SOLUTIONS MANUAL for Accounting: Building Business Skills, 4th Edition Carlon, Mladenovic-McAlpine,

Page 1


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

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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

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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

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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

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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

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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

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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

1.18


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

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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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Solutions manual to accompany Accounting: building business skills 4e

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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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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Solutions manual to accompany Accounting: building business skills 4e

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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Solutions manual to accompany Accounting: building business skills 4e

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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Solutions manual to accompany Accounting: building business skills 4e

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.

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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)

3.107

1 320

1 440

1 680

3 600

1 00

3 000

360

1 00

1 080

660


Chapter 3: Accrual accounting concepts

(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


Chapter 3: Accrual accounting concepts

(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


Solutions manual to accompany Accounting: building business skills 4e

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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Chapter 3: Accrual accounting concepts

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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Chapter 3: Accrual accounting concepts

(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

3.118

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

3.119

$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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Solutions manual to accompany Accounting: building business skills 4e

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


Chapter 3: Accrual accounting concepts

(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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Solutions manual to accompany Accounting: building business skills 4e

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


Chapter 3: Accrual accounting concepts

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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Solutions manual to accompany Accounting: building business skills 4e

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


Solutions manual to accompany Accounting: building business skills 4e

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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Solutions manual to accompany Accounting: building business skills 4e

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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Solutions manual to accompany Accounting: building business skills 4e

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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Solutions manual to accompany Accounting: building business skills 4e

(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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Solutions manual to accompany Accounting: building business skills 4e

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

6.121


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:

6.123


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

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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.

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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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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.

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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.

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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 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.

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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.

12.13


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


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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

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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

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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


Chapter 12: Financial statement analysis

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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Chapter 12: Financial statement analysis

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 intergrating GAAP

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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Solutions manual to accompany Accounting: building business skills 4e

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


Chapter 13: Analysing and intergrating GAAP

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


Chapter 13: Analysing and intergrating GAAP

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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Chapter 13: Analysing and intergrating GAAP

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.

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.

Monetary Principle: the items included in the accounting records must be able to be expressed in monetary terms.

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.

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


Solutions manual to accompany Accounting: building business skills 4e

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


Chapter 13: Analysing and intergrating GAAP

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.

Installation of a waste water treatment plant

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

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

Increased internal recycling across the group

Energy and Climate •

Installed 670 solar panels to deliver clean, renewable energy to the Eastern creek distribution centre

Waste water treatment plant provides renewable energy

Relocation of head office to a 5 star green rated building

Measuring and reporting carbon use and emissions

Contribution to earth hour turning off iconic Coke sign kings cross

COMMUNITY •

CCA Foundations - 2008/9 $2.4 million in community projects

CCA 2008/9 $17.9 million in community projects

CCA and SPCA and employees supporter Victoria bushfire victims

Generous donations to: food banks, national breast cancer foundation, drought assistance,

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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Chapter 13: Analysing and intergrating GAAP

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


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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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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

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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.

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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

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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)

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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

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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

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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

14.13


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)

14.20


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


Solutions manual to accompany Accounting: building business skills 4e

(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.

14.31


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)

14.33


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.

14.41


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.

14.43


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

14.45


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’.

15.50


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

15.51


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

15.53


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.

15.54


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.)

15.55


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.

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(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.

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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

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(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

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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

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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

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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.

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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

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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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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


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(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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(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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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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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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(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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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

18.1

1,5,6,8

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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.

18.2


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.

18.5


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.

18.6


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%

18.7


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’

18.8


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.

18.10


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.)

18.11


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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