000 27,800 37,200 890,000
Cr
Cost of Goods Manufactured Dr Cr
$27,800 37,200
Income Statement Dr
Cr
$56,000
$54,600
$23,400 46,500
$353,000 38,200 45,000 9,000 352,000 205,300 996,000 236,500 280,900 27,400 17,200 19,000 40,000 11,000 12,900 13,300 98,500 115,200 36,000 $1,998,500
Statement of Financial Position Dr Cr $16,700 62,900 54,600 23,400 46,500 890,000 353,000 38,200 45,000 9,000 352,000 205,300
996,000 236,500 280,900 27,400 17,200 19,000 40,000 11,000 12,900 13,300 98,500 115,200 36,000
$1,998,500
723,200 $723,200
14.37
69,900 653,300 $723,200
653,300 959,000 91,600 $1,050,600
1,050,600
1,094,100
$1,050,600
$1,094,100
1,002,500 91,600 $1,094,100
Chapter 14: Introduction to management accounting
(b) Everheart Manufacturing Ltd Cost of Goods Manufactured Schedule for the year ended 30 June 2012 Work in process inventory, 1/7/01 Direct materials: Raw materials inventory, 1/7/11 Raw materials purchased Total raw materials available for use Less: Raw materials inventory, 30/6/12 Direct materials used Direct labour Manufacturing overhead: Factory manager’s salary Indirect labour Factory depreciation Factor repairs Factory power Factory rates and taxes Factory insurance Total manufacturing overhead Total manufacturing costs Total cost of work in process Less: Work in process, 30/6/12 Cost of goods manufactured
$27,800 $37,200 37,200 236,500 236,500 273,700 273,700 (46,500) 46,500 $227,200 280,900 40,000 40,000 27,400 27,400 19,000 19,000 17,200 17,200 13,300 13,300 12,900 12,900 11,000 11,000 140,800 648,900 676,700 (23,400) $653,300
(c) Everheart Manufacturing Ltd Income Statement for the year ended 30 June 2012 Sales Cost of sales: Finished goods inventory, 1/7/11 Cost of goods manufactured Cost of goods available for sale Less: Finished goods inventory, 30/6/12 Cost of sales Gross profit Operating expenses Selling expenses Administrative expenses Total operating expenses Profit before income tax Income tax expense Profit
14.38
$996,000 $56,000 653,300 709,300 (54,600) 654,700 341,300 98,500 115,200 213,700 127,600 36,000 $91,600
Solutions manual to accompany Accounting: building business skills 4e
Everheart Manufacturing Ltd Statement of Financial Position as at 30 June 2012 Current assets Cash Accounts receivable (net) Inventories: Finished goods Work in process Raw materials Total current assets Property, plant and equipment: Plant assets Less: Accumulated depreciation Total assets Current liabilities: Accounts payable Bills payable Income taxes payable Total liabilities Net assets
$16,700 62,900 $54,600 23,400 46,500
890,000 (353,000)
124,500 204,100
537,000 741,100
38,200 45,000 9,000 92,200 $648,900
Shareholders’ Equity Share capital Retained earnings($205,300 + $91,600) Total Shareholders’ Equity
352,000 296,900 $648,900
(d) General Journal June 30
June 30
Work in process inventory, 30/6/12 Raw materials inventory, 30/6/12 Manufacturing summary
$23,400 46,500
Manufacturing summary Work in Process Inventory 1//7/11 Raw materials Inventory 1/7/11 Raw materials purchases Direct labour Indirect labour Factory repairs Factory depreciation Factor manager’s salary Factory insurance Factory rates and taxes Factory power
723,200
14.39
$69,900
27,800 37,200 236,500 280,900 27,400 17,200 19,000 40,000 11,000 12,900 13,300
Chapter 14: Introduction to management accounting
June 30
June 30
June 30
Finished Goods Inventory, 30/6/12 Sales Income Summary
54,600 996,000
Income Summary Finished Goods Inventory, 1/7/11 Manufacturing Summary Selling Expenses Administrative Expenses Income Tax Expense
959,000
Income Summary Retained Earnings
91,600
1,050,600
56,000 653,300 98,500 115,200 36,000
91,600
(e) June 30
June 30 June 30
Closing entry
Closing entry Retained Earnings
Manufacturing Summary $723,200 June 30 Closing entry June 30 Income Summary $723,200
Income Summary $959,000 June 30 91,600 $1,050,600
Closing entry
$69,900 653,300 $723,200
$1,050,600
$1,050,600
14.40
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BBS 14.1 GOLF, ANYONE? LTD
Since the questions were fairly open ended, the following are only suggested answers. The class may be able to think of others or of more items for each one. (a)
(b)
(c)
Marshall Loadsman
Needs information on sales, perhaps by salesperson and by territory.
Anthony Chan
Needs cost information for his department.
Martine Clancy
Needs all accounting information.
Jack Jones
Needs product cost information.
Louise Parker
Needs information on component costs and costs for her department.
Marshall Loadsman
Income statement.
Anthony Chan
None.
Martine Clancy
All.
Jack Jones
Income statement and cost of goods manufactured schedule.
Louise Parker
None.
Marshall Loadsman
Sales by Territory – Detailed information, possibly by product line, issued daily or weekly.
Anthony Chan
Cost of Computer Programs – Accumulated cost incurred by each major program used including maintenance and updates of program, issued monthly.
Martine Clancy
Cost of Preparing Reports – Detailed analysis of all reports provided, their frequency, time and estimated cost to prepare, issued monthly.
Jack Jones
Cost of Product – Detailed cost by product line, including a comparison with estimated costs for that product. Issued as each batch of production is completed.
Louise Parker
Cost of Product Design – Accumulate total costs of each new product, issued at end of each project.
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Chapter 14: Introduction to management accounting
BBS 14.2 CSL Ltd (a) The principal activities of CSL Ltd during the financial year ended 30 June 2010 were the research, development, manufacture, marketing and distribution of biopharmaceutical and allied products.
(b)
Latest report available was the year ended 30 June 2010
Sales Revenue Cost of Sales Revenue decreased by 3.6% over 2009, while cost of sales decreased by 9%.
2010 $’m 4,456 2,185
2009 $’m 4,622 2,400
(c) The consolidated entity is organised in the following business segments: • CSL Behring – manufactures, markets and develops plasma products. • Intellectual Property Licensing – revenue and associated expenses from the licensing of Intellectual Property generated by the company to unrelated third parties. • Other Human Health – comprises CSL Bioplasma and CSL Biotherapies. These businesses manufacture and distribute biotherapeutic products.
Segments CSL Behring Intellectual Property Licensing Other Human Health Total
Revenue $m 2,504 112 966 3,582
Revenue % 70% 3% 27% 100
14.42
Solutions manual to accompany Accounting: building business skills 4e
BBS 14.3 Solution is provided for Qantas Airways Ltd. www.qantas.com.au Based on the 2010 annual report: (a)
What is the main strategy for the company in the current year? The Qantas Group developed a strategy to create two airlines – Qantas and Jestar over the past couple of years. The company’s two-brand strategy remains central to its future growth plans and success. The pillars of the company’s strategy are: • Safety as a first priority, backed by commitment to world’s best safety practices and reporting; • Utilising the right aircraft on the right routes, with fleet renewal delivering effective fleets flying on an optimal route network; • Customer service excellence; • Operational efficiency and achieving simplicity and further productivity across the business units; • Two strong complementary brands – Qantas and Jetstar as the best premium and low fares brands respectively* * p15 of the 2010 Annual report.
(b)
Outline the performance measures/indicators the entity uses to assess if the company is meeting its stated objectives. Qantas’s performance is assessed against the strategy, budgets and forecasts using financial and non-financial measures. Underlying Profit Before Tax (PBT) is the key budgetary and financial performance measure for the Qantas Group. Key financial metrics include: underlying profit before tax, operating cash flow and earnings per share. Operational measures include: • Customer service i.e. Qantas performance in Skytrax World Airline Awards - a global independent passenger survey of airline standards; • Operational / Punctuality, measured against on-time departures and arrival targets; • People / Safety, a measure of Lost Time Injury and Serious Injury rates per employee • Unit cost performance, a measure of Net Expenditure divided by Group Available Seat Kilometres (ASKs)
A summary of these results are provided on p.41 of the 2010 annual report. (c)
Describe the risk management policy (include an outline of monitoring mechanisms the company uses). Qantas is a complex business and faces a range of strategic, financial and operational risks. To manage these and other risks, the Board of Directors is responsible for reviewing and approving the Qantas Group Risk Management Framework which is underpinned by three interrelated elements: governance, risk management and assurance.
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Chapter 14: Introduction to management accounting
Qantas’s risk management policy sets out the minimum requirements and roles and responsibilities for managing risk across the Qantas Group. Summaries of the risk management policy and other significant risk policies are included in the Qantas Group Business Practice Document (available in the Corporate Governance section on the Qantas website). Some of the mechanisms used by Qantas to address risks include: • Assist employees to develop and enhance risk management skills and competences by providing comprehensive support including risk specialists, systems, standards, procedures, training and tools; • Each business unit is required to prepare and submit a detailed risk register outlining the key risks to achieving their objectives and mitigating actions during the quarterly risk reporting process; • The internal auditor, through an independent third party validation, also reports to the Board of Directors and relevant Board Committees that there is an effective risk management process in place for the financial period and up to date of signing the financial report.
(d)
What are the performance measures used to report on the social and environmental issues associated with the company The Qantas Group has adopted an investor approach to sustainability. This investor approach includes a commitment to managing and reporting on Environment, Social and Governance (ESG) performance. Fuel conservation is the most important element of Qantas’s environmental strategy. Improving fuel efficiency can minimise cost and manage environmental impact. Aviation Carbon Dioxide Emission is used to report fuel efficiency. On the social front, Qantas reports on the range of benefits and well-being initiatives in its workplace, which include: Diversity of employees (e.g. % women in senior positions, % women directors on the Qantas Board) and Investment in training.
14.44
Solutions manual to accompany Accounting: building business skills 4e
CRITICAL THINKING BBS 14.4 DESKINS MANUFACTURING LTD
Ending Raw Materials Inventory Beginning raw materials + Raw materials purchased = Raw materials available for use = $16,000 + $360,000 = $376,000 Raw materials available for use – Direct materials used = Ending raw materials Direct materials = $376,000 - $362,000 = $14,000 Ending Work in Process Inventory Direct materials + Direct labour + Manufacturing overhead = Total manufacturing costs = $362,000 + $280,000 + ($280,000 x 60%) = $810,000 Beginning work in process inventory + Total manufacturing costs = Total cost of work in process = $22,000 + $810,000 = $832,000 Cost of goods manufactured + Beginning finished goods inventory = Cost of goods available for use Cost of goods manufactured + $56,000 = $850,000 Cost of goods manufactured = $850,000 - $56,000 = $794,000 Total cost of work in process – Ending work in process inventory = Cost of goods manufactured $832,000 – Ending work in process inventory = $794,000 Ending work in process inventory = $832,000 - $794,000 = $38,000 Ending Finished Goods Inventory Sales – Cost of sales (60% sales) = Gross profit(40% of sales) $1,300,000 – Cost of sales = $1,300,000 - $780,000($1.3m x60%) = $520,000 Cost of goods available for sale – Ending finished goods inventory = Cost of sales $850,000 – Ending finished goods inventory = $780,000 Ending finished goods inventory = $850,000 - $780,000 = $70,000
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Chapter 14: Introduction to management accounting
Or alternatively: Deskins Manufacturing Ltd Cost of Goods Manufactured Schedule for the month ended 31 January 2013 Derived inventory amounts Work in process inventory 1/1/13 Direct materials: Raw materials inventory 1/1/13 Purchases Raw materials inventory 31/1/13 Direct materials used Direct labour Manufacturing overhead (280,000 x 60%) Total manufacturing costs Total cost of work in process Work in process 31/1/13 Cost of goods manufactured
$22,000 $16,000 360,000 376,000 14,000
$14,000 $362,000 280,000 168,000 810,000 832,000 (38,000) $794,000
$38,000
Deskins Manufacturing Ltd Income statement for the month ended 31 January 2013
Sales Cost of sales: Finished goods inventory 1/1/13 Cost of goods manufactured Cost of goods available Finished goods inventory 31/1/13 Cost of sales (1,300,000 x 60%) Gross profit (1,300, 000 x 40%)
$1,300,000 $56,000 794,000 850,000 (70,000)
$70,000 780,000 $520,000
Insurance claim
14.46
$122,000
Solutions manual to accompany Accounting: building business skills 4e
BBS 14.5 The later chapters will explain how this information is used and what the relevant information is for the various decisions to be made. 1.
Billabong International The types of information for a new store in Canada: ▪ demographics of the area population likely to buy the snow wear products ▪ cost of renting/building premises for the store ▪ location of main competitors for similar products ▪ marketing information of major events to provide opportunities for promotion of brands.
2.
Qantas The types of information for altering flights: ▪ The current cost of each flight broken down into the individual components such as fuel, personnel, terminal charges, etc. ▪ The expected usage of the flight, competitors’ routes ▪ Availability of planes, staff, terminal space ▪ Estimated costing of varying the flights.
3.
Coca-cola Amatil The types of information in deciding to invest in new flavour beverage: ▪ Estimated net returns ▪ Funding budgets ▪ Consumer demand for such products ▪ Cost associated with developing the new drink
4.
CSR LTD The types of information for production schedules would be: ▪ Expected sales for coming quarter, broken down into weekly order dates ▪ Minimum and maximum inventory levels ▪ Staffing costs ▪ Machine productive capacities.
14.47
Chapter 14: Introduction to management accounting
BBS 14.6 STEVEN ROGER
Date:
14 April 2012
To:
Steven Roger
From:
Anne Student, Assistant Accountant
Re:
Management Accounting Techniques
Mr Roger, I am employed in your firm as the assistant accountant and I have been at meetings when you expressed your frustration at the lack of performance of your company. I am writing you this memo to point out to you that there are accounting techniques that can provide you with the relevant information you require. Management accounting can provide specific reports designed to meet the information needs you desire. The information can be broken down into various products and store locations. This must be requested before the start of the period so it can be coded appropriately to provide the detailed data. Cost-volume-profit analysis can be undertaken where the costs are split into fixed, mixed and variable costs, so that changes in volume/activity and the reaction of the costs can be analysed. Flexible budgets can be prepared providing the basis for controlling costs and expenses by assigning responsibility for cost centres. Finally incremental analysis can be undertaken where we look at the relevant cost appropriate when making a decision such as a change in a product or the addition or removal of a product line. Software is available which can monitor the supply chain and the business can implement a Total Quality Management system. If you would like to discuss or have more details on any of the above, please contact me and arrange a suitable time to meet.
14.48
Solutions manual to accompany Accounting: building business skills 4e
BBS 14.7 CASPER LTD
(a)
The stakeholders in this situation are: The users of Casper Ltd’s financial statements John Shepherd, the accountant The director of finance The CEO of Casper Ltd Potential investors of the company’s debentures.
(b)
The ethical issues in this situation pertain to the adherence to sound and acceptable accounting principles. Intentional violation of generally accepted accounting principles in order to satisfy a practical short-term personal or company need and thus create misleading financial statements would be unethical. Selecting one acceptable method of accounting and reporting among other acceptable methods is not necessarily unethical.
(c)
Ethically, the management of Casper Ltd should be trying to report the financial condition and results of operations as fairly as possible; that is, in accordance with GAAP. Normally, advertising costs are expensed in the period in which they are incurred because it is very difficult to associate them with specific future benefits. At best, if the benefits will be derived in future periods, then they would constitute a prepayment. From the facts in this situation, it is not the case. Disguising the cost as part of inventory is a deliberate deceit to convince the market the company is preforming better than the reality. John should inform management what is acceptable accounting and what is not. The advertising costs should be expensed as a period cost in the current reporting period.
14.49
Chapter 14: Introduction to management accounting
BBS 14.8 a) Key challenges and strategies for businesses in relation to climate change: • Facing the global challenge of achieving more from using fewer resources • Dealing with the uncertain brought about by a carbon emission trading scheme • Devising waste management reduction strategies that are linked to resources management • Developing broad-based, multilateral solutions for waste management • Be proactive, rather than reactive, to changes in the business environment b) Some of the changing roles of the accounting profession in response to environmental issues: • Looking beyond measuring and monitoring visible financial costs • Recognising the intangibility of managing risk • Developing specific accounting standards to match innovation • Measuring and reporting businesses’ environmental footprint c) Students’ answer may vary according to their own research. Some of the key features of ‘carbon accounting’ include: • Measurement of broader environmental costs of doing business • Measuring and reporting of carbon dioxide emissions • Also referred to as greenhouse gas accounting
14.50
Chapter 15: Cost accounting systems
CHAPTER 15 – COST ACCOUNTING SYSTEMS ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives 1. Explain the characteristics and purposes of cost accounting systems. 2.
Describe the flow of costs in a job order cost system.
3.
Explain a job cost sheet and the accounting entries for a job order cost system.
4.
Describe the flow of costs in a process cost system.
5.
Prepare the accounting entries for a process cost system.
6.
Prepare a production cost report.
7.
Recognise the difference between traditional costing and activity-based costing.
8.
Identify the activity cost pools and activity drivers used in activity-based systems.
9.
Understand the benefits and limitations of activity-based costing.
10.
Differentiate between value-added and non-value-added activities.
11.
Explain just-in-time (JIT) processing.
Brief Exercises 1
Exercises
Problems
2
1, 2, 3
PSA1 PSB1
1, 2, 3,4
PSA1,2 PSB1,2
5,7
PSA3 PSB4,5
5,6,8
PSA4,5 PSB3,5
3,12
PSA6,7,8,9, 10 PSB6,7,8,9, 10
9,10,11,12
PSA6,7,8, 9,10 PSB6,7,8, 9, 10
11
PSA8
3,10,12,13
PSA7,10 PSB7,10
3,4
5,7
6, 7
3
15.1
Solutions manual to accompany Accounting: building business skills 4e
ANSWERS TO QUESTIONS 1.
2.
(a)
Cost accounting involves the measuring, recording and reporting of product or service costs. A cost accounting system consists of manufacturing cost accounts that are fully integrated into the general ledger of a company.
(b)
An important feature of a product cost accounting system is the use of a perpetual inventory system that provides information immediately on the cost of a product. For financial accounting product costs are needed to value inventory in the Statement of financial position and the cost of sales in the Income Statement.
The major steps in the flow of costs in a job order cost accounting system are: (1)
accumulating the manufacturing costs incurred
(2)
assigning the accumulated costs to work done.
3.
The purpose of a job cost sheet is to record the costs chargeable to a specific job and to determine the total and unit cost of the completed job.
4.
Under-applied overhead means that the overhead assigned to work in process is less than the overhead incurred. Over-applied overhead means that the overhead assigned to work in process is greater than the overhead incurred. Manufacturing Overhead will have a debit balance when overhead is under-applied and a credit balance when overhead is over-applied. At the end of the year under- or over-applied overhead is usually considered to be an adjustment to cost of sales.
5.
The features of process cost accounting are:
6.
(1)
separate work-in-process accounts for each process
(2)
production cost reports
(3)
product costs calculated for each accounting period
(4)
unit costs calculated based on total manufacturing costs.
In developing an ABC costing system it is a two stage process. First you need to indentify activities in the business and assign costs to those activities and then the second stage is you need to identify each product or service use of that activity. In practical terms this means assigning overhead costs to activity cost pools and then assigning the costs to the product or service using the cost driver. For example the activity cost pool may be inspecting and testing and the driver is the number of inspections.
15.2
Chapter 15: Cost accounting systems
7.
(a)
The principal differences are: Activity-Based Costing
(1) Primary focus (2) Bases of allocation (3) Total product costs
(b)
Activities performed in making products Multiple cost drivers Sum of the costs of activities consumed in making the product.
Traditional Costing Units of production Single unit-level bases Direct materials plus manufacturing overhead.
There are two assumptions that must be met in using ABC: (1)
All overhead costs related to the activity must be driven by the cost driver used to assign costs to products.
(2)
All overhead costs related to the activity should respond proportionally to changes in the activity level of the cost driver.
8.
Identifying non-value-added activities highlights for managers the activities that should be reduced or eliminated because they add no worth to the product.
9.
(a)
Just-in-time processing philosophy is to have the right amount of materials, products or parts at the time they are needed. Under JIT processing raw materials are received just in time for use in production, using a demand-pull approach in manufacturing.
(b)
The major elements in JIT processing for a business entity are that they must possess: 1. Dependable suppliers who will deliver on short notice 2. A multi-skilled workforce to operate work centre areas 3. A total quality control system.
10.
The overall objective of using ABC in service industries is no different than for manufacturing industries; that is, improved costing of services rendered (by job, service contract or customer). The general approach to costing is the same – analyse operations, identify activities, allocate overhead costs to activity cost pools and identify and use cost drivers to assign the cost pools to the services.
15.3
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 15.1 (a) Job costing (b) Process costing (c) Process costing (d) Job costing (e) Process costing
BRIEF EXERCISE 15.2 DIAMOND TOOL & DIE PTY LTD
Raw Materials Inventory (1) Purchases
(4) Materials used
Work in Process Inventory (4) Direct materials used
(7) Cost of completed jobs
Finished Goods Inventory (7) Cost of completed jobs
(8) Cost of goods sold
(5) Direct labour used (6) Overhead applied
Factory Labour (2) Factory labour incurred
Cost of sales
(5) Factory labour used
(8) Cost of goods sold
Manufacturing Overhead (3) Depreciation insurance repairs
(6) Overhead applied
(4) Indirect materials (5) Indirect labour
15.4
Chapter 15: Cost accounting systems
BRIEF EXERCISE 15.3 BURROUGH MANUFACTURING
(a)
January Beginning work in process
March
May
July
-
-
-
-
Started into production
9 000
15 000
20 000
25 000
Total units to be accounted for
9 000
15 000
20 000
25 000
Transferred out
7 000
12 000
16 000
10 000
Ending work in process
2 000
3 000
4 000
15 000
Total units accounted for
9 000
15 000
20 000
25 000
(b)
Materials
Conversion Costs
January
9000 (7 000 + 2 000)
8 200[7 000 + (2 000 x 60%)]
March
15 000 (12 000 + 3 000)
12 900 [12 000 + (3 000 x 30%)]
May
20 000 (16 000 + 4 000)
19 200 [16 000 + (4 000 x 80%)]
July
25 000 (10 000 + 15 000)
16 000 [10 000 + (15 000 x 40%)]
BRIEF EXERCISE 15.4 CLARK MANUFACTURING
Materials
Units transferred out Work in process, 30 March Materials (2,000 x 100%) Conversion costs (2,000 x 60%) Total equivalent units
11,000
Conversion Costs
11,000
2,000 13,000
1,200 12,200
BRIEF EXERCISE 15.5 SMYTH LTD
Machine set-ups Machining Inspections
$180 000 ÷ 2 000 $325 000 ÷ 25 000 $70 000 ÷ 1 750
15.5
= $90 per set-up = $13 per machine hour = $40 per inspection
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 15.6 DEWEY NOVELTY PTY LTD 1.
Non-value-added
5.
Non-value-added
2.
Non-value-added
6.
Non-value-added
3.
Value-added
7.
Non-value-added
4.
Non-value-added
8.
Value-added
BRIEF EXERCISE 15.7 ELBURN PLASTICS LTD
(a) (b) (c) (d) (e) (f) (g) (h)
Facility-level Unit-level Product-level Unit-level Batch-level Batch-level Product-level Facility-level
15.6
Chapter 15: Cost accounting systems
SOLUTIONS TO EXERCISES EXERCISE 15.1 STANDISH LTD (a) 1.
The source documents are: Direct materials – Materials requisition slips Direct labour – Time tickets Manufacturing overhead – Predetermined overhead rate.
2.
$20,200 ($7,000 + $8,000 + $5,200).
3.
Last year 65% ($5,200 ÷ $8,000); this year 70% (either $4,900 ÷ $7,000 or $3,500 ÷ $5,000)
(b) Jan 31
Jan 31
Jan 31
Jan 31
Work in Process Inventory Raw Materials Inventory
9,000
Work in Process Inventory Factory Labour
12,000
Work in Process Inventory Manufacturing Overhead Applied
8,400
Finished Goods Inventory Work in Process Inventory
49,600
9,000
12,000
15.7
8,400
49,600
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 15.2 KANG PTY LTD
(a)? + $50,000 + $42,500 = $185,650 (a) = $93,150 $185,650+ (b) = $203,100 (b) = $17,450 $203,100 – (c) = $193,700 (c) = $9,400 [Note: The instructions indicate that manufacturing overhead is applied on the basis of direct labour cost, and the rate is the same in all cases. From Case A, a student should note the overhead rate to be 85% ($42,500 ÷ $50,000).] (d) = .85 x $90,000 (d) = $76,500 $85,000 + $90,000 + $76,500 = (e) (e) = $251,500 $251,500 + $15,500 = (f) (f) = $258,400 $258,400- $12,200 = (g) (g) = $267,000 [Note:(h) and (i) are solved together.] (i) = .85(h) $63,150 + (h) + .85(h) = $287,000 1.85(h) = $223,850 (h) = $121,000 (i) = $102,850 $287,000 +$18,000 = (j) (j) =$305,000 $305,000 – (k) = $262,000 (k) = $43,000
15.8
Chapter 15: Cost accounting systems
EXERCISE 15.3 (a) Just-in-time processing (b) Job costing (c) Activity-based costing (d) Non-valued added (e) Overhead (f) Under-applied
15.9
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 15.4 BERG PRINTING COMPANY
1
2
3
4
5
6.
$ 172 000
Raw Materials Inventory Accounts Payable
$ 172 000
Factory Labour Factory Wages Payable
87 300
Work in Process Inventory Manufacturing Overhead Control Raw Materials Inventory
150 530 4 470
Work in Process Inventory Manufacturing Overhead Control Factory Labour
84 000 3 300
Manufacturing Overhead Control Accounts Payable
39 500
Manufacturing Overhead Control Accumulated Depr’n_Machinery
14 ,550
Work in Process Inventory Manufacturing Overhead Applied ($84,000 x 75%)
63 000
Finished Goods Inventory Work in Process Inventory (*as per calculation on job sheet)
235 180
87 300
155 000
87 300
39 500
14 550
63 000
235 80
Calculation of finished jobs Job
A20 A21 A22
Direct Materials $
Direct Labour $
Manufacturing Overhead $
32,240 42,920 39,270
18,000 26,000 25,000
15.10
13,500 19,500 18,750
Total $ 63 740 88 420 83 020 $235 180
Chapter 15: Cost accounting systems
EXERCISE 15.5 KOHLER LTD (a)
Materials Units transferred out Work in process 31 July: 1,000 x 100% 1,000 x 40%
8 000
Materials Costs in July Equivalent units Unit costs
(c)
8 000
1 000 9 000
(b)
Conversion Costs
$900 000 9 000 $100.00
Transferred out (8 000 x $150.00) Work in process: Materials (1,000 x $100) Conversion costs (400 x $50) Total costs
400 8 400 Conversion Costs $420 000 8 400 $50.00
Total $1 320 000 $150.00 $1 200 000
$100 000 20 000
15.11
120 000 $1 320 000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 15.6 NAGANO MANUFACTURING
Quantities
Physical Units
Equivalent Units Materials Conversion Costs
(Step 1) Units to be accounted for: Work in process, 1 February Started into production Total units
15 000 60 000 75 000
Units accounted for: Transferred out Work in process, 28 February Total units
49 000 26 000 75 000
Costs Unit costs (Step 3) Costs in February Equivalent units Unit costs (a) ÷ (b)
(a) (b)
(Step 2)
49 000 26 000 75 000
49 000 5 200 54 200
Materials
Conversion Costs
$198 000 75 ,000 $2.64
$113 820 54 200 $2.10
Costs to be accounted for: Work in process, 1 February Started into production Total costs
Total
$311 820 $4.74
$32 175 279 645 $311 820
Cost Reconciliation Schedule (Step 4) Costs accounted for: Transferred out (49,000 x $4.74) Materials costs (26,000 x $2.64) Conversion costs (5,200 x $2.10) Total costs
$232 260 68 640 10 920
15.12
79 560 $311 820
Chapter 15: Cost accounting systems
EXERCISE 15.7 HENDERSON MANUFACTURING
Henderson Manufacturing General Journal
1.
2.
3.
4.
5.
6.
7.
8.
9.
Date Account name (narration) Raw Materials Inventory Accounts Payable
Debit $ 35,600
Credit $ 35,600
Factory Labour Wages Payable
56,000
Manufacturing Overhead Cash Accounts Payable
70,000
Work in Process – Cutting Work in Process – Assembly Raw Materials Inventory
15,700 8,900
Work in Process – Cutting Work in Process – Assembly Factory Labour
29,000 27,000
Work in Process – Cutting Work in Process – Assembly Manufacturing Overhead Applied
34,800 32,400
Work in Process – Assembly Work in Process – Cutting
67,700
Finished Goods Inventory Work in Process – Assembly
134,900
Cost of Sales Finished Goods Inventory
130,000
Accounts Receivable Sales
200,000
56,000
42,000 28,000
24,600
56,000
67,200
67,700
134,900
130,000
200,000
15.13
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 15.8 LARRY LAIR Memo To:
Larry Lair
From: Student Re:
Ending inventory
The reason for any confusion related to your department's ending inventory quantity stems from the fact that the quantity can be measured in two different ways, depending on what the information is used for. The ending inventory quantity can be measured in physical units or equivalent units. Physical units are actual units present without regard to the stage of completion. Your department's ending inventory in physical units is at least double the amount reported as equivalent units. Equivalent units measure the work done on the physical units, expressed in terms of fully completed units. Therefore, if your ending inventory contains 2,000 units which are 50% complete, that is equivalent to having 1,000 completed units at month end. Therefore, that ending inventory could be expressed as containing 2,000 physical units or 1,000 equivalent units. I hope this clears up any misunderstandings. Please contact me if you have any further questions.
15.14
Chapter 15: Cost accounting systems
EXERCISE 15.9 ROBINA JAM FACTORY
(a) The overhead rates are: Activity cost pools
Estimated Overhead
Purchasing Blending Packaging
$12,000 35,000 6,750
Expected use of cost drivers 500 9,800 540
Rate per cost driver unit $24.00 $3.57 $12.50
(b) The assignment of the overhead costs per unit to each product is as follows:
Purchasing ($24/order) Blending ($3.57/L) Packaging ($12.5/carton) Total allocated overhead No. of bottles Overhead per unit
Blueberry Driver Units Amount 200 $4,800
Raspberry Driver Units Amount 300 $7,200
2,400
$8,568
7,400
$26,418
180
$2,250
360
$4,500
$15,618
$38,118
4,500
13,500
$3.47
$2.82
15.15
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 15.10 VALLIANCE VINEYARDS
(a)
The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.
(b)
Labour hours Labour hours Labour hours Litres of chemicals Number of cartfuls Number of cartfuls Litres of juice Litres of juice
9. 10. 11. 12. 13. 14. 15.
Litres of wine or months of ageing Number of bottles Number of bottles Number of boxes Number of shipments Number of litres processed Number of litres processed
1. Value-added. It is assumed that any activity which directly enhances or improves the quality or quantity of the vines, grapes, or wine, is a value-added activity. 2. Value-added 9. Value-added 3. Non-value-added 10. Value-added 4. Value-added 11. Non-value-added 5. Non-value-added 12. Non-value-added 6. Value-added 13. Non-value-added 7. Value-added 14. Non-value-added 8. Value-added 15. Non-value-added
15.16
Chapter 15: Cost accounting systems
EXERCISE 15.11 AMEND INSTRUMENT LTD
(a)
The overhead rates are: Activity
Overhead
Materials handling Machine set-ups Quality inspections (b)
Expected Use of Cost Drivers
Overhead Rate
1,000 requisitions 500 set-ups 600 inspections
$35 54 45
$35,000 27,000 27,000
The assignment of the overhead costs to products is as follows: Instruments Cost Requisitions ($35) Set-ups ($54) Inspections ($45) Total costs (a)
Gauges
Number
Cost
400 200 200
$14,000 10,800 9,000 $33,800
Total units (b) Cost per unit (a) ÷ (b)
Number 600 300 400
Cost $21,000 16,200 18,000 $55,200
50
300
$676
$184
Total Overhead $35,000 27,000 27,000 $89,000
(c) To:
Memo The Chief Executive Officer, Amend Instrument Ltd
From: Student Re:
Benefits of activity-based costing (ABC)
ABC focuses on the activities performed in producing a product. Overhead costs are assigned to products based on cost drivers that measure the activities performed on the product. The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced. The improved cost data should also lead to better management decisions. More accurate product costing should contribute to setting selling prices which will achieve desired profitability levels. In addition, it should be helpful in deciding whether to discontinue or expand a product line or in deciding whether to make or buy a product component.
15.17
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 15.12 STYLISH CLOTHING COMPANY (a)
(1)
(2)
Traditional product costing system: Selling costs assigned in March to the ‘high intensity’ product line. $400,000 X .60 = $240,000 Activity-based costing system: Cost Driver
Activity Cost Pool Sales commissions Advertising-TV/Radio Advertising-Newspaper Catalogues Cost of catalogue sales Credit and collection
(b)
(c)
Overhead Rate x
$930,000 250 3,000 60,000 8,500 $930,000 $1,478,400
= $.05 per sale $300 per min $10 per col $2.50 per cat $1.00 per order $.03 per sale
Overhead cost assigned $ 46,500 75,000 30,000 150,000 8,500 27,900 $337,900
As compared to ABC, traditional costing grossly undercosts the selling costs assigned to the ‘high intensity’ product line. The difference of $97,900 ($337,900-$240,000) in the month of March is a 29% understatement. All six activities, as selling activities, are non-value-added activities.
15.18
Chapter 15: Cost accounting systems
EXERCISE 15.13 GROAT AND GROAT
Value-Added Activities
Hours
Writing contracts and letters Taking depositions Contemplating a legal strategy
1.0 1.5 1.5 4.0
Non-Value-Added Activities
Hours
Attending staff meetings Doing research Travelling to and from court Eating lunch Instructing Barristers Entertaining a prospective client
0.5 1.0 1.0 1.0 2.5 1.5 7.5
Questionable Classifications Writing contracts is value-added; writing letters may be value-added if related to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique, related to a specific case, and is billable. Research may be non-valued added if it is something the solicitor should already have known and is not billable to the client.
15.19
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 15.1 MERCURY LTD General Journal (a)
1.
2.
3.
4.
5.
6.
8.
Raw Materials Inventory Accounts Payable
3,860
Manufacturing Overhead Accumulated dep’d equipment Accounts Payable
1,100
Work in Process Manufacturing Overhead Raw Materials Inventory
4,900 1,500
Work in Process Manufacturing Overhead Factory Labour
2,660 1,200
Work in Process ($2,660 x 150%) Manufacturing Overhead Applied
3,990
Finished Goods Inventory Work in Process
13,450
Rockford Aurora Moline Total
10
Direct materials 1,700 1,300 2,200
$ 3,900
Factory Labour Wages Payable
Job
9.
$ 3,900
3,860
700 400
6,400
3,860
3,990
13,450 Direct Labour 1,020 900 1,380
Manufacturing overhead 1,530 1,350 2,070
Total costs 4,250 3,550 5,650 $13,450
Cost of sales Finished Goods Inventory
13,450
Accounts Receivable Sales
18,900
Cash
18,900
13,450
18,900
Accounts Receivable
18,900
15.20
Chapter 15: Cost accounting systems
(b) Work in Process Inventory 1/6 Balance 5,900 Completed work Direct materials 4,900 Balance c/d Direct labour 2,660 Manufacturing overhead 3,990 17,450 30/6 Balance 4,000
(c)
13,450 4,000
17,450
Work in process inventory Elgin $2,000 direct materials + $800 direct labour + $1,200 Manufacturing overhead = $4,000
(d) Mercury Ltd Cost of goods Manufactured for the month of June 2013 $ Work in process 1 June Direct materials used Direct labour Manufacturing overhead Total cost work in process Less: Work in process 30 June Cost of goods manufactured
$ 5,900
4,900 2,660 3,990
15.21
11,550 17,450 (4,000) $13,450
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 15.2 URBANA MANUFACTURING LTD (a)
Calculation of pre-determined overhead rate Department D: $1,170,000 ÷ $1,500,000 = 78% of direct labour cost Department E: $1,500,000 ÷ 120,000 = $12.50 per direct labour hour Department K: $1,248,000 ÷ 156,000 = $8.00 per machine hour
(b) Manufacturing costs Manufacturing costs Direct materials Direct labour Overhead applied Total * $120,000 x 78% **11,000 x$12.50 ***12,480 x $8.00
D $ 140,000 120,000 *93,600 $353,600
Department E $ 126,000 110,000 **137,500 $373,500
K $ 93,600 45,000 ***99,840 $238,4400
D $ 98,000 93,600 $4,400
Department E $ 129,000 137,500 ($8,500)
K $ 96,000 99,840 ($3,840)
(c) Manufacturing overhead Incurred Applied Under(over) applied
(d)
The $7,940 over applied overhead is credited to the cost of sales section of the income statement.
15.22
Chapter 15: Cost accounting systems
PROBLEM SET A 15.3 VARGAS LTD
General Journal October 2012 1. Raw Materials Inventory Accounts Payable 2.
3.
4.
5.
6.
7.
8.
9.
$
$
400,000 400,000
Work in Process – Mixing Work in Process – Packaging Raw Materials Inventory
210,000 45,000
Factory Labour Cash/Wages Payable
238,900
Work in Process – Mixing Work in Process – Packaging Factory Labour
182,500 56,400
Manufacturing Overhead Accounts Payable
790,000
Work in Process – Mixing Work in Process – Packaging Manufacturing Overhead Applied
700,000 175,000
Work in Process – Packaging Work in Process – Mixing
999,000
255,000
238,900
238,900
790,000
875,000
999,000
Finished Goods Inventory Work in Process – Packaging
1,455,000
Cost of sales Finished Goods Inventory
1,540,000
Accounts Receivable Sales
2,500,000
1,455,000
1,540,000
2,500,000
15.23
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 15.4 FREEDO LTD (a)
1. Physical units Units to be accounted for: Work in process, 1 June Started into production Total units
Stamping Dept Plant A Plant B R12 refrigerators F24 freezers 0 20,000 20,000
0 20,000 20,000
2. Equivalent units
Transferred out Work in process, 30June 2,000 (100% materials, 75% conversion costs) Total units
Plant A-R12 refrigerators Materials Conversion 18,000 18,000 ..1,500
20,000
19,500
Plant B- F24 freezers Materials Conversion 17,500 17,500
Transferred out Work in process, 30 June 2,500 (100% materials, 60% conversion costs) Total units
3. Unit cost of production Materials ($840,000÷20,000) ($700,000÷20,000) Conversion costs ($643,500÷19,500) ($570,000÷19,000) Total unit cost
2000
..2,500
..1,500
20,000
19,000
R12 refrigerators $42
F24 freezers $35
33 $75
4. R12 refrigerators Transferred out 18,000 x $75 Work in process Materials (2,000 x$42) Conversion (1,500 x$33) Total Costs
30 $65
$1,350,000 $84,000 49,500
F24 freezers Transferred out 17,500 x $65 Work in process Materials (2,500 x$35) Conversion (1,500 x$30) Total Costs
…133,500 $1,483,500
$1,137,500 $87,500 45,000
15.24
…132,500 $1,270,000
Chapter 15: Cost accounting systems
(b) Plant A Production Cost Report for the month ended 30 June 2013
Quantities
Equivalent Units Physical Conversion Units Materials Costs (Step 1)
Units to be accounted for: Work in process, 1 June Started into production Total units
20,000 20,000
Units accounted for: Transferred out Work in process, 30 June Total units
18,000 2,000 20,000
(Step 2)
18,000 2,000 20,000
Costs
Materials
Unit costs (Step 3) Costs in June Equivalent units Unit costs (a) ÷ (b)
(a) (b)
$840,000 20,000 $42
18,000 1,500 19,500
(2,000 x 75%)
Conversion Costs
Total
$643,500 $1,483,500 19,500 $33 $75
Costs to be accounted for: Work in process, 1 June Started into production Total costs
1,483,500 $1,483,500
Cost Reconciliation Schedule (Step 4) Costs accounted for: Transferred out (18,000 x $75) Work in process, 30 June Materials (2,000 x $42) Conversion costs (1,500 x $33) Total costs
15.25
$1,350,000 $84,000 49,500
133,500 $1,483,500
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 15.5 TAYLOR PROCESSING LTD
Taylor Processing Company Mixing and Blending Department Production Cost Report for the month ended 31 October Equivalent Units
Quantities Units to be accounted for: Work in process, 1 October (40% materials, 20% conversion costs) Started into production Units accounted for: Transferred out Work in process, 31 October (50% materials, 25% conversion costs) Total units
Physical Units
Materials Conversion Costs
20,000 160,000 180,000 140,000
140,000
140,000
40,000 180,000
20,000 160,000
10,000 150,000
Materials
Conversion Costs
$240,000 160,000 $1.50
$90,000 150,000 $0.60
Costs Unit costs Costs in March Equivalent units Unit costs Costs to be accounted for: Work in process, 1 October Started into production Total costs
Total $330,000 $2.10
$30,000 300,000 $330,000
Cost reconciliation schedule Costs accounted for: Transferred out (140,000 x $2.10) Work in process, 31 October: Materials (20,000 x $1.50) Conversion costs (10,000 x $0.60) Total costs
$294,000 30,000 6,000
15.26
36,000 $330,000
Chapter 15: Cost accounting systems
PROBLEM SET A 15.6 CHRIS AT BURLEIGH LTD. Traditional costing:
1. Material handling costs $120,000 ÷ 2,000* hours = $60 per direct labour hour (* 700 DLH for short boards + 1300 DLH for long boards) a. One short board: 700 hours x $60 = $42,000; $42,000 ÷ 200 units = $210/unit b. One long board: 1,300 hours x $60 = $78,000; $78,000 ÷ 150 units = $520/unit 2. Purchasing activity costs $45,600 ÷ 2,000 hours = $22.80 per direct labour hour a. One short board: 700 hours x $22.80 = $15,960; $15,960 ÷ 200 units = $79.80/unit b. One long board: 1,300 hours x $22.80 = $29,640; $29,640 ÷ 150 units = $197.60/unit Activity-based costing: 1. Material handling costs $120,000 ÷ 500* moves = $240 per move (*300 moves for short boards + 200 moves for long boards) a. One short board: 300 moves x $240 = $72,000; $72,000 ÷ 200 units = $360/unit b. One long board: 200 moves x $240 = $48,000; 48,000 ÷ 150 units = 320/unit 2. Purchasing activity costs $45,600 ÷ 800 orders = $57 per order a. One short board: 450 orders x $57 = $25,650; $25,650 ÷ 200 units = $128.25/unit b. One long board: 350 orders x $57 = $19,950; $19,950 ÷ 150 units = $133/unit 15.27
Solutions manual to accompany Accounting: building business skills 4e
Summary Short Board Traditional costing ABC Difference per board
(c)
$289.80 488.25 ($-198.45)
Long Board $717.60 453 $264.60
The traditional costing methods under priced the short board by $198.45 per unit. This may account for the 200 production run when compared with the more expensive long board. The long board using the traditional method was over costed by $264.60 per unit and therefore may be missing additional sales (assuming the selling price was also over priced), than if it were costed and priced correctly. It may prove to be more profitable to produce the long board. Further information regarding competitors pricing and demand would be needed before any further decisions are made.
15.28
Chapter 15: Cost accounting systems
PROBLEM SET A 15.7 CURLY-SOO LTD (a) Calculation of unit costs – Traditional costing
Manufacturing Costs
Products Hair Hair Curler Dryer
Direct materials Direct labour Overhead Total unit cost
$5.25 8.00 3.68 $16.93
$9.75 8.00 3.68 $21.43
(b)
Activity Cost Pool
Estimated Overhead
Purchasing Receiving Assembling Testing Finishing Packing and shipping
÷
$57,500 42,000 169,600 52,000 60,000 60,500 $441,600
Expected Use of Cost Drivers
Activity-Based Overhead Rate
=
500 orders 168,000 kg 848,000 parts 130,000 tests 120,000 units 12,100 cartons
$115 per order $0.25 per kg $0.20 per part $0.40 per test $0.50 per unit $5.00 per ctn
(c) Hair Curler
Activity Cost Pool Purchasing Receiving Assembling Testing Finishing Packing and shipping Total assigned cost
Expected Use of Drivers
170 70,000 424,000 82,000 80,000 8,040
x
Overhead Rate
$115.00 $0.25 $0.20 $0.40 $0.50 $5.00
Hair Dryer
=
Cost Assigned
Expected Use of Drivers
$19,550 17,500 84,800 32,800 40,000 …40,200
330 98,000 424,000 48,000 40,000 4,060
x
Overhead Rate
$115.00 $0.25 $0.20 $0.40 $0.50 $5.00
=
Cost Assigned
$37,950 24,500 84,800 19,200 20,000 …20,300
$234,850
$206,750
Units produced
80,000
40,000
Overhead cost per unit
$2.94
$5.17
15.29
Solutions manual to accompany Accounting: building business skills 4e
(d) ABC Manufacturing Costs
Hair Curler
Direct materials Direct labour Overhead Total cost per unit
(e) Activity Purchasing Receiving Assembling Testing Finishing Packing and shipping
(f)
$5.25 8.00 …2.94 $16.19
Hair Dryer $9.75 8.00 …5.17 $22.92
Value vs Non-Value-Added Non-value-added Non-value-added Value-added Non-value-added Value-added Value-added
(1)
Activity-based costing shows the Hair dryer absorb 75% more overhead per unit than the hair curler.
(2)
The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $3.68, but rather $2.94 for the hair curlers and $5.17 for the hair dryers. Under traditional costing, the margin of error on the hair curlers was an over statement of $0.74 or 25% and an understatement of $1.49 or 29% on the hair dryers. These distorted overhead assignments have likely led to overpricing the curlers and underpricing the hair dryer.
15.30
Chapter 15: Cost accounting systems
PROBLEM SET A 15.8 CASTRO CABINET COMPANY LTD
Kitchen cabinets (a) Predetermined overhead rate using machine hours: $1,650,000 ÷ 100,000 hrs = $16.50 per machine hour (b) Manufacturing cost per kitchen under traditional costing:
(c)
Direct materials Direct labour Overhead (15,000 x $16.50) Total cost of 50 kitchens
$180,000 200,000 247,500 $627,500
Cost per kitchen ($627,500 ÷ 50)
$12,550
Manufacturing cost per cabinet under activity-based costing:
Activity Cost Pool
Calculation of Activity-Based Overhead Rate Estimated Total Estimated Overhead ÷ Drivers =
Purchasing Handling materials Production Setting up machines Inspecting Inventory control Power
$114,400 164,320 400,000 174,480 184,800 252,000 360,000 $1,650,000
650 orders 8,000 moves 100,000 D/L hours 1,200 set-ups 6,000 inspections 36,000 components 90,000 m2
Activity-Based Overhead Rate $176 per order $20.54 per move $4 per D/L hour $145.40 per set-up $30.80 per inspection $7 per component $4 per m2
Calculation of Overhead to Order of 50 kitchens Expected Use of x Activity-Based Activity Cost Pool Drivers Overhead Rate Purchasing Handling materials Production Setting up machines Inspecting Inventory control Power Total overhead assigned
50 orders 800 moves 12,000 D/L hours 100 set-ups 450 inspections 3,000 components 8,000 m2
15.31
$176 $20.54 $4 $145.40 $30.80 $7 $4
=
Cost Assigned $8,800 16,432 48,000 14,540 13,860 21,000 32,000 $154,632
Solutions manual to accompany Accounting: building business skills 4e
Total manufacturing cost per kitchen under ABC: Direct materials Direct labour Overhead Total cost of 50 kitchens
$180,000 200,000 154,632 $534,632
Total cost per kitchen
$10,692.64
(d) The difference between the traditional cost and the activity-based cost per unit, $12,550.00 versus $10,692.64, is $1,857.36 or 17.3% of the more correct ABC cost per unit. Activitybased costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity-cost drivers under ABC than the single cost driver used with the traditional volumebased system.
15.32
Chapter 15: Cost accounting systems
PROBLEM SET A 15.9 JACKSON ELECTRONICS
(a)
The allocation of total manufacturing overhead using activity-based costing is as follows: Royale
Activity-Based Overhead Rate Purchase orders @ $30 Machine set-ups @ $50 Machine hours @ $40 Quality control @ $25 Total costs assigned (a)
Drivers Used
Cost Assigned
15,000 6,000 75,000 8,000
$450,000 300,000 3,000,000 200,000 $3,950,000
Majestic Drivers Cost Used Assigned
25,000 12,000 45,000 20,000
$750,000 600,000 1,800,000 500,000 $3,650,000
Units produced (b)
25,000
10,000
Cost per unit (a) ÷ (b)
$158
$365
(b)
$1,200,000 900,000 4,800,000 700,000 $7,600,000
The cost per unit and the gross profit of each product under ABC costing were: Royale
Direct materials Direct labour Manufacturing overhead Total cost per unit Sales price per unit Cost per unit Gross profit (loss)
(c)
Total Overhead
Majestic
$700 120 158 $978
$420 100 365 $885
$1,600 978 $622
$1,300 885 $415
Activity-based costing reveals a very different situation than traditional costing. Management must be stunned to learn that the ‘Majestic’ profit margin is $415 per unit, while its other product ‘Royale’ earns gross profit of $622 per unit. Management’s future plans for the two models are not sound. By applying ABC and activity based management analysis the company may determine how to reduce the costs of producing the ‘Majestic model’. Customer demand and future technology changes need also to be taken into account when making such decisions.
15.33
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 15.10 HORSES AND DOGS VETERINARY CLINIC (a)
Calculation of assigned overhead under traditional: Total cost of services ÷ Direct labour hours $260,000 ÷ 5,000 = $52 Overhead assigned to Farm animals: $52 x 2,000 Overhead assigned to Pets: $52 x 3,000
(b)
(1)
Calculation of activity-based overhead rate:
Activity Cost Pool Drug treatment Surgery Travel Consultation Accounting/office Boarding/grooming
(2)
= $104,000 = $156,000
Estimated Overhead
÷
Total Expected Use of Cost Drivers
$64,000 65,000 28,000 33,000 30,000 40,000 $260,000
=
4,000 treatments 800 operations 28,000 kms 3,000 calls/app’nt 5,000 d/l hrs Direct
Activity-Based Overhead Rate $16 per treatment $81.25 per operation $1 per kms $11 per appointment $6 per DL hr Direct
Assignment of overhead to farm animals and pets: Farm animals
Activity Cost Pool Drug treatment Surgery Travel Consultation Accounting/office Boarding/grooming Overhead assigned
Expected Use of Drivers
1,800 200 26,000 600 2,000
Pets
Overhead Rate
Cost Assigned
Expected Use of Drivers
$16 $81.25 $1 $11 $6 Direct
$28,800 16,250 26,000 6,600 12,000
2,200 600 2,000 2,400 3,000
$89,650
15.34
Overhead Rate
Cost Assigned
$16 $81.25 $1 $11 $6 Direct
$35,200 48,750 2,000 26,400 18,000 40,000 $170,350
Chapter 15: Cost accounting systems
(c)
(d)
Activity
Value-Added vs Non-Value-Added
Drug treatment Surgery Travel Consultation Accounting/office Boarding/grooming
Value-added Value-added Non-value-added Value-added Non-value-added Value-added
Overhead is assigned to the two service lines as follows:
Traditional costing ABC Difference
Farm animals
Pets
$104,000 89,650 $14,350
$156,000 170,350 $14,350
There is a difference of $14,350 which Farm Animals services are over assigned and costing is overstated by 13.7%. This means the clinic may be undercharging for the Pets services and the Farm Animal services are providing a greater contribution than was originally thought.
15.35
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 15.1 ASTICIO MANUFACTURING (a) Work in Process Inventory 1/1 Balance (i) 115 500 Completed work (v) (3) Direct materials (ii) 90 000 Balance c/d Direct labour (iii) 130 000 Manufacturing overh’d (iv) 162 500 498 000 31/12 Balance 175 000
(i)
(ii)
(iii)
(iv)
(v)
Opening WIP Job 7650 Job 7651
498 000
$63 000 52 500 115 500
Direct materials Job 7650 Job 7651 Job 7652
$22 000 28 000 40 000 $90 000
Direct Labour Job 7650 Job 7651 Job 7652
$30 000 40 000 60 000 $130 000
Manufacturing Overhead Job 7650 Job 7651 Job 7652
$37 500 50 000 75 000 $162 500
Completed jobs (1) Job 7650 Beginning balance Direct materials Direct labour Manufacturing overhead
(2)
323 000 175 000
$63 000 22 000 30 000 37 500 $152 500
Job 7651 Beginning balance Direct materials Direct labour Manufacturing overhead
$52 500 28 000 40 000 50 000 $170 500 15.36
Chapter 15: Cost accounting systems
(3)
Total cost of completed work Job 7650 Job 7651
$152 500 170 500 $323 000
Work in process balance
$175 000
Unfinished Job No. 7652 (a)
(b)
(a)
Current year’s cost Direct materials Direct labour Manufacturing overhead
$175 000
$40 000 60 000 75 000 $175 000
Actual overhead costs Incurred on account Indirect materials Indirect labour Depreciation
$120 000 12 000 18 000 6 000 $156 000
Applied overhead costs Job 7650 Job 7651 Job 7652
$37 500 50 000 75 000 $162 500
Actual overhead Applied overhead Overapplied overhead
$156 000 162 500 $6 500
(b) Manufacturing Overhead Applied Cost of sales
6 500 6 500
(c) (c)
Sales (given) Cost of sales Add: Job 7648 Job 7649 Job 7650
$390 000 $98 000 62 000 152 500 312 500 (6 560)
Deduct: Overapplied overhead Gross profit
15.37
306 000 $84 000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.2 HAN WU MANUFACTURING (a)
Predetermined overhead rate based on direct labour cost $ 500 000 ÷ 20 000 = $25 per direct labour hour *Overhead estimated only $500 000 not $1 500 000 (b) See solution under part (e) (c)
Journal entries for January
1.
Raw Materials Inventory Accounts Payable
2.
3.
$ 45 000
$ 45 000
Factory Labour Payroll Tax Payable Wages Payable
31 500
Manufacturing Overhead Raw Materials Inventory Factory Labour Accumulated depreciation Accounts Payable (error in some text has only $1500)
33 750
Work in Process Raw Materials Inventory ($5,000+$20,000+$15,000) Work in Process Factory Labour ($3,000+$12,000+$9,000) Work in Process Manufacturing Overhead Applied ((200+800+600) x$25)
40 000
6 500 25 000
10 000 7 500 1 250 15 000
(d) 1.
2.
3.
40 000 24 000 24 000 40 000 40 000
(e) Job No. 50 Date
31/12 Jan
Direct Materials $
10 000 5 000 15 000 Cost of completed jobs Direct materials Direct labour Manufacturing overhead Total Cost
Direct Labour $ 6 000 3 000 9 000
Manufacturing Overhead $
Total $
10 500 5 000 15 500 15 000 9 000 15 500 $39 500
15.38
Chapter 15: Cost accounting systems
Job No. 51 Date
Direct Materials $
Jan
20 000 20 000 Cost of completed jobs Direct materials Direct labour Manufacturing overhead Total Cost
Job No. 52 Date
Jan
Direct Labour $
Manufacturing Overhead $
12 000 12 000
Total $
20 000 20 000 20 000 12 000 20 000 $52 000
Direct Materials $
Direct Labour $
15 000
9 000
Manufacturing Overhead $
Total $
15 000
Cost of completed jobs Direct materials Direct labour Manufacturing overhead Total Cost
8.
Finished Goods Inventory Work in Process – Packaging ($39 500 + $45 000)
$ 91 500
$ 91 500
(f) Cost of sales Finished Goods Inventory ($45 000+$39 500) Accounts Receivable Sales ($67 000 + $74 000)
(g) The finished goods inventory is job #51 at value of $52 000. (h) *Manufacturing overhead incurred $ 33 750 Manufacturing applied $ 40 000 Over applied $ 6 250 *error in some text accounts payable should be $15 000 not $1 500.
15.39
84 500 84 500 141 000 141 000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.3 BUEHLER SKIS (a)
(b)
Physical units Units to be accounted for: Work in process, 1 January Started into production Total units
0 35,200 35,200
Units accounted for: Transferred out Work in process, 31 January Total units
31,200 4,000 35,200
Equivalent units
Units transferred out Work in process, 31 January: 4,000 x 100% 4,000 x 65% Total equivalent units
Materials
Conversion Costs
31,200
31,200
4,000 35,200
2,600 33,800
(c) Unit Costs Materials ($400,400 ÷ 35,200) Conversion costs ($351,120 ÷ 33,800) Total manufacturing cost (d)
Costs accounted for: Transferred out (31,200 x $21.77) Work in process, 31 January: Materials (4,000 x $11.38) Conversion cots (2,600 x $10.39) Total costs
15.40
$11.38 $10.39 $21.77
$679,224 $45,520 27,014
72,534 $751,758
Chapter 15: Cost accounting systems
(e) Moulding Department Production Cost Report for the month ended 30 June 2013
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1) Units to be accounted for: Work in process, 1 June Started into production Total units
35,200 35,200
Units accounted for: Transferred out Work in process, 30 June Total units
31,200 4,000 35,200
(Step 2)
Costs Unit costs (Step 3) Costs in June Equivalent units Unit costs (a) ÷ (b)
(a) (b)
31,200 4,000 35,200
31,200 2,600 33,800
Materials
Conversion Costs
$400,400 35,200 $11.38
$351,120 33,800 $10.39
(4,000 x 65%)
Costs to be accounted for: Work in process, 1 June Started into production Total costs
Total
$751,520 $21.77
751,520 $751,520*
Cost Reconciliation Schedule (Step 4) Costs accounted for: Transferred out (31,200 x $21.77) Work in process, 30 June Materials (4,000 x $11.38) Conversion costs (2600 x $10.39) Total costs *Difference of $238 due to rounding
15.41
$679,224 $45,520 27,014
72,534 $751,758*
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.4 PICKARD PTY LTD
1.
2.
3.
4.
5.
6.
7.
8.
9.
Raw Materials Inventory Accounts Payable
25,000
Work in Process – Blending Work in Process – Packaging Raw Materials Inventory
16,930 7,140
Factory Labour Wages Payable
18,770
Work in Process – Blending Work in Process – Packaging Factory Labour
13,320 5,450
Manufacturing Overhead Accounts Payable
41,500
Work in Process – Blending (900 x $35) Work in Process – Packaging (300 x $35) Manufacturing Overhead Applied
31,500 10,500
Work in Process – Packaging Work in Process – Blending
54,940
Finished Goods Inventory Work in Process – Packaging
74,490
Accounts Receivable Sales
90,000
Cost of sales Finished Goods Inventory
62,000
25,000
24,070
18,770
18,770
41,500
42,000
54,940
74,490
90,000
62,000
15.42
Chapter 15: Cost accounting systems
PROBLEM SET B 15.5 FLUID CLEANERS Equivalent Units
Quantities Units to be accounted for: Work in process, 1 March (40% materials, 20% conversion costs) Started into production Units accounted for: Transferred out Work in process, 31 March (60% materials, 20% conversion costs) Total units
Physical Units
Materials Conversion Costs
10,000 100,000 110,000 95,000
95,000
95,000
15,000 110,000
9,000 104,000
3,000 98,000
Materials
Conversion Costs
$156,000 104,000 $1.50
$98,000 98,000 $1.00
Costs Unit costs Costs in March Equivalent units Unit costs Costs to be accounted for: Work in process, 1 March Started into production Total costs
Total $254,000 $2.50
$8,700 245,300 $254,000
Cost reconciliation schedule Costs accounted for: Transferred out (95,000 x $2.50) Work in process, 31 March: Materials (9,000 x $1.50) Conversion costs (3,000 x $1) Total costs
$237,500 13,500 3,000
15.43
16,500 $254,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.6 PRINCE BOAT LTD. (a) Traditional costing: 1. Material handling costs
$245,000 ÷ 460* hours = $533 per direct labour hour (rounded) *Sail Boat 175 hours + Power Boat 285 hours a. One Sail Boat 175 hours x $533 = $93,275; $93,275 ÷ 50 units = $1,865.5 per unit b. One Power Boat 285 hours x $533 = $151,905; $151,905 ÷30 units=$5,063.5 per unit 2. Purchasing activity costs $69,800 ÷ 460 hours = $152 per direct labour hour (rounded) a. One Sail Boat 175 hours x $152 = $26,600; $26,600 ÷ 50 units = $532 per unit b. One Power Boat 285 hours x $152 = $43,320; $43,320 ÷ 30 units = $1,444 per unit (b) Activity-based costing: 1. Material handling costs $245,000 ÷ 100* moves = $2450 per move * Sail Boat 20 moves + Power Boat 80 moves a. One Sail Boat 20 moves x $2450 = $49,000; $49,000 ÷ 50 units = $980 per unit b. One Power Boat 80 moves x $2,450 = $196,000; $196,000 ÷30units = $6,533 per unit 2. Purchasing activity costs $69,800 ÷ 200 orders = $349 per order a. One Sail Boat 80 orders x $349 = $27,920; $27,920 ÷ 50 units = $558.40 per unit b. One Power Boat 120 orders x $349 = $41,880; $41,880 ÷ 30units = $1,396 per unit
15.44
Chapter 15: Cost accounting systems
Summary
Traditional costing ABC Difference per board
(c)
Sail Boat
Power Boat
$2,397.50 1538.40 $859.10
$6,507.50 7929 ($1,421.50)
The traditional costing methods under priced the Power Boat by $1,421.50 per unit. The Sail Boat using the traditional method was over costed by $859.10 per unit and therefore may be missing additional sales (assuming the selling price was also over priced), than if it were costed and priced correctly. It may prove to be more profitable to produce Sail Boat. Further information regarding competitors pricing and demand would be needed before any further decisions are made.
15.45
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.7 SPARTAN SAFETY
(a) Calculation of unit costs – Traditional costing
Manufacturing Costs
Products Home Commercial Model Model
Direct materials Direct labour Overhead Total unit cost
$18.50 19.00 *23.25 $60.75
$26.50 19.00 *23.25 $68.75
*$15.50 x 1.5 = $23.25 (b)
Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping
Estimated Overhead $70,350 150,500 381,600 51,000 52,080 787,250 $1,492,780
÷
Expected Use of Cost Drivers
=
335,000 kg 35,000 Machine hr 212,000 parts 25,500 tests 6,510 litre 335,000 kg
Activity-Based Overhead Rate $.21 per kg $4.30 per machine hr $1.80 per part $2.00 per test $8.00 per litre $2.35 per kg
(c)
Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping Total
Home Model Expected Use of Overhead Cost Drivers x Rate = Assigned
215,000 27,000 162,000 15,500 4,510 215,000
$.21 $4.30 $1.80 $2.00 $8.00 $2.35
$45,150 116,100 291,600 31,000 36,080 505,250 $1,025,180 15.46
Commercial Model Expected Use of Overhead Cost Drivers x Rate = Assigned
120,000 8,000 50,000 10,000 2,000 120,000
$.21 $4.30 $1.80 $2.00 $8.00 $2.35
$25,200 34,400 90,000 20,000 16,000 282,000 $467,600
Chapter 15: Cost accounting systems
assigned cost Units produced Overhead cost per unit
54,000
10,200
$18.98
$45.84
(d) ABC Manufacturing Costs
Home Model
Direct materials Direct labour Overhead Total cost per unit
Commercial Model
$18.50 19.00 18.98 $56.48
$26.50 19.00 45.84 $91.34
(e)
(f)
Activity
Value vs Non-Value-Added
Receiving Forming Assembling Testing Painting Packing and shipping
Non-value-added Value-added Value-added Non-value-added Value-added Value-added
(1)
Activity-based costing shows the commercial model absorbs nearly 2 ½ times as much overhead per unit as the home model.
(2)
The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $23.25, but rather $18.98 for the home model and $45.84 for the commercial model. Under traditional costing, the margin of error on the commercial model was 101%, an understatement of $23.51 on an assignment of $23.25. These distorted overhead assignments have likely led to overpricing the home model and underpricing the commercial model.
15.47
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.8 DESIGNED STAIRS
(a) Predetermined overhead rate using machine hours: $819,840 ÷ 100,000 hrs = $8.1984 per machine hour (b) Manufacturing cost per stair under traditional costing: Direct materials Direct labour Overhead (14,500 x $8.1984) Total cost of 280 stairs
$103,600.00 112,000.00 118,876.80 $334,476.80
Cost per stair ($334,476.80 ÷ 280) (c)
$1,194.56
Manufacturing cost per stair under activity-based costing:
Activity Cost Pool
Calculation of Activity-Based Overhead Rate Estimated Total Estimated Overhead ÷ Drivers =
Purchasing Handling materials Production Setting up machines Inspecting Inventory control Power
$57,000 82,000 200,000 84,840 90,000 126,000 180,000 $819,840
600 orders 8,000 moves 100,000 D/L hours 1,200 set-ups 6,000 inspections 168,000 components 90,000 m2
Activity-Based Overhead Rate $95 per order $10.25 per move $2 per D/L hour $70.70 per set-up $15 per inspection $.75 per component $2 per m2
Calculation of Overhead to Order of 280 Stairs Expected Use of x Activity-Based Activity Cost Pool Drivers Overhead Rate Purchasing Handling materials Production Setting up machines Inspecting Inventory control Power Total overhead assigned
60 orders 800 moves 5,000 D/L hours 100 set-ups 450 inspections 16,000 components 8,000 m2
Total manufacturing cost per stair under ABC:
15.48
$95 $10.25 $2 $70.70 $15 $.75 $2
=
Cost Assigned $5,700 8,200 10,000 7,070 6,750 12,000 16,000 $65,720
Chapter 15: Cost accounting systems
Direct materials Direct labour Overhead Total cost of 280 stairs
$103,600 112,000 65,720 $281,320
Total cost per stair (d)
$1,004.71
The difference between the traditional cost and the activity-based cost per unit, $1,194.56 versus $1,004.71, is not great in amount but $189.85 ($1,194.56 - $1,004.71) is 18.9% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity-cost drivers under ABC than the single cost driver used with the traditional volume-based system.
15.49
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 15.9 LETO PLASTICS
(a)
The allocation of total manufacturing overhead using activity-based costing is as follows:
Activity-Based Overhead Rate Purchase orders @ $40 Machine set-ups @ $250 Machine hours @ $4 Tests and inspections @ $20 Total costs assigned (a)
Ice House Cool Chest Drivers Cost Drivers Cost Used Assigned Used Assigned
2,500 500 60,000 5,000
$100,000 125,000 240,000 100,000 $565,000
2,000 300 20,000 3,000
$80,000 75,000 80,000 60,000 $295,000
Units produced (b)
50,000
20,000
Cost per unit (a) ÷ (b)
$11.30
$14.75
(b)
Total Overhead
$180,000 200,000 320,000 160,000 $860,000
The cost per unit and the gross profit of each product under ABC costing were: Ice House
Cool Chest
Direct materials Direct labour Manufacturing overhead Total cost per unit
$9.50 8.00 11.30 $28.80
$6.00 5.00 14.75 $25.75
Sales price per unit Cost per unit Gross profit (loss)
$35.00 28.80 $6.20
$24.00 25.75 $(1.75)
(c)
Activity-based costing reveals a very different situation than traditional costing. Management must be stunned to learn that the ‘Cool Chest’ is unprofitable, losing $1.75 per unit, while its other product ‘Ice House’ earns gross profit of $6.20 per unit. Obviously, management must revise its marketing and selling efforts as well as its pricing, and maybe its production of the ‘Cool Chest’.
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Chapter 15: Cost accounting systems
PROBLEM SET B 15.10 WISE AND OTHERWISE
(a)
Calculation of assigned overhead under traditional costing (‘direct labour dollars’ appears in the first line of the schedule of overhead data): Predetermined overhead rate x direct labour dollars Overhead assigned to audit: .40 x $1,000,000 Overhead assigned to tax: .40 x $900,000
(b)
(1)
Calculation of activity-based overhead rate:
Activity Cost Pool Employee training Typing and secretarial Computing Facility rental Travel
(2)
= $400,000 = $360,000
Estimated Overhead
÷
$209,000 76,200 204,000 142,500 128,300 $760,000
Total Expected Use of Cost Drivers
=
$1,900,000 DL dollars 2,500 reports/forms 60,000 minutes 38 employees Direct
Activity-Based Overhead Rate $0.11 per DL dollar $30.48 per report/form $3.40 per minute $3,750 per employee Direct
Assignment of overhead to audit and tax services: AUDIT
Activity Cost Pool
Expected Use of Drivers
Employee $1,000,000 training Typing 600 and secretarial Computing 25,000 Facility 20 rental Travel 86,800 Overhead assigned
TAX Expected Overhead Cost Use of Overhead Cost x Rate = Assigned Drivers X Rate = Assigned $.11
$110,000
$900,000
$.11
$99,000
$30.48
18,288
1,900
$30.48
57,912
$3.40 $3,750
85,000 75,000
35,000 18
$3.40 $3,750
119,000 67,500
Direct
86,800 $375,088
41,500
Direct
41,500 $384,912
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Solutions manual to accompany Accounting: building business skills 4e
(c)
(d)
Activity
Value-Added vs Non-Value-Added
Employee training Word processing Computing Facility rental Travel
Non-value-added Value-added Value-added Non-value-added Non-value-added
Overhead is assigned to the two service lines as follows:
Traditional costing ABC Difference
Audit
Tax
$400,000 375,088 $24,912
$360,000 384,912 $24,912
There is a difference of $24,912 between the two overhead allocation methods, but in this case the difference is less than 7%.
15.52
Chapter 15: Cost accounting systems
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BBS 15.1 DAVIDSON FURNITURE
(a)
The unit cost of materials for Framing department for May is: $140 ($420,000 ÷ 3,000).
(b)
The materials cost of the sofas transferred out is $350,000 (2,500 x $140). Conversion costs therefore are $200,000 ($550,000 - $350,000) and per unit conversion cost is $80 ($200,000 ÷ 2,500). Or $550,000÷ 2500= Total cost $$220. $220 less material$140= $80 conversion cost.
(c)
There are 500 units in ending work-in-process inventory (3,000 started – 2,500 transferred out). The materials cost is $70,000 (500 x $1140). Thus, the conversion costs in the inventory are $10,000($80,000-$70,000). $13,000 divided by $80 per unit conversion cost equals 125 units or 25% (125 ÷ 500) complete.
BBS15.2 NEW TECH PHARMACEUTICALS
(a)
Calculation of activity-based overhead ratio: Total Estimated Expected Use of Activity Cost Pool Overhead ÷ Cost Drivers Market analysis Product design Product development Prototype testing
(b)
$1 050 000 2 280 000 3 600 000 1 400 000
=
15 000 hours 2 500 designs 90 products 700 redesigns
Activity-Based Overhead Rate $70 per hour $912 per design $40 000 per product $2 000 per redesign
Charges to in-house manufacturing department:
Activity Cost Pool
Cost Drivers Used
Overhead Rate
Cost Assigned
Market Analysis Product Design Product Development Prototype Testing Total overhead assigned
1,800 hours 280 designs 10 products 92 redesigns
$70 $912 $40 000 $2 000
$126 000 255 360 400 000 184 000 $965 360
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Solutions manual to accompany Accounting: building business skills 4e
(c)
Charges to outside R & D contractor:
Activity Cost Pool
Cost Drivers Used
Overhead Rate
Cost Assigned
Market Analysis Product Design Product Development Prototype Testing Total overhead assigned
800 hours 178 designs 3 products 70 redesigns
$70 $912 $40 000 $2 000
$56 000 162 336 120 000 140 000 478 336
(d)
Activity-based costing permits the company to identify its R & D costs by the activities that cause the costs. That is, ABC allows closer scrutiny of the causes for cost incurrences hence greater control. By charging in-house manufacturing departments for their fair share of their company’s R & D costs, these departments may exert their own control over such costs. Activity-based costing allows New Tech to compile realistic costs for bidding and charging outside users of its R & D department’s services.
BBS 15.3 The answer the students will give will depend on the companies selected. The task was to select two manufacturing companies that are likely to use process costing. What the students should address is why they believe the manufacturer would use process costing and if there was anything in the website that convinced them that the process costing was suitable.
BBS 15.4 BETTER MANAGEMENT
(a)
Activity-based management (ABM) is a cost accounting tool applying cost analysis, target costing and management accounting across the organisation. Activity-based management (ABM) enables managers to enhance profits through cost control and tracking practices.
(b)
Supply chain management encompasses value chain analysis to identify components associated with the product/service flowing through procurement, warehousing and logistics.
(c)
The key benefit of Just-in-time processing is that if implemented well, it reduces duplication of material handling and storage costs. The risk of stock-out may be increased if reliable supplier relationship has not been established.
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Chapter 15: Cost accounting systems
CRITICAL THINKING BBS 15.5 COSTELLO PRODUCTS (a)
The manufacturing cost element that is responsible for the fluctuating unit costs is manufacturing overhead. Manufacturing overhead is being included as incurred rather than being applied on a predetermined basis. Direct materials and direct labour are not the cause as they have the same unit cost per batch in each quarter.
(b)
The solution is to apply overhead using a predetermined overhead rate based on a relevant basis of production activity. Based on actual overhead incurred and using batches of product TC1 as the activity base, the overhead rate is $22,500 per batch [($157,500 + $184,000 + $146,000 + $187,500) ÷ 30]. Another approach would be to use direct labour cost as the relevant basis to apply overhead on a predetermined basis. For example, a rate of 125% of direct labour cost ($675,000 ÷ $540,000) could be used. Either approach will provide the same result.
(c)
The quarterly results using a predetermined overhead rate are as follows:
Costs Direct materials Direct labour Manufacturing overhead applied Total
1 $ 150,000 90,000 112,500 $352,500
Quarter 2 3 $ $ 330,000 120,000 198,000 72,000 247,500 90,000 $775,500 $282,000
4 $ 300,000 180,000 225,000 $705,000
Production in batches
5
11
4
10
Unit cost (per batch)
$70,500
$70,500
$70,500
$70,500
(Note: The unit cost of a batch remains the same in each quarter. Both sales and production should be pleased with this solution to fluctuating unit costs.)
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Solutions manual to accompany Accounting: building business skills 4e
BBS 15.6 MENDOZA LTD
(a)
The unit cost suggests that Jeff took the highest total costs and divided these costs by the units started into production. The highest total costs would be the total costs charged to the Mixing Department ($88,000 + $600,000 + $785,800) divided by the units started during July (100,000 litres), which results in a per-unit cost of $14.74 (1,473,800 ÷ 100,000).
(b)
The principal errors made by Jeff were: (1) he did not compute equivalent units of production (2) he did not use the weighted-average costing method (3) he did not assign costs to ending work-in-process.
(c) Equivalent Units
Quantities
Physical Units
Units to be accounted for: Work in process, 1 July Started into production Total units
(Step 1) 8,000 100,000 108,000
Units accounted for: Transferred out Work in process, 31 July Total units
103,000 5,000 108,000
Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b)
(a) (b)
Materials Conversion Costs
103,000 5,000 108,000
103,000 1,000 104,000
Materials
Conversion Costs
621,000 108,000 $5.75
Total
852,800 $1,473,800 104,000 $8.20 $13.95
Costs to be accounted for: Work in process, 1 July Started into production Total costs
$88,000 1,385,800 $1,473,800
Cost reconciliation schedule (Step 4) Costs accounted for: Transferred out (103,000 x $13.95) Work in process, 31 July: Materials (5,000 x $5.75) Conversion costs (1,000 x $8.20) Total costs
15.56
$1,436,850 28,750 8,200
36,950 $1,473,800
Chapter 15: Cost accounting systems
BBS 15.7 To:
EASY RELAX Sue Smithers, Regional Sales Manager
From:
Maria King, Accounting Manager
Re:
Production Cost Reports
Clara, congratulations again on your promotion! It is going to be great working with you. It kind of reminds me of our days at Hammonds Furniture after school (although this work is more fun, and it certainly pays better!) I’ll try to clear up some of the questions you raised in your fax. Here in the Furniture Division, we use process costing rather than the job order system that Special Projects uses. The reason for this is that we produce all our products in a more or less continuous process, even when we run occasional special orders. You see, all our workers are assigned a particular part of the process to control. One might be in charge of making sure the mixing machines work properly, while another verifies the weight of the finished products. Whichever job a worker is assigned, he or she stays with it to completion, or at least the completion of that particular process. That’s different to what you had in Special Projects, where workers moved from job to job. That’s why we don’t usually track the orders separately. Our special orders are for various quantities of the furniture we produce, so only the Packing Department needs to be concerned with the particular set of products shipped to the particular customer – which is its ordinary concern anyway. Your next question was about ‘what in the world’ an equivalent unit is. Well, you know already that Special Projects bids on various jobs, and then costs are recorded when the jobs are complete. The costs accumulated on jobs that aren’t complete are reflected in Work in Process inventory. We in furniture goods can’t use that method for a simple reason – we produce our products in batches that we keep going fairly continuously. Or, in other words, we don’t have ‘jobs’ that we can record as ‘complete’. A batch may contain enough of our product to fill thirty or more orders, so we may have thirty or more ‘jobs’ in each batch. One job may happen to be filled from two batches. Since the cost of each batch is about the same, it isn’t worth keeping track of separately. At the end of the month, we need to record what we finished and what still remains undone. Equivalent units are the way we measure the amount of work we have done on our work in process. It’s kind of like comparing the size of a dining table with the size of a coffee table. It doesn’t make sense to compare by counting the number of tables you have. We compare by the number of ‘units’ of materials or labour that are required to finish a product completely. If it requires half the materials and 30 minutes of labour for a finished table, for example, then the half the materials and 30 minutes are ‘finished equivalents’. If we have 30 tables 50% complete, then we have 15 ‘finished equivalent’ tables. Your last question is the easiest to answer. You get four reports because we use four processes here in Furniture Division. Each process has to report its status at the end of every month. It’s kind of like we have four miniature factories, each reporting ‘completion’ of a certain number of products. The products from one department are used as raw materials for other departments, so we have a chain of reports. Notice that the units and costs transferred out of Process 1 are the same as the units and costs transferred into Process 2, and so on. I hope this helps. Call, write or fax me any time! 15.57
Solutions manual to accompany Accounting: building business skills 4e
BBS 15.8 FONTERRA CO-OPERATIVE
Fonterra Co-operative Group sustainability 1. The term sustainability is about making sure the social, economic and environmental needs of our community are met and kept healthy for future generations. Sustainable development must not just be about economic growth but also environmental quality and social equity. Corporate social responsibility (CSR) for business means companies must be aware and have a core understanding of CSR characteristics; an understanding of the basic issues and how they may affect decision making; to be able to apply this basic knowledge with competence to specific activities; and have strategic alignment ie have an in depth understanding of the issues and posses the expertise to embed CSR principles into the business decision making process. 2. FONTERRA’s latest sustainability report. The answer will change here depending on which year the sustainability report is accessed. The following is the link to the website where the report can be downloaded. http://www.fonterra.com/wps/wcm/connect/fonterracom/fonterra.com/Home/
The students are required to report on: goals, measurement and achievement in • Water • Waste • Resources- and energy use, and • Climate change
15.58
Chapter 15: Cost-volume-profit relationships
CHAPTER 16 — COST-VOLUME-PROFIT RELATIONSHIPS ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
1.
Distinguish between variable, fixed and mixed cost behaviour.
1
1,2
PSA 1, PSB 1,
2.
Explain the difference between absorption costing and variable costing.
2
1,3
PSA 2,3,4, PSB 2,3,4
3.
Explain the five basic assumptions of cost-volume-profit (CVP) analysis.
4.
Indicate the meaning of contribution margin and identify break-even point and the use of break-even analysis.
3,4
1, 4, 5, 6,8,9
PSA 1,5, 7 8 9,10 PSB 1,5,6 7 8,9,10
5.
Determine target net profit by applying formula
5
7
PSA 5,6,10 PSB 5,10
6.
Explain how CVP analysis is used with multiple products.
7, 8
10, 11, 12
PSA 8, PSB 8
7.
Describe the essential features of a CVP income statement.
6
13
PSA 5,9 PSB 5,9
15.1
Solutions manual to accompany Accounting: building business skills 4e
ANSWERS TO QUESTIONS 1.
2.
(a)
Cost behaviour analysis is the study of how specific costs respond to changes in the level of activity within a company.
(b)
Cost behaviour analysis is important to management in planning business operations and in deciding between alternative courses of action.
(a)
The activity index identifies the activity that causes changes in the behaviour of costs. Once the index is determined, it is possible to classify the behaviour of costs in response to changes in activity levels into three categories: variable, fixed or mixed.
(b)
Variable costs may be defined in total or on a per-unit basis. Variable costs in total vary directly and proportionately with changes in the activity level. Variable costs per unit remain the same at every level of activity.
3.
Under absorption costing, both variable and fixed manufacturing costs are considered to be product costs. Under variable costing, only variable manufacturing costs are product costs and fixed manufacturing costs are expensed when incurred.
4
(a)
The relevant range is the range of activity that a company expects to operate during the year.
(b)
Disagree. The behaviour of both fixed and variable costs are linear only over a certain range of activity.
5.
The basic assumptions of CVP analysis are: 1. The behaviour of both costs and revenues is linear throughout the relevant range of the activity index. 2. All costs can be classified as either variable or fixed with reasonable accuracy. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold. 5. When more than one type of product is sold, total sales will be in a constant sales mix. Sales mix complicates CVP analysis because different products will have different cost relationships.
6.
Contribution margin is $18 ($40 - $22). The contribution margin ratio is 45% ($18 ÷ $40).
7.
At breakeven sales, variable costs are $390,000 ($600,000 – $210,000) or 65% of sales ($390,000 ÷ $600,000). The sales volume to achieve net profit of $56,000 is as follows: x = 65%x + $210,000 + $56,000 .35x = $266,000 x = $760,000
Chapter 15: Cost-volume-profit relationships
8.
Contribution margin for Product A is $8 and $12 for Product B. Weighted average contribution margin can then be calculated as $10.40 ([($8 x 2) + ($12 x 3)] / 5). As shown below:
Selling Price Unit variable cost Contribution Margin Sales Mix Weighted CM
9.
Product Product A B Total 20 30 12 18 8 2 16
12 3 36
WACM
5 52
10.4
The contribution margin per unit of limited resources is determined by dividing the contribution margin per unit of the product by the number of units of the limited resources required to produce the product.
10.
Reeves Ltd CVP Income statement
Sales
$900,000
Variable expenses: Cost of sales
$350,000
Operating expenses
140,000
Contribution margin
490,000 410,000
Fixed expenses: Cost of sales
150,000
Operating expenses
60,000
Profit
15.3
210,000 $200,000
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 16.1 KIWI & CO Indirect labour is a variable cost because it increases in total directly and proportionately with the change in the activity level. Supervisors’ salaries are a fixed cost because it remains the same in total regardless of changes in the activity level. Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level. BRIEF EXERCISE 16.2 The difference between absorption costing and variable costing net profit arises because absorption costing defers some fixed manufacturing overhead in ending inventory, while variable costing expenses all the fixed manufacturing overhead in the period incurred. Since Kate’s beauty salon is a service business which has no fixed manufacturing overhead or inventory, therefore there will be no difference between absorption costing and variable costing net profit. BRIEF EXERCISE 16.3 1.
2.
3.
(a)
$160 ($400 - $240)
(b)
40% ($160 ÷ $400)
(c)
$560 ($700 – $140)
(d)
20% ($140 ÷ $700)
(e)
$1 200 ($480 ÷ 40%)
(f)
$720 ($1 200 – $480)
BRIEF EXERCISE 16.4 SMART LTD (a)
x = .65x + $140 000 .35x = $140 000 x = $400 000
(b)
Contribution margin per unit $175 ($500 – $325) x = $140 000 ÷ $175 x = 800 units 800 units x $500= $400 000
Chapter 15: Cost-volume-profit relationships
BRIEF EXERCISE 16.5 RANCH LTD x = .75x + $180,000 + $60,000 .25x = $240,000 x = $960,000
BRIEF EXERCISE 16.6 WHITEHEAD MANUFACTURING LTD CVP Income statement for the quarter ended 31 March 2013 Sales Variable expenses: Cost of sales Selling expenses Administrative expenses Total variable expenses Contribution margin Fixed expenses: Cost of sales Selling expenses Administrative expenses Total fixed expenses Profit
$2,300,000 $785,000 195,000 78,000 1,058,000 1,242,000 600,000 80,000 112,000 792,000 $450,000
BRIEF EXERCISE 16.7 LOOS PTY LTD Product Unit Data
Contribution margin Sales mix
AA
BB
$100
$200
3
1
Total contribution margin = $500 [($100 x $3) + ($200 x 1)] Weighted average unit contribution margin = $125 ($500 ÷ 4) Unit sales = 2,400 units ($300,000 ÷ $125). Loos should sell 1,800 units of Product AA (2,400 x 3/4) and 600 units of Product BB (2,400 x 1/4).
15.5
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 16.8 CRUZ LTD
Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]
Product A
Product B
$10 2 $5
$12 3 $4
Chapter 15: Cost-volume-profit relationships
SOLUTIONS TO EXERCISES EXERCISE 16.1 (a) Total fixed costs (b) Contribution margin (c) Absorption costing (d) Break-even point (e) Variable cost (f) Margin of safety
EXERCISE 16.2 MASSEY & CO (a)
The determination as to whether a cost is variable, fixed or mixed can be made by comparing the cost in total and on a per-unit basis at two different levels of production. Variable Costs Fixed Costs Mixed Costs
(b)
Vary in total but remain constant on a per-unit basis. Remain constant in total but vary on a per-unit basis. Contain both a fixed element and a variable element. Vary both in total and on a per-unit basis.
Using these criteria as a guideline, the classification is as follows: Direct materials Direct labour Electricity
Variable Variable Mixed
Rent Maintenance Supervisors’ salaries
15.7
Fixed Mixed Fixed
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 16.3 DESKMATE LTD (a) Manufacturing costs under variable costing: Direct materials Direct labour Variable manufacturing overhead Total unit cost
$60 45 30 $135
(b)
Deskmate Ltd Income Statement (using variable costing) For the year ended 30 June 2013
Sales ($300 x 1500 units) Cost of sales Inventory, 1 July 2009 Cost of goods manufactured ($135 x 2500 units) Cost of goods available for sale Less: Inventory, 30 June 2010 ($135 x 1000 units) Cost of sales Gross profit Fixed manufacturing overhead Less: Selling and administrative expenses (variable $15 x 1500 units) + (fixed $50,000) Total expenses Profit from operation
$450,000 $0 337,500 337,500 (135,000) 202,500 247,500 150,000 72,500 222,500 $25,000
EXERCISE 16.4 MARIA’S BEAUTY SALON
(a)
Contribution margin (in dollars): $112,000 (2,800 x $40) – $78,400 ($112,000 x 70%) = $33,600. Contribution margin (per unit): $40 – $28 ($40 x 70%) = $12 Contribution margin (ratio): $12 ÷ $40 = 30%
(b)
Breakeven sales (in dollars): Breakeven sales (in units):
(c)
Margin of safety (in dollars): Margin of safety (ratio):
$21,000 = $70,000 30% $21,000 = 1,750 units $12
$112,000 – $70,000 = $42,000 ÷ $112,000 =
$42,000 37.5%
Chapter 15: Cost-volume-profit relationships
EXERCISE 16.5 TRUE & CO (a)
$3,200
Sales Line
2,800 Total Cost Line
DOLLARS (000)
2,400 2,000
Breakeven Point
1,600 1,400
1,200 800
Fixed Cost Line
400 100 200 300 400 500 600 700 800 350
Number of Units (in thousands)
(b)
(c)
(1)
Breakeven sales in units: $4x = $2x + $700,000 2x = $700,000 X = 350,000 units
(2)
Breakeven sales in dollars: X = .50x + $700,000 .50x = $700,000 X = $1,400,000
(1) (2)
Margin of safety in dollars: Margin of safety ratio:
$2,000,000 – $1,400,000 $600,000 ÷ $2,000,000
15.9
= $600,000 = $30%
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 16.6 WIGGINS LTD (a)
Unit contribution margin
Variable cost per unit
=
Fixed Costs Breakeven Sales in Units
=
$105,000 ($350,000 $7.00 )
=
$2.10
= = =
Unit selling price – Unit contribution margin $7.00 – $2.10 $4.90
OR 50,000 x $7.00 = 50,000X + $105,000 where x = Variable cost per unit Variable cost per unit = $4.90
(b)
Contribution margin ratio
=
$2.10 ÷ $7.00 =30%
Fixed costs
= = =
Breakeven sales units x Unit contribution margin ($455,000 ÷ $7.00) x $2.10 $136,500
= = =
Breakeven sales x Contribution margin ratio $455,000 x 30% $136,500
OR Fixed costs
Since fixed costs were $105,000 in 2006, the increase in 2007 is $31,500 ($136,500 – $105,000).
Chapter 15: Cost-volume-profit relationships
EXERCISE 16.7 VOWELL LTD
(a)
Sales $150x $60x x OR
= = = =
Variable Cost + Fixed Cost + Target Net Profit $90x + $630,000 + $90,000 $720,000 12,000 units
Units sold in 2012
=
(b)
Units needed in 2013
=
(c)
$630,000 + $150,000 x - $90
($630,000 + $90,000) = 12,000 units ($150 - $90)
($630,000 + $150,000*) = 13,000 units ($150 - $90) *$90,000 + $60,000 = $150,000 = 12,000 units, where x = new selling price
= x – $90
$780,000 12,000
x
= $155.00
EXERCISE 16.8 ANGEL LTD
1.
Increase selling prices to $88 ($80 x 110%) Profit = $440,000 – $290,000 – $90,000 = $60,000
2.
Reduce variable costs to 62% of sales. Profit = $400,000 – $248,000 – $90,000 = $62,000
3
Reduce fixed costs to $80,000 ($90,000 – $10,000) Profit = $400,000 – $290,000 – $80,000 = $30,000 Alternative 2, decreasing variable costs to 62% of sales will produce the highest profit.
15.11
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 16.9 PEPPER LTD
1.
Increase selling prices to $94.50 ($90.00 x 105%) Profit = $945,000 – $630,000 – $230,000 = $85,000
2.
Reduce variable costs to 65% of sales. Profit = $900,000 – $585,000 – $230,000 = $85,000
3
Reduce fixed costs to $200,000 ($230,000 – $30,000) Profit = $900,000 – $630,000 – $200,000 = $70,000
Memo To: CEO, Pepper Ltd From: Management Accountant Date: 15 May, 2010 Re: Evaluation of three options to increase profit
The following three options to increase profit are analysed: (1) Increase selling price by 7% with no change in total variable costs; (2) Reduce variable costs to 65% of sales; (3) Reduce fixed costs by $30,000
It was found that both options (1) or (2) will produce the highest profit of $85,000. But Option (2) would be preferable than Option (1) because the increase in selling price may cause a reduction in the number of units sold. Thus sales revenue may decrease under Option (1).
Chapter 15: Cost-volume-profit relationships
EXERCISE 16.10 BURNIE LTD
(a)
Sales mix of X:Y = 80,000 ÷ 40,000 = 2:1
(b)
Unit Data Selling price Variable manufacturing costs Contribution margin Sales mix
Total contribution margin: Product X – $7.00 x 80,000 Product Y – $10.00 x 40,000 Total
= =
Product X
Product Y
$11.00 4.00 $7.00
$18.00 8.00 $10.00
2
1
$560,000 400,000 $960,000
Weighted average unit contribution margin: $960,000 ÷ 120,000 = $8.00 OR Product X – $7.00 x 2 = Product Y – $10.00 x 1 =
$14.00 10.00 $24.00
Weighted average unit contribution margin: $24.00÷ 3 units= $8.00 per unit (c)
Break-even point in units = ($256,000 +$80,000)÷$8.00= 42,000 units (Product A – 28,000; 2/3 x 42,000; Product B – 14,000; 1/3 x 42,000)
15.13
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 16.11 THE HOME APPLIANCE CENTRE
(a) Step 1 – Determine unit contribution margin: Economy
Standard
$500 400 $100
$650 500 $150
Economy
Standard
500 5 $500
300 3 $450
Unit selling price Unit variable costs Unit contribution margin (a)
Deluxe $800 600 $200
Step 2 – Determine weighted contribution margin:
Expected unit sales Sales mix ratio (b) Weighted contribution margin (a) x (b)
Deluxe 200 2 $400
Step 3 – Determine the weighted average unit contribution margin for all products: ($500 +$450 +$400) ÷ 10 = $135 Breakeven sales in units = $297,000 ÷ $135 = 2,200 units
Breakeven sales in units Sales dollars Variable costs Contribution margin
Economy
Standard
Deluxe
Total
1100 (5/10)
660 (3/10)
440 (2/10)
2200
$550,000 440,000 $110,000
$429,000 330,000 $99,000
$352,000 264,000 $88,000
$1,331,000 1,034,000 $297,000
Chapter 15: Cost-volume-profit relationships
EXERCISE 16.12 SENSOR PTY LTD
(a)
Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resources (a) ÷ (b)
A
Product B
$5 2 $2.50
$3.50 1 $3.50
C $2 2 $1
(b)
Product B should be manufactured because it results in the highest contribution margin per machine hour.
(c)
(1) A Machine hours (a) (1,500 ÷ 3) Contribution margin per unit of limited resource (b) Total contribution margin [(a) x (b)]
500 $2.50 $1,250
Product B 500 $3.50 $1,750
C 500 $1 $500
The total contribution margin is $3,500 ($1,250 + $1,750 + $500). (2)
Product B
Machine hours (a) Contribution margin per unit of limited resource (b) Total contribution margin [(a) x (b)]
15.15
1,500 $3.50 $5,250
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 16.13 CHALET LTD
CVP Income Statement for year ended 31 December 2013 $ Sales (60,000 x $25) Less: Variable expenses (60,000 x $12) Contribution margin Less Fixed expenses Profit
1,500,000 720,000 780,000 500,000 $280,000
Alternative: Chalet Ltd CVP Income Statement for year ended 31 December 2013 $ Sales (63,000 x $23.80) Less: Variable expenses (63,000 x $9.60) Contribution margin Less Fixed expenses ($500,000 +$50,000) Profit
1,499,400 604,800 894,600 550,000 $344,600
1. 60,000 x 105%=63,000units 2. $25 – ($2.40 x 50%)= $23.80 3. $720,000 ÷ 60,000 =$12 reduce by 20% $12 x80% = $9.60
1,2 3
Chapter 15: Cost-volume-profit relationships
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 16.1 CUTE NAILS SALON
(a)
Variable costs (per manicure) Manicurists’ commission Rent Supplies Total variable
(b)
$7.00 .50 5.00 $12.50
Fixed costs (per month) Salaries Rent Advertising Power Magazines Depreciation Total fixed
Breakeven in units $25x = $12.5x + $11,875 $12.5x = $11,875 x = 950 units or manicures
$10,050 800 300 280 45 400 $11,875
Breakeven in dollars x = .50xa + $11,875 .50x = $11,875 x = $23,750 a
$12.5 ÷ $25
(c)
(d)
Cute Nails Salon
Profit = $37,500 – [($12.50 x 1,500) + $11,875] = $6,875
15.17
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 16.2 POULLAS LTD (a) Income statement for the year ended 30 June (Variable Costing)
Sales Variable expenses: Inventory, 1/1 Variable manufacturing costs Cost of goods available for sale Inventory, 31/12 Variable cost of sales Variable selling expenses Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead Administrative Total fixed expenses Profit from operations
2013
2014
$20,400,000
$24,000,000
16,800,000 (1) 16,800,000 2,520,000 (2) 14,280,000 2,040,000 (3) 16,320,000 4,080,000
2,520,000 14,280,000 16,800,000 16,800,000 2,400,000 19,200,000 4,800,000
2,000,000 1,800,000 3,800,000 $280,000
2,000,000 1,800,000 3,800,000 $1,000,000
2013 Calculations (1) (2) (3)
200,000 x $84 ($120 x 70%) 30,000 x $84 170,000 X $12($120 x 10%)
(4)
(5)
2014 Calculations (4) (5)
170,000 x $84 200,000 x $12
(b) Poullas Ltd Income statement for the year ended 31 December (Absorption Costing)
Sales Cost of sales Inventory, 1/1 Cost of goods manufactured Cost of goods available for sale Inventory, 31/12 Cost of sales Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Profit from operations
2013
2014
$20,400,000
$24,000,000
18,800,000 (1) 18,800,000 2,820,000 (2) 15,980,000 4,420,000
2,820,000 16,280,000 (3) 19,100,000 19,100,000 4,900,000
2,040,000 1,800,000 3,840,000 $580,000
2,400,000 1,800,000 4,200,000 $700,000
Chapter 15: Cost-volume-profit relationships
2013 Calculations (1) (2)
(c)
200,000 x [$84 + ($2,000,000 ÷ 200,000)] 30,000 x $94
2014 Calculations (3)
170,000 x [$84 + ($2,000,000 ÷ 170,000)]
The variable costing and the absorption costing profit from operations can be reconciled as follows: 2010 2011
Variable costing income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing
$280,000
$1,000,000
$2,000,000
$2,000,000
(1,700,000)
(2,300,000)
(1)
(2)
Difference Absorption costing income
300,000 $580,000
(1)
(300,000) $700,000
In 2013, with absorption costing $1,700,000 {$2,000,000 x (170,000 sold÷200,000 units produced} of the fixed manufacturing overhead is expensed as part of cost of sales, and $300,000 ($2,000,000-$1,700,000) is included in the ending inventory. (2) In 2014, with absorption costing $2,300,000 of fixed manufacturing overhead is expensed as part of cost of sales. This includes the fixed manufacturing overhead of $2,000,000 plus $300,000 of fixed manufacturing overhead from 2013 that was included in the beginning inventory for 2014.
15.19
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 16.3 KARMING METAL LTD
(a) Income statement for the year ended 30 June (Variable Costing)
Sales Variable expenses: Inventory, 1/1 Variable manufacturing costs Cost of goods available for sale Inventory, 31/12 Variable cost of sales Variable selling expenses Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead Administrative Total fixed expenses Profit from operations
2013
2014
$2 400 000
$3 200 000
2013 Calculations (1) (2) (3)
40 000 x $16 ($80 x 20%) 10,000 x $16 30 000 x $8
640 000 (1) 640 000 160 000 (2) 480 000 240 000 (3) 720 000 1 680 000
160 000 480 000 640 000 640 000 320 000 960 000 2 240 000
1 200 000 200 000 1 400 000 $280 000
1 200 000 200 000 1 400 000 $840 000
(4)
(5)
2014 Calculations (4) (5)
30 000 x $16 40 000 x $8
(b) Karming Metal Ltd Income statement for the year ended 31 December (Absorption Costing)
Sales Cost of sales Inventory, 1/1 Cost of goods manufactured Cost of goods available for sale Inventory, 31/12 Cost of sales Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Profit from operations
2013
2014
$2 400 000
$3 200 000
1 840 000 (1) 1 840 000 60 000 (2) 1 380 000 1 020 000
460 000 1 680 000 (3) 2 140 000 2 140 000 1 060 000
240 000 200 000 440 000 $580 000
320 000 200 000 520 000 $540 000
Chapter 15: Cost-volume-profit relationships
2013 Calculations (1) (2)
(c)
40 000 x [$16 + ($1 200 000 ÷ 40 000)] 10 000 x $46
2014 Calculations (3)
30 000 x [$16 + ($1 200 000 ÷ 30 000)]
The variable costing and the absorption costing profit from operations can be reconciled as follows: 2013 2014
Variable costing income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing
$280 000
$840 000
$1 200 000
$1 200 000
(900 000)
(1 500 000)
(1)
(2)
Difference Absorption costing income
300 000 $580 000
(1)
(300 000) $540 000
In 2013, with absorption costing $900 000 {$1 200 000 x (30 000 sold÷40 000 units produced} of the fixed manufacturing overhead is expensed as part of cost of sales, and $300 000 ($1 200 000 x (10 000 inventorty÷40 000 units produced}) is included in the ending inventory. (2) In 2014, with absorption costing $1 500 000 of fixed manufacturing overhead is expensed as part of cost of sales. This includes the fixed manufacturing overhead of $1 200 000 plus $300 000 of fixed manufacturing overhead from 2013 that was included in the beginning inventory for 2014.
15.21
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 16.4 RAIN HEAVEN LTD. (a) Manufacturing costs: Type of cost Unit variable manufacturing costs Unit fixed manufacturing overhead ($10,000/2,000 units) Total unit cost
(i) Absorption costing $15
(ii) Variable costing $15
5 $20
$15
(b) (i) Rain Heaven Ltd Income Statement (using absorption costing) For the month ended 31 January 2012 Sales ($40 x 1000 units) Cost of sales Inventory, 1 January Cost of goods manufactured ($20 x 2000 units) Cost of goods available for sale Less: Inventory, 31 January ($20 x 1000 units) Cost of sales Gross profit Less: Selling and administrative expenses (variable $4 x 1000 units) + (fixed $8000)
$40 000 $0 40 000 40 000 (20,000) 20 000 20 000 12 000
Profit from operations
$8 000
(b) (ii) Rain Heaven Ltd Income Statement (using variable costing) For the month ended 31 January 2012 Sales ($40 x 2000 units) Cost of sales Inventory, 1 January $0 Cost of goods manufactured ($15 x 2000 units) 30 000 Cost of goods available for sale 30 000 Less: Inventory, 31 January ($15 x 1000 units) (15,000) Cost of sales Gross profit Fixed manufacturing overhead Less: Selling and administrative expenses (variable $4 x 1000 units) + (fixed $8000) Total expenses Profit from operations (c)
$40,000
15 000 25 000
10 000 12 000 22 000 $3 000
Profits are different because what are included as product costs are different under the two costing methods. Under absorption costing, all manufacturing costs, i.e. direct materials, direct labour and overheads are all counted as product cost. However, under variable costing, only direct materials, direct labour and variable overheads are included as product cost.
Chapter 15: Cost-volume-profit relationships
During the first month of Rain Heaven’s operation, production exceeded sales by 1000 units. Therefore, absorption costing net profit is higher than variable costing net profit. This is because absorption costing defers $5,000 (1,000 units $5 fixed manufacturing overhead per unit) to next month as an asset in the ending inventory. In contrast, variable costing expenses all the fixed manufacturing overhead in the current period.
15.23
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 16.5 TYSON LTD
(a) CVP Income statement for the year ending 31 December 2013
Net sales Variable expenses: Cost of sales Selling expenses Administrative expenses Total variable expenses Contribution margin Fixed expenses: Cost of sales Selling expenses Administrative expenses Total fixed expenses Profit
(1)
(b)
(c)
(d)
$1,800,000 $980,000 (1) 80,000 20,000 1,080,000 720,000 283,000 65,000 52,000 400,000 $320,000
Direct materials $400,000 + Direct labour $280,000 + Variable manufacturing overhead $300,000
Variable costs = 60 % of sales ($1,080,000 ÷ $1,800,000) or $0.24 per bottle ($.40 x 60%). Total fixed costs = $400,000. (1)
$.40x $.16x x
= $.24x + $400,000 = $400,000 = 2,500,000 units (breakeven)
(2)
x .40x x
= .60x + $400,000 = $400,000 = $1,000,000 (breakeven)
Contribution margin ratio
= ($.40 - $.24) ÷ $.40 = 40%
Margin of safety ratio
= ($1,800,000 - $1,000,000) ÷ $1,800,000 = 44%
Required sales: x = .60x + $400,000 + $150,000 .40x = $550,000 x = $1,375,000
Chapter 15: Cost-volume-profit relationships
PROBLEM SET A 16.6 CRUZ MANUFACTURING LTD
(a)
Sales were $2,400,000 and variable expenses were $1,560,000 which means variable expenses were 65% of sales ($1,560,000 ÷ $2,400,000). Therefore, the breakeven point in dollars is: x .35x x
(b)
1.
= .65x + $1,050,000 = $1,050,000 = $3,000,000 The effect of this alternative is to increase the selling price per unit to $5 ($4 x 125%). Total sales become $3,000,000 (600,000 x $5). Thus, the percentage of variable costs to net sales changes to 52% ($1,560,000 ÷ $3,000,000). The new breakeven point is:
x .48x x 2.
= .52x + $1,050,000 = $1,050,000 = $2,187,500 The effects of this alternative are to change total fixed costs to $910,000 ($1,050,000- $140,000) and to change the percentage of variable costs to net sales to 68% (65% + 3%). The new breakeven point is:
x .32x x
= .68x + $910,000 = $910,000 = $2,843,750
3.
The effects of this alternative are: (1) variable and fixed cost of sales are $2,100,000 become vc $1,260,000 and fc $ 840,000, (2) total variable costs become $1,380,000 ($1,260,000 + $72,000 + $48,000), and (3) total fixed costs are $1,230,000 ($840,000 + $228,000 + $162,000). The new breakeven point is:
x x .425x x
= = = =
($1380,000 ÷ $2,400,000)x + $1,230,000 .575x + $1,230,000 $1,230,000 $2,894,118 (rounded)
Alternative 1 is the recommended course of action using breakeven analysis because it has the lowest breakeven point.
15.25
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 16.7 MIX N MATCH
(a) Monthly fixed costs: Depreciation ($12,000/4 years/12 months) Rent Total fixed costs
$250 800 $1,050
(b) Selling price Unit variable costs Contribution margin per unit Contribution margin ratio ($2/$3.5)
$3.5 1.5 $2 57%
Contribution margin is $2/cup which means that for each cup of coffee you sell, $2 will go towards covering the fixed costs and profit. Likewise, a contribution margin of 57% means that for each dollar of sales, 57 cents will go towards covering fixed costs and profit. (c) BEP = Total monthly fixed costs / contribution margin, i.e. $1050/$2 = 525 cups
Chapter 15: Cost-volume-profit relationships
PROBLEM SET A 16.8 MIX N MATCH
(a) Monthly fixed costs: Depreciation ($12,000/4 years/12 months) Rent Total fixed costs
Existing Operation
New plan
Total
$250 800 $1,050
$250 1,100 $1,350
$500 1,900 $2,400
Total
WACM
(b) Selling price Unit variable costs Contribution margin per unit Sales mix Contribution margin sales mix
Coffee $3.5 1.5 $2 3 6
Juice $4.5 1.5 $3 2 6
5 12
$2.4
The weighted average contribution margin is $2.4, meaning that each basket of sales of 3 cups of coffee to 2 glasses of juice will generate $2.4 towards covering fixed costs and contribution to profit. (c) BEP for the sales mix = Total monthly fixed costs / weighted average contribution margin; $2,400 / $2.4 = 1,000 units Sales for coffee = 1,000 units x 3/5 = 600 cups Sales for juice = 1,000 units x 2/5 = 400 glasses
No. of cups/glasses Selling price Sales Unit variable costs Contribution margin per unit Total monthly fixed costs Profit
Coffee 600 $3.5 $2,100 $900 $1,200
Juice 400 $4.5 $1,800 $600 $1,200
15.27
Total 1,000 $3,900 $1,500 $2,400 $2,400 $0
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 16.9 VALUE SHOE STORE
(a)
(b)
Current breakeven point:
$40x $20x x
= $20x + $240,000 (where x = pairs of shoes) = $240,000 = 12,000 pairs of shoes
New breakeven point:
$38x $18x x
= $20x + ($240,000 + $48,000) = $288,000 = 16,000 pairs of shoes
Current margin of safety percentage = = New margin of safety percentage
= =
(c)
(20,000 x $40) - (12,000 x $40) (20,000 x $40) 40%
(24,000 x $38) - (16,000 x $38) (24,000 x $38) 33% (rounded)
Value Shoe Store CVP Income statement Current Sales (20,000 x $40) Variable expenses (20,000 x $20) Contribution margin Fixed expenses Net Profit
$800,000 400,000 400,000 240,000 $160,000
New $912,000 480,000 432,000 288,000 $144,000
(24,000 x $38) (24,000 x $20)
The proposed changes will raise the breakeven point 4,000 units or 33%. This is a significant increase. Margin of safety is 7% lower and profit is $16,000 lower. The recommendation is to not accept the proposed changes.
Chapter 15: Cost-volume-profit relationships
PROBLEM SET A 16.10 VISTA LTD
(a) Unit sales Less: Unit variable costs Unit contribution margin Contribution margin ratio (b) ÷ (a) (b) Fixed costs Contribution margin ratio Breakeven sales (a) ÷ (b) (c)
Fixed costs Profit Fixed costs + net profit Contribution margin ratio Required sales (a) ÷ (b)
(a) (b)
(a) (b)
(a) (b)
15.29
Clearfrost
Superfreeze
$420 252 $168 40%
$630 441 $189 30%
$84,000 40% $210,000
$84,000 30% $280,000
$84,000 36,000 120,000 40% $300,000
$84,000 48,000 132,000 30% $440,000
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 16.1 THE UNIVERSITY BARBER SHOP (a)
Variable costs (per haircut) Barbers’ commission Rent Barber supplies Total variable
(b)
$4.00 0.60 0.40 $5.00
Fixed costs (per month) Barbers’ salaries Rent Depreciation Electricity Advertising Total fixed
Breakeven in units $10x = $5x + $7 000 $5x = $7 000 x = 1 400 units or haircuts
$5 200 800 500 300 200 $7 000
Breakeven in dollars x = .50xa + $7 000 .50x = $7 000 x = $14 000 a
$5 ÷ $10
(c)
(d)
The University Barber Shop
Profit = $16 000 – [($5.00 x 1 600) + $7 000] = $1 000
Chapter 15: Cost-volume-profit relationships
PROBLEM SET B 16.2 TINGA LTD
(a) Income statement for the year ended 31 December (Variable Costing) 2012 Sales Variable expenses: Inventory, 1/1 Variable manufacturing costs Cost of goods available for sale Inventory, 31/12 Variable cost of sales Variable selling expenses Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead Administrative Total fixed expenses Profit from operations
$4,000,000
$5,000,000
1,250,000 (1) 1,250,000 250,000 (2) 1,000,000 240,000 (3) 1,240,000 2,760,000
250,000 1,000,000 1,250,000 1,250,000 300,000 1,550,000 3,450,000
1,400,000 250,000 1,650,000 $1,110,000
1,400,000 250,000 1,650,000 $1,800,000
2012 Calculations (1) (2) (3)
50,000 x $25 ($100 x 25%) 10,000 x $25 40,000 X $6
2013
2013 Calculations (4) (5)
15.31
40,000 x $25 50,000 x $6
(4)
(5)
Solutions manual to accompany Accounting: building business skills 4e
(b) Tinga Ltd Income statement for the year ended 31 December (Absorption Costing)
Sales Cost of sales Inventory, 1/1 Cost of goods manufactured Cost of goods available for sale Inventory, 31/12 Cost of sales Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Profit from operations
2012
2013
$4,000,000
$5,000,000
2,650,000 (1) 2,650,000 530,000 (2) 2,120,000 1,880,000
530,000 2,400,000 2,930,000 2,930,000 2,070,000
240,000 250,000 490,000 $1,390,000
300,000 250,000 550,000 $1,520,000
2012 Calculations
(3)
2013 Calculations
(1) (2)
50,000 x [$25 + ($1,400,000 ÷ 50,000)] 10,000 x $53
(3)
40,000 x [$25 + ($1,400,000 ÷ 40,000)]
(c)
The variable costing and the absorption costing profit from operations can be reconciled as follows: 2012
Variable costing income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing Difference Absorption costing income (1)
(2)
2013
$1,110,000
$1,800,000
$1,400,000
$1,400,000
(1,120,000)
(1,680,000)
(1)
(2)
280,000 $1,390,000
(280,000) $1,520,000
In 2012, with absorption costing $1,120,000 {$1,400,000 x (40,000 sold÷50,000 units produced} of the fixed manufacturing overhead is expensed as part of cost of sales, and $280,000 ($1,400,000-$1,120,000) is included in the ending inventory. In 2013, with absorption costing $1,680,000 of fixed manufacturing overhead is expensed as part of cost of sales. This includes the fixed manufacturing overhead of $1,400,000 plus $280,000 of fixed manufacturing overhead from 2012 that was included in the beginning inventory for 2013.
Chapter 15: Cost-volume-profit relationships
PROBLEM SET B 16.3 GLOWBUS (a) Income statement for the year ended 30 June (Variable Costing)
Sales Variable expenses: Inventory, 1/1 Variable manufacturing costs Cost of goods available for sale Inventory, 31/12 Variable cost of sales Variable selling expenses Total variable expenses Contribution margin Fixed expenses: Manufacturing overhead Administrative Total fixed expenses Profit from operations
2012
2013
$6 000 000
$8 000 000
2013 Calculations (1) (2) (3)
4 000 x $300 ($2000 x 15%) 1 000 x $300 3 000 x $200
1 200 000 (1) 1 200 000 300 000 (2) 900 000 600 000 (3) 1 500 000 4 500 000
300 000 900 000 1 200 000 1 200 000 800 000 2 000 000 6 000 000
2 400 000 600 000 3 000 000 $1 500 000
2 400 000 600 000 3 000 000 $3 000 000
(4)
(5)
2014 Calculations (4) (5)
3 000 x $300 4 000 x $200
(b) Glowbus Income statement for the year ended 31 December (Absorption Costing)
Sales Cost of sales Inventory, 1/1 Cost of goods manufactured Cost of goods available for sale Inventory, 31/12 Cost of sales Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Profit from operations
15.33
2012
2013
$6 000 000
$8 000 000
3 600 000 (1) 3 600 000 900 000 (2) 2 700 000 3 300 000
900 000 3 300 000 (3) 4 200 000 4 200 000 3 800 000
600 000 600 000 1 200 000 $2 100 000
800 000 600 000 1 400 000 $2 400 000
Solutions manual to accompany Accounting: building business skills 4e
2012 Calculations (1) (2)
(c)
4 000 x [$300 + ($2 400 000 ÷ 4 000)] 1 000 x $900
(3)
3 000 x [$300 + ($2 400 000 ÷ 3 000)]
The variable costing and the absorption costing profit from operations can be reconciled as follows: 2012 2013
Variable costing income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing Difference Absorption costing income (1)
2013 Calculations
$1 500 000
$3 000 000
$2 400 000
$2 400 000
(1 800 000)
(3 000 000)
(1)
(2)
600 000 $2 100 000
(600 000) $2 400 000
In 2012, with absorption costing $1 800 000 {$2 400 000 x (3 000 sold÷4 000 units produced} of the fixed manufacturing overhead is expensed as part of cost of sales, and $600 000 ($2 400 000 x (1 000 inventorty÷4 000 units produced}) is included in the ending inventory. (2) In 2013, with absorption costing $1 500 000 of fixed manufacturing overhead is expensed as part of cost of sales. This includes the fixed manufacturing overhead of $2 400 000 plus $600 000 of fixed manufacturing overhead from 2012 that was included in the beginning inventory for 2013.
Chapter 15: Cost-volume-profit relationships
PROBLEM SET B 16.4 ELLA LANG DESIGN
(a) Manufacturing costs: Type of cost Unit variable manufacturing costs Unit fixed manufacturing overhead ($100000/2000 units) Total unit cost
(i) Absorption costing $150
(ii) Variable costing $150
50 $200
$150
(b) (i) Ella Lang Design Income Statement (using absorption costing) For the year ended 31 December 2012 Sales ($400 x 1000 units) Cost of sales Inventory, 1 January Cost of goods manufactured ($200 x 2000 units) Cost of goods available for sale Less: Inventory, 31 December ($200 x 1000 units) Cost of sales Gross profit Less: Selling and administrative expenses (variable $40 x 1000 units) + (fixed $80,000)
$400,000 $0 400,000 400,000 (200,000) 200,000 200,000 (120,000)
Profit from operations
$80,000
(b) (ii) Ella Lang Design Income Statement (using variable costing) For the year ended 31 December 2012 Sales ($400 x 1000 units) Cost of sales Inventory, 1 January $0 Cost of goods manufactured ($150 x 2000 units) 300,000 Cost of goods available for sale 300,000 Less: Inventory, 31 December ($150 x 1000 units) (150,000) Cost of sales Gross profit Fixed manufacturing overhead
$400,000
150,000 250,000
100,000
Less: Selling and administrative expenses (variable $40 x 1000 units) + (fixed $80000) Total expenses Profit from operations
120,000 (220,000) $30,000
15.35
Solutions manual to accompany Accounting: building business skills 4e (c)
Profits are different because what is included as product costs are different under the two costing methods. Under absorption costing, all manufacturing costs, i.e. direct materials, direct labour and overheads are all counted as product cost. However, under variable costing, only direct materials, direct labour and variable overheads are included as product cost. During the first year of operation of Ella Lang’s Design, production exceeded sales by 1000 units. Therefore, absorption costing net profit is higher than variable costing net profit. This is because absorption costing defers $50,000 (1,000 units $50 fixed manufacturing overhead per unit) to next year as an asset in the ending inventory. In contrast, variable costing expenses all the fixed manufacturing overhead in the current period.
Chapter 15: Cost-volume-profit relationships
PROBLEM SET B 16.5 CORBIN LTD (a) CVP Income statement for the year ending 31 December 2013
Net sales Variable expenses: Cost of sales Selling expenses Administrative & Financial expenses Total variable expenses Contribution margin Fixed expenses: Cost of sales Selling expenses Administrative & Financial expenses Total fixed expenses Profit
(1)
(b)
(c)
(d)
$2 000 000 $1 080 000 (1) 90 000 34 000 1 204 000 796 000 380 000 150 000 66,000 606,000 $190,000
Direct materials $360 000 + Direct labour $450 000 + Variable manufacturing overhead $270 000
Variable costs = 60.2 % of sales ($1204000 ÷ $2000000) or $0.301 per bottle ($.50 x 60.2%). Total fixed costs = $606 000. (1)
$.50x $.199x x
= $.301x + $606 000 = $606 000 = 3 045 227 units (breakeven) note round up to nest unit
(2)
x .398x x
= .602x + $606 000 = $606 000 = $1,522 613 (breakeven)
Contribution margin ratio
= ($.50 - $.301) ÷ $.5 = 39.8%
Margin of safety ratio
= ($2 000 000 - $1 522 613) ÷ $2 000 000 = 23.87%
Required sales: x = .602x + $606 000 + $220 000 .398x = $826 000 x = $2 075 377
15.37
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 16.6 UNIQUE MANUFACTURING
(a)
(b)
Sales were $2 250 000 and variable expenses were $1 575 000 which means variable expenses were 70% of sales ($1,575,000 ÷ $2,250,000). Therefore, the breakeven point in dollars is: x .30x x
= .70x + $1 260 000 = $1 260 000 = $4 200 000
1.
The effect of this alternative is to increase the selling price per unit to $52.50. Total sales become $3,150,000 (60,000 x $52.50). Thus, the percentage of variable costs to net sales changes to 50% ($1,575,000 ÷ $3,150,000). The new breakeven point is:
x .50x x
= .50x + $1 260000 = $1 260 000 = $2 520 000
2.
The effects of this alternative are to change total fixed costs to $1,035,000 ($1,260,000 - $225,000) and to change the percentage of variable costs to net sales to 75% (70% + 5%). The new breakeven point is:
x .25x x
= .75x + $1 035 000 = $1 035 000 = $4 140 000
3.
The effects of this alternative are: (1) variable and fixed cost of sales become $1,012,500 each, (2) total variable costs become $1,192,500 ($1,012,500 + $110,000 + $70,000), and (3) total fixed costs are $1,642,500 ($1,012,500 + $520,000 + $110,000). The new breakeven point is:
x x .47x x
= = = =
$1 192 500 ÷ $2 250 000)x + $1 642 500 .53x + $1 642 500 $1 642 500 $3 494 681 (rounded)
Alternative 1 is the recommended course of action using breakeven analysis because it has the lowest breakeven point.
Chapter 15: Cost-volume-profit relationships
PROBLEM SET B 16.7 SUPER CHARGE (a) Monthly fixed costs: Depreciation ($24,000/4 years/12 months) Rent Total fixed costs
$500 1,000 $1,500
(b) Selling price Unit variable costs Contribution margin per unit Contribution margin ratio ($3/$4.5)
$4.5 1.5 $3 67%
Contribution margin is $3/glass which means that for each glass of juice you sell, $3 will go towards covering the fixed costs and profit. Likewise, a contribution margin of 67% means that for each dollar of sales, 67 cents will go towards covering fixed costs and profit. (c) BEP = Total monthly fixed costs / contribution margin, i.e. $1,500/$3 = 500 glasses
PROBLEM SET B 16.8 SUPER CHARGE (a) Monthly fixed costs: Depreciation ($24,000 and $28,800 /4 years/12 months) Rent Total fixed costs
Existing operation
New plan
Total
$500 1,000 $1,500
$600 1,200 $1,800
$1,100 2,200 $3,300
(b) Selling price Unit variable costs Contribution margin per unit Sales mix Weighted average contribution margin
Juice $4.5 1.5 3 3
Yogurt $4.5 1.5 3 2
Total
$9
$6
$15
WACM
5 $3
The weighted average contribution margin is $3, meaning that each basket of sales of 3 glasses of juice to 2 cups of yogurt will generate $3 towards covering fixed costs and contribution to profit. (c) BEP for the sales mix = Total monthly fixed costs / weighted average contribution margin; $3,3003/$3 = 1,100 units Sales for juice = 1,100 units x 3/5 = 660 glasses Sales for yogurt = 1,100 units x 2/5 = 440 cups
No. of glasses / cups Selling price Sales Variable costs Contribution margin per unit Total monthly fixed costs Profit
Juice 660 $4.5 2,970 990 1,980
Yogurt 440 $4.5 1,980 660 1,320
15.39
Total 1,100 4,950 1,650 3,300 3,300 $0
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 16.9 THRIFTY SHOE STORE
(a)
(b)
Current breakeven point:
$30x $15x x
= $15x + $210,000 (where x = pairs of shoes) = $210,000 = 14,000 pairs of shoes
New breakeven point:
$28x $13x x
= $15x + ($210,000 + $37,000) = $247,000 = 19,000 pairs of shoes
Current margin of safety percentage = = New margin of safety percentage
= =
(c)
[(16,000 x $30) - (14,000 x $30) (16,000 x $30) 12.5%
[(21,000 x $28) - (19,000 x $28) (21,000 x $28) 9.5%
Thrifty Shoe Store CVP Income statement Current Sales (16,000 x $30) Variable expenses (16,000 x $15) Contribution margin Fixed expenses Net Profit
$480,000 240,000 240,000 210,000 $30,000
New $588,000 315,000 273,000 247,000 $26,000
(21,000 x $28) (21,000 x $15)
The proposed changes will raise the breakeven point 5,000 pair of shoes or 36%. This is a significant increase. Margin of safety is 3% lower and profit is $4,000 lower. The recommendation is to not accept the proposed changes.
Chapter 15: Cost-volume-profit relationships
PROBLEM SET B 16.10 CASHMERE LTD
(a) Unit sales Less: Unit variable costs Unit contribution margin Contribution margin ratio (b) ÷ (a)
(a) (b)
(b) Fixed costs Contribution margin ratio Breakeven sales (a) ÷ (b) (c)
(a) (b)
Fixed costs Profit Fixed costs + profit Contribution margin ratio Required sales (a) ÷ (b)
(a) (b)
15.41
Turbotub
Untraclean
$400 280 $120 30%
$500 375 $125 25%
$90,000 30% $300,000
$90,000 25% $360,000
$90,000 36,000 126,000 30% $420,000
$90,000 30,000 120,000 25% $480,000
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BBS 16.1 RIVERINA AND MURRAY
(a) The variable costs per unit are: Cost of sales ($840,000 ÷ 300,000) Selling expenses ($165,000 ÷ 300,000) Administrative expenses ($45,000 ÷ 300,000) Fixed Costs ($360,000+$110,000+$135,000+$15,000)
$2.80 0.55 0.15 $3.50 = 620 000
The breakeven points are: x = ($3.50 ÷ $5.00)x + $620,000 x = .7x + $620,000 .30x = $620,000 x = $2,066,667 $5.00x = $1.50x = x =
(b)
$3.50x + $620,000 $620,000 413,334 units or $2 066 667 ÷ $5 ($1500000÷300000) = 413,334 Note must round up a you can’t sell .40 of a unit.
Riverina’s Plan Variable unit cost of sales = $4.05 ($3.50 +$0.55) Sales volume – 390,000 units (300,000 x 130%) Total sales = 390,000 x $6.00 = $1,690,000 Profit calculations: Sales(390 000 x $6) Variable expenses: Cost of sales (390,000 x $3.35) Selling expenses (390,000 x $.55) Administrative expenses (390,000 x $0.15) Total variable expenses Contribution margin Fixed expenses: Cost of sales Selling expenses Administrative expenses Financial expenses Total fixed expenses Profit
2 340 000 $1,306,500 214,500 58,500 1,579,500 760,500 $360,000 110,000 135,000 15,000 620,000 $140,500
Chapter 15: Cost-volume-profit relationships
New breakeven sales x = ($4.05 ÷ $6)x + $620,000 x = .675x + $480,000 .325x = $620,000 x = $1,907,692 (rounded) or 317,949 units (c)
Murray’s Plan Sales [450,000 x ($5.00 - $.20)] Variable expenses: Cost of sales (450,000 x $2.80) Selling expenses (450,000 x $.65) Administrative expenses (450,000 x $.15) Total variable expenses Contribution margin Fixed expenses: Cost of sales Selling expenses ($110,000 + $20,000) Administrative expenses Financial expenses Total fixed expenses Profit/(Loss)
$2,160,000 $1,260,000 292,500 67,500 1,620,000 540,000 $360,000 130,000 135,000 15,000 640,000 ($100,000)
New breakeven sales: x = ($1,620,000 ÷ $2,160,000)x + $640,000 x = .75x + $640,000 .25x = $640,000 x = $2,560,000 or 533,334 units (d)
Riverina’s plan should be accepted as it produces a profit not a loss and a lower breakeven point than Murray’s plan.
15.43
Solutions manual to accompany Accounting: building business skills 4e
BBS 16.2 CSR Ltd (Answer is for www.csr.com.au) (a)
“CSR is the name behind some of the market's most trusted and recognised brand names in providing building products for residential and commercial construction. Names that builders and generations of Australians have come to know and trust. Like Gyprock™ plasterboard, Bradford™ Insulation, PGH™ bricks and Pavers, Monier™ and Wunderlich™ rooftiles and Viridian™ glass to name a few. CSR operates low cost manufacturing facilities and a strong distribution network to service our customers across Australia and New Zealand.” ( source CSR website 23/11/2011 ‘about us’
(b)
Major industry segments (from CSR 2011 Note 1 in the notes to the financial statements). ▪ Building products ▪ Glass ▪ Aluminium ▪ Property NOTE CSR sold its sugar business in 2010 (c)
Production costs of pavers or bricks – 2 each category. Fixed Costs Supervisors’ salaries Depreciation on factory building Insurance on factory building or equipment Leases on equipment used in factory Maintenance Cleaning of factory Air conditioning/heating Variable Costs Raw materials – clay and shale Labour on production line Inspections and quality control Depreciation on equipment if units-of-production method used. Power costs Students may argue that the costs are mixed or some may have described them as variable. The concept of relevant range could also be discussed.
BBS 16.3 BMW (a) Main steps in making motor vehicles: 1. Origin - Cut out of steel and aluminium plates 2. Dies and tooling – tools and dies constructed and produced for press plant and body shop 3. Press plant – crude panels cut into shapes and right forms 4. Body shop – Industrial robots put together metal components to form the body of a car 5. Paint shop – layers of paint are applied on vehicles 6. Modules – components such as the engines, seats and cockpits etc. are completed in advance
Chapter 15: Cost-volume-profit relationships
7. Assembly – assembly workers completed the painted bodyshells 8. Finish – functional and visual inspection of the completed cars (b) Two variable costs: Aluminium; Paint Two fixed costs: Rent of assembly plant; depreciation of industrial robots
15.45
Solutions manual to accompany Accounting: building business skills 4e
CRITICAL THINKING BBS 16.4 Suggestions for discussion Relevant range: Time, one semester Fixed expenses include: Rent – stays the same for each semester Transportation – if purchased weekly/monthly ticket Car Insurance, Registration Variable expenses include: Textbook – total cost change with number of subjects studied Printing – the more printing of notes, the higher the printing costs Eating-out Mixed expenses: Mobile phone charges Internet charges Tuition fee – fixed portion: union fee; variable portion: tuition charge per subject/per credit point
BBS 16.5 To:
My Classmate
From:
Your Classmate
Subject:
Cost-Volume-Profit Questions
In response to your request for help, I send you the following: (a)
The mathematical formula for breakeven sales is: Breakeven Sales = Variable Costs + Fixed Costs Breakeven sales in dollars is found by expressing variable costs as a percentage of unit selling price. For example, if the percentage is 70%, the breakeven formula becomes x .70x + Fixed Costs. The answer will be in sales dollars. Breakeven sales in units is found by using unit selling price and unit variable costs in the formula. For example, if the selling price is $300 and variable costs are $210, the breakeven formula becomes $300x - $210x + Fixed Costs. The answer will be in sales units.
(b)
The formulas for contribution margin per unit and contribution margin ratio differ as shown below: Unit Selling Price – Unit Variable Costs = Contribution Margin per Unit Contribution Margin per Unit ÷ Unit Selling Price = Contribution Margin Ratio You can see that CM per Unit is used in calculating the CM ratio.
Chapter 15: Cost-volume-profit relationships
(c)
When contribution margin is used to determine breakeven sales, total fixed costs are divided by either the contribution margin ratio or contribution margin per unit. Using the CM ratio results in determining the breakeven point in dollars. Using CM per unit results in determining the breakeven point in units.
The formula for determining breakeven sales in dollars is: Fixed Costs ÷ Contribution Margin Ratio = Breakeven Sales in Dollars The formula for determining breakeven sales in units is: Fixed Costs ÷ Contribution Margin per Unit = Breakeven Sales in Units. I hope this memorandum answers your questions.
15.47
Solutions manual to accompany Accounting: building business skills 4e
BBS 16.6 To:
A Manager, CEO
From:
A Student
Subject:
Benefits of Variable Costing
As you are aware, absorption costing, where both fixed and variable manufacturing costs are treated as products costs, is used for external reporting in accordance with generally accepted accounting principles. Many argue that to prepare variable costing information is a waste of time and money. Variable costs are costs which vary in total directly and proportionately with changes in activity level, within a relevant range. Under variable costing, it is only direct material, direct labour, and variable manufacturing costs which are considered product costs. Fixed manufacturing costs are treated as period costs as they are incurred irrespective of the volume of factory capacity utilised. The benefits of variable costing are that it forces management to evaluate the cost behaviour patterns of each cost item. This information is presented in a profit and loss format and provides the basis for CVP analysis, flexible budgeting, cost control and resource allocation. I hope you consider the benefits of variable costing information and ensure it is prepared as a tool for management decision-making. BBS 16.7 BMW 1 “Launched in 1999, the Dow Jones Sustainability Indexes are the first global indexes tracking the financial performance of the leading sustainability-driven companies worldwide. Based on the cooperation of Dow Jones Indexes and SAM they provide asset managers with reliable and objective benchmarks to manage sustainability portfolios. Currently approximately 60 DJSI licenses are held by asset managers in 16 countries to manage a variety of financial products including active and passive funds, certificates and segregated accounts. In total, these licensees presently manage over 8 billion USD based on the DJSI.” Since the question was prepared BMW now use the GRI Index and 2. The response here will depend on the latest sustainability report. The following is the link and then click on the responsibility tab. http://www.bmwgroup.com/e/nav/index.html?http://www.bmwgroup.com/e/0_0_www_bmwgroup_c om/home/home.html “Sustainability
Corporate sustainability is firmly established as a guiding principle of the company’s strategy and culture. The BMW Group complies with the ten principles of the Global Compact and the Cleaner Production Declaration of the United Nations Environmental Program (UNEP). In addition, the company also adheres to the agreements of the International Labour Organisation (ILO), the OECD’s guidelines for multinational companies and the Business Charter for Sustainable Development issued by the International Chamber of Commerce (ICC). For six consecutive years the BMW Group has been named as the world’s most sustainable automobile company in the Dow Jones Sustainability Index. The BMW Group is the only automobile company to have been listed in the top three every year since the Dow Jones Sustainability Indexes were founded in 1999” excerpt from 2010 Sustainability report’
Chapter 15: Cost-volume-profit relationships
BUILDING BUSINESS SKILLS 16.8 SWAN LTD
(a)
The stakeholders in this situation are: Richard Blake, accountant of Swan Ltd The dislocated personnel of Swan Ltd The senior management who made the decision.
(b)
The ethical issue is that due to Richard’s erroneous calculations, decisions were made which affected the employees of the company, causing their relocation. The real issue for Richard is that he should either admit that his forecast calculations were in error so next time someone may check the calculations or keep quiet due to compensating issues that profit will be about what was expected and the error will not be detected.
(c)
Richard’s alternatives are: ▪ ▪
Keep quiet. Confess his mistake to management.
The students’ recommendation should recognise the practical aspects of the situation but they should be idealistic and ethical. If the students can’t be totally ethical when really nothing is at stake, how can they expect to be ethical under real-world pressures?
15.49
Chapter 17: Budgeting
CHAPTER 17 - BUDGETING ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
Building Business Skills
1.
Outline the benefits and essential elements of effective budgeting.
6,7,9
2.
Identify and describe the components of the master budget.
1,2
1,2,3,4,5,6
1A,2A,3A,5A 1B,2B,3B,5B
3.
Explain and prepare the main sections of a cash budget.
3
7
4A, 4B
4.
Describe the sources for preparing the budgeted income statement and balance sheet
4
6
1A,2A,5A,6A 1B,2B,5B,6B
4,6,7
5.
Indicate the applicability of budgeting in non-manufacturing entities.
8
5A, 5B
3, 4
6.
Explain the concept of budgetary control.
5
7A,8A,7B,8B
7
7.
Compare and contrast the use of static and flexible budgets.
6
3, 9,10
7A,8A,9A 7B,8B,9B
5,8
8.
Describe the concept of responsibility accounting.
3, 11
10A, 11A, 10B, 11B
2
9.
Identify the content of responsibility reports and their use in performance evaluation.
3, 12,13
10A,11A,12A 10B,11B,12B
2,8
7, 8
17.1
1,4,6 9
Solutions manual to accompany Accounting: building business skills 4e
ANSWERS TO QUESTIONS 1.
2.
The primary benefits of budgeting are: (1)
It requires all levels of management to plan ahead.
(2)
It provides definite objectives for evaluating subsequent performance.
(3)
It creates an early warning system for potential problems, which gives management additional time to solve the problem.
(4)
It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives.
(5)
It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends on the company’s operations.
(6)
It contributes to positive behaviour patterns throughout the organisation by motivating personnel to meet planned objectives.
The essentials of effective budgeting are: (1)
a sound organisational structure
(2)
research and analysis
(3)
management acceptance of the budget.
3.
The required units of production are 36,000 (30,000 + 10,000 – 4,000).
4.
The required units of production are 154,000 (150,000 + 10,000 – 6,000).
5.
In a service enterprise, expected revenues can be obtained from expected output or expected input. The former is based on anticipated billings of clients for services rendered. The latter is based on expected billable time of the professional staff.
6.
Purpose (a) (b) (c)
7.
Name of Report Wastage Departmental overhead costs Income statement
Frequency
Primary Recipient(s)
Daily Monthly Monthly and Quarterly
Production Manager Department Manager Top Management
Yes, this is true. A flexible budget is a series of static budgets at different levels of activity.
17.2
Chapter 17: Budgeting
8.
9.
10.
The steps in preparing a flexible budget are: (1)
Identify the activity index and the relevant range of activity.
(2)
Identify the variable costs and determine the budgeted variable cost per unit of activity for each cost.
(3)
Identify the fixed costs and determine the budgeted amount for each cost.
(4)
Prepare a budget for selected increments of activity within the relevant range.
Ann should know that the following conditions contribute to the use of responsibility accounting: (1)
Costs and revenues can be directly associated with the specific level of management responsibility.
(2)
The costs and revenues are controllable at the level of responsibility with which they are associated.
(3)
Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues.
Return on investment (ROI) measures the effectiveness of a manager of an investment centre in terms of the usage of assets to generate profit. ROI is influenced by profit margin and the valuation of operating assets.
17.3
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 17.1 O’CONNOR MANUFACTURING
17.4
Chapter 17: Budgeting
BRIEF EXERCISE 17.2 HAUGHT & SON Direct Labour Budget for the six months ended 30 June 2012 Quarter 1 Units to be produced Direct labour time (hours) per unit Total required direct labour hours Direct labour cost per hour Total direct labour cost
5000 1.5 7,500 x $12 $90,000
2
Six Months
6,000 x 1.5 9,000 x $12 $108,000
11,000 x 1.5 16,500 x $12 $198,000
BRIEF EXERCISE 17.3 LIANG INDUSTRIES
Collections from Customers January February March
Credit Sales January, February, March,
$300,000 $275,000 $450,000
$180,000
$180,000
$120,000 165,000 $285,000
$110,000 270,000 $380,000
BRIEF EXERCISE 17.4 BIRTLES PTY LTD Budgeted Income statement for the year ended 31 December
Sales Cost of sales (60,000 x $35) Gross profit Selling and administrative expenses Profit before income taxes Income tax expense Profit
$3,000,000 2,100,000 900,000 600,000 300,000 90,000 $210,000
17.5
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 17.5 MARCO CONSULTING
Service Revenue Salary expense Rent expense Other operating expenses Profit
Budget Actual Difference $85,000 $95,000 $10,000 F 55,000 62,000 7,000 U 12,000 12,000 0 10,000 14,000 4,000 U $8,000 $7,000 1,000 U
% 12% 13% 0% 40% 13%
Comments: Service Revenue exceeded budgeted figure by $10,000 (12%) so this is good. However, both salary and other operating expenses were over the budgeted amounts by $7000 and $2500 (13% and 40%). The over-spending resulted in the profit being $1000 less than budgeted. BRIEF EXERCISE 17.6 BIRCH LTD
Static Budget Report for the month ended 31 January
Direct Labour (10,000 x $20)
Budget
Actual
Difference
$200,000
$207,000
$7,000 U
Budget
Actual
Difference
$216,000
$207,000
$9,000 F
Birch Ltd Flexible Budget Report for the month ended 31 January
Direct Labour (10,800 x $20)
The static budget does not provide a proper basis for evaluating performance because the budget is not based on the hours actually worked. In contrast, the flexible budget provides the proper basis for evaluating performance because the budget is based on the hours actually worked.
17.6
Chapter 17: Budgeting
BRIEF EXERCISE 17.7 LEHMAN MANUFACTURING
Aqua Division Management Responsibility Report for the year ended 31 December 2013
Sales Variable costs Contribution margin Controllable fixed costs Controllable margin
Budget
Actual
Difference
$2,500,000 1,500,000 1,000,000 400,000 $600,000
$2,600,000 1,550,000 1,050,000 410,000 $640,000
$100,000 F 50,000 U 50,000 F 10,000 U $40,000 F
BRIEF EXERCISE 17.8 DINGO LTD
(a)
ROI calculations A. 25% ($1,800,000 ÷ $7,200,000) B. 30% ($2,880,000 ÷ $9,000,000) C. 32% ($3,840,000 ÷ $12,000,000)
(b)
Expected ROI given changes next year: (A)
An increase sales by 10% is $240,000 ($2,400,000 x 10%) and in turn the controllable margin by $192,000 ($240,000 x 80%). The new ROI is 27.7% ($1,992,000 ÷ $7,200,000)
(B)
A decrease in costs results in a corresponding increase in controllable margin. The new ROI is 32.5% ($3,120,000 ÷ $9,600,000).
(C)
A decrease in average operating assets reduces the denominator. The new ROI is 33.3% ($3,840,000 ÷ $11,520,000).
17.7
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO EXERCISES EXERCISE 17.1 L QUICK ELECTRONICS LTD Sales Budget for six months ending 30 June 2012
Produc t XQ103 XQ104
Quarter 1 Units Sellin Total g Sale price s 45,00 $12 $540,000 0 18,00 $20360,000 0 63,00 $900,000 0
Quarter 2 Six months Sellin Total Units Sellin Total g Sales g Sales price price $12 $480,00 85,000 $12 $1,020,00 0 0 $20 400,000 38,000 $20 760,000
Units
40,00 0 20,00 0 60,00 0
$880,00 0
123,00 0
$1,780,00 0
EXERCISE 17.2 S. STAHL PTY LTD Production Budget for the year ending 31 December 2013
Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units
1
PRODUCT HD-240 Quarter 2 3
4
Year
7,000 5,400 12,400 4,200 8,200
9,000 6,000 15,000 5,400 9,600
12,000 5,460(2) 17,460 7,200 10,260
38,000 5,460 43,460 4,200 39,260
1
PRODUCT LL-250 Quarter 2 3
4
Year
12,000 12,000 24,000 7,200 16,800
20,000 13,200 33,200 12,000 21,200
40,000 9,360 49,360 24,000 25,360
94,000 9,360 103,360 7,200 96,160
10,000 7,200 17,200 6,000 11,200
(1) 60% of next quarter’s sales (2) 60% (7,000 x 130%)
Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units
17.8
22,000 24,000 46,000 13,200, 32,800
Chapter 17: Budgeting (1) 60% of next quarter’s sales (2) 60% (12,000 X 130%)
EXERCISE 17.3 (a) Profit centres (b) Master budget (c) Sales budget (d) Return on investment (e) Flexible budget (f) Investment centre
17.9
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 17.4 KASPER LTD (a) Kasper Ltd Production Budget for the six months ended 30 June 2013 Quarter
Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units
1
2
6,000 2,250 8,250 1,500 6,750
9,000 2,000 11,000 2,250 8,750
(3)
Six Months
(2)
15,500
25% of next quarter’s sales 25% x 8,000 (3) 25% x 6,000 (1) (2)
(b) Kasper Pty Ltd Direct Materials Budget for the six months ended 30 June 2013 Quarter 1
Units to be produced Direct materials per unit Total kilograms needed for production Add: Desired ending direct materials (kilograms) (1) Total materials required Less: Beginning direct materials (kilograms) Direct materials purchases Cost per kilogram Total cost of direct materials purchases 50% of next quarter’s production [50% x (8,750 x 3)] 50% x (6,750 x 3). (3) 50% x (8,500 x 3) (1) (2)
17.10
6,750 x3 20,250 13,125 33,375 10,125 23,250 x $5 $116,250
2
(2)
8,750 x3 26,250 12,750 39,000 13,125 25875 x $5 $129,375
Six Months
(3)
$245,625
Chapter 17: Budgeting
EXERCISE 17.5 MANIES PTY LTD Direct Labour Budget for the year ended 31 December 2012 Quarter 1 Units to be produced Direct labour time (hours) per unit Total required direct labour hours Direct labour cost per hour Total direct labour cost
2
20,000 25,000 x 1.6 x 1.6 32,000 40,000 x $14 x $14 $448,000 $560,000
17.11
3
4
Year
35,000 30,000 110,000 x 1.6 x 1.6 x 1.6 56,000 48,000 176,000 x $15 x $15 $840,000 $720,000 $2,568,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 17.6 SALLY LTD (a)
Budgeted Income Statement for the year ended 31 December 2013
Sales Cost of sales (see below) Gross profit Selling and administrative expenses Profit before income tax Income tax expense ($250,000 x 30%) Profit
$2,000,000 1,600,000 400,000 150,000 250,000 75,000 $175,000
Calculation of Cost of Sales
Cost of one unit of finished goods: Direct materials (2 x $5) Direct labour (3 x $12) Manufacturing overhead (3 x $6) Total
$10 36 18 $64
25,000 units x $64 = $1,600,000
(b). The budgeted income statement and balance sheet are prepared from (a) the sales budget, (b) the budgets for direct materials, direct labour and manufacturing overhead, and (c ) the selling and administrative expense budget and the cash budget.
17.12
Chapter 17: Budgeting
EXERCISE 17.7 SALA PTY LTD Cash Budget for the two months ended 28 February 2013 January Beginning cash balance Add: Receipts Collections from customers Sale of securities Total receipts Total available cash Less: Disbursements Direct materials Direct labour Manufacturing overhead (less $1,000 dep’n) Selling and administrative expenses Total disbursements Excess (deficiency) of available cash over disbursements Financing Borrowings Repayments Ending cash balance
17.13
February
$32,000
$20,000
87,000 15,000 102,000 134,000
169,000 169,000 189,000
50,000 40,000 20,000 15,000 125,000 9,000
88,000 45,000 29,000 20,000 182,000 7,000
11,000 $20,000
13,000 $20,000
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 17.8 RAILWAY STREET STORES (a) Railway Street Stores Inventory Purchases Budget for the month ended 30 June 2012
Budgeted cost of sales ($800,000 x 60%) Desired ending inventory ($540,000* x 30%) Total Less: Beginning merchandise inventory ($480,000** x 30%) Budgeted merchandise purchases
$480,000 162,000 642,000 144,000 $498,000
* ($900,000 x 60% = $540,000) ** ($800,000 x60%) = $480,000)
(b) Railway Street Stores Budgeted Income statement for the month ended 30 June 2012
Sales Cost of sales: Inventory 1 June Purchases Cost of goods available for sale Less: Inventory 30 June Cost of sales (60%) Gross profit (40%)
$800,000 $144,000 498,000 642,000 162,000 480,000 $320,000
17.14
Chapter 17: Budgeting
EXERCISE 17.9 DEEVA LTD (a) Deeva Ltd Monthly Flexible Manufacturing Overhead Budget for the year 2012 Activity level Direct labour hours Variable costs: Indirect labour ($1.5) Indirect materials ($.75) Electricity ($.45) Total variable ($2.70)
7,000
8,000
9,000
10,000
$10,500 5,250 3,150 $18,900
$12,000 6,000 3,600 $21,600
$13,500 6,750 4,050 $24,300
$15000 7,500 4,500 $27,000
Fixed costs: Supervision Depreciation Rates and taxes Total fixed Total costs
4,500 2,250 1,200 7,950 $26,850
4,500 2,250 1,200 7,950 $29,550
4,500 2,250 1,200 7,950 $32,250
4,500 2,250 1,200 7,950 $34,950
17.15
Solutions manual to accompany Accounting: building business skills 4e
(b) Deeva Ltd Manufacturing Overhead Budget Report (Flexible) for the month ended 31 July 2012 Difference Direct labour hours (DLH) Expected 9,000 Actual 9,000
Budget at 9,000 DLH
Actual Costs 9,000 DLH
Favourable F Unfavourable U
Variable costs: Indirect labour Indirect materials Electricity Total variable
$13,500 6,750 4,050 24,300
$13,050 6,450 3,750 $23,250
$450 F 300 F 300 F 1,050F
Fixed costs: Supervision Depreciation Rates and taxes Total fixed Total costs
4,500 2,250 1,200 7,950 $32,250
4,500 2,250 1,200 7,950 $31,200
$1,050 F
(c) Deeva Ltd Manufacturing Overhead Budget Report (Flexible) for the month ended 31 July 2012 Difference Direct labour hours (DLH) Expected 8,500 Actual 8,500
Budget at 8,500 DLH
Actual Costs 8,500 DLH
Favourable F Unfavourable U
Variable costs: Indirect labour($1.50) Indirect materials (0.75) Electricity (0.45) Total variable ($2.70)
$12,750 6,375 3,825 22,950
$13,050 6,450 3,750 $23,250
$300 U 75 U 75 F 300 U
Fixed costs: Supervision Depreciation Rates and taxes Total fixed Total costs
4,500 2,250 1,200 7,950 $30,900
4,500 2,250 1,200 7,950 $31,200
$300 U
17.16
Chapter 17: Budgeting
(d)
In case (b) the performance for the month was satisfactory. In case (c) management may need to determine the causes of the unfavourable differences for indirect labour and indirect materials, or since the differences are small, 2.4% for indirect labour and 1.2% for indirect materials, they might be considered immaterial.
17.17
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 17.10 O’KEEFE PTY LTD (a) O’Keefe Pty Ltd Selling Expense Budget Report (Flexible) Clothing Department for the month ended 31 October 2012
Difference Sales in units Expected Actual
12,000 15,000
Budget 15,000
Actual 10,000
Favourable F Unfavourable U
Variable expenses: Sales commissions ($.30) Advertising expense ($.15) Travel expense ($.65) Free samples ($.10) Total variable ($1.20)
$4,500 2,250 9,750 1,500 18,000
$4,200 2,100 9,150 1,550 17,000
$300 F 150 F 600 F 50 U 1,000 F
Fixed expenses: Rent Sales salaries Office salaries Depreciation – motor vehicle Total fixed expenses Total costs
1,500 1,200 800 500 4,000 $22,000
1,500 1,200 800 500 4,000 $21,000
$1,000 F
(b)
Todd should not have been reprimanded. As shown in the flexible budget report, variable costs were $1,000 below budget.
17.18
Chapter 17: Budgeting
EXERCISE 17.11 AZA STEEL Responsibility reports for the month of July 2012 (a)
To Brisbane Department Manager – Finishing
Controllable Costs Direct Materials Direct Labour Manufacturing Overhead Total
Month: July
Budget $46,000 82,000 49,200 $177,200
Actual $42,000 83,000 51,000 $176,000
Favourable Unfavourable $4,000 F 1,000 U 1,800 U $1,200 F
(b) Factory Manager – Brisbane
Controllable Costs Brisbane Office Departments: Machining Finishing Total
Month: July
Budget
Actual
Favourable Unfavourable
$92,000
$95,000
$3,000 U
214,000 177,200 $483,200
218,000 176,000 $489,000
4,000 U 1,200 F $5,800 U
(c) To Production Manager – Production
Month: July
Controllable Costs
Budget
Production Manager Assembly factories: Adelaide Brisbane Perth Total
$130,000
Actual
Favourable Unfavourable
$132,000
$2,000 U
421,000 426,000 483,200 489,000 499,000 494,000 $1,533,200 $1,541,000
5,000 U 5,800 U 5,000 F $7,800 U
17.19
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 17.12 AMANDA MEDIA LTD
(a) (1) (2) (3) (4)
Controllable margin ($320,000 - $180,000) Variable expenses ($450,000 - $320,000) Controllable fixed costs ($450,000 - $185,000) Service revenue ($230,000 + $450,000)
$140,000 130,000 265,000 680,000
(b) Amanda Media Ltd. Online Media Division for the year ended 30 June 2013
Sales Variable expenses Contribution margin Controllable fixed costs Controllable margin
Budget
Actual
Difference
Favourable/ Unfavourable
$680,000 230,000 450,000 265,000
$600,000 220,000 380,000 265,000
-$80,000 -10,000 -70,000 0
U
$185,000
$115,000
-$70,000
U
F U
EXERCISE 17.13 MASTERCRAFT DIVISION (a)
Controllable margin = ($3,600,000 - $2,160,000) - $720,000 = $720,000 ROI = $7200,000 ÷ $6,000,000 = 12.0%
(b)
1.
Contribution margin percentage is 40% ($1,440,000 ÷ $3,600,000) Increase in controllable margin = $384,000 x 40% = $153,600 ROI = ($720,000 + $153,600) ÷ $6,000,000 = 14.6%
2.
Variable cost reduce by $120,000, therefore CM & controllable margin increase ROI = ($720,000 + $120,000) ÷ $6,000,000 = 14.0%
3.
Assets reduced by $300,000 ROI = 720,000 ÷ ($6,000,000 - $300,000) = 12.6%
17.20
Chapter 17: Budgeting
SOLUTIONS TO PROBLEM SET A PROBLEM SET A 17.1 OAKBROOK FARM SUPPLY LTD Sales Budget for the six months ended 30 June 2012 Quarter 1 Expected unit sales Unit selling price Total sales
2
Six Months
35,000 50,000 85,000 x $60 x $60 x $60 $2,100,000 $3,000,000 $5,100,000
Oakbrook Farm Supply Production Budget for the six months ended 30 June 2012 Quarter 1 2 Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
35,000 12,000 47,000 8,000 39,000
50,000 18,000 68,000 12,000 56,000
Six Months
95,000
Oakbrook Farm Supply Direct Materials Budget – Gumm for the six months ended 30 June 2012 Quarter 1 Units to be produced Direct materials per unit Total kilograms needed for production Add: Desired ending direct materials (kilograms) Total materials required Less: Beginning direct materials (kilograms) Direct materials purchases Cost per kilogram Total cost of direct materials purchases
17.21
39,000 x5 195,000 10,000 205,000 9,000 196,000 x $3 $588,000
2
Six Months
56,000 x5 280,000 13,000 293,000 10,000 283,000 x $3 $849,000 $1,437,000
Solutions manual to accompany Accounting: building business skills 4e
Oakbrook Farm Supply Direct Materials Budget – Tarr for the six months ended 30 June 2012 Quarter 1 Units to be produced Direct materials per unit Total kilograms needed for production Add: Desired ending direct materials (kilograms) Total materials required Less: Beginning direct materials (kilograms) Direct materials purchases Cost per kilogram Total cost of direct materials purchases
2
39,000 x8 312,000 20,000 332,000 14,000 318,000 x $1.50 $477,000
Six Months
56,000 x8 448,000 25,000 473,000 20,000 453,000 x $1.50 $679,500 $1,156,500
Oakbrook Farm Supply Direct Labour Budget for the six months ended 30 June 2012 Quarter
Units to be produced Direct labour time (hours) per unit Total required direct labour hours Direct labour cost per hour Total direct labour cost
1
2
Six Months
39,000 x .25 9,750 x $12 $117,000
56,000 x .25 14,000 x $12 $168,000
95,000 x .25 23,750 x $12 $285,000
Oakbrook Farm Supply Selling and Administrative Expense Budget for the six months ended 30 June 2012 Quarter
Variable (8% of sales) Fixed Total
17.22
1
2
Six Months
168,000 175,000 $343,000
$240,000 175,000 $415,000
$408,000 350,000 $758,000
Chapter 17: Budgeting
Oakbrook Farm Supply Budgeted Income statement for the six months ended 30June 2012 Sales Cost of sales (85,000x $34.50) Gross profit Selling and administrative expenses Profit form ordinary activities Income tax expense (30%) Profit
$5,100,000 2,932,500 2,167,500 758,000 1,409,500 422,850 $986,650
*Standard Cost Per Bag
Quantity
Unit Cost
Total
Cost Element Direct materials: Gumm Tarr Direct labour Manufacturing overhead (150% of direct labour cost) Total
5 kilograms 8 kilograms .25 hour
$3.00 1.50 12.00
$15.00 12.00 3.00 4.50 $34.50
(c ) Budgetary control consists of (A) preparing periodic budget reports that compare actual results with planned objectives, (b) analysing the differences to determine their causes, (c ) taking appropriate corrective action, and (d) modifying future plans, is necessary.
17.23
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 17.2 JOE DUNHAM LTD (a) Joe Dunham Ltd Sales Budget for the year 30 June 2012 JB 50 Expected unit sales Unit selling price Total sales
JB 60
TOTAL
480,000 180,000 x $20 X $25 $9,600,000 $4,500,000
$14,100,000
(b) Joe Dunham Ltd Production Budget for the year 30 June 2012 JB 50
JB 60
TOTAL
480,000 25,000 505,000 30,000 475,000
180,000 15,000 195,000 10,000 185,000
660,000
Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
(c) Joe Dunham Ltd Direct Materials Budget for the six months ended 30 June 2012 JB 50 Units to be produced Direct materials per unit Total kilograms needed for production Add: Desired ending direct materials (kilograms) Total materials required Less: Beginning direct materials (kilograms) Direct materials purchases Cost per kilogram Total cost of direct materials purchases
17.24
JB 60
TOTAL
475,000 185,000 x2 x3 950,000 555,000 30,000 15,000 980,000 570,000 40,000 10,000 940,000 560,000 x $3 x $4 $2,820,000 $2,240,000 $5,060,000
Chapter 17: Budgeting
(d) Joe Dunham Ltd Direct Labour Budget for the six months ended 30 June 2012 JB 50 Units to be produced Direct labour time (hours) per unit Total required direct labour hours Direct labour cost per hour Total direct labour cost
475,000 x .40 190,000 x $11 $2,090,000
JB 60 185,000 x .60 111,000 x $11 $1,221,000
TOTAL 660,000 301,000 x $11 $3,311,000
(e) Joe Dunham Ltd Budgeted Income statement for the six months ended 30 June 2012
Sales Cost of sales (see below) Gross profit Less: Selling expenses Administrative expenses
JB 50 9,600,000 5,760,000 3,840,000
JB 60 4,500,000 3,600,000 900,000
TOTAL $14,100,000 9,360,000 4,740,000
660,000 420,000 1,080,000
360,000 340,000 700,000
1,020,000 760,000 1,780,000 2,960,000 888.000 $2,072,000
Profit form ordinary activities Income tax expense (30%) Profit (1) JB 50 480,000 x $12 =$5,760,000 (2) JB 60 180,000 x $20 = $3,600,000
17.25
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 17.3 HINDU INDUSTRIES LTD (a) Hindu Industries Ltd Sales Budget for the year ending 31 December 2014
Expected unit sales Unit selling price Total sales
Plan A
Plan B
*665,000 x $9.40 $6,251,000
850,000 x $8.50 $7,225,000
*$6,300,000 ÷ $9 = 700,000. 700,000 x95%=665,000 ** 700,000 +150,000 = 850,000 (b) Hindu Industries Ltd Production Budget for the year ending 31 December 2014 Plan A Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units *665,000 x4%
Plan B
665,000 *26,600 691,600 30,000 661,600
850,000 40,000 890,000 30,000 860,000
(c) Variable costs = $4.50 ($1.60 +$2.00 + $0.90) for both plans Plan A Total Variable costs Total fixed costs Total costs (a) Total units (b) Unit Cost (a) ÷ (b)
Plan B
661,600 x $2,977,200 $4.50 1,800,000 $4,777,200
$3,870,000
661,600
860,000
$7.22
$6.59
860,000 x $4.50
1,800,000 $5,670,000
The difference is due to the fact that fixed costs are spread over a larger number of units (198,400) in Plan B. 17.26
Chapter 17: Budgeting
(d)
Gross Profit calculation
Sales Less Cost of Sales Gross Profit
665,000 x $7.22
Plan A
Plan B
$6,251,000
$7,225,000
4,801,300
5,601,500
$1,449,700
$1,623,500
850,000 x $6.59
Plan B should be accepted as it produces a higher gross profit than Plan A
17.27
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 17.4 SIERRA STAR (a)
(1) Sierra Star Expected Collections from Customers
November ($200,000) December ($280,000) January ($350,000) February ($400,000) Totals
January
February
$40,000 84,000 175,000 $299,000
$56,000 105,000 200,000 $361,000
(2) Expected Payments for Direct Materials
December ($90,000) January ($95,000) February ($110,000) Totals
17.28
January
February
$54,000 38,000 $92,000
$57,000 44,000 $101,000
Chapter 17: Budgeting
(b) Sierra Star Cash Budget for the two months ended 28 February 2014
Beginning cash balance Add: Receipts: Collections from customers [See Schedule (1)] Interest receivable Sale of investments Total receipts Total available cash Less: Disbursements: Direct materials [See Schedule (2)] Direct labour Manufacturing overhead Selling and administrative expenses Purchase of land Total disbursements Excess (deficiency) of available cash over disbursements Financing: Borrowings Repayments Ending cash balance
17.29
January
February
$60,000
$55,000
299,000 3,000
361,000 5,000 366,000 421,000
302,000 362,000 92,000 80,000 60,000 75,000 307,000 55,000
101,000 95,000 75,000 85,000 20,000 376,000 45,000
$55,000
5,000 $50,000
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 17.5 REX LTD (a)
Rex Ltd Auckland Store Purchases Budget for the months of July and August 2014
Budgeted cost of sales Desired ending inventory Total Less: Beginning inventory Required purchases (1)
July
August
$280,000 78,750 358,750 70,000 $288,750
$315,000 87,500 402,500 78,750 $323,750
July
August
$400,000
$450,000
70,000 288,750 358,750 78,750 280,000 120,000
78,750 323,750 402,500 87,500 315,000 135,000
20,000 16,000 8,000 12,000 3,000 700 500 300 60,500 59,500 17,850 $41,650
20,000 18,000 9,000 13,500 3,000 700 500 300 65,000 70,000 21,000 $49,000
$500,000 x 70% x 25% = $87,500
(b) Rex Ltd Auckland Store Budgeted Income Statement for the months of July and August 2014
Sales Cost of sales: Beginning inventory Purchases Cost of goods available for sale Less: Ending inventory Cost of sales Gross profit Operating expenses: Sales salaries Advertising Delivery Sales commissions Rent Depreciation Electricity Insurance Total Profit from ordinary activities Income tax expense (30%) Profit
17.30
(1)
Chapter 17: Budgeting
PROBLEM SET A 17.6 SAGE INDUSTRIES
Sage Industries Budgeted Income statement for the year ended 31 December 2013 Sales (10,000 x $40) Cost of sales: Finished goods inventory 1 January Cost of goods manufactured ($120000+$80000+$30000)
$57,500 230,000
Cost of goods available for sale Less: Finished goods inventory 31 December (4,500 x $23)
287,500 103,500
Cost of sales Gross profit Selling and administrative expenses Profit from operations Interest expense Profit before income taxes Income tax expense (30%) Profit
$400,000
184,000 216,000 50,000 166,000 5,000 161,000 48,300 $112,700
17.31
Solutions manual to accompany Accounting: building business skills 4e
Sage Industries Budgeted Balance sheet as at 31 December 2013
Current assets: Cash Accounts receivable ($100,000 x 40%) Finished goods inventory (4,500 units x $23)
$42,200 40,000 103,500
Total current assets
$185,700
Property, plant and equipment: Equipment ($40,000 + $30,000) Less: Accumulated depreciation ($10,000 + $5,000)
$70,000 15,000
55,000
Total assets
$240,700
Liabilities: Bank loan ($40,000 - $10,000) Accounts payable ($30000x50% + $8,000)
$30,000 23,000
Income taxes payable Total liabilities Shareholders’ equity Share capital Retained earnings ($30,000 + $112,700 - $20,000) Total shareholders’ equity Total liabilities and shareholders’ equity
15,000 68,000 $50,000 122,700 172,700 $240,700
17.32
Chapter 17: Budgeting
PROBLEM SET A 17.7 GREISH LTD (a) Greish Ltd Assembly Department Monthly Flexible Manufacturing Overhead Budget for the year ended 31 December 2013
Activity level: Direct labour hours Variable costs: Indirect labour ($.30) Indirect materials ($.20) Repairs ($.10) Power ($.08) Lubricants ($.04) Total variable ($0.72)
18,000
20,000
22,000
24000
$5,400 3,600 1,800 1,440 720 $12,960
$6,000 4,000 2,000 1,600 800 $14,400
$6,600 4,400 2,200 1,760 880 $15,840
$7,200 4,800 2,400 1,920 960 $17,280
Fixed costs: Supervision Depreciation Insurance Rent Rates and taxes Total fixed Total costs
$6,000 3,000 800 600 500 $10,900 $23,860
$6,000 3,000 800 600 500 $10,900 $25,300
$6,000 3,000 800 600 500 $10,900 $26,740
$6,000 3,000 800 600 500 $10,900 $28,180
17.33
Solutions manual to accompany Accounting: building business skills 4e
(b) Greish Ltd Assembly Department Manufacturing Overhead Budget Report (Flexible) for the month ended 31 January 2013
Direct labour hours (DLH) Expected 20,500 Actual 20,000 Variable costs: Indirect labour Indirect materials Repairs Electricity Lubricants Total variable Fixed costs: Supervision Depreciation Insurance Rent Rates and taxes Total fixed Total costs
(c)
Budget at 20,000 DLH
Actual Costs 20,000 DLH
Difference Favourable F Unfavourable U
6,000 4,000 2,000 1,600 800 14,400
6,200 3,600 1,600 1,250 830 13,480
-200 U 400 F 400 F 350 F -30 U 920F
6,000 3,000 800 600 500 10,900 $25,300
6,000 3,000 800 700 500 11,000 $24,480
0 0 0 -100 U 0 0
Control over both variable and fixed costs was good.
17.34
$820 F
Chapter 17: Budgeting
PROBLEM SET A 17.8 NIGH LTD
(a)
Budgeted fixed costs plus (budgeted variable costs per unit x activity level). $34,000 + $3.20 [$192,000 ÷ (720,000÷12)] x activity level
(b) Nigh Ltd Assembly Department Budget Report (Flexible) for the month ended 31 August 2014
Units) Expected 62,000 Actual 58,000 Variable costs: Direct Materials ($0.80) Direct Labour ($1.30) Indirect materials ($0.40) Indirect labour ($0.30) Power ($0.25) Maintenance ($0.15) Total variable ($3.20) Fixed costs: Rent Supervision Depreciation Total fixed Total costs
Difference Favourable F Unfavourable U
Budget at 58,000 units
Actual Costs 58,000 units
$46,400 75,400 23,200 17,400 14,500 8,700 $185,600
$47,000 74,100 24,200 17,500 14,900 9,200 $186,900
600 F 1,300 U 1,000 U 100 U 400 U 500 U 1,300 U
10,000 17,000 7,000 34,000 $219,600
10,000 17,000 7,000 34,000 $220,900
$1,300 U
This report shows a better basis for evaluating performance because the budget is based on the level of activity actually achieved. The manager should be criticised because every variable cost except direct labour was over budget.
17.35
Solutions manual to accompany Accounting: building business skills 4e
(c) Nigh Ltd Assembly Department Budget Report (Flexible) for the month ended 30 September 2014
Units) Expected 65,000 Actual 64,000 Variable costs: Direct Materials ($0.80) Direct Labour ($1.30) Indirect materials ($0.40) Indirect labour ($0.30) Power ($0.25) Maintenance ($0.15) Total variable ($3.20) Fixed costs: Rent Supervision Depreciation Total fixed Total costs
Difference Favourable F Unfavourable U
Budget at 64,000 units
Actual Costs 64,000 units
$51,200 83,200 25,600 19,200 16,000 9,600 $204,800
$51,700 81,510 26,620 19,250 16,390 10,120 $205,590
500 U 1,690 F 1,020 U 50U 390 U 520 U 790 U
10,000 17,000 7,000 34,000 $238,800
10,000 17,000 7,000 34,000 $239,590
$790 U
The manager’s performance was slightly better in September than in August. However each variable cost except Direct Labour is still over budget.
17.36
Chapter 17: Budgeting
PROBLEM SET A 17.19 TIGER MANUFACTURING PTY LTD
Monthly Flexible Manufacturing Overhead Budget Assembly Department for the month ending 31 July 2013 (a) Activity level: Direct labour hours Variable costs: Indirect labour ($1) Indirect materials ($0.75) Electricity ($0.3) Maintenance ($0.2) Total variable ($2.25)
18,000
20,000
22,000
24,000
$18,000 $13,500 $5,400 $3,600 40,500
$20,000 $15,000 $6,000 $4,000 45,000
$22,000 $16,500 $6,600 $4,400 49,500
$24,000 $18,000 $7,200 $4,800 54,000
Fixed costs: Supervision Depreciation Insurance and taxes Total fixed Total costs
12,500 7,500 5,000 25,000 $65,500
12,500 7,500 5,000 25,000 $70,000
12,500 7,500 5,000 25,000 $74,500
12,500 7,500 5,000 25,000 $79,000
Tiger Manufacturing Pty Ltd Budget performance report Assembly Department for the month ending 31 July 2013 (b)
Direct labour hours (DLH) Expected 22,500 Actual 22,000 Variable costs: Indirect labour Indirect materials Electricity Maintenance Total variable Fixed costs: Supervision Depreciation Insurance and taxes Total fixed Total costs
Budget at 22, 000 DLH
Actual Costs 22, 000 DLH
Difference
$22,000 16,500 6,600 4,400 49,500
$21,000 15,000 5,800 4,200
46,000
$1,000 $1,500 $800 $200 $3,500
$12,500 7,500 5,000 25,000 $74,500
$12,500 7,500 5,000 25,000 $71,000
0 0 0 0 3,500 F
17.37
F/UF
F F F F F
Solutions manual to accompany Accounting: building business skills 4e
(c) The department has effectively controlled all the costs in July with variable costs all having favourable variances and there were no variances for the fixed costs. (d) The formula is fixed costs of $25,000 plus total variable costs of $2.25 per direct labour hour. (e)
Flexible budget manufacturing overhead 90 80
Costs (000)
70 60 Variable Cost Fixed Cost Total Cost
50 40 30 20 10 0 2
4
6
8
10 12 14 16 18 20 22 24 26 Direct labour hour(000)
17.38
Chapter 17: Budgeting
PROBLEM SET A 17.10 EVER GREEN LTD (a) Responsibility Reports No. 1 To: Bottling Department Manager – Brisbane Division Month: December Controllable Costs:
Budget
Actual
Differences
Indirect labour Indirect materials Maintenance Electricity Supervision Total
$109,500 $70,000 $30,750 $30,150 $30,000 $270,400
$136,000 $55,200 $30,600 $28,900 $30,000 $280,700
$26,500 ($14,800) ($150) ($1,250) $0 $10,300
F/UF U F F F U
No. 2 To Division Production Manager – Brisbane Division Month: December Controllable Costs:
Budget
Actual
Brisbane Division Departments:
$38,000
$37,000
Squeezing Bottling Packaging Total
Differences
F/UF
($1,000)
240,000 270,400 175,300 $723,700
228,000 280,700 184,000 $729,700
($12,000) $10,300 $8,700 $6,000
Controllable Costs:
Budget
Actual
Differences
General Manager Production Divisions:
$68,000
$65,800
F F U U U
No. 3 To General Manager – Production Month: December F/UF
Brisbane Sydney Melbourne Total
723,700 620,000 548,000 $1,959,700
17.39
729,700 654,000 553,000 $2,002,500
($2,200) F U U U
$6,000 $34,000 $5,000 $42,800 U
Solutions manual to accompany Accounting: building business skills 4e
No. 4 To Managing Director Month: December Controllable Costs:
Budget
Actual
Managing Director General Managers: Production Finance Sales Total
$76,000
$74,800
1,959,700 115,000 167,000 $2,317,700
2,002,500 108,000 172,000 $2,357,300
(b) (b) 1.
Differences F/UF ($1,200) F $42,800 ($7,000) $5,000 $39,600
U F U U
Within the Brisbane Division, the rankings of the department managers were: (1) Squeezing (2) Packaging (3) Bottling
2.
At the Division Manager level, the rankings were: (1) Melbourne (2) Brisbane (3) Sydney
3.
Rankings in terms of dollars may be somewhat misleading in this case because of the substantial difference between the production budget and the other budgets. On a percentage basis the differences and rankings are: (1) Finance, 6% Favourable (2) Production, 2% Unfavourable (3) Sales 3% Unfavourable
17.40
Chapter 17: Budgeting
PROBLEM SET A 17.11 LOCO MANUFACTURING
Furniture Division Management Responsibility Report for the year ended 31 December 2013 (a)
Budget
Actual Costs
Difference Favourable F Unfavourable U
Sales
$2,500,000
$2,550,000
$50,000 F
Variable costs: Cost of sales Selling and administrative Total
1,300,000 220,000 1,520,000
1,257,000 227,000 1,484,000
43,000 F 7,000 U 36,000 F
Contribution margin
980,000
1,066,000
86,000 F
Controllable fixed costs: Cost of sales Selling and administrative Total
200,000 50,000 250,000
205,000 52,000 257,000
5,000 U 2,000 U 7,000 U
Controllable margin
$730,000
$809,000
$79,000 F
(b)
The manager did effectively control revenues and costs. Contribution margin was $86,000 favourable and controllable margin was $79,000 favourable. The manager was effective in controlling Sales and cost of sales, but not fixed costs. However, the unfavourable difference of $7,000 was only 2.8% of the expected fixed costs.
(c)
Two costs are excluded from the report: (1) non-controllable fixed costs; and (2) indirect fixed costs. The reason is that neither cost is controllable by the Furniture Division Manager.
17.41
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 17.12 RIDDER MANUFACTURING LTD
Lawnmower Division Management Responsibility Report For the year ended 31 December 2014 (a)
Budget
Actual Costs
Difference Favourable F Unfavourable U
Sales
$3,000,000
$2,800,000
$200,000 U
Variable costs: Cost of sales Selling and administrative Total
1,250,000 350,000 1,600,000
1,400,000 300,000 1,700,000
150,000 U 50,000 F 100,000 U
Contribution margin
1,400,000
1,100,000
300,000 U
270,000 130,000 400,000
270,000 130,000 400,000
-
$1,000,000
$700,000
$300,000 U
*25%
**17.5
7.5% U
Controllable fixed costs: Cost of sales Selling and administrative Total Controllable margin ROI *$1,000,000 ÷ $4,000,000 **$700,000 ÷ $4,000,000 (b)
The performance of the manager of the lawnmower division was below budget expectations for the year. The item top management would be likely to investigate is the reason why sales were $200,000 below budget. Next inquiry would be made as to the reason variable cost of sales is $150,000 unfavourable. Finally, the reasons for the favourable variable selling and administrative expenses would be discussed. It is conceivable that an inadequate selling effort contributed to the lower sales.
(c)
1.
[$700,000 + ($1,400,000 x 15%)] = 22.75% $4,000,000
2.
$700,000 = 21.9% ($4,000,000 x 80%)
3.
($700,000 + $200,000) = 22.5% $4,000,000
17.42
Chapter 17: Budgeting
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 17.1 BLUE MOUNTAIN FARM SUPPLY Blue Mountain Farm Supply Sales Budget for the six months ended 30 June 2012 Quarter
Expected unit sales Unit selling price Total sales
1
2
Six Months
40,000 x $60 $2,400,000
60,000 x $60 $3,600,000
100,000 x $60 $6,000,000
Blue Mountain Farm Supply Production Budget for the six months ended 30 June 2012 Quarter
Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
17.43
1
2
40,000 15,000 55,000 10,000 45,000
60,000 20,000 80,000 15,000 65,000
Six Months
110,000
Solutions manual to accompany Accounting: building business skills 4e
Blue Mountain Farm Supply Direct Materials Budget – Crup for the six months ended 30 June 2012 Quarter
Units to be produced Direct materials per unit Total kilograms needed for production Add: Desired ending direct materials (kilograms) Total materials required Less: Beginning direct materials (kilograms) Direct materials purchases Cost per kilogram Total cost of direct materials purchases
1
2
Six Months
45,000 x6 270,000 12,000 282,000 9,000 273,000 x $3 $819,000
65,000 x6 390,000 15,000 405,000 12,000 393,000 x $3 $1,179,000
$1,998,000
Blue Mountain Farm Supply Direct Labour Budget for the six months ended 30 June 2012 Quarter 1 Units to be produced Direct labour time (hours) per unit Total required direct labour hours Direct labour cost per hour Total direct labour cost
2
45,000 x .25 11,250 x $10 $112,500
65,000 x .25 16,250 x $10 $162,500
Six Months 110,000 x .25 27,500 x $10 $275,000
Blue Mountain Farm Supply Selling and Administrative Expense Budget for the six months ended 30 June 2012 Quarter 1 Variable (10% of sales) Fixed Total
240,000 150,000 $390,000
17.44
2 $360,000 150,000 $510,000
Six Months $600,000 300,000 $900,000
Chapter 17: Budgeting
Blue Mountain Farm Supply Budgeted Income Statement for the six months ended 30June 2012 Sales Cost of sales (100,000 x $38)* Gross profit Selling and administrative expenses Profit form ordinary activities Income tax expense (30%) Profit
$6,000,000 3,800,000 2,200,000 900,000 1,300,000 390,000 $910,000
*Standard Cost Per Bag
Quantity Cost Element Direct materials: Crup Dert Direct labour Manufacturing overhead (100% of direct labour cost) Total
17.45
6 kilograms 10 kilograms .25 hour
Unit Cost
$3.00 1.50 10.00
Total
$18.00 15.00 2.50 2.50 $38.00
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 17.2 ROYAL PALM LTD (a) Royal Palm Ltd Sales Budget for the year ending 30 June 2012
Expected unit sales Unit selling price Total sales
Product RP 188
Product RP 268
22,000 30 $660,000
14,000 40 $560,000
Product RP 188
Product RP 268
22,000 4,840 26,840 4,400 22,440
14,000 3,080 17,080 2,800 14,280
Product RP 188
Product RP 268
22,440 2 44,880
14,280 3 42,840
TOTAL
$1,220,000
(b) Royal Palm Ltd Production Budget for the year ending 30 June 2012
Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
TOTAL
36,720
(c) Royal Palm Ltd Direct Materials Budget for the year ending 30 June 2012
Units to be produced Direct materials per unit Total kilograms needed for production
17.46
TOTAL
Chapter 17: Budgeting
Add: Desired ending direct materials (kilograms) Total materials required Less: Beginning direct materials (kilograms) Direct materials purchases Cost per kilogram Total cost of direct materials purchases
8,000
5,000
52,880 10,000
47,840 7,000
42,880 4 $171,520
40,840 5 $204,200
Product RP 188
Product RP 268
22,440 0.4 8,976 15 $134,640
14,280 0.6 8,568 15 $128,520
$375,720
(d) Royal Palm Ltd Direct Labour Budget for the year ending 30 June 2012
Units to be produced Direct labour time (hours) per unit Total required direct labour hours Direct labour cost per hour Total direct labour cost
17.47
TOTAL
36,720 17,544 15 $263,160
Solutions manual to accompany Accounting: building business skills 4e
(e) Royal Palm Ltd Budgeted Income statement for the year ending 30 June 2012
Sales Cost of sales (see below) Gross profit Less: Selling expenses Administrative expenses
Product RP 188
Product RP 268
TOTAL
660,000 308,000 352,000
560,000 336,000 224,000
$1,220,000 644,000 576,000
110,000 44,000 154,000
84,000 28,000 112,000
194,000 72,000 266,000 310,000 93000 $217,000
Profit from ordinary activities Income tax expense (30%) Profit (1) RP 188: 22,000 units x $14 =$308,000 (2) RP 268: 14,000 units x $24 = $336,000
17.48
Chapter 17: Budgeting
PROBLEM SET B 17.3 DAVID CHAMBERS LTD (a) David Chambers Ltd Sales Budget for the year ending 31 December 2013
Expected unit sales Unit selling price Total sales
Plan A
Plan B
*590,625 x $8.60 $5,079,375
756,250 x $7.60 $5,747,500
*656,250 x 90%= 590,635 ** 656,250 +100,000 = 756,250 (b) David Chambers Ltd Production Budget for the year ending 31 December 2014 Plan A Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
Plan B
59,625 87,500 678,125 75,000 603,125
756,250 100,000 856,250 75,000 781,250
(c) Variable costs = $4.00 ($2.00 +$1.50 + $0.50) for both plans Plan A Total Variable costs Total fixed costs Total costs (a) Total units (b) Unit Cost (a) ÷ (b)
603,125x $4 $2,412,500 965,000 $3,377,500
Plan B $3,125,000 781,250x$4 965,000 $4,090,000
603125
781,250
$5.60
$5.23
The difference is due to the fact that fixed costs are spread over a larger number of units (178,125) in Plan B. 17.49
Solutions manual to accompany Accounting: building business skills 4e
(d)
Gross Profit calculation
Sales Less Cost of Sales Gross Profit
590,625 x $5.60
Plan A
Plan B
$5,079,375 3,307,500
$5,747,500 3,955,188
$1,771,875
$1,792,312
756,250 x $5.23
Plan B should be accepted as it produces a higher gross profit than Plan A
17.50
Chapter 17: Budgeting
PROBLEM SET B 17.4 ZHANG LTD (a)
(1) Zhang Ltd Expected Collections from Customers
November ($260,000) December ($300,000) January ($360,000) February ($400,000) Totals
January
February
$52,000 90,000 180,000 $322,000
$60,000 108,000 200,000 $368,000
(2) Expected Payments for Direct Materials
December ($1000,000) January ($125,000) February ($130,000) Totals
17.51
January
February
$40,000 75,000 $115,000
$50,000 78,000 $128,000
Solutions manual to accompany Accounting: building business skills 4e
(b) Zhang Ltd Cash Budget for the two months ended 28 February 2014
Beginning cash balance Add: Receipts: Collections from customers [See Schedule (1)] Notes receivable Sale of investments Total receipts Total available cash Less: Disbursements: Direct materials [See Schedule (2)] Direct labour Manufacturing overhead Selling and administrative expenses Drawings Total disbursements Excess (deficiency) of available cash over disbursements Financing: Borrowings Repayments Ending cash balance
17.52
January
February
$70,000
$54,000
322,000 15,000
368,000 6,000 374,000 428,000
337,000 407,000 115,000 90,000 70,000 78,000 353,000 54,000
128,000 100,000 75,000 85,000 5,000 393,000 35,000
$54,000
15,000 $50,000
Chapter 17: Budgeting
PROBLEM SET B 17.5 MORRIS LTD (a) Morris Ltd Darwin Store Purchases Budget For the months of January and February 2014 January Budgeted cost of sales Desired ending inventory Total Less: Beginning inventory Required purchases *$66,000x 30% = $19800 **$66,000 x 110% 60% x 30% = $13068 ***$60000x30% = $18000
February
$60,000 $19,800* 79,800 $18,000*** $61,800
$66,000 13068** 79,068 19,800 $59,268
(b) Morris Ltd Darwin Store Budgeted income statement For the months of January and February 2014
Sales Cost of sales: Beginning inventory Purchases Cost of goods available for sale Less: Ending inventory Cost of sales Gross profit Operating expenses: Sales salaries Advertising Delivery Sales commissions Rent Depreciation Electricity Insurance Total Profit from ordinary activities Income tax expense (30%) Profit
17.53
January $100,000
February $110,000
18,000 61,800 79,800 19,800 60,000 $40,000
19,800 59,268 79,068 13,068 66,000 $44,000
$8,000 5,000 3,000 5,000 3,000 800 1000 500 26,300 $13,700 4,110 $9,590
$8,000 5,500 3,300 5,500 3,000 800 1000 500 27,600 $16,400 4,920 $11,480
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 17.6 VIOLA INDUSTRIES
Budgeted Income statement for the year ended 31 December 2013
Sales (8,000 x $35) Cost of sales: Finished goods inventory 1 January Cost of goods manufactured ($72,400 + $38,600 + $42,000) Cost of goods available for sale Finished goods inventory 31 December (2,500 x $18) Cost of sales Gross profit Selling and administrative expenses Profit from operations Interest expense Profit before income taxes Income tax expense (30%) Profit
$280,000 $30,000 153,000 183,000 45,000 138,000 142,000 76,000 66,000 3,500 62,500 18,750 $43,750
Viola Industries Budgeted Balance sheet as at 31 December 2013
Current assets: Cash Accounts receivable ($80,000 x 40%) Finished goods inventory (2,500 units x $18) Total current assets Property, plant and equipment: Equipment ($40,000 + $24,000) Less: Accumulated depreciation ($10,000 + $4,000) Total assets Liabilities: Bank loan ($25,000 - $8,000) Accounts payable ($8,500 + $7,500) Income taxes payable Total liabilities Shareholders’ equity Share capital Retained earnings ($30,000 + $43,750 - $5,000) Total shareholders’ equity Total liabilities and shareholders’ equity
17.54
$29,750 32,000 45,000 $106,750
$64,000 (14,000)
50,000 $156,750
$17,000 16,000 5,000 38,000 $50,000 68,750 118,750 $156,750
Chapter 17: Budgeting
PROBLEM SET B 17.7 CZERNKOWSKI & CO (a) Czernkowski & Co Packaging Department Monthly Flexible Manufacturing Overhead Budget for the year ended 31 December 2014
Activity level: Direct labour hours Variable costs: Indirect labour ($.40) Indirect materials ($.25) Repairs ($.15) Electricity ($.20) Lubricants ($.05) Total variable ($1.05)
27,000
30,000
33,000
36,000
$10,800 6,750 4,050 5,400 1,350 28,350
$12,000 7,500 4,500 6,000 1,500 31,500
$13,200 8,250 4,950 6,600 1,650 34,650
$14,400 9,000 5,400 7,200 1,800 37,800
Fixed costs: Supervision Depreciation Insurance Rent Rates and taxes Total fixed Total costs
7,500 4,500 2,250 3,000 1,500 18,750 $47,100
7,500 4,500 2,250 3,000 1,500 18,750 $50,250
7,500 4,500 2,250 3,000 1,500 18,750 $53,400
7,500 4,500 2,250 3,000 1,500 18,750 $56,550
17.55
Solutions manual to accompany Accounting: building business skills 4e
(b) Czernkowski & Co Packaging Department Manufacturing Overhead Budget Report (Flexible) for the month ended 31 October 2014
Direct labour hours (DLH) Expected 27,500 Actual 27,000 Variable costs: Indirect labour Indirect materials Repairs Electricity Lubricants Total variable Fixed costs: Supervision Depreciation Insurance Rent Rates and taxes Total fixed Total costs
(c)
Difference Favourable F Unfavourable U
Budget at 27,000 DLH
Actual Costs 27,000 DLH
$10,800 6,750 4,050 5,400 1,350 28,350
$11,760 6,400 4,000 5,900 1,640 29,700
$960 U 350 F 50 F 500 U 290 U 1,350 U
7,500 4,500 2,250 3,000 1,500 18,750 $47,100
7,500 4,500 2,225 3,000 1,500 18,725 $48,425
25 F 25 F $1,325 U
The overall performance of management was slightly unfavourable. However, none of the unfavourable differences exceeded 10% of budget except for lubricants (21%).
17.56
Chapter 17: Budgeting
PROBLEM SET B 17.8 LORCH LTD (a)
Budgeted fixed costs plus (budgeted variable costs per unit x activity level). $23,000 + $2.40 [$120,000 ÷ ($600,000÷12)] x activity level
(b) Lorch Ltd Packaging Department Budget Report (Flexible) for the month ended 31 May 2013
Units) Expected 57,000 Actual 55,000 Variable costs: Direct Materials ($0.60) Direct Labour ($1.00) Indirect materials ($0.30) Indirect labour ($0.25) Power ($0.15) Maintenance ($0.10) Total variable ($2.40) Fixed costs: Rent Supervision Depreciation Total fixed Total costs
Difference Favourable F Unfavourable U
Budget at 55,000 units
Actual Costs 55,000 units
33,000 55,000 16,500 13,750 8,250 5,500 132,000
32,000 53,000 15,200 13,000 7,100 5,200 125,500
1,000 F 2,000 F 1,300 F 750 F 1,150 F 300 F 6,500 F
9,000 9,000 5,000 23,000 $155,000
9,000 9,000 5,000 23,000 $148,500
___-___ $6,500 F
This report shows a better basis for evaluating performance because the budget is based on the level of activity actually achieved.
17.57
Solutions manual to accompany Accounting: building business skills 4e
(c) Lorch Ltd Packaging Department Budget Report (Flexible) for the month ended 30 June 2013
Units) Expected 39,000 Actual 40,000 Variable costs: Direct Materials ($0.60) Direct Labour ($1.00) Indirect materials ($0.30) Indirect labour ($0.25) Power ($0.15) Maintenance ($0.10) Total variable ($2.40) Fixed costs: Rent Supervision Depreciation Total fixed Total costs
Difference Favourable F Unfavourable U
Budget at 40,000 units
Actual Costs 40,000 units
$24,000 40,000 12,000 10,000 6,000 4,000 96,000
$25,600 42,400 12,160 10,400 5,680 4,160 100,400
$1,600 U 2,400 U 160 U 400 U 320 U 160 U 4,400 U
9,000 9,000 5,000 23,000 $119,000
9,000 9,000 5,000 23,000 $123,400
$4,400 U
The manager should be criticised because every variable cost was over budget.
17.58
Chapter 17: Budgeting
PROBLEM SET B 17.9 TARIQ MANUFACTURING PTY LTD (a) Tariq Manufacturing Pty Ltd Monthly Flexible Manufacturing Overhead Budget Assembly Department for the year ending 31 December 2012
Activity level: Direct labour hours Variable costs: Indirect labour ($1.20) Indirect materials ($.70) Electricity ($.30) Maintenance ($.20) Total variable ($2.40)
22,500
25,000
27,500
30,000
$27,000 15,750 6,750 4,500 54,000
$30,000 17,500 7,500 5,000 60,000
$33,000 19,250 8,250 5,500 66,000
$36,000 21,000 9,000 6,000 72,000
Fixed costs: Supervision Depreciation Insurance and taxes Total fixed Total costs
15,000 10,000 5,000 30,000 $84,000
15,000 10,000 5,000 30,000 $90,000
15,000 10,000 5,000 30,000 $96,000
15,000 10,000 5,000 30,000 $102,000
(b) Tariq Manufacturing Pty Ltd Assembly Department Manufacturing Overhead Budget Report (Flexible) for the month ended 31 July 2012
Direct labour hours (DLH) Expected 27,500 Actual 27,500 Variable costs: Indirect labour Indirect materials Electricity Maintenance Total variable Fixed costs: Supervision Depreciation Insurance and taxes Total fixed Total costs
Difference Favourable F Unfavourable U
Budget at 27,500 DLH
Actual Costs 27,500 DLH
$33,000 19,250 8,250 5,500 66,000
$32,000 17,000 8,100 5,400 62,500
$1,000 F 2,250 F 150 F 100 F 3,500 F
15,000 10,000 5,000 30,000 $96,000
15,000 10,000 5,000 30,000 $92,500
$3,500 F
17.59
Solutions manual to accompany Accounting: building business skills 4e
(c)
Based on the above budget report, control over costs was effective. For variable costs, all differences were favourable. For fixed costs, there were no differences between budgeted and actual costs.
(d)
The formula is fixed costs of $30,000 plus total variable costs of $2.40 per direct labour hour.
(e)
Total Budgeted Cost Line
$80 70
Costs in (000)
60 50 Budgeted Variable Costs
40 30 20 10
Budgeted Fixed Costs
5
10
15
20
25
30
35
Direct Labor Hours in (000)
17.60
40
45
50
Chapter 17: Budgeting
PROBLEM SET B 17.10 OTTO PRODUCTS Otto Products Responsibility Reports
(a) Responsibility reports for cost centres compare actual costs with flexible budget data. The reports show only controllable costs and no distinction is made between variable and fixed costs. Responsibility reports for profit centres show contribution margin, controllable fixed costs, and controllable margin for each profit centre. The main basis for evaluating performance in investment centres is return on investment (ROI). The formula for calculating ROI for investment centres is: Controllable margin (in dollars) / Average operating assets. (b) No. 1 To: Cutting Department Manager – Melbourne Division
Month: January
Controllable Costs:
Budget
Actual
Indirect labour Indirect materials Maintenance Electricity Supervision Total
$70,000 46,000 18,000 17,000 20,000 $171,000
$73,000 46,700 20,500 20,100 20,000 $180,300
No. 2 To Division Production Manager – Melbourne Division
Fav/Unfav $3,000 U 700 U 2,500 U 3,100 U $9,300 U
Month: January
Controllable Costs:
Budget
Actual
Fav/Unfav
Melbourne Division Departments: Cutting Shaping Finishing Total
$51,000 171,000 148,000 208,000 $578,000
$52,500 180,300 158,000 210,000 $600,800
$1,500 U 9,300 U 10,000 U 2,000 U $22,800 U
17.61
Solutions manual to accompany Accounting: building business skills 4e
No. 3 To General Manager – Production
Month: January
Controllable Costs: General Manager Production Divisions: Melbourne Christchurch Adelaide Total
Budget
Actual
Fav/Unfav
$64,000 578,000 673,000 715,000 $2,030,000
$65,000 600,800 676,000 722,000 $2,063,800
$1,000 U 22,800 U 3,000 U 7,000 U $33,800 U
No. 4 To Managing Director
Month: January
Controllable Costs:
Budget
Managing Director General Managers: Production Marketing Finance Total
$74,200
$76,400
$2,200 U
2,030,000 130,000 105,000 $2,339,200
2,063,800 133,600 107,000 $2,380,800
33,800 U 3,600 U 2,000 U $41,600 U
(c)
Actual
Fav/Unfav
1.
Within the Melbourne Division, the rankings of the department managers were: (1) Finishing (2) Cutting (3) Shaping.
2.
At the Division Manager level, the rankings were: (1) Christchurch (2) Adelaide (3) Melbourne.
3.
Rankings in terms of dollars may be somewhat misleading in this case because of the substantial difference between the production budget and the other budgets. On a percentage basis the differences and rankings are: (1) Production, .017 (2) Finance, .019 (3) Marketing. .028
17.62
Chapter 17: Budgeting
PROBLEM SET B 17.11 MCCLUSKEY MANUFACTURING McCluskey Manufacturing Home Appliance Division Management Responsibility Report for the year ended 31 December 2014 (a)
Budget
Actual Costs
Difference Favourable F Unfavourable U
Sales
$2,400,000
$2,300,000
$100,000 U
Variable costs: Cost of sales Selling and administrative Total
1,200,000 240,000 1,440,000
1,260,000 230,000 1,490,000
60,000 U 10,000 F 50,000 U
Contribution margin
960,000
810,000
150,000 U
Controllable fixed costs: Cost of sales Selling and administrative Total
200,000 60,000 260,000
190,000 66,000 256,000
10,000 F 6,000 U 4,000 F
Controllable margin
$700,000
$554,000
$146,000 U
(b)
The manager did not effectively control revenues and costs. Contribution margin was $150,000 unfavourable and controllable margin was $146,000 unfavourable. Contribution margin was unfavourable primarily because sales were $100,000 under budget and variable cost of sales was $60,000 over budget. Apparently the manager was unable to control variable cost of sales when sales failed to meet budget expectations. The manager was effective in controlling fixed costs. However, the favourable difference of $4,000 was only 27% of the unfavourable difference in contribution margin.
(c)
Two costs are excluded from the report: (1) non-controllable fixed costs (2) indirect fixed costs. The reason is that neither cost is controllable by the Home Appliance Division Manager.
17.63
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 17.12 KURIAN MANUFACTURING LTD Kurian Manufacturing Ltd Home Division Management Responsibility Report for the year ended 31 December 2013 (a)
Actual Costs
Difference Favourable F Unfavourable U
$1,400,000
$1,500,000
$100,000 F
Variable costs: Cost of sales Selling and administrative Total
600,000 100,000 700,000
700,000 125000 825,000
100,000 U 25,000 U 125,000 U
Contribution margin
700,000
675,000
25,000 F
Controllable fixed costs: Cost of sales Selling and administrative Total
170,000 100,000 270,000
170,000 100,000 270,000
-
Controllable margin
$430,000
$405,000
$25,000 U
*21.5%
**20.25
1.25% U
Budget Sales
ROI *$430,000 ÷ $2,000,000 **$405.000 ÷ $2,000,000 (b)
The performance of the manager of the home division was slightly below budget expectations for the year. The item top management would be likely to investigate is the reason why variable cost of sales is $100,000 unfavourable. In making the inquiry, it should be recognised that the budget amount should be adjusted for the increased sales as follows $1,500,000 x ($600,000÷$1,400,000) = $643,000. Thus, there should be an explanation of a $57,000 ($7000,000 - $643,000) unfavourable difference.
(c)
1.
$405,000 + ($700,000 x 6%) = 22.35% $2,000,000
2.
$405,000 = 22.5% $2,000,000 - ($2,000,000 x 10%)
3.
($405,000 + $90,000) = 24.75% $2,000,000
17.64
Chapter 17: Budgeting
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BBS 17.1 ERGO LTD (a)
(b)
Raw materials
Either lower quality materials resulting in an inferior product and possible lost sales, or fewer units produced resulting in lost sales.
Direct labour
Reducing production resulting in lost sales, or reduction in quality of product resulting in lost sales.
Insurance
Less coverage; may increase risk beyond acceptable levels.
Depreciation
To reduce depreciation, fixed assets would have to be disposed of, and this could result in less production and lost sales.
Machine repairs
Less efficient operations, or lost production and sales.
Sales salaries
Lost sales
Office salaries
Less effective administrative functions.
Factory salaries
Lost production due to inefficiency, and therefore lost sales.
Given the nature of their product, a decline in quality should be avoided, since this could result in lower future sales. Raw materials represent the largest single cost, and thus perhaps the greatest potential savings. Perhaps substitute materials of similar quality can be found, or less expensive materials can be used for aspects of the product where quality is not as critical. Additionally, it may be possible to renegotiate prices with suppliers. Ergo should be very reluctant to reduce repair costs, since in the long run this can be very expensive. Perhaps salaried and hourly employees can be encouraged to take pay cuts if a profit-sharing mechanism is introduced.
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BBS 17.2 OUTBACK
(a)
Sally Worthing – Profit Centre: Responsible for sales, inventory cost, advertising, sales personnel, printing and travel. She is not responsible for the assets invested in her division and probably does not control the rent or depreciation costs either. As a profit centre manager, she might have control of the insurance, but she probably does not. Guan Wei – Cost Centre: Responsible for inventory cost, advertising, sales personnel, printing, and travel. As a cost centre manager, he might or might not have control of rent and insurance costs, but he probably does not. He does not have control of the assets invested in his department; thus, he does not have control of the depreciation. Owen Hadley – Investment Centre: Responsible for all items shown.
(b)
Sally Worthington Budget difference: The inventory cost is 30% ($390,000 ÷ $300,000) above budget and so should definitely be brought to her attention. Travel is 25% below budget. Students may differ as to whether they believe that this should be brought to her attention. The differences in rent and depreciation should not be brought to her attention because she does not control those costs. Guan Wei Budget differences: The inventory cost which is 20% above budget should definitely be brought to his attention. Travel costs are 33% below budget. This should probably be brought to his attention so that he can make sure that the purpose that was to have been served by travel is being adequately served by other means. The 66% increase in rent and 10% decrease in depreciation are not under his control and so should not be brought to his attention. It should probably be pointed out to students that all budget differences are monitored by someone within the company. These differences that are not the responsibility of the various managers, but are still within the scope of top management’s responsibility. Oscar Hadley Budget differences: As manager of an investment centre, Mr Hadley is responsible for all categories of the budget. The selection in this case would be which differences merit his attention. Any decrease in a company’s gross profit margin (gross profit ÷ sales) is a cause for concern. (Remember the gross profit is sales minus cost of sales.) Thus, the 5% increase in cost of sales should be brought to his attention. Travel is below budget 25%, which is $1000. This is not a large percentage of total costs, nor is it a large dollar amount, so there could be an argument that this should be left out. The 20% increase in rent is only a $4,000 increase, so it could be included, though it might be left out as immaterial. The 50% increase in depreciation should definitely be included.
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Chapter 17: Budgeting
BBS 17.3 Students can choose either the Australian or New Zealand governments’ budgets to answer these questions. (a) The Australian government’s main source of income: • Income taxation revenue, including: individuals and other withholding taxes, fringe benefits tax, superannuation funds tax, company tax • Excise and customs revenue, including petrol, diesel, crude oil, beer, spirits and tobacco • Other taxation revenue, including: wine and luxury car tax • Non-taxation income, including sales of goods and services, dividends and interest received (b) The Australian government’s main types of expenses: • General public services • Defence • Education • Health • Social security and welfare • Community services and culture • Industry and workforce • Infrastructure, transport and energy (c) The Australian government forecasts that the underlying cash deficit is estimated to be $40.8 billion in 2010-11.
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BBS 17.4 GOLD COAST CITY COUNCIL
Gold Coast City Council has a very extensive website explaining the rates. The following information is from the website. (a)
1.
Components of the rates are: • • • • • • •
2.
3.
(b)
Differential General Rates Special rates and charges apply in relation to safety cameras, promotional activities in Broadbeach, Surfers Paradise and Coolangatta. Separate rates and charges Water charges Wastewater charges Class A+ Recycled Water Refuse service charge
There are a number of differential general rates and minimum general rates, which are set depending on whether properties are residential, commercial/industrial or rural. The minimum general rate for an owner occupied residential property is $683. The average general rate payable for owner occupied residential properties is $1,063. The water service charge for residential properties is $160 and $285 for nonresidential properties based on 20mm water service connection. The charge for water consumption is $2.24 per kilolitre for all properties.
Major business activities/programs of the council are: • • • • • • • • • •
City Planning – planning and management City Transport – road and public transport. Community Health and Safety – provides public health and safety community awareness programs. Conservation and Environment – protects and preserves natural environment. Integrated Water Cycle – plans and manages water supply, collection and treatment of water and wastewater. Parks, Recreation and Culture – provides a range of recreational programs and facilities. Waste Management – manage recycling facilities. Economic Development Internal Services Organisational Capability
These business groups run as profit making enterprises and thereby funding is obtained from external sources and internal sources by providing services and products to the council itself. Budgets are prepared for each business and the consolidated group. The Council business group is managed by a holding entity committee (akin to a Board of Directors in a public company). 17.68
Chapter 17: Budgeting
(c) The business activity selected was the City Planning. The three main types of services it provides are: • Land management and development control • Land use and urban planning • Streetscape The sources of revenues / funds are: • General revenue • Fees and charges • Internal revenue • Developer contributions and reserves • Contribution Revenue • Loans
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CRITICAL THINKING BBS 17.5 GREEN PASTURES
(a)
(1)
The primary causes of the loss in profit were the decrease in the number of boarding days and the decrease in the boarding fee. The number of boarding days decreased by 2,920 or approximately 13% (2,920 days ÷ 21,900 days), and the boarding fee decreased from $25(a) per day to $20(b) per day, a decrease of 20% ($5 ÷ $25). Together these resulted in a $167,900 decrease in sales revenue, a decrease of approximately 31% ($167,900 ÷ $547,500). (a)
$547,500 ÷ 21,900 days $379,600 ÷ 18,980 days
(b)
= $25 per day = $20 per day
(2)
Management did a poor job in controlling variable expenses. Given that boarding days declined by about 13%, variable expenses should decline by about 13%, or 2,920 more precisely, variable expenses should decline by $25,404 $190,530 x 21,900 . However, variable expenses only declined by $13,826 or about 7% ($13,826 ÷ $190,530). To repeat, management did a poor job in controlling variable expenses. Management did a better job in controlling fixed expenses. Fixed expenses were under budget by $5,000 and this includes the additional expenses incurred in advertising and entertainment.
(3)
Management’s decisions to stay competitive probably were sound. Given the decline in boarding days, the decision not to replace the worker was sound. The decision to reduce rates was probably forced by the competition. Without the additional advertising and entertainment expenses, the loss in profit might have been even greater.
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Chapter 17: Budgeting
(b) Green Pastures Income statement Flexible Budget Report for the year ended 31 December 2013 Difference Boarding days (BD) Expected Actual
Budget at 18,980 BD
Actual at 18,980 BD
Favourable F Unfavourable U
Sales ($25) Less: variable expenses: Feed ($5) Veterinary fees ($3) Blacksmith fees ($.30) Supplies ($.40) Total variable expenses ($8.70)
$474,500
$379,600
$94,900 U
94,900 56,940 5,694 7,592 165,126
104,390 58,838 6,074 7,402 176,704
9,490 U 1,898 U 380 U 190 F 11,578 U
Contribution margin Less fixed expenses: Depreciation Insurance Utilities Repairs and maintenance Labour Advertising Entertainment Total fixed expenses Profit
309,374
202,896
106,478 U
40,000 11,000 14,000 11,000 96,000 8,000 5,000 185,000 $124,374
40,000 11,000 12,000 10,000 88,000 12,000 7,000 180,000 $22,896
2,000 F 1,000 F 8,000 F 4,000 U 2,000 U 5,000 F $101,478 U
(c)
(1)
21,900 18,980
The primary causes of the loss in profit are the decreases in boarding rates and volume. The average daily rate charged was $20 ($379,600 ÷ 18,980). This rate resulted in a decrease in sales revenue of $94,900 or 20% ($94,900 ÷ $474,500). Given that it is ‘an extremely competitive business’, if Green Pastures had not reduced rates, boarding days almost certainly would have declined even more.
(2)
Management did a poor job of controlling variable expenses. These expenses in total were $11,578 over budget or 7% ($11,578 ÷ $165,126). Moreover each individual variable expense was over budget, except for supplies. Management did a good job on controlling fixed expenses as noted in part (a).
(3)
As noted in part (a), management’s decision to stay competitive probably was sound.
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(d)
Given that the industry is ‘extremely competitive’, management should consider two options. One, become the lowest cost operator. If Green Pastures is the company with the lowest operating costs, it can under-price its competitors and take customers away from them (increasing its sales). Eventually some of its competitors (those with the highest operating costs) will go out of business, and Green Pastures will get their customers, or at least some of them. Option two is to offer its customers a superior product or service. If customers perceive that Green Pastures is the ‘best’ boarding stable in Sydney, the company will take customers away from its competitors. Also, if Green Pastures is perceived as the ‘best’, many customers will be willing to pay a premium for its boarding service, and Green Pastures will be able to raise its rates.
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Chapter 17: Budgeting
BBS 17.6 FISHER LTD (a)
The budget at Fisher Ltd is an imposed ‘top-down’ budget which fails to consider both the need for realistic data and the human interaction essential to an effective budgeting/control process. The CEO has not given any basis for his goals, so no one knows if they are realistic for the company. True participation of company employees in the preparation of the budget is minimal and limited to mechanical gathering and manipulation of data. This suggests there will be little enthusiasm for implementing the budget. The budget process is the merging of the requirements of all facets of the company on a basis of sound judgement and equity. Specific instances of poor procedures other than the approach and goals may include the following: 1.
The sales by product line should be based upon accurate sales forecast of the potential market. Therefore, the sales by product line should be developed first to derive the sales target rather than the reverse.
2.
Production costs probably would be the easiest and most certain costs to estimate. Given variable and fixed production costs, the company can calculate the sales volume necessary to cover manufacturing costs plus the costs of other aspects of the operation. This would be helpful before the marketing and corporate head office budgets are set.
3.
The initial meeting between CFO, the finance director, the marketing manager and the production manager should be held much earlier in the budgeting process. It is held when all parties are already at logger heads.
(b)
Fisher Ltd should consider a ‘bottom-up’ approach for the budget process. This means that the employees responsible for the performance under the budget would participate in the decisions by which the budget is established. In addition, this approach requires initial and continuing involvement of sales, financial and production personnel to define sales and profit goals which are realistic within the constraints under which management operate. Although this approach is more time consuming, it will save time in the end as it will produce a budget which is more acceptable, honest and has a workable goalcontrolling mechanism. The sales forecast should be developed considering internal sales forecasts as well as the external factors. Cost within departments should be divided into fixed and variable, discretionary and nondiscretionary.
(c)
The functional areas should not necessarily be expected to cut costs when sales volume falls below budget. The time frame of the budget (annual) is short enough so that many costs are relatively fixed in amount. For those costs which are fixed, there is little hope for a reduction as a result of short run changes in production. However the functional areas should be expected to cut costs should sales volume fall below target when: 1. Control is exercised over the costs within their function 2.
Budgeted costs were more than adequate for the original sales target (i.e.: slack was present).
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3.
Budgeted costs vary to some extent with changes in sales
3.
There are discretionary costs which can be delayed or omitted without serious impact on the department.
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Chapter 17: Budgeting
BBS 17.7 VEK-TEK LTD (a)
At best, if you disclose the errors in your calculations, you will be embarrassed. At worst, you will be dismissed without a recommendation for another job.
(b)
The managing director will continue making presentations using data that are grossly overstated. In time, your error may be detected when the events you projected do not materialise.
(c)
The most ethical scenario would be to admit your error, let the managing director know about the error, provide the managing director with corrected projections, and allow the managing director to decide how to alter his presentations during the second week of his speech-making.
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BBS 17.8 CATHEDRAL LTD
(a)
B Sherrick should be able to control all the variable expenses and the fixed expenses of supervision and inspection. Insurance and depreciation ordinarily are not the responsibility of the department manager.
(b)
The total variable cost per unit is $26.50 ($159,000 ÷ 6000). The total budgeted cost during the month to manufacture 4500 units is variable costs $119,250 (4,500 × $26.50) plus fixed costs ($105 000), for a total of $224,250 ($119,250+ $105,000).
(c)
Flexible manufacturing overhead budget report Cathedral Ltd Production Department Manufacturing overhead Budget Report (Flexible) For the month ended 30 April 2012
Units) Expected 6,000 Actual 4,500 Variable costs: Indirect materials ($12.50) Indirect labour ($6.00) Maintenance ($5.00) Manufacturing Supplies($3.00) Total variable ($26.50) Fixed costs: Supervision Inspection costs Insurance expenses Depreciation Total fixed Total costs
Difference Favourable F Unfavourable U
Budget at 4,500 units
Actual Costs 4,500 units
$56,250 27,000 22,500 13,500 119,250
$75,600 40,500 24,600 15,300 156,000
$19,350 U 13,500 U 2,100 U 1,800 U 36,750 U
51,000 3,000 6,000 45,000 105,000 $224,250
57,900 3,600 6,600 44,100 112,200 $268,200
6,900 U 600 U 600 U 900 F 7,200 U $43,950 U
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Chapter 17: Budgeting
(d)
Responsibility Report Cathedral Ltd Production Department Manufacturing Overhead Responsibility Report For the month ended 30 April 2012
Controllable Costs
Indirect materials Indirect labour Maintenance Manufacturing Supplies Supervision Inspection costs Total
Budget
Actual
$56,250 27,000 22,500 13,500 51,000 3,000 $173,250
$75,600 40,500 24,600 15,300 57,900 3,600 $217,500
Difference Favourable F Unfavourable U $19,350 U 13,500 U 2,100 U 1,800 U 6,900 U 600 U $44,250 U
MEMO To:
Ms B Sherrick – Production Manager
From:
Mr A Student – General Manager
Subject:
Performance evaluation for the month of April 2012
Your performance in controlling costs that are your responsibility was very disappointing in the month of April 2010. As indicated in the accompanying responsibility report, total costs were $44 250 over budget. On a percentage basis, costs were 26% over budget. As you can see, actual costs were over budget for every cost item. In three instances, costs were significantly over budget (indirect materials 34%, indirect labour 50%, and supervision 14%). It is imperative that you get costs under control in your department as soon as possible. We need to talk about ways to implement more effective cost control measures. Please meet in my office at 9 a.m. on Wednesday to discuss possible alternatives.
Respectfully Andrew Student
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BBS 17.9 Suggestions for discussion Sources of income may include: • Salary from part-time work • AustStudy from the government • Pocket money from parents • Scholarship Expenses may include: • Tuition fee • Textbooks • Rent • Transportation • Food and drinks • Health care • Mobile phones Use of surplus – pay off debt (HECS fee, credit card), invest in share market, pay for holiday Funding of deficit – borrow from parents, credit card debt
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Chapter 17: Budgeting
BBS 17.10 (a) Sound, Economics and Ecological (b) Eight attributes or elements of Social Sustainability have been identified 1. Community participation and Social capital 2. Community access 3. Local character and cultural and indigenous heritage 4. Natural hazard mitigation 5. Housing choice 6. Human health and safety 7. Residential amenity 8. Transport services (c) State Land area protected (km2) The Gold Coast has a large range of ecosystems and habitats, is possibly the most biologically diverse city in Australia, and has more bird species than Kakadu. This biodiversity is underpinned by some 72,250 ha (almost 50 percent of the Gold Coast) of remnant bushland. Only about 10 percent of this bushland is committed to development, with a further 28 percent highly likely to be affected. Some 35 percent of vegetation is completely protected by State and Council provisions and the remaining 27 percent is unlikely to be developed. Pressure Rate of clearing (km2 /yr) Despite this wealth of biodiversity, there are many species that are rare, threatened or endangered. There are 76 known animal species and around 99 known plant species recognised, under legislation, as being at risk. Clearing and habitat destruction, which is the primary threat to biodiversity, is often associated with the growth of a city. Road traffic and inappropriate fire regimes are examples of a number of factors associated with land management practices that threaten biodiversity. Response Expenditure ($) Governments provide a range of levels of protection to the biodiversity of the area, including: federal laws and agreements, state laws and crown land, national parks and reserves, and reserves, and council local laws and policies. Council continues to implement the Bushfire Management Strategy, Nature Conservation Strategy, Beaches to Bushland programs and Coastal Dune Restoration programs. Community groups and private landholders also work to conserve biodiversity. At the time the solution was prepared, the 2005-06 report was current.
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CHAPTER 18 – INCREMENTAL ANALYSIS AND CAPITAL BUDGETING ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Brief Exercises
Exercises
Problems
Building Business Skills
1.
Identify the steps in management’s decision making process.
2.
Describe the concept of incremental analysis.
3.
Describe the common types of decisions involving incremental analysis.
4.
Discuss the capital budgeting evaluation process and explain what inputs are used in capital budgeting.
5.
Explain the net present value method.
5
7,8,9,11,12
5A, 6A, 7A,8A,9A, 10A 5B,6B, 7B,8B,9B, 10B
2,3,6
6.
Explain the internal rate of return method.
6
9,10,12
5A,6A,7A,9A 5B, 6B, 7B,9B
3,6
7.
Explain other capital budgeting techniques.
7, 8
1,7, 8,11,12
5A,6A,10A 5B,6B,10B
3,6
1
5,8
1
1
6
2, 3, 4
2, 3, 4, 5,6
1A, 2A 3A,4A 1B,2B,3B, 4B
1
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1,5,6,8
3,4,7
Chapter 18: Incremental analysis and capital budgeting
ANSWERS TO QUESTIONS 1.
The following steps are frequently involved in management’s decision-making process: (1)
Identify the problem and assign responsibility.
(2)
Determine and evaluate possible courses of action.
(3)
Make a decision.
(4)
Review results of the decision.
2.
Disagree. Incremental analysis involves the identification of financial data that change under alternative courses of action.
3.
The manufacturing costs that are relevant in the make or buy decision are those that will change if the parts are purchased.
4.
The decision rule in a decision to sell a product or to process it further is: Process further as long as the incremental revenue from the additional processing exceeds the incremental processing costs.
5.
Profit will be lower if an unprofitable product line is eliminated when the product line is producing a positive contribution margin and its fixed costs cannot be avoided or reduced.
6.
The decision rule is: Accept the project when net present value is nil or positive; reject the project when net present value is negative.
7.
The steps are: 1.
Calculate the rate of return factor by dividing capital investment by annual cash inflows.
2.
Use the factor and the table showing present value of an annuity of 1 to find the internal rate of return.
8.
Examples of intangible benefits of investment projects would be increased product quality, increased safety, continued employment of existing employees. Intangible benefits often complicate the capital budgeting process because their value can be difficult to quantify. Ignoring intangible benefits may result in rejecting projects that would be financially beneficial to the company.
9.
The cash payback technique is relatively easy to calculate and understand. However, it should not ordinarily be the only basis for the capital budgeting decision because it ignores the profitability of the investment and the time value of money.
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Solutions manual to accompany Accounting: building business skills 4e
10.
The advantages of this method are the simplicity of its calculation and management’s familiarity with the accounting terms used in the computation. A limitation is that it does not consider the time value of money. Also, by employing accrual accounting numbers rather than cash flows, it ignores the fact that the value of investment proposals is based on the cash flows that it generates.
18.3
Chapter 18: Incremental analysis and capital budgeting
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18.1 Answers would vary according to the big-ticket items selected. If a laptop computer is selected as an example, then: • relevant costs, which are costs that differ across different alternatives, would include the cost of different models of laptops or desktop computers; • opportunity cost, which is the benefit that may be obtained from following an alternative course of action, would include the lost benefit from buying a desktop computer; • sunk cost, which is a cost that cannot be changed, would be the costs of the existing laptop/desktop computer and the cost of software that is being replaced. BRIEF EXERCISE 18.2 ESSEX LTD Reject Order Revenues Costs – Variable manufacturing – Shipping Profit
Profit Increase (Decrease)
Accept Order $-
$100,000 80,000 4,000 $16,000
$100,000 (80,000) (4,000) $16,000
The special order should be accepted.
BRIEF EXERCISE 18.3 TYRON LTD
Retain Equipment Variable manufacturing costs New machine cost Total
$700,000 $700,000
*($700,000 – 550,000) x 4=$600,000 The old factory machine should be replaced. 18.4
Replace Equipment $550,000 300,000 $850,000
4-Year Profit Increase (Decrease) *$600,000 (300,000) $300,000
Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 18.4 SPRING LTD
Continue Sales Variable expenses Contribution margin Fixed expenses Profit
Eliminate
$300,000 270,000 30,000 60,000 $(30,000)
$28,000 ($28,000)
Profit Increase (Decrease) ($300,000) 270,000 (30,000) 32,000 $ 2,000
The Eagle product line should be discontinued because $30,000 of contribution margin is less than the $32,000 of fixed cost savings.
BRIEF EXERCISE 18.5 LINDY BOTTLING LTD
Cash Flows
Present value of annual cash flows Present value of residual value
$33,000 -
x
x x
10% Discount Factor
=
5.33493 .46651
= =
Present Value
$176,053 $176,053 200,000 ($23,947)
Capital investment Net present value
The reduction in downtime would have to have a present value of at least $23,947 in order for the project to be acceptable.
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Chapter 18: Incremental analysis and capital budgeting
BRIEF EXERCISE 18.6 SMITH LTD
When net annual cash inflows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash inflows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. Since this exercise has a residual value, not all cash flows are equal. In this case the internal rate of return can be approximated by identifying the discount rate that will result in a net present value of nil. By experimenting with various rates we determined that the net present value is approximately nil when a discount rate of approximately 10% is used. Net annual cash inflows = $400,000 - $158,000 = $242,000. Cash Flows
Present value of annual cash flows Present value of residual value
$242,000 700,000
x
x x
Capital investment Net present value
10% Discount Factor
=
7.60608 .23939
= =
Present Value
$1,840,671 167,573 $2,008,244 2,008,000 $244
The 10% internal rate of return exceeds the company’s 7% hurdle rate; thus the project should be accepted. BRIEF EXERCISE 18.7 SNAKE LTD
Payback period: $600,000 ÷ ($10,000 + $60,000) = 8.57 years.
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Solutions manual to accompany Accounting: building business skills 4e
BRIEF EXERCISE 18.8 MARAIS OIL
The annual rate of return is calculated by dividing expected annual profit by the average investment. The company’s expected annual profit is: $100,000 - $80,000 = $20,000 Its average investment is: $410,000 + $10,000 = $210,000 2
Therefore, its annual rate of return is: $20,000 ÷ $210,000 = 9.5%
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Chapter 18: Incremental analysis and capital budgeting
SOLUTIONS TO EXERCISES EXERCISE 18.1 (a) Opportunity costs (b) Non-financial data (c) Required rate of return (d) Time value of money (e) Cash payback period (f) Cost of capital EXERCISE 18.2 WEBSTER LTD
(a). Incremental analysis is the process that is used to identify financial data that change under alternative courses of action. These data are relevant to the decision because they will vary in the future among the possible alternatives.
Webster Ltd (b)
Reject Order Revenues (15,000 x $6.00) Cost of sales Operating expenses Profit
Profit Increase (Decrease)
Accept Order $$-
$90,000 63,000 23,250 b. $3,750
(1)a. (2) c.
$90,000 (63,000) (23,250) $3,750
(1)
Variable cost of sales Variable cost of sales per unit Variable cost of sales for the special order
= $2,400,000 x 70% = $1,680,000 = $1,680,000 ÷ 400,000 = $4.20 = $4.20 x 15,000 = $63,000
(2)
Variable operating expenses $540,000 ÷ 400,000 = $1.35 per unit; 15,000 x $1.35 = $20,250; $20,250 + $3,000 = $23,250.
(c)
As shown in the incremental analysis, Webster Ltd should accept the special order because incremental revenues exceed incremental expenses by $3,750.
= $900,000 x 60% = $540,000’
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Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 18.3 (a) WALLACE LTD
Make Direct materials (30,000 x $4.00) Direct labour (30,000 x $6.00) Variable manufacturing costs ($180,000 x 50%) Fixed manufacturing costs Purchase price (30,000 x $13.50) Total annual cost
Buy
$120,000 $180,000 90,000 40,000 40,000 405,000 $430,000 $445,000
Profit Increase (Decrease) $120,000 180,000 90,000 (405,000) ($15,000)
(b)
No, Wallace Ltd should not purchase the lamps. As indicated by the incremental analysis, it would cost the company $15,000 more to purchase the lamps.
(c)
Yes, by purchasing the lamp shades, a total cost saving of $20,000 will result as shown below:
Total annual cost (above) Opportunity cost Total cost
18.9
Make
Buy
Profit Increase (Decrease)
$430,000 35,000 $465,000
$445,000 $445,000
($15,000) 35,000 $20,000
Chapter 18: Incremental analysis and capital budgeting
EXERCISE 18.4 DEBBIE CHEUNG
Sales per unit Costs per unit Direct materials Direct labour Total Profit per unit
Sell (Basic Kit)
Process Further (Stage 2 Kit)
Profit Increase (Decrease)
$27.00
$32.00
$5.00
$12.00 $12.00 $15.00
$6.00 (1) 8.00 (2) $14.00 $18.00
$6.00 (8.00) 2.00 $3.00
(1)
The cost of materials decreases because Debbie can make two Stage 2 Kits from the materials for a basic kit.
(2)
The total time to make the two kits is one hour at $16 per hour or $8.00 per unit.
Debbie should carry the Stage 2 Kits. The incremental revenue $5.00 exceeds the incremental processing costs by $3.00. Thus, profit will increase by processing the kits further.
EXERCISE 18.5 YAN PRODUCTIONS
Retain Machine Operating costs New machine cost (Depr.) Residual value (old) Total (1) (2)
$110,000 $110,000
Profit Increase (Decrease)
Replace Machine (1)
$90,000 25,000 (7,000) $108,000
(2)
$20,000 (25,000) 7,000 $2,000
$22,000 x 5 $18,000 x 5
The current machine should be replaced. The incremental analysis shows that profit for the fiveyear period will be $2,000 higher by replacing the current machine.
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Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 18.6 WINSER LTD (a) Winser Ltd
Continue Sales Variable expenses: Cost of sales Operating expenses Total variable Contribution margin Fixed expenses: Cost of sales Operating expenses Total fixed Profit (loss)
Profit Increase (Decrease)
Eliminate
$98,200
-
($98,200)
60,000 12,000 72,000 26,200
-
60,000 12,000 72,000 26,200
16,470 26,600 43,070 (16,870)
16,470 24,600 43,070 (43,070)
(26,200)
Lisa is incorrect. The incremental analysis shows that profit will be $26,200 less if the Brisbane Division is eliminated. This amount equals the contribution margin that would be lost through discontinuing the division. (Note: None of the fixed costs can be avoided.)
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Chapter 18: Incremental analysis and capital budgeting
EXERCISE 18.7 GRIGOR MANUFACTURING
(a)
AA = $22,000 ÷ ($31,500 ÷ 3) = 2.10 years BB = $22,000 ÷ ($28,500 ÷ 3) = 2.32 years CC = $22,000 ÷ ($33,000 ÷ 3) = 2.00.years The most desirable project is CC because it has the shortest payback period and meets Grigor’s requirements. The least desirable project is BB because it has the longest payback period.
(b) Discount Factor
Cash Inflow
Present Value
Cash Inflow
1 .86957 2 .75614 3 .65752 Total present value Investment Net present value
$7,500 9,000 15,000
$6,522 6,805 9,863 23,190
$9,500 9,500 9,500
Year
22,000 $1,190
Present Value $8,261 7,183 6,246 21,690 (1) 22,000 ($310)
Cash Inflow
Present Value
$13,000 9,000 11,000
$11,304 6,805 7,233 25,342 22,000 $3,342
(1) This total may also be obtained from Table 4, (p982 of text): $9,500 x 2.28323 = $21,690.
Project CC is still the best project. Also, on the basis of net present values, all of the projects except BB are acceptable.
18.12
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 18.8 SMITHERS LTD
(a)
The cash payback period is: $85,000 ÷ $12,000 = 7.08years Note the residual value is not taken into account as it is received after the payback period. The net present value is:
Present value of annual cash flows Present value of residual value
Cash Flows
x
8% Discount Factor
=
$12,000 35,000
x x
5.74664 .54027
= =
Capital investment Net present value
(b)
Present Value
$68,960 18,909 $87,869 85,000 $2,869
In order to meet the cash payback criteria the project would have to have a cash payback period of less than 4 years (8 ÷ 2). It does not meet this criterion. The net present value is positive however, suggesting the project should be accepted. The reason for the difference is that the project’s high estimated residual value increases the present value of the project. The net present value is a better indicator of the project’s worth.
18.13
Chapter 18: Incremental analysis and capital budgeting
EXERCISE 18.9 KRANE LTD
Machine A
Present value of annual cash flows Present value of residual value
Cash Flows
x
9% Discount Factor
=
$25,000 -
x x
5.53482 .50187
= =
Present Value $138,370 $138,370 125,000 $13,370
Capital investment Net present value Internal rate of return $125,000 ÷ $25,000 = 5
Table 4, p982 of text, the factor for 8 periods which is closest to five is between 11 and 12%. Say 11.5%.
Machine B
Present value of annual cash flows Present value of residual value Capital investment Net present value
Cash Flows $40,500 -
x
8% Discount Factor
=
x x
5.53482 .50187
= =
Present Value $224,160 $224,160 270,000 ($45,840)
Internal rate of return $270,000 ÷ $40,500 = 6.66666 Table 4, p982, the factor for 8 periods which is closest to 6.66666 is between 4 and 5%. Say 4.5%. Machine B has a negative lower net present value and an internal rate of return of only 4.5%, which is less than the required return. Machine A has a positive net present value and an internal rate of return of approximately 11.5%. Therefore Machine A is the preferred machine.
18.14
Solutions manual to accompany Accounting: building business skills 4e
EXERCISE 18.10 NOVAK INDUSTRIES (a)
Project
Investment
22A 23A 24A
$240,000 ÷ ($15,000 + $40,000*) = $270,000 ÷ $26,400 + $30,000) = $288,000 ÷ ($22,000 + $36,000) = *$240,000 ÷ 6yrs=$40,000 p.a .dep’n
(b)
÷
(Profit + Depreciation)
=
Internal Rate of Return Factor
Closest Discount Factor
Internal Rate of Return
4.364 4.787 4.966
4.35526 4.77158 4.96764
10% 15% 12%
The acceptable projects are 23A and 24A because their rates of return are equal to or greater than the 12% minimum required rate of return.
EXERCISE 18.11 DEEPRA STEEL
(a)
(1)
Cash payback: $180,000 ÷ $58,000 = 3.10 years.
(2)
Return on average investment = $21,000 ÷ [($180,000 + $0) ÷ 2] = 23%.
(b) Item
Amount
Years
PV Factor
Annual cash inflows Capital investment Net present value
$58,000 $180,000
1-5 Now
3.35216 1.00000
18.15
Present Value $194,425 180,000 $14,425
Chapter 18: Incremental analysis and capital budgeting
EXERCISE 18.12 MANNING OYSTER FARM
(1) Cash payback (years): = Amount invested / Expected annual net cash inflows
=700000/156000
=500000/128000
Cash payback in years
9.21
8.62
Exp. Annual profit = Net annual cash inflows - Annual Depreciation
=76000-35000
=58000-13000
Exp. Annual profit =
$41,000
$45,000
Avg. investment = (Initial investment + Residual value)/2
=(700000+0)/2
=(500000+240000)/2
Avg. investment =
$350,000
$370,000
RAI =Exp. annual profit / Avg. investment
=41000/350000
=45000/370000
RAI =
11.71%
12.16%
$746,176
$569,450
(2) Return on average investment (RAI): =Exp. annual profit / Avg. investment
(3) Net present value (NPV): PV of annuity of annual net cash inflows, 20 yrs @8% PV of residual value at the end of 20 yrs @8%
$51,480
Total PV of net cash inflows
$746,176
$620,930
Initial investment
$700,000
$500,000
NPV
$46,176
$120,930
Annuity PV factor = Investment / Expected annual net cash inflows
9.210526316
8.620689655
IRR for annuity PV factor for 20 years
8.5%
9.5%
(4) Internal rate of return (IRR):
Plan B is better than Plan A because it has shorter payback period, higher return on average investment, higher NPV and IRR.
18.16
Solutions manual to accompany Accounting: building business skills 4e
SOLUTIONS TO PROBLEM SET A
PROBLEM SET A 18.1 TAMPURA MANUFACTURING
Tampura Manufacturing (a) Make LINC
Buy LINC
Direct materials Direct labour Indirect labour Electricity Depreciation Rates and taxes Insurance Purchase price Freight and inspection Receiving costs Total annual cost
$33,250 32,200 3,150 2,450 2,500 600 1,500 $75,650
$900 200 600 75,000 2,100 750 $79,550
Profit Increase (Decrease) $33,250 32,200 3,150 2,450 1,600 400 900 (75,000) (2,100) (750) ($3,900)
(b)
The company should continue to make LINC because profit would be $3,900 less if LINC were purchased from the supplier.
(c)
The decision would be different. Because of the opportunity cost of $4,000, profit will be $100 higher than if LINC is purchased as shown below:
Make LINC
Buy LINC
Total annual cost Opportunity cost Total cost
(d)
$75,650 4,000 $79,650
$79,550 $79,550
Profit Increase (Decrease) ($3,900) 4,000 $100
Non-financial factors include: (1) the adverse effect on employees if LINC is purchased; (2) how long the supplier will be able to satisfy the Tampura Manufacturing Company’s quality control standards at the quoted price per unit; and (3) whether the supplier will deliver the units when they are needed by Tampura.
18.17
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET A 18.2 CHAMPION RUNNER LTD (a) Make shoes in-house
Relevant costs: Direct materials Direct labour Variable overhead Fixed overhead Purchase cost from outsider Total cost of obtaining shoes Profit from other products Net cost of obtaining 10,000 pairs of shoes
$100,000 60,000 50,000 90,000
Outsourcing
Make another products
$300,000
$60,000 250,000 $310,000
$90,000 250,000 $340,000 -50,000
$300,000
$310,000
$290,000
(b) The alternative of outsourcing and using the spare facilities to make another product is the option with the lowest cost for producing 10,000 pairs of shoes. Assuming other non-financial information has been taken into account, the third option appears to be the best course of action. PROBLEM SET A 18.3 ROSE LTD (a)
35,000 units
Make TROPICA
Buy TROPICA
$70,000 72,000 7,500 1,500 1,800 1,000 153,800 3,600 $157,400
$-
Direct materials ($2) Direct labour 3x2,000x$12 Indirect labour Utilities Depreciation Taxes and Insurance Rent Storage (4500 x$0.80) Purchase price ($4) Freight and inspection ($0.40) Receiving costs Storage (4,500 x 0.80) Total annual cost
(3,600) 140,000 14,000 8,500 $158,900
Profit Increase (Decrease) $70,000 72,000 7,500 1,500 1,800 1,000 3,600 (140,000) (14,000) ( 8,500) 3,600 ($1,500)
The company should continue to make Tropica because profit would be $1,500 less if Tropica were purchased from the supplier.
18.18
Solutions manual to accompany Accounting: building business skills 4e
(b)
The decision would be different. Because of the opportunity cost of $10,000, profit will be $8,500 higher than if Tropica is manufactured as shown below:
Total annual cost Opportunity cost 10,000 Total cost
(c)
Make TROPICA
Profit Buy Increase TROPICA (Decrease)
$157,400 10,000 $167,400
$158,900 $158,900
($1,500) 10,000 $8,500
Non-financial factors include: (1) the adverse effect on employees if TROPICA is purchased; (2) how long the supplier will be able to satisfy Rose Ltd’s quality control standards at the quoted price per unit; and (3) whether the supplier will deliver the units when they are needed by Rose.
18.19
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET A 18.4 SIMPSON MANUFACTURING (a)
Sales Variable expenses: Cost of sales Selling and administrative Total variable expenses Contribution margin
(b)
III
IV
$200,000
$300,000
175,500 45,500 221,000 ($21,000)
210,000 30,000 240,000 $60,000
(1) Profit Increase Continue Eliminate (Decrease)
Division III Contribution margin (above) Fixed expenses: Cost of sales Selling and administrative Total fixed expenses Profit (Loss) from operations
($21,000)
$-
$21,000
19,500 19,500 39,000 ($60,000)
9,750 9,750 19,500 ($19,500)
9,750 9,750 19,500 $40,500
(2) Profit Increase Continue Eliminate (Decrease)
Division IV Contribution margin (above) Fixed expenses: Cost of sales Selling and administrative Total fixed expenses Profit (Loss) from operations
$60,000
$-
($60,000)
70,000 20,000 90,000 ($30,000)
35,000 10,000 45,000 ($45,000)
35,000 10,000 45,000 ($15,000)
The III Division should be eliminated because it is producing negative contribution margin ($21,000). Profit from operations will increase $40,500 if the division is discontinued. The IV Division should be continued as its contribution margin, $60,000, is greater than the savings in fixed costs ($90,000 - $45,000 = $45,000) that would result from elimination. Therefore, profit from operations would decrease $15,000 if the IV Division was eliminated.
18.20
Solutions manual to accompany Accounting: building business skills 4e
(c) Simpson Manufacturing CVP Income Statement for the quarter ended 31 March 2013 Divisions
Sales Variable expenses: Cost of sales Selling and administrative Total variable expenses Contribution margin Fixed expenses: Cost of sales (1) Selling and administrative (2) Total fixed expenses Profit (Loss) from operations
(d)
I
II
IV
Total
$490,000
$410,000
$300,000 $1,200,000
210,000 24,000 234,000 256,000
200,000 40,000 240,000 170,000
210,000 30,000 240,000 60,000
620,000 94,000 714,000 486,000
93.25 39.25 132,500 $123,500
53,250 43,250 96,500 $73,500
73,250 23,250 96,500 ($36,500)
219,750 105,750 325,500 $160,500
(1)
Division’s own fixed costs plus its share of III’s unavoidable fixed costs of $9,750 which is $3,250 for each division.
(2)
Division’s own fixed costs plus its share of III’s unavoidable fixed costs of $9,750 which is $3,250 for each division.
Total profit from operations with Division III is $120,000 (given). Without Division III, profit from operations is $160,500. The difference of $40,500 ($160,500 - $120,000) is the incremental profit that is gained through elimination of Division III.
18.21
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET A 18.5 VERA & TUCKER
(a)
Project Tic Project Tac Project Toe
= $150,000 ÷ [($13,000 + $30,000)] = 3.49 years = $160,000 ÷ [($14,400 + $32,000)] = 3.45 years = $200,000 ÷ [($20,000 + $40,000)] = 3.33 years
(b)
Net present value: Project Tic
Item
Amount
Annual cash flows Capital investment Net present value
Years
PV Factor
1-5
3.35216
$43,000
Project Tac Year
Discount Factor
1 2 3 4 5
.86957 .75614 .65752 .57175 .49718
Cash Inflow
Total Capital investment Net present value
(c)
$144,143 150,000 ($5,857)
Project Toe PV
$50,000 49,000 48,000 44,000 41,000 $232,000
Present Value
$43,479 37,051 31,561 25,157 20,384 157,632 160,000 ($2,368)
Cash Inflow
PV
$67,000 62,000 61,000 58,000 52,000 $300,000
$58,261 46,881 40,109 33,162 25,853 204,266 200,000 $4,266
Return on average investment Project Tic Project Tac Project Toe
= $13,000 ÷ [($150,000 + $0) ÷ 2] = 17.33% = $14,400 ÷ [($160,000 + $0) ÷ 2] = 18% = $20,000 ÷ [($200,000 + $0) ÷ 2] = 20%
(d) Project
Net Present Value
Cash Payback
Return on Ave Investment
Tic Tac Toe
3 2 1
3 2 1
3 2 1
The best project is Toe.
18.22
Solutions manual to accompany Accounting: building business skills 4e
(e). Under the net present value method, the present value of future net cash inflows is compared with the capital investment to determine net present value. The decision rule is: accept the project if net present value is nil or positive; reject the project if net present value is negative. The objective of the internal rate of return method is to find the interest yield of potential investment, which is expressed as a percentage rate. The decision rule is: accept the project when the internal rate of return is equal to or greater than the required rate of return; reject the project when the internal rate of return is less than the required rate.
18.23
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET A 18.6 Jason Leo (a) (1) Annual Profit
Fee revenue (5x10x6x30x$12) Expenses: Salaries Expenses Depreciation ($72,000 ÷ 3) Total expenses Profit Cash inflow
(b)
(c)
(2) Annual Cash Inflow
$108,000
$108,000
50,000 30,000 24,000 104,000 $4,000
50,000 30,000 80,000 $28,000
(1)
Cash payback period = $72,000 ÷ $28,000 = 2.57 years.
(2)
Return on average investment = $4,000 ÷ ((72,000+0)/2)= 11.11%
Present value of annual cash inflows ($28,000 x 2.40183*) = Capital investment = Net present value
$67,251 72,000 ($4,749)
* 12% factor for 3 years (assumed required rate of return). (d)
The calculations show that the proposed commuter is a bad investment. The return on average investment is 11.88%, which is below the required rate of return of 12% and net present value is negative. The cash payback period is 85% (2.57 ÷ 3) of the useful life of the equipment.
18.24
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 18.7 FRESH WATER TESTING (a)
Option A.
Present value of annual cash flows Present value of cost to rebuild Present value of residual value
Cash Flows $20,000 (50,000) -
(a)
x
9% Discount Factor
=
x x x
5.53482 .70843 .50187
= = =
Capital investment Net present value
Present Value $110,696 (17,356) $93,340 90,000 $3,340
(a)
Net annual cash inflow = $180,000 - $160,00 = $20,000 Note the cost to rebuild is over 4 periods not 8. The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately nil. This is accomplished with a 10% discount rate.
Present value of annual cash flows Present value of cost to rebuild Present value of residual value
Cash Flows $30,800 (24,500) -
(a)
x
10% Discount Factor
=
x x x
5.33493 .68301 .46651
= = =
Capital investment Net present value
(a)
Present Value $106,699 (16,734) $89,965 90,000 ($35)
Net annual cash inflow = $180,000 - $160,000 = $20,000.
Option B.
Present value of annual cash flows Present value of residual value
Cash Flows
x
9% Discount Factor
$32,000 27,500
x x
5.53482 . 50187
(b)
Capital investment Net present value
(b)
Net annual cash inflow = $140,000 - $108,000 = $32,000
18.25
= = =
Present Value $177,114 13,801 $190,915 170,000 $20,915
Chapter 18: Incremental analysis and capital budgeting
Internal rate of return on Option B is calculated below:
Present value of annual cash flows Present value of residual value
Cash Flows $32,000 27,500
Capital investment Net present value
(b)
x
12% Discount Factor
=
x x
4.96764 .40388
= =
Present Value $158,964 11,107 $170,071 170,000 $71
Option A has a lower net present value than Option B and also a lower internal rate of return. Therefore, Option B is the preferred project.
18.26
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET A 18.8 WAVERLEY COUNCIL
(a)
The present value based on the original estimates is as follows:
Present value of annual cash flows Present value of cost of overhaul(end yr 5) Present value of residual value
Cash Flows
x
$10,000 (7,000) 25,000
x x x
10% Discount Factor
=
Present Value
6.14457 = .62092 = .38554 =
$61,446 (4,346) 9,638 $66,738 70,000 ($3,262)
Capital investment Net present value
Based on its negative present value, the garbage truck should not be purchased. (b) The present value based on the revised estimates is as follows:
Present value of annual cash flows Present value of cost of overhaul Present value of residual value
Cash Flows 12,000* (7,000) 25,000
Capital investment Net present value *$10,000 +($400+800+500+300)
x
10% Discount Factor
=
x x x
6.14457 .62092 .38554
= = =
Present Value $73,735 (4,346) 9,638 $79,027 70,000 $9,027
Based on the revised figures, the garbage truck has a positive net present value and therefore should be purchased. (c)
The present value of the intangible benefits was $12,289 (the increase in the net present value from a negative $3,262 to a positive $9,027). Vu’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $3,262. That is the amount by which the original estimate fell short of having a positive net present value.
18.27
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET A 18.9 LEISURE LTD
(a)
Using the original estimates, the present value is calculated as follows:
Cash Flows Present value of annual cash flows Present value of residual value
a
$90,000 1,500,000
x
8% Discount Factor
=
x x
9.81815 .21455
= =
Capital investment ($300,000 +$500,000) Net present value
Present Value $883,633 321,825 $1,205,458 800,000 $405,458
a
Net annual cash inflows = $950,000 - $860,000 = 90,000
The positive present value of the project suggests that it should be accepted. (b)
Using the revised estimates, the present value is calculated as follows: 8% Cash Discount Flows x Factor =
Present value of annual cash flows Present value of residual value
b
$20,000 1,500,000
x x
9.81815 .21455
= =
Capital investment Net present value
Present Value $196,363 321,825 $518,188 800,000 ($281,812)
b
Net annual cash inflows = $780,000 - $760,000 = 20,000
Under these revised estimates the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of students declines, expenses don’t decline proportionately. (c)
Using the original estimates, but a 11% discount rate, the present value is calculated as follows: 11% Cash Discount Present Flows x Factor = Value
Present value of annual cash flows Present value of residual value
c
$90,000 1,500,000
Capital investment Net present value c
Net annual cash inflows = $950,000 - $860,000 = 90,000
18.28
x x
7.96333 .12403
= =
$716,700 186,045 $902,745 800,000 $102,745
Solutions manual to accompany Accounting: building business skills 4e
The positive present value of the project suggests that it should be accepted; however it is not nearly as profitable using a 11% discount rate. (d) The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately nil. This will take trial and error method. In this case the internal rate of return was approximately 12%.
Present value of annual cash flows Present value of residual value
Cash Flows $25,200 1,250,000
Capital investment Net present value
x
12% Discount Factor
=
x x
3.60478 .56743
= =
Present Value $90,840 709,287 $800,127 800,000 $27
The project had a high internal rate of return even though the business itself was not generating much cash flows because the property increased significantly in value during the 5-year period.
18.29
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET A 18.10 TOBY (a) Option 1 – Going to Uni The cash flow for this option is best presented by the following timeline:
Year 0
1
2
3
4
5
6
7
8
-8000 -5000 -13000
-8000 -5000 -13000
-8000 -5000 -13000
+20000
+20000
+30000
+35000
+40000
Total investment:
=13000x3 =$39000
Average net annual cash inflows:
=(20+20+30+35+40)/5 =$30000
(1) Cash payback:
=Amount invested / Net annual cash inflow =$39000 / $30000 =1.3 years
(2) Net present value (assuming discount rate of 10%): Discount factor Present value of cash inflow @4 years 10% Present value of cash inflow @5 years 10% Present value of cash inflow @6 years 10% Present value of cash inflow @7 years 10% Present value of cash inflow @8 years 10% Total Present value of cash inflows
$20,000 20,000 30,000 35,000 40,000
0.68301 0.62092 0.56447 0.51316 0.46651
= = = = =
$ $ $ $ $ $
13,660.20 12,418.40 16,934.10 17,960.60 18,660.40 79,633.70
PV of annuity of cash outflows, 3 years 10%
13,000
2.48685
=
$
32,329.05
$
47,304.65
Net Present Value (NPV)
18.30
Solutions manual to accompany Accounting: building business skills 4e
Option 2 – Starting apprenticeship The cash flow for this option is best presented by the following timeline:
Year 0
1
2
3
4
5
6
7
8
+10000
+10000
+10000
+15000
+15000
+20000
+20000
+20000
Total investment:
$0
Average net annual cash inflows:
=(10+10+10+15+15+20+20+20)/8 $15,000
(1) Cash payback:
=Amount invested / Net annual cash inflow Cash payback period is not relevant since there is no investment required under this option
(2) Net present value (assuming discount rate of 10%): Present value of cash inflow @1 years 10% Present value of cash inflow @2 years 10% Present value of cash inflow @3 years 10% Present value of cash inflow @4 years 10% Present value of cash inflow @5 years 10% Present value of cash inflow @6 years 10% Present value of cash inflow @7 years 10% Present value of cash inflow @8 years 10% Total Present value of cash inflows
10000 10000 10000 15000 15000 20000 20000 20000
Cash outflow
0
Net Present Value (NPV)
0.90909 0.82645 0.75132 0.68301 0.62092 0.56447 0.51316 0.46651
= = = = = = = =
$ 9,090.90 $ 8,264.50 $ 7,513.20 $10,245.15 $ 9,313.80 $11,289.40 $10,263.20 $ 9,330.20 $50,441.75
=
$
-
$50,441.75
(b) and (c) The second option, i.e. starting apprenticeship, seems to be a better option as it involves no cash investment and yields a higher net present value. However, other factors, such as the long term (beyond 8 years) cash flow and qualitative factors, such as career prospects, are important factors that needed to be considered.
18.31
Chapter 18: Incremental analysis and capital budgeting
SOLUTIONS TO PROBLEM SET B PROBLEM SET B 18.1 BALLS R US (a) Balls R Us Reject Order
Revenues (10,000 x $34) Cost of sales Selling and administrative expenses Profit
Accept Order
$$-
$340,000 300,000 (1) 23,500 (2) $16,500
Profit Increase (Decrease) $340,000 (300,000) (23,500) $16,500
(1)
Variable costs = $3,600,000 - $900,000 = $2,700,000; $2,700,000 ÷ 90,000 units = $30 per unit; 10,000 x $30 = $300,000
(2)
Variable costs = $360,000 - $180,000 = $180,000; $180,000 ÷ 90,000 units = $2 per unit; 10,000 x ($2.00 + $0.35) = $23,500.
(b)
Yes, the special order should be accepted because profit will be increased by $16,500.
(c)
Unit selling price = $30 (variable manufacturing costs) + $2.35 variable selling and administrative expenses + $2.50 profit = $34.85.
(d)
Non-financial factors to be considered are: (1) possible effect on domestic sales; (2) possible alternative uses of the unused factory capacity; and (3) ability to meet customers’ schedule for delivery without increasing costs.
18.32
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 18.2 CLASSIC MEMORY LTD (A) Make shoes in-house
Relevant costs: Direct materials Direct labour Variable overhead Fixed overhead Purchase cost from outsider Total cost of obtaining shoes Profit from other products Net cost of obtaining 20,000 units of photo albums (b)
$70,000 $45,000 $32,000 $53,000
Outsourcing
Make another products
$200,000
$43,000 160,000 $203,000
$53,000 160,000 $213,000 -30,000
$200,000
$203,000
$183,000
The alternative of outsourcing and using the spare facilities to make another product is the option with the lowest cost for producing 20,000 units of photo albums. Assuming other non-financial information has been taken into account, the third option appears to be the best course of action.
18.33
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET B 18.3 GRANGER MANUFACTURING (a)
8,000 units
Make WISCO
Buy WISCO
Profit Increase (Decrease)
Direct materials ($5.50) Direct labour ($5.70) Indirect labour ($0.55) Electricity ($0.42) Depreciation Rates and taxes Insurance Purchase price Freight and inspection ($0.35) Receiving costs Total annual cost
$44,000 45,600 4,400 3,360 3,000 1,100 720 240 1,800 680 100,000 2,800 1,000 $102,880 $105,820
$44,000 45,600 4,400 3,360 1,900 480 1,120 (100,000) (2,800) (1,000) ($2,940)
(b)
The company should continue to make WISCO because profit would be $2,940 less if WISCO were purchased from the supplier.
(c)
The decision would be different. Because of the opportunity cost of $4,000, profit will be $1,060 higher if WISCO is purchased as shown below:
Buy WISCO
Profit Increase (Decrease)
$102,880 $105,820 4,000 $106,880 $105,820
($2,940) 4,000 $1,060
Make WISCO Total annual cost Opportunity cost Total cost
(d)
Non-financial factors include: (1) the adverse effect on employees if WISCO is purchased; (2) how long the supplier will be able to satisfy Granger Manufacturing Company’s quality control standards at the quoted price per unit; and (3) whether the supplier will deliver the units when they are needed by Granger.
18.34
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 18.4 MODINE MANUFACTURING
(a)
Sales Variable expenses: Cost of sales Selling and administrative Total variable expenses Contribution margin
(b)
Adelaide
Otago
$440,000
$520,000
361,000 96,000 457,000 ($17,000)
378,000 72,000 450,000 $70,000
(1) Profit Increase Continue Eliminate (Decrease)
Adelaide Division Contribution margin (above) Fixed expenses: Cost of sales Selling and administrative Total fixed expenses Profit (Loss) from operations
($17,000) 19,000 24,000 43,000 ($60,000)
$17,000 7,600 9,600 17,200 ($17,200)
11,400 14,400 25,800 $42,800
(2) Profit Increase Continue Eliminate (Decrease)
Otago Division Contribution margin (above) Fixed expenses: Cost of sales Selling and administrative Total fixed expenses Profit (Loss) from operations
$70,000 42,000 48,000 90,000 ($20,000)
($70,000) 16,800 19,200 36,000 ($36,000)
25,200 28,800 54,000 ($16,000)
The Adelaide Division should be eliminated because it is producing negative contribution margin ($17,000). Profit from operations will increase $42,800 if the division is discontinued. The Otago Division should be continued as its contribution margin, $70,000, is greater than the savings in fixed costs ($90,000 - $36,000 = $54,000) that would result from elimination. Therefore, profit from operations would decrease $16,000 if the Otago Division was eliminated. 18.35
Chapter 18: Incremental analysis and capital budgeting
(c) Modine Manufacturing CVP Income Statement for the quarter ended 31 March 2013 Divisions Sydney Perth Otago Sales Variable expenses: Cost of sales Selling and administrative Total variable expenses Contribution margin Fixed expenses: Cost of sales (1) Selling and administrative (2) Total fixed expenses Profit (Loss) from operations
(d)
Total
$730,000
$920,000
$520,000 $2,170,000
384,000 124,200 508,200 221,800
518,400 172,200 690,600 229,400
378,000 72,000 450,000 70,000
1,280,400 368,400 1,648,800 521,200
98,280 85,680 183,960 $37,840
61,400 78,600 140,000 $89,400
43,520 49,920 93,440 ($23,440)
203,200 214,200 417,400 $103,800
(1)
Division’s own fixed costs plus its share of Adelaide’s unavoidable fixed costs of $7,600. (Sydney $2,280, Perth $3,800, and Otago $1,520).
(2)
Division’s own fixed costs plus its share of Adelaide’s unavoidable fixed costs of $9,600. (Sydney $2,880, Perth $4,800 and Otago $1,920).
Total profit from operations with the Adelaide Division is $61,000 (given). Without the Adelaide Division, profit from operations is $103,800. The difference of $42,800 ($103,800 - $61,000) is the incremental profit that is gained through elimination of the Adelaide Division.
18.36
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 18.5 SMITH & JONES
(a)
Project Brown = $200,000 ÷ [($16,000 + $40,000)] = 3.57 years Project Red = $260,000 ÷ [($24,000 + $52,000)] = 3.42 years Project Yellow = $300,000 ÷ [($28,800 + $60,000)] = 3.38years
(b)
Net present value: Project Red
Item
Amount
Annual cash flows Capital investment Net present value
Years
PV Factor
1-5
3.69590
$76,000
Project Brown Year
Discount Factor
1 2 3 4 5
0.90090 0.81162 0.73119 0.65873 0.59345
$68,000 58,000 54,000 51,000 49,000 280,000
Total Capital investment Net present value
(c)
Cash Inflow
PV $61,261 47,074 39,484 33,595 29,079 210,493 200,000 $10,493
Cash Inflow $97,000 89,000 88,000 86,000 84,000 444,000
Project Brown = $16,000 ÷ [($200,000 + $0) ÷ 2] = 16.0% Project Red = $24,000 ÷ [($260,000 + $0) ÷ 2] = 18.46% Project Yellow = $28,800 ÷ [($300,000 + $0) ÷ 2] = 19.2% (d) Project
Net Present Value
Cash Payback
Return on Ave Investment
Brown Red Yellow
3 2 1
3 2 1
3 2 1
18.37
$280,888 260,000 $20,888
Project Yellow
Return on average investment
The best project is Yellow.
Present Value
PV $87,387 72,234 64,345 56,651 49,850 330,467 300,000 $30,467
Chapter 18: Incremental analysis and capital budgeting
(e) The other two techniques are cash payback method and the return on average investment. The cash payback technique identifies the time period to recover the cost of the investment. The formula is: cost of capital expenditure divided by estimated net annual cash inflow equals cash payback period. The return on average investment method uses accounting data to indicate the profitability of a capital investment. It is obtained by dividing the expected annual profit by the amount of the average investment. The higher the rate of return, the more attractive the investment.
18.38
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 18.6 ANGELIC DAY CARE CENTRE (a) (1) Annual Profit
Fee revenue (12 x $300 x 52) Expenses: Salaries Food and supplies Depreciation ($50,000 ÷ 5) Total expenses Profit Cash inflow
(b)
(c)
(2) Annual Cash Inflow
$187,200
$187,200
148,000 24,000 10,000 182,000 $5,200
148,000 24,000 172,000 $15,200
(1)
Cash payback period = $50,000 ÷ $15,200 = 3.29 years.
(2)
Return on average investment = $5,200 ÷ ((50,000+0)/2)= 20.8%
Present value of annual cash inflows ($15,200 x 3.60478*) = Capital investment = Net present value
$54,793 50,000 $4,793
* 12% factor for 5 years (assumed required rate of return). (d)
The calculations show that the proposed day care centre is a good investment. The return on average investment is 20.88%, which is above the required rate of return of 12% and net present value is positive. A minor negative factor is that the cash payback period is 68% (3.29 ÷ 5) of the useful life of the equipment.
18.39
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET B 18.7 AUCKLAND CLINIC (a)
Option A.
Cash Flows Present value of annual cash flows Present value of cost to rebuild Present value of residual value
(a)
$46,200 (75,000) -
x
8% Discount Factor
=
x x x
5.74664 .73503 .54027
= = =
Capital investment Net present value
Present Value $265,495 (55,127) $210,368 202,500 $7,868
(a)
Net annual cash inflow = $105,000 - $58,800 = $46,200. Note the cost to rebuild is over 4 periods not 8. The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately nil. This is accomplished with a 9% discount rate.
Cash Flows Present value of annual cash flows Present value of cost to rebuild Present value of residual value
(a)
$46,200 (75,000) -
x
9% Discount Factor
=
x x x
5.53482 .70843 .50187
= = =
Capital investment Net present value
Present Value $255,709 (53,132) $202,577 202,500 $77
(a)
Net annual cash inflow = $105,000 - $58,800 = $46,200. Option B.
Cash Flows Present value of annual cash flows Present value of residual value
(b)
$60,000 15,000
x
8% Discount Factor
=
x x
5.74664 .54027
= =
Capital investment Net present value
(b)
Net annual cash inflow = $105,000 - $45,000 = $60,000
18.40
Present Value $344,798 8,104 $352,902 304,500 $48,402
Solutions manual to accompany Accounting: building business skills 4e
Internal rate of return on Option B is calculated below:
Present value of annual cash flows Present value of residual value
Cash Flows $60,000 15,000
Capital investment Net present value
(b)
x
12% Discount Factor
=
x x
4.96764 .40388
= =
Present Value $298,058 6,058 $304,116 304,500 ($384)
Option A has a lower net present value than Option B and also a lower internal rate of return. Therefore, Option B is the preferred project.
18.41
Chapter 18: Incremental analysis and capital budgeting
PROBLEM SET B 18.8 SMASH AND BASH
(a)
The present value based on the original estimates is as follows:
Cash Flows Present value of annual cash flows Present value of cost of overhaul Present value of residual value
$8,400 (5,600) 21,000
x
9% Discount Factor
=
x x x
5.53482 .70843 .50187
= = =
Capital investment Net present value
Present Value $46,493 (3,967) 10,539 $53,065 77,000 ($23,935)
Based on its negative present value, the tow truck should not be purchased. (b)
The present value based on the revised estimates is as follows:
Present value of annual cash flows Present value of cost of overhaul Present value of residual value
Cash Flows 18,200* (5,600) 21,000
Capital investment Net present value *$8,400+7,700+1,400+700=$18,200
x
9% Discount Factor
=
x x x
5.53482 .70843 .50187
= = =
Present Value $100,734 (3,967) 10,539 $107,306 77,000 $30,306
Based on the revised figures, the tow truck has a positive net present value and therefore should be purchased. (c)
The present value of the intangible benefits was $54,241 (the increase in the net present value from a negative $23,935 to a positive $30,306). Steve’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $23,935. That is the amount by which the original estimate fell short of having a positive net present value.
18.42
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 18.9 TIGGER LTD
(a)
Using the original estimates, the present value is calculated as follows: 9% Cash Discount Flows x Factor = a
Present value of annual cash flows Present value of residual value
$140,000 2,100,000
x x
Present Value
9.12855 = .17843 =
$1,277,997 374,703 $1,652,700 980,000 $672,700
Capital investment ($280,000 +$700,000) Net present value a
Net annual cash inflows = $1,344,000 - $1,204,000= $140,000.
The positive present value of the project suggests that it should be accepted. (b)
Using the revised estimates, the present value is calculated as follows: 9% Cash Discount Present Flows x Factor = Value Present value of annual cash flows Present value of residual value
b
$40,000 2,100,000
x x
9.12855 = .17843 =
Capital investment Net present value
$365,142 374,703 $739,845 980,000 ($240,155)
b
Net annual cash inflows = $1,100,000 - $1,060,000 = $40,000.
Under these revised estimates the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of students declines, expenses don’t decline proportionately. (c)
Using the original estimates, but a 12% discount rate, the present value is calculated as follows: 12% Cash Discount Present Flows x Factor = Value Present value of annual cash flows Present value of residual value
c
$140,000 2,100,000
x x
7.46944 = .10367 =
Capital investment Net present value
$1,045,722 217,707 $1,263,429 980,000 $283,429
c
Net annual cash inflows = $1,344,000 - $1,204,000= $140,000.
The positive present value of the project suggests that it should be accepted; however it is not nearly as profitable using a 12% discount rate. 18.43
Chapter 18: Incremental analysis and capital budgeting
(d)
The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately nil. This will take trial and error method. In this case the internal rate of return was approximately 12%.
Present value of annual cash flows Present value of residual value
Cash Flows
x
$20,000 1,600,000
x x
Capital investment Net present value
12% Discount Factor
=
3.60478 = .56743 =
Present Value $72,096 907,888 $979,984 980,000 ($16)
The project had a high internal rate of return even though the business itself was not generating much cash flow because the property increased significantly in value during the 5-year period.
18.44
Solutions manual to accompany Accounting: building business skills 4e
PROBLEM SET B 18.10 ANNIE (a) Option 1 – Going to Uni The cash flow for this option is best presented by the following timeline:
Year 0
1
2
3
4
5
6
7
8
-9000 -6000 -15000
-9000 -6000 -15000
-9000 -6000 -15000
+23000
+23000
+32000
+36000
+40000
Total investment:
=15000x3 $45000
Average net annual cash inflows:
=(23+23+32+36+40)/5 $30800
(1) Cash payback:
=Amount invested / Net annual cash inflow =$45000 / $30800 =1.5 years
(2) Net present value (assuming discount rate of 10%): Discount Factor Present value of cash inflow @4 years 10% Present value of cash inflow @5 years 10% Present value of cash inflow @6 years 10% Present value of cash inflow @7 years 10% Present value of cash inflow @8 years 10% Total Present value of cash inflows
23000 23000 32000 36000 40000
0.68301 0.62092 0.56447 0.51316 0.46651
= = = = =
$15,709.23 $14,281.16 $18,063.04 $18,473.76 $18,660.40 $85,187.59
PV of annuity of cash outflows, 3 years 10%
15000
2.48685
=
$37,302.75
Net Present Value (NPV)
$47,884.84
18.45
Chapter 18: Incremental analysis and capital budgeting
Option 2 – Starting apprenticeship The cash flow for this option is best presented by the following timeline:
Year 0
1
2
3
4
5
6
7
8
+15000
+15000
+15000
+20000
+20000
+28000
+28000
+28000
Total investment:
$0
Average net annual cash inflows:
=(15+15+15+20+20+28+28+28)/8 $21125
(1) Cash payback:
=Amount invested / Net annual cash inflow Cash payback period is not relevant since there is no investment required under this option
(2) Net present value (assuming discount rate of 10%): Present value of cash inflow @1 years 10% Present value of cash inflow @2 years 10% Present value of cash inflow @3 years 10% Present value of cash inflow @4 years 10% Present value of cash inflow @5 years 10% Present value of cash inflow @6 years 10% Present value of cash inflow @7 years 10% Present value of cash inflow @8 years 10% Total Present value of cash inflows
15000 15000 15000 20000 20000 28000 28000 28000
Cash outflow
0
Net Present Value (NPV)
0.90909 0.82645 0.75132 0.68301 0.62092 0.56447 0.51316 0.46651
= = = = = = = =
$13,636.35 $12,396.75 $11,269.80 $13,660.20 $12,418.40 $15,805.16 $14,368.48 $13,062.28 $69,314.52
=
$
-
$69,314.52
(b) and (c) The second option, i.e. starting apprenticeship in a salon, seems to be a better option as it involves no cash investment and yields a higher net present value. However, other factors, such as the long term (beyond 8 years) cash flow and qualitative factors, such as career prospects, are important factors that needed to be considered.
18.46
Solutions manual to accompany Accounting: building business skills 4e
BUILDING BUSINESS SKILLS FINANCIAL REPORTING AND ANALYSIS BBS 18.1 GADGETS LTD (a) Buy – Golden Star
Buy - Alpha
$50.00
$50.00
$50.00
$5.00 3.50 1.50 5.00 5.00 $20.00 $30.00 $300,000
$40.00 $2.00 $42.00 $8 $80,000
$12.00 $2.00 $14.00 $36.00 $360,000
Make Sales revenue Variable manufacturing cost: Circuit board Casing Blades (3 @ $.50 each) Labour Overhead Purchase cost Fixed manufacturing cost* Total manufacturing cost Profit per unit Total profit
*The $20,000 cost that will continue to be incurred even if the product is not manufactured, divided by the 10,000 units. The company will make the most profit if the coffee grinders are purchased from Alpha Company. The company will make $60,000 less if it manufactures them. The company will make $280,000 less if the clocks are purchased from Golden Star. (b)
There are several important non-financial factors described in the case. Other factors might be identified as well. The factors described are: The Company is having serious difficulty manufacturing the coffee grinders, therefore it would probably be willing to have someone else manufacture the coffee grinders, even if it cost more to do so. The most promising company appears to be Alpha; however there is a serious question about Alpha’s ability to remain in business. However, the company could purchase just this one order from Alpha and then continue to search for another manufacturer, or stop manufacturing the coffee grinders. Golden Star’s stringent requirements for preferred customer status in the form of large sales requirements appear to limit the possibilities for Gadgets Ltd to use it as a supplier. However if Gadgets Ltd does desire to continue to offer the coffee grinders because of their popularity, then perhaps Golden Star could be used in the future.
(c)
Many answers are possible depending upon each group’s assessment of the seriousness of the issues mentioned in (b). One answer would be: The Company should use Alpha to manufacture the Xmart order. After that, the company should not offer the coffee grinders any longer, especially since the coffee grinders are not longer profitable. It does not seem like a good idea to keep spending money to modify the process.
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Chapter 18: Incremental analysis and capital budgeting
BBS 18.2 WINDSOR LTD
(a)
Using the original estimates, the present value is calculated as follows:
Present value of annual cash flows Present value of residual value
Cash Flows $ a 800,000 3,200,000
x
12% Discount Factor
=
x x
6.81086 .18270
= =
Present Value $ 5,448,688 584,640 6,033,328 7,200,000 ($1,166,672)
Capital investment Net present value
a
Net annual cash inflows = $6,400,000 - $5,600,000= $800,000
The negative net present value of the project suggests that it should be rejected. (b)
Using the revised estimates, the net present value is calculated as follows:
Present value of annual cash flows Present value of residual value
Cash Flows $ b 1,280,00 0 3,200,000
x
12% Discount Factor
=
x
6.81086
=
x
.18270
=
Present Value $ 8,717,901 584,640 9,302,541 7,200,000 $2,102,541
Capital investment Net present value
b
Net annual cash inflows = $6,700,000 - $5,420,000=$1,280,000
Under these revised estimates the project should be accepted.
(c)
Using the original estimates, but an 8% discount rate, the net present value is calculated as follows:
Present value of annual cash flows Present value of residual value
Cash Flows $ c 800,000 3,200,000
Capital investment Net present value 18.48
x
8% Discount Factor
=
x x
8.55948 .31524
= =
Present Value $ 6,847,584 1,008,768 7,856,352 7,200,000 $656,352
Solutions manual to accompany Accounting: building business skills 4e
c
Net annual cash inflows = $6,400,000 - $5,600,000= $800,000
Using the original estimates, but the lower discount rate, the net present value is positive suggesting the project should be accepted.
(d)
If Virginia is correct in either her belief that the estimated net annual cash flows are too conservative, or that the discount rate being used is too high, then the project is acceptable. At a minimum, this analysis suggests that further investigation is warranted.
BBS 18.3 The answer here will depend on the companies selected by the student. An alternative would be to limit the choice to, say, 6 companies and discuss the results in class. BBS 18.4 ADACEL TECHNOLOGY LTD
(a)
Types of systems include air traffic management, defence and telecommunication, business solutions, software engineering and simulations. The simulations and training is world class and leading edge. The simulators include airport control towers, radar simulators, airport vehicle, defence force with ships’ bridge simulators and radar and sonar simulators. Simulation is also applied to e-Learning to aid business, governments and corporate customers train large numbers of people to use the intranets and the internet. The simulation systems are now advanced to include voice recognition and synthesis capability.
(b)
Adacel’s customers include: US Air Force, NASA’s, ANZ Banking Group, Shell, UK National Health Service, CGU Insurance, Lockheed Martin, SGI Inc, Australian state and federal governments. This is an exhaustive list.
(c)
Adacel’s head office is Brighton, Victoria. They also have offices located in Sydney, Perth and Brisbane within Australia and overseas in Manchester, Los Angeles, Orlando, Washington DC and Montreal. However the customers are worldwide, so it is not essential to be located in close proximity to the client.
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Chapter 18: Incremental analysis and capital budgeting
CRITICAL THINKING BBS 18.5
Students can discuss the answer to this question in various ways. One way is to draw up a table, to discuss the various costs associated with the “work” or “study” option, as below (the list is not exhaustive):
Relevant costs
Opportunity costs
Sunk costs
Work Living expenses related to summer work The loss in income from delayed work due to not graduating earlier The course fees paid to date
18.50
Study Course fee, living expenses related to studying The foregone income from working The course fees paid to date
Solutions manual to accompany Accounting: building business skills 4e
BBS 18.6 EVAN LTD
(a)
Incremental analysis
Sales Costs and expenses: Cost of sales Selling expenses Administrative expenses Depreciation Loss on disposal of machine Total costs and expenses Profit
(1) (2) (3) (4) (5) (6)
Retain Old Machine
Purchase New Machine
Profit Increase (Decrease)
$11,000,000 (1)
$13,200,000 (2)
$2,200,000
7,975,000 (3) 1,400,000 800,000 72,000 10,247,000 $753,000
9,372,000 (4) 1,540,000 900,000 450,000 (5) 72,000 (6) 12,334,000 $866,000
(1,397,000) (140,000) (100,000) (378,000) (72,000) (2,087,000) $113,000
22,000 x $100 x 5 years = $11,000,000 $11,000,000 x 120% = $13,200,000 $11,000,000 x (100% - 27.5%) = $7,975,000 $13,200,000 x (100% - 29%) = $9,372,000 $430,000 + $5,000 + $15,000 = $450,000 Assuming old machine has nil scrap value.
Using the calculation from above, complete the case. (b)
Return on average investment = ($866,000 ÷ 5) ÷ [($450,000 + $0) ÷ 2] = 77%
(c)
Cash payback period = $450,000 ÷ [($866,000 + $450,000 + 72,000) ÷ 5] = 1.62 years
(d) Net present value =
Amount
Factor
Present Value
Annual cash inflows Capital investment (cash outflow) Net present value
*$277,600 ($450,000)
3.35216
$930,560 (450,000) $480,560
* ($866,000 + $450,000 + 72,000) ÷ 5
(e)
The new machine should be purchased. The analysis shows that profit will be $866,000 over the five years with the new machine, which results in a 77% return on average investment. The cash payback period of 1.62 years meets management’s minimum requirement of three years. In addition, net present value is $480,560 positive, which indicates that the investment meets the required minimum rate of return of 15%.
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Chapter 18: Incremental analysis and capital budgeting
BBS 18.7 HENRY FISHER To:
Ivan Chan – Factory Manager
From:
Henry Fisher – Production Manager
Ivan, I have spent considerable time thinking about the dilemma created by the new X100 machine. Clearly it is far superior to our existing machine. There is no question that it would save us tremendous amounts of money. I hope I am not overstepping my bounds here, but I just reviewed a chapter in my management accounting text on incremental analysis which has made me think we need to reconsider this decision. The key to incremental analysis is identifying relevant costs. Relevant costs are those that vary depending on the course of action taken. In our situation, a relevant cost would be the savings that we would experience were we to purchase the new machine. The book value of the existing machine is not a relevant cost since it would not be changed by purchasing or not purchasing the new machine. Costs incurred in the past that do not change are referred to as sunk costs. Sunk costs are irrelevant to incremental analysis. I would really like to lay out an analysis of our options to decide the proper course of action. I am concerned that by using the old machine for a couple of years, the profitability of the factory could be impacted negatively. Respectfully Henry Fisher
BBS 18.8 WRISTON MANUFACTURING LTD
(a)
Many factors need to be considered when determining whether to close a division. The loss of jobs can have a devastating impact on a community and on the morale of remaining employees. From a financial perspective, closing a division that is reporting losses will not necessarily increase the reported profit of the company. The reason is that if fixed costs that have been allocated to a division that is closed are reallocated to the remaining division, the company’s profit might actually decrease. This sounds as though it would most likely be the case at Wriston.
(b)
It is not unusual to re-evaluate fixed cost allocations periodically. However, the allocation should be based on the underlying economics of the situation, rather than the motives of individuals.
(c)
Eve should explain to the board of directors that the change in profit is due to a reallocation and that closing the plumbing division is not advisable. In this case, being honest is not only the ethical thing to do, but it will also maximise the company’s profit.
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Solutions manual to accompany Accounting: building business skills 4e
BBS 18.9 a). Key findings include: • • • • • •
No airline recycles all of the major recyclables: aluminum cans, glass, plastic, paper. No airline has a comprehensive program for minimizing onboard waste. No airline has a comprehensive program for minimizing or composting food waste. All airlines offer over-packaged snacks with wrappers that aren’t always recyclable. None of the airlines are working with manufacturers to think out of the box or bag to reduce this waste. No airline provides good public information about its recycling programs. T heir websites and sustainability and annual reports all lack transparency and details about the waste they generate and how they are addressing it. No airline provides a regular report showing metrics on how it is progressing, or not, toward its recycling goals.
(b). Industry Actions 1. Industry support for recycling. T he airline industry as a whole, including its trade associations, the Air Transport Association (ATA) and the International Air Transport Association (IATA), should encourage all member airlines to adopt goals for recycling or composting that will lead to overall industry resource recovery of 50 percent of waste by 2012, and zero waste by 2020. This goal can be achieved through greater use of recyclable and compostable materials on flights, and increased coordination between airports and airlines in separating and processing waste. Even in international flights, it is entirely possible to institute recycling programs that do not conflict with government requirements (and the ATA and IATA can play a role in these discussions with the government). The ATA and IATA should also work with airports in order to improve their cooperation in recycling. 2. Each individual airline should set its own goals, with an overall target of recycling or composting at least 70 percent of waste by 2015. Each airline should also work to reuse materials on flights where appropriate. 3. Each airline should reduce the materials and packaging brought onto flights, which will reduce waste overall. Each airline should work to ensure that all packaging, cups, plates, and utensils should be recyclable or compostable. 4. As an interim measure, as airlines increase their recycling, they should Encourage passengers to remove any recyclable items that the airline doesn’t recycle from the plane and place them in airport recycling bins themselves. For example, some airlines currently do not recycle magazines and newspapers. These airlines can encourage passengers to take these items off the plane with them and recycle them in airport recycling bins. Consumer Actions 1. Concerned passengers can help encourage greater recycling by letting airlines know that environmental responsibility is an important factor in their choice of airlines. As a passenger (particularly if you participate in a frequent flyer program with an airline), when you contact airlines to plan your trips, ask what recycling programs are in place and encourage the airlines to create programs if none exist and expand programs already in place. Green America will be collecting data from thousands of airline passengers in 2010 and will publish a follow-up report at the end of 2010, detailing 18.53
Chapter 18: Incremental analysis and capital budgeting
whether there has been any improvement in airline recycling, to persuade companies to clean up their act. A tracking form is can be found on p. 31 and is also available on the Responsible Shopper website (www.responsibleshopper.org). 2. During flights, ask the flight attendants if the waste on that flight is recycled. Attendants know best what items are truly recycled. If the airline does not recycle, or only recycles limited items, politely let the flight attendants know that you would like the airline to recycle more. Then, write to the airline (please see the resources for Passengers’ section of this report on p. 32) and let them know that you would like to see them do more. 3. If the airline does not recycle, take their recyclable items (cans, cups, And papers) off the plane and recycle them in the airport. Then, as noted in Step 2 above, write to the airline and let management know that you would like to see them recycle and have a program for composting waste. 4.
While conducting research for this report, Green America discovered that many airlines do not actually recycle what they claim to recycle. Help Green America check recycling policies against practices on flights, to hold airlines accountable in enforcing their recycling and to push them to do better. Over the next year, Green America will be collecting information from passengers on thousands of flights from all different airlines in an attempt to track the reality of what is being recycled. I f you are flying over the next year, whether domestically or internationally, please ask your flight attendant about what will actually get recycled from the flight. Then, use the form on the next page to report this information to our research team. If you are flying on an airline that offers Internet service, you can go to our website and report to us directly from the air (www.responsibleshopper.org).
(c). The airlines’ recycling programs were judged in six categories: 1. Diversity in in-flight waste recycled, with Delta Airlines, Virgin America and Continential Airlines are the best and US Airway is the worst of all. 2. Future in-flight recycling plans, for example, Virgin Atlantic is the best airline, and US Airways and Air Tran are the worst airlines. 3. Education and encouragement of employees in onboard recycling programs. For instance, Delta Airlines is the best, and there were 7 airlines that fall in the worst category, such as British Airways. 4. Size of the in-flight recycling program 5. Other in-flight sustainability initiatives 6. Best program overall, US Airways is the worst airline, and Delta Airlines is the best one.
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