TEST BANK For Financial Accounting: Reporting, Analysis and Decision Making 5th Edition by StudyGuide

Chapter 1: An introduction to accounting

Chapter 1: An introduction to accounting Multiple-choice questions

1. The provision of accounting information within the business entity is referred to as: a. financial accounting. *b. management accounting. c. commercial accounting. d. public accounting. Answer: b Learning objective 1.1 – Explain the business context and the need for decision making. Feedback: The provision of information within the business entity is referred to as management accounting. 2. The accounting process includes which steps: *a. identifying, measuring, recording and communicating. b. identifying, recording, communicating and justifying. c. measuring, adjusting, recording and communicating. d. measuring, evaluating, recording and communicating. Answer: a Learning objective 1.2 – Define accounting, describe the accounting process and define the diverse role of accountants. Feedback: The four steps of the accounting process are identifying, measuring, recording and communicating relevant transactions and events. 3. The sole trader form of business organisation: a. must have at least two owners. b. combines business records with the personal records of the owner. *c. results in the owner having personal liability for the debts of the business. d. is a separate legal entity. Answer: c Learning objective 1.3 – Explain the characteristics of the main forms of business organisation. Feedback: Under the sole trader business structure the owner of the business has no separate legal existence from the business. The owner of the business is therefore personally liable for the debts of the business.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. The majority of business in Australia is transacted by: a. sole traders. b. partnerships. c. government units. *d. companies. Answer: d Learning objective 1.3 – Explain the characteristics of the main forms of business organisation. Feedback: The majority of business in Australia is transacted by companies. 5. One advantage of the company form of business structure is that: a. it has limited life. b. the liability of the owners is unlimited. *c. it provides the owners with shared control. d. it makes higher profits. Answer: c Learning objective 1.3 – Explain the characteristics of the main forms of business organisation. Feedback: A company is a separate legal entity and has an indefinite life that is independent of the shareholders. Shareholders of most companies have limited liability for the debts of the company and if there is more than one director, the decision making is usually a shared responsibility. 6. A company has the following set of characteristics: a. provides owners with shared control, simple to establish. b. simple to set up, owner retains control. *c. complex to set up, provides owners with shared control. d. provides owners with shared control, unlimited liability. Answer: c Learning objective 1.3 – Explain the characteristics of the main forms of business organisation. Feedback: There are initial costs associated with incorporation for a company and then ongoing fees and regulations to comply with. If there is more than one director, then the decision making is usually a shared responsibility. Shareholders of most companies have limited liability for the debts of the company.

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Chapter 1: An introduction to accounting

7. Which of the following statements is false? *a. The definition of reporting entity forms the foundation of the Conceptual Framework as all other elements flow from it. b. A reporting entity must prepare general purpose financial reports that comply with accounting standards. c. Political or economic importance is a factor in determining whether an entity is a reporting entity. d. The objective of general purpose financial reports is to provide information that is useful to existing and potential investors, creditors and other external users. Answer: a Learning objective 1.4 – Understand the Conceptual Framework and the purpose of financial reporting. Feedback: The objective of general purpose reporting forms the foundation of the Conceptual Framework. If we know why we need to report then who needs to report can be determined and then what and how the information is to be reported follow. All the other statements are correct. 8. The purpose of financial reports is to: *a. provide information for decision making. b. report profit. c. pay tax to the ATO. d. report to the bank. Answer: a Learning objective 1.4 – Understand the Conceptual Framework and the purpose of financial reporting. Feedback: The purpose of financial reports is to provide information for decision making. 9. Who of the following would not be considered an internal user of accounting data for the XYZ Company Ltd? a. the chief executive officer of the company. b. a production manager. c. the company's sales manager. *d. a share investor. Answer: d Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Internal users of accounting information are managers who plan, organise and control the business.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. Which of the following user groups would use accounting information to determine whether an advertising proposal will be cost effective? a. investors in shares. *b. marketing managers. c. creditors. d. chief financial officer. Answer: b Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Evaluating an advertising proposal would occur internally and would typically be undertaken in the marketing department. 11. Which of the following user groups is an internal user of accounting information for the XYZ Company Ltd? a. auditors from the Australian Taxation Office. *b. management of XYZ Company. c. creditors of XYZ Company. d. customers of XYZ Company. Answer: b Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Managers are internal users of accounting information. 12. Which of the following users would not be considered an internal user of accounting data for a company? a. the chief executive officer of the company. b. the financial director of the company. *c. a creditor of the company. d. a salesperson employed by the company. Answer: c Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Creditors are an external resource provider.

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Chapter 1: An introduction to accounting

13. Which of the following is not a principal type of business activity? a. operating. b. investing. c. financing. *d. delivering. Answer: d Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: The three main types of business activities are operating, investing and financing. Delivery is a function of operating activities. 14. Borrowing money is an example of a/an: a. marketing activity. *b. financing activity. c. investing activity. d. operating activity. Answer: b Learning objective 1.5 – Identify users of financial reports and describe users' information needs. Feedback: Borrowing money is one of the two main sources of outside funds for companies. The other is the issue of shares to investors. 15. Buying assets required to operate a business is an example of a/an: a. advertising activity. b. financing activity. *c. investing activity. d. operating activity. Answer: c Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Investing activities involve purchasing resources an entity needs in order to operate.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. The activity involved with employing the resources of the business to generate revenues is: a. accounting. b. financing. c. investing. *d. operating. Answer: d Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Once a business has acquired resources it needs to employ those resources to generate revenues from operating activities. 17. Buying and selling products are examples of: *a. operating activities. b. investing activities. c. financing activities. d. delivering activities. Answer: a Learning objective 1.5 – Identify the users of financial reports and describe users' information needs. Feedback: Buying and selling products are examples of operating activities. 18. The common characteristic possessed by all assets is: a. long life. b. great monetary value. c. tangible nature. *d. future economic benefit. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: An asset is defined in the Conceptual Framework as a resource controlled by the entity as a result of past events from which future economic benefits are expected.

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Chapter 1: An introduction to accounting

19. Dividends paid: a. increase assets. b. increase expenses. c. decrease revenues. *d. decrease retained earnings. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Retained earnings refers to company profits that have been accumulated and not distributed as dividends to shareholders. 20. Resources owned by a business are referred to as: a. equity. b. liabilities. *c. assets. d. revenues. Answer: c Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Assets are defined in the Conceptual Framework as a resource controlled by the entity as a result of past events from which future economic benefits are expected. 21. The financial statement that summarises the changes in retained earnings for a specific period of time is the: a. statement of financial position. b. income statement. c. statement of cash flows. *d. statement of changes in equity. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The statement of changes in equity reports profit for the period and transactions with owners of the company such as share capital movements and dividends. The statement of changes in equity explains the link between the income statement and the statement of financial position.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. Retained earnings at the end of the period is equal to: a. retained earnings at the beginning of the period plus profit minus liabilities. *b. retained earnings at the beginning of the period plus profit minus dividends paid. c. profit plus total assets. d. assets plus liabilities. Answer: b Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Retained earnings refers to company profits that have been accumulated and not distributed as dividends to shareholders. 23. A company's policy toward dividend distributions and growth could best be determined by examining the: a. statement of financial position. b. income statement. *c. statement of changes in equity. d. statement of cash flows. Answer: c Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Shareholders and other external users can see how much profit has been distributed as dividends by reading the statement of changes in equity. 24. An income statement: a. summarises changes in retained earnings for a specific period of time. b. reports the changes in assets, liabilities, and equity for a specific period of time. c. reports the assets, liabilities, and equity at a specific date. *d. presents the revenues and expenses for a specific period of time. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The purpose of the income statement is to report the success or failure of the entity's operations for a period of time.

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Chapter 1: An introduction to accounting

25. If retained earnings increases from the beginning of the year to the end of the year, then: a. profit is less than dividends paid. b. dividends paid are greater than profit. c. additional investments are less than losses. *d. profit is greater than dividends paid. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Profits increase equity and are accumulated into retained earnings. Dividends reduce retained earnings. 26. The statement of changes in equity does not show: a. the beginning balance of retained earnings. *b. total revenue. c. the amount of dividends paid. d. the ending balance of retained earnings. Answer: b Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Total revenue is shown in the Income Statement. 27. Johnny's Car Repairs had total assets of $60,000 and total liabilities of $40,000 at the beginning of the year. During the year the business recorded $100,000 in revenues, $55,000 in expenses, and dividends of $10,000 were distributed. Equity at the end of the year is: *a. $55,000. b. $35,000. c. $65,000. d. $45,000. Answer: a Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Beginning equity was $20,000 ($60,000 - $40,000), profit for the year is $45,000 ($100,000 - $55,000) therefore $20,000 + $45,000 - $10,000 = $55,000.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. Johnny's Car Repairs had total assets of $60,000 and total liabilities of $40,000 at the beginning of the year. During the year the business recorded $100,000 in revenues, $55,000 in expenses, and dividends of $10,000 were distributed. Profit reported by Johnny's Car Repairs for the year was: a. $35,000 *b. $45,000 c. $20,000 d. $90,000 Answer: b Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Profit is $45,000 ($100,000 - $55,000). 29. If total liabilities increased by $25,000 and equity increased by $5,000 during a period of time, then total assets: a. decrease by $20,000. b. increase by $20,000. c. increase by $25,000. *d. increase by $30,000. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Assets = Liabilities + Equity therefore assets = $25,000 + $5,000. 30. If total liabilities decreased by $14,000 during a period of time and equity increased by $6,000 during the same period, then the change in total assets is: a. an increase of $14,000. b. an increase of $20,000. *c. a decrease of $8,000. d. an increase of $8,000. Answer: c Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Assets = Liabilities + Equity therefore assets = - $14,000 + $6,000 = $8,000.

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Chapter 1: An introduction to accounting

31. The statement of financial position: a. summarises the changes in retained earnings for a specific period of time. b. reports changes in assets, liabilities, and equity over a period of time. *c. reports assets, liabilities, and equity at a specific point in time. d. presents revenues and expenses for a specific period of time. Answer: c Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The statement of financial position reports assets and claims to those assets at a specific point in time. 32. Which of the following financial statements is concerned with a business at a point in time? *a. statement of financial position. b. income statement. c. statement of changes in equity. d. statement of cash flows . Answer: a Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The statement of financial position reports assets and claims to those assets at a specific point in time. 33. Liabilities of a company are amounts or obligations owed to: a. investors. b. owners. *c. creditors. d. shareholders. Answer: c Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Claims of creditors are called liabilities.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. Equity can be described as claims of a. creditors on total assets. *b. owners on total assets. c. customers on total assets. d. auditors on total assets. Answer: b Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Claims of owners are called equity or shareholders' equity. 35. Equity: a. is always equal to cash on hand. b. is equal to liabilities plus assets. *c. includes retained earnings and issued shares. d. is shown on the income statement. Answer: c Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Equity of a company comprises two parts - share capital and retained earnings. 36. Retained earnings represents: a. the shareholders' claim on total assets. b. the amount of cash held by the business. c. the total of revenue for the period. *d. the amount of profit held in the company for future use. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Retained earnings are the accumulated profits of the company that have not been distributed as dividends to shareholders and is available for future expansion.

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Chapter 1: An introduction to accounting

37. An annual report includes all of the following except: a. chairman and directors' reports. b. notes to the financial statements. c. an auditor's report. *d. detailed salary package of clerical staff. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: An annual report would not contain detailed information regarding the salaries or clerical staff. This type of information is for internal decision making only and is not available for external users. 38. The information needed to determine whether a company is using accounting methods similar to those of its competitors would be found in the: a. auditor's report. b. statement of financial position. c. directors' report. *d. notes to the financial statements. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The notes to the financial statements include descriptions of the accounting policies and methods used in preparing the statements. 39. In the annual report, where would a financial statement reader find out if the company's financial statements give a true and fair view of its financial position and operating results? a. notes to the financial statements. b. directors' report. c. statement of financial position. *d. auditor's report. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: It is the auditor's responsibility to state whether or not the financial statements provide a true and fair view of the company's financial position and operating results.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. A company's reviews of operations, dividend details and information about important events after the date of the financial statements are all found in the: a. auditor's report. *b. directors' report. c. notes to the financial statements. d. income statement. Answer: b Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Operational review and information relating to dividends, and post balance day events is included in the directors' report.

41. Categories usually found on the face of a classified statement of financial position include: *a. assets, liabilities, equity. b. revenues, expenses, profit. c. cash receipts, cash payments. d. retained earnings dividends. Answer: a Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The main sections in the statement of financial position are assets, liabilities and equity. 42. Cash is usually classified as: a. revenue. b. an expense. c. retained earnings. *d. a current asset. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Cash is usually classified as a current asset.

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Chapter 1: An introduction to accounting

43. Included among current liabilities on a classified statement of financial position would be: a. cash. b. property, plant and equipment. c. deferred tax assets. *d. short-term borrowings. Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: Short term borrowings are debts that are due to be settled within 12 months and are included as current liabilities in a classified statement of financial position.

44. Which financial statement would indicate whether the company relies on debt or equity to finance its assets? a. statement of cash flows b. statement of changes in equity c. income statement *d. statement of financial position Answer: d Learning objective 1.6 – Identify the elements of each of the four main financial statements. Feedback: The statement of financial position reports assets and claims to those assets at a specific point in time. The claims to the assets are of two types: creditors (debts) and equity (claims by the owner/s). 45. The Financial Reporting Council (FRC) is responsible to the government for: *a. the broad oversight of the accounting standard-setting process. b. urgent accounting issues. c. development of a conceptual framework for financial reporting. d. taxation issues for companies. Answer: a Learning objective 1.7 – Describe the financial reporting environment. Feedback: The FRC is the body that advises the Commonwealth Government on the accounting standard-setting and auditing standard-setting processes.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. Accounting standards issues by the Australian Accounting Standards Board (AASB) are consistent with those issued by the: a. Financial Reporting Council (FRC). b. Australian Taxation Office. c. Urgent Issues Group. *d. International Accounting Standards Board. Answer: d Learning objective 1.7 – Describe the financial reporting environment. Feedback: The accounting standards issued by the Australian Accounting Standards Board (AASB) are substantially consistent with those issued by the International Accounting Standards Board. 47. Which of the following statements is false? a. GAAP in Australia is a combination of accounting standards and interpretations as well as concepts and principles that have developed over time. b. The Australian Securities and Investments Commission monitors a company's compliance with accounting standards and the Corporations Act. *c. Members of the FRC are appointed by the Australian Accounting Standards Board. d. Listed public companies must comply with Australian Securities Exchange listing rules which, for financial reporting purposes, focus on disclosure of information. Answer: c Learning objective 1.7 – Describe the financial reporting environment. Feedback: Members of the FRC appoint members of the AASB. Members of the FRC are appointed by the Commonwealth Treasurer and include key stakeholders from the business community, the professional accounting bodies, governments and regulatory agencies. All other statements are correct. 48. The going concern assumption is inappropriate when: a. the business is just starting up. *b. liquidation appears likely. c. market values are higher than costs. d. the business is organised as a sole trader. Answer: b Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: The going concern principle states that the business will remain in operation for the foreseeable future.

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Chapter 1: An introduction to accounting

49. The accounting principle which assumes that a business will remain in operation for the foreseeable future is the: a. monetary principle. b. accounting entity concept. c. full disclosure principle. *d. going concern principle. Answer: d Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: The going concern principle states that the business will remain in operation for the foreseeable future.

50. The going concern principle assumes that the business: a. will be liquidated in the near future. b. will be purchased by another business. c. is in a growth industry. *d. will remain in operation for the foreseeable future. Answer: d Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: The going concern principle assumes the business will remain in operation for the foreseeable future. 51. The accounting entity concept states that each entity: *a. can be separately identified and accounted for. b. cannot reasonably report all of its activities in financial statements. c. cannot distinguish events of the business from its owners. d. will remain in operation for the foreseeable future. Answer: a Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: The accounting entity concept states that every entity can be separately identified and accounted for.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

52. What are the qualitative characteristics that enhance the decision usefulness of relevant information faithfully represented in financial statements? a. Generally accepted accounting principles (GAAP). b. Accounting entity concept and the cost principle. c. Comparability, verifiability and understandability. *d. Comparability, verifiability, understandability and timeliness. Answer: d Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: Information is more relevant and reliability when it is comparable, verifiable and understandable. Information must also be available to users before it ceases to be relevant.

53. The accounting period concept states that: a. the business will remain in operation for the foreseeable future. *b. the life of a business can be divided into artificial time periods. c. every business entity can be separately identified and accounted for. d. only those events that can be expressed in money may be included in the accounting records. Answer: b Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: The accounting period concept states the life of a business can be divided into artificial periods and that useful reports covering those periods can be prepared. 54. The cost principle requires assets to be initially recorded at: a. market value. *b. the amount paid for them. c. selling price. d. liquidation value. Answer: b Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: The cost principle states that all assets are initially recorded in the accounts at their purchase price or cost.

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Chapter 1: An introduction to accounting

55. Accounting information is relevant if it: *a. would influence a business decision. b. makes no difference to a business decision. c. is not material to a business decision. d. is immaterial. Answer: a Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: Accounting information is considered to be relevant if it is capable of making a difference in a business decision. 56. Comparability of financial information results when: a. different entities use different accounting principles. *b. different entities use the same accounting principles. c. that information can be depended upon to be relevant. d. the financial reports are understandable. Answer: b Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. Feedback: In accounting, comparability is achieved when an entity uses the same or consistent accounting principles each year and different entities use the same accounting principles. 57. Liquidity ratios measure: *a. the ability of a company to pay its obligations that are due within the next year or operating cycle. b. the operating success of a company for a period of time. c. the ability of a company to survive over a long time. d. the extent to which a company's assets are financed by debt. Answer: a Learning objective 1.9 – Calculate and interpret ratios for analysing an entity's profitability, liquidity and solvency. Feedback: Liquidity ratios measure the short-term ability of the entity to pay its obligations that are due within the next year or operating cycle.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

58. The return on assets ratio is calculated by: *a. dividing profit by average assets. b. dividing profit by total assets at the end of a period. c. dividing total assets at the end of a period by profit. d. dividing average assets by profit. Answer: a Learning objective 1.9 – Calculate and interpret ratios for analysing an entity's profitability, liquidity and solvency. Feedback: Return on assets is calculated by dividing profit by average assets.

59. Solvency measures the ability of a business to: *a. repay its long-term debts at maturity and interest as it becomes due. b. meet its short-term obligations. c. pay its obligations that will fall due within the operating cycle. d. turn its inventory into cash. Answer: a Learning objective 1.9 – Calculate and interpret ratios for analysing an entity's profitability, liquidity and solvency. Feedback: Solvency is an entity's ability to pay interest as it becomes due and to repay the debt at maturity. 60. A debt to total assets ratio of 80%: a. means that 20% of investment in assets has been provided by lenders. *b. is undesirable for creditors . c. is desirable for creditors. d. is likely to be supported by cyclical entities that have fluctuating profits, such as many high-tech companies. Answer: b Learning objective 1.9 – Calculate and interpret ratios for analysing an entity's profitability, liquidity and solvency. Feedback: A high debt to total asset ratio is undesirable to creditors as there is less chance of them receiving debt repayment from shareholders' funds if the company goes into liquidation. Generally, companies with stable profits can support high levels of debt.

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Chapter 1: An introduction to accounting

Exercises 61. Indicate in the spaces provided whether each item would appear on the statement of cash flows as an: (O) operating activity, (I) investing activity, or (F) financing activity.

____ ____ ____ ____ ____

a. b. c. d. e.

Cash receipts from customers. Issuing shares for cash. Payment of cash dividends. Cash purchase of equipment. Cash payments to suppliers.

____ f. Sale proceeds of old machine for cash

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. O F F

a. b. c.

I O I

d. e. f.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

62. Prepare an income statement, statement of changes in equity, and a statement of financial position for the dental practice of Jerry Cole, from the items listed below for the month of October 2015. Equity (October 1) Shares Accounts payable Equipment Service revenue Dividends paid Dental supplies consumed Cash Water and light expense Dental supplies on hand Salaries expense Accounts receivable Rent expense

$15,000 30,000 7,000 30,000 25,000 6,000 3,500 11,000 700 2,800 7,000 14,000 2,000

JERRY COLE DENTAL PRACTICE Income Statement for the month ended 31 October 2015 _____________________________________________________________________________ Revenues

Expenses

Total expenses

Profit

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Chapter 1: An introduction to accounting

JERRY COLE DENTAL PRACTICE Statement of Changes in Owner’s Equity for the month ended 31 October 2015 _____________________________________________________________________________ Equity, 1 October Add:

Less: Equity, 31 October

JERRY COLE Statement of Financial Position at 31 October 2015 _____________________________________________________________________________ Assets Current assets

Non-current assets

Total assets $ Liabilities and Equity Liabilities $ Equity $ Total liabilities and equity

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

JERRY COLE DENTAL PRACTICE Income Statement for the month ended 31 October 2015 ___________________________________________________________________________________ Revenues ........................................................................................................... $…. Service revenue .......................................................................................... 25,000 Expenses ............................................................................................................ $… Salaries expense ......................................................................................... 7,000 Dental supplies consumed........................................................................... 3,500 Rent expense .............................................................................................. 2,000 Water and light expense ............................................................................. 700 Total expenses ..................................................................................... 13,200 Profit .............................................................................................................. 11,800

JERRY COLE DENTAL PRACTICE Statement of Changes in Equity for the month ended 31 October 2015 ___________________________________________________________________________________ Equity, 1 October ............................................................................................. 15,000 Add: Profit ........................................................................................................ 11,800 26,800 Less: Drawings .................................................................................................. 6,000 Equity, 31 October ........................................................................................... 20,800

JERRY COLE DENTAL PRACTICE Statement of Financial Position at 31 October 2015 ___________________________________________________________________________________ Assets Current assets Cash .............................................................................................................. Accounts receivable .......................................................................................... Dental supplies ................................................................................................. Total current assets ............................................................................................ Non-current assets Equipment ........................................................................................................ Total assets ......................................................................................................

11,000 14,000 2,800 27,800 30,000 57,800

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Chapter 1: An introduction to accounting

Liabilities and Equity Liabilities Accounts payable ....................................................................................... *Equity .............................................................................................................

7,000 50,800

Total liabilities and equity .............................................................................

57,800

*Note: Jerry Cole, Dental Practice, is structured as a Sole Trader. Unlike a company the liability for the debts of the business is unlimited for the sole trader. Therefore the equity of the owner is reported as a single item – Owner’s equity and distributions to the owner are called “drawings” not dividends.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

63. Use the following information to calculate for the year ended 31 December 2015 (a) profit, (b) ending retained earnings, and (c) total assets. Supplies (unused) $ 500 Operating expenses 10,000 Accounts payable 11,000 Accounts receivable 4,000 Share capital 10,000 Equipment Retained earnings (beginning) 4,000

Revenues Cash Dividends paid Accrued expenses payable 3,500

$15,000 16,000 8,000 2,000

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. (a) $5,000 (15,000-10,000=5,000) (b) $1,000 (4,000+5,000-8,000=1,000) (c) $24,000 (500+4,000+16,000+3,500-2,000=24,000)

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Chapter 1: An introduction to accounting

64. Use the following accounts and information to prepare an income statement, a statement of changes in equity, and a statement of financial position for Lazares Services Ltd for the month ended 31 July 2015. Accounts payable Accounts receivable Buildings Cash Revenues Share capital Retained earnings (beginning)

$ 3,100 1,400 60,000 15,600 15,700 52,000 25,900

Dividends paid Insurance expense Supplies Accrued expenses payable Rent expense Salaries expense

$ 8,000 2,200 400 3,300 2,400 10,000

LAZARES SERVICES LTD Income Statement for the month ended 31July 2015 _____________________________________________________________________________ Revenues $ Expenses $

Total expenses Profit

LAZARES SERVICES LTD Statement of Changes in Equity for the month ended 31 July 2015 _____________________________________________________________________________ Retained Earnings, 1 July Add:

Less:

Retained Earnings, 31 July

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

LAZARES SERVICES LTD Statement of Financial Position at 31 July 2015 _____________________________________________________________________________ $ $ Assets Current assets

Non-current assets

Total assets

Liabilities and Equity Liabilities

Equity

Total liabilities and equity

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Chapter 1: An introduction to accounting

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. LAZARES SERVICES LTD Income Statement for the month ended 31 July 2015 ___________________________________________________________________________________ Revenues Service revenue .......................................................................................... $15,700 Expenses Salaries expense ......................................................................................... $10,000 Rent expense .............................................................................................. 2,400 Insurance expense ...................................................................................... 2,200 Total expenses ..................................................................................... 14,600 Profit .............................................................................................................. $ 1,100

LAZARES INDUSTRIES LTD Statement of Changes in Equity for the month ended 31 July 2015 ___________________________________________________________________________________ Retained Earnings, 1 July ................................................................................ $25,900 Add: Profit ........................................................................................................ 1,100 27,000 Less: Dividends paid ......................................................................................... 8,000 Retained Earnings, 31 July .............................................................................. $19,000

LAZARES INDUSTRIES LTD Statement of Financial Position 31 July 2015 ___________________________________________________________________________________ Assets Current assets Cash .............................................................................................................. Accounts receivable .......................................................................................... Supplies ............................................................................................................

$ 15,600 1,400 400 17,400

Non-current assets Building ............................................................................................................. Total assets ...................................................................................................... Liabilities and Equity Current liabilities Accounts payable .............................................................................................. Accrued expenses payable ................................................................................ Total liabilities ................................................................................................. Equity Share capital ................................................................................................ Retained earnings ........................................................................................ Total liabilities and Equity .........................................................................

60,000 $77,400

$ 3,100 3,300 $ 6,400 $52,000 19,000

71,000 $77,400

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

65. Listed below in alphabetical order are statement of financial position items of Rowen Ltd at 31 December 2015. Prepare a classified statement of financial position. Accounts payable Accounts receivable Building Cash Share capital Land Office equipment Retained profit

8,000 16,000 66,000 11,000 80,000 31,000 5,000 41,000

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

ROWEN LTD Statement of Financial Position at 31 December 2015 ASSETS Current assets Cash Accounts receivable

$ 11,000 16,000 27,000

Non-current assets Office equipment Building Land

5,000 66,000 31,000 102,000 $129,000

Total assets

LIABILITIES Current liabilities Accounts payable

$ 8,000

EQUITY Share capital Retained earnings Total equity and liabilities

$80,000 41,000 121,000 $129 000

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Chapter 1: An introduction to accounting

66. Indicate in the spaces provided whether each item would appear on the Income Statement (IS), Statement of Financial Position (SFP), or Statement of Changes in Equity (SCE): a. _____ Service Revenue

g. _____ Accounts Receivable

b. _____ Water and Light Expense

h. _____ Share Capital

c. _____ Cash

i. _____ Equipment

d. _____ Accounts Payable

j. _____ Advertising Expense

e. _____ Office Supplies

k. _____ Dividends paid

f. _____ Wage Expense

l. _____ Income Tax Payable

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. a. b. c. d. e. f.

IS IS SFP SFP SFP IS

g. h. i. j. k. l.

SFP SFP SFP IS SCE SFP

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

67. The directors of Tomas Sanchez Ltd were reviewing the company business activities at the end of the year (2015) and decided to prepare a Statement of Changes in Equity. At the beginning of the year company assets were $500,000, liabilities were $150,000, and share capital was $100,000. Profit for the year was $420,000. Dividends paid of $220,000 were paid during the year. Prepare a Statement of Changes in Equity for Tomas Sanchez Ltd. Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

TOMAS SANCHEZ LTD Statement of Changes in Equity for the year ended 31 December 2015 Retained earnings, 1 January 2012 ($500,000-$150,000-$100,000) Add: Profit Less: Dividends paid Retained earnings, 31 December 2015

$250,000 420,000 670,000 220,000 $450,000

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Chapter 1: An introduction to accounting

68. At 1 September 2015, the Statement of Financial Position for Arnold's Restaurant Ltd contained the following items: Accounts Payable Accounts Receivable Building Cash Furniture

$ 3,800 1,600 68,000 5,000 18,700

Land Share capital Loan Payable Supplies Retained earnings

$33,000 ? 46,000 4,600 43,200

The following transactions occurred during the next two days: shareholders invested an additional $22,000 cash in the business and accounts payable were paid in full. Prepare a statement of financial position for Arnold's Restaurant Ltd at 3 September 2015. Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. ARNOLD'S RESTAURANT LTD Statement of Financial Position at 3 September 2015 ASSETS Current Assets Cash (a) Accounts receivable Supplies

$ 23,200 1,600 4,600 29,400

Non-current assets Furniture Building Land

18,700 68,000 33,000 119,700 $149,100

Total assets LIABILITIES Non-current liability (b) Loan payable

$ 46,000

EQUITY Share capital(c) Retained earnings

$59,900 43,200 103,100

Total liabilities and Equity

$149,100

(a) Cash: ($5,000 + $22,000 - $3,800) = $23,200 (b) Non-current liability (Accounts Payable) ($3,800 - $3,800) = $0 (c) Share capital: Beginning balance = $37 900 Additional investment in shares = $22,000 Ending balance $59 900

1.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

69. From the following list of selected items taken from the records of Downing Clinic Ltd, identify those that would appear on the Statement of Financial Position. a. b. c. d. e.

Share capital Patient Revenue Land Wages Expense Loan Payable

f. g. h. i. j.

Accounts Payable Cash Medical Supplies Expense Medical Supplies Water and Light Expense

Answer: a, c, e, f, g, i. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

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Chapter 1: An introduction to accounting

70. One item is omitted in each of the following summaries of Statement of Financial Positions and Income Statements for three different companies, X Ltd, Y Ltd, and Z Ltd. Determine the amounts of the missing items, identifying each company by letter. X Ltd

Company Y Ltd

$400,000 250,000

$150,000 105,000

$199,000 168,000

450,000 280,000

195,000 95,000

195,000 169,000

79,000

78,000

Dividends paid

70,000

83,000

Revenue

195,000

187,000

Expenses

155,000

113,000

185,000

Z Ltd Beginning of the Year: Assets Liabilities End of the Year: Assets Liabilities During the Year: Additional Investment by Shareholders

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

Company X Ltd ($50,000) Beginning Equity ($400,000 - $250,000) Additional investments (balancing figure) Profit for year ($195,000 - $155,000) Less Dividends paid Ending Equity ($450,000 - $280,000) Company Y Ltd ($172,000) Beginning Equity ($150,000 - $105,000) Additional investments Profit for year (with revenue as the balancing figure) [Revenues = $45,000+Revenues+$79,000-$113,000-$83,000=$100,000) Less Dividends paid Ending Equity ($195,000 - $95,000) Company Z Ltd ($85,000) Beginning Equity ($199,000 - $168,000) Additional investments Profit for year ($187,000 - $185,000) Less Dividends paid (balancing figure) Ending Equity ($195,000 - $169,000)

$150,000 50,000 40,000 240,000 70,000 $170,000

$ 45,000 79,000 59,000 183,000 83,000 $100,000

$ 31,000 78,000 2,000 111,000 85,000 $ 26,000

1.35

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

71. Determine the missing items. Assets = Liabilities + Equity $70,000 (b) $84,000

$52,000 $28,000 (c)

(a) $30,000 $50,000

Answer: a. $18,000 b. $58,000 c. $34,000 Learning objective 1.6 – Identify the elements of each of the four main financial statements.

72. Identify which of the following items appear in a statement of financial position. a) Service revenue b) Cash c) Share capital d) Accounts payable e) Rent expense f) Supplies g) Land Answer: b, c, d, f, g. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

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Chapter 1: An introduction to accounting

73. For the items listed below, fill in the appropriate code letter to indicate whether the item is an asset, liability, or equity item. Code A L E

Asset Liability Equity _____

1. Rent Expense

_____

6. Cash

_____

2. Office Equipment

_____

7. Accounts Receivable

_____

3. Accounts Payable

_____

8. Retained earnings

_____

4. Share capital

_____

9. Service Revenue

_____

5. Insurance Expense

_____ 10. Loan Payable

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. 1. 2. 3. 4. 5.

E A L E E

6. 7. 8. 9. 10.

A A E E L

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

74. Classify each of these items as an asset (A), liability (L), or Equity (E). _____ 1. _____ 2. _____ 3. _____ 4. _____ 5. _____ 6. _____ 7. _____ 8.

Accounts receivable Accounts payable Share capital Office Supplies Retained earnings Cash Loan Payable Equipment

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. 1. 2. 3. 4. 5. 6. 7. 8.

A L E A E A L A

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Chapter 1: An introduction to accounting

75. At the beginning of the year, Wise Company Ltd had total assets of $700,000 and total liabilities of $300,000. Answer the following questions viewing each situation as being independent of the others. 1. If total assets increased $225,000 during the year, and total liabilities decreased $100,000, what is the amount of equity at the end of the year? 2. During the year, total liabilities increased $315,000 and Equity decreased $130,000. What is the amount of total assets at the end of the year? 3. If total assets decreased $60,000 and Equity increased $180,000 during the year, what is the amount of total liabilities at the end of the year?

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

Beginning Change Ending

Total Assets $700,000 225,000 $925,000

Beginning Change Ending

Total Assets $700,000 $185,000 $885,000 (2)

Beginning Change Ending

Total Assets $700,000 (60,000) $640,000

Total Liabilities $300,000 (100,000) $200,000

Total Liabilities $300,000 315,000 $615,000

Total Liabilities $300,000 ($240,000) $ 60,000 (3)

Equity $400,000 $325,000 $725,000 (1)

Equity $400,000 (130,000) $270,000

Equity $400,000 180,000 $580,000

1.39

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

76. Reinhart’s Carpet Cleaning Ltd has the following statement of financial position items: Van Accounts Payable Cash Cleaning Supplies Accounts Receivable

Loan Payable Share Capital Retained earnings Equipment

Identify which items are (1) Assets (2) Liabilities (3) Equity

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. 1. Assets - Van, Cash, Cleaning Supplies, Accounts Receivable, Equipment. 2. Liabilities - Accounts Payable, Loan Payable. 3. Equity - Share capital, Retained earnings.

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Chapter 1: An introduction to accounting

77. On 1 June 2015, Lewis Company Ltd prepared a Statement of Financial Position that shows the following: Assets (no cash) ......................................................................... $125,000 Liabilities ................................................................................... 75,000 Equity .......................................................................................... 50,000 Shortly thereafter, all of the assets were sold for cash. How would the statement of financial position appear immediately after the sale of the assets for cash for each of the following cases?

Cash A

Cash Received for the Assets $135,000

Balances Immediately After Sale Assets Liabilities = Equity $________ $________ $________

Cash B

125,000

________

Cash C

110,000

________

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements.

Cash A Cash B Cash C

Cash Received for the Assets $135,000 125,000 110,000

Balances Immediately After Sale Assets Liabilities = Equity $135,000 $75,000 $60,000 125,000 75,000 50,000 110,000 75,000 35,000

1.41

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

78. Compute the missing amount in each category of the accounting equation.

(a) (b) (c)

Assets $260,000 $178,000 $ ?

Liabilities $ ? $ 73,000 $202,000

Equity $ 98,000 $ ? $310,000

Answer below. Learning objective 1.6 – Identify the elements of each of the four main financial statements. (a) $162,000 ($260,000 - $98,000 = $162,000) (b) $105,000 ($178,000 - $73,000 = $105,000) (c) $512,000 ($202,000 + $310,000 = $512,000)

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Chapter 1: An introduction to accounting

Completion statements 79. Presented below are the qualitative characteristics of information contained in general-purpose financial reports. a. relevance b. reliability c. comparability d. understandability Identify the qualitative characteristic that fits the statement below. 1. Information in general-purpose financial reports should be_____________ to users who have the proficiency to comprehend the significant accounting practices. 2. Financial report information is ______________ when different entities use the same accounting principles. 3. Accounting information is _____________ if it would make a difference in a business decision. 4. Information that can be depended on and without undue error is said to be _________.

Answer below. Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. 1. 2. 3. 4.

d c a b

understandable comparable relevant reliable

1.43

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

80. Complete the following statements: 1.

A business organised as a separate legal entity owned by shareholders is a ___________. LO3

Managers are _______________ of accounting information who plan, organise, and control a business. LO5

_________________ activities involve collecting the necessary funds to support the business. LO5

The ________________ reports the assets, liabilities, and equity of a business at a specific date. LO6

The claim of owners on the assets of a business is known as ________________. LO6

The basic accounting _______________.LO6

The primary purpose of a ________________ is to provide financial information about the cash receipts and cash payments of a business. LO6

The _________________ is prepared by an independent auditor stating the auditor’s opinion as to the truth and fairness of the presentation of the financial statements. LO6

The _________________ principle states that assets should be recorded at their cost. LO8

equation

Assets

____________

10. If different entities use the same accounting principle, the financial reports of those entities are _________________ . LO8

Answer below. Learning objective 1.3, 1.5, 1.6, 1.8. 1. 2. 3. 4. 5.

company internal users financing Statement of Financial Position equity

6. 7. 8. 9. 10.

Liabilities, Equity Statement of Cash Flows auditor's report cost comparable

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Chapter 1: An introduction to accounting

Matching 81. Match the items below by entering the appropriate code letter in the space provided.

A. Internal users B. Directors’ report C. Annual report D. Sole trader E. Timeliness ____

F. Australian Securities Exchange G. Assets H. Liabilities I. Expenses J. Retained earnings

1. Financial information is collected quickly so that it does not lose its relevance.

____

2. Consumed assets or services.

____

3. Ownership is limited to one person.

____

4. Officers and others who manage the business.

____

5. Creditor claims against the assets of the business.

____

6. An organisation that produces listing rules that companies must comply with.

____

7. A report prepared by directors that presents audited financial information.

____

8. A section of the annual report that presents management’s views.

____

9. Future economic benefits.

____ 10. Accumulated profit that has not been distributed as dividends to owners.

Answer below. Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. 1. 2. 3. 4. 5.

E I D A H

6. 7. 8. 9. 10.

F C B G J

1.45

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

82. Presented below are the basic assumptions and principles underlying financial statements. a. Cost principle b. Accounting entity concept c. Full disclosure principle

d. Going concern principle e. Monetary principle f. Accounting period concept

Identify the basic concept or principle that is described below. ____ 1. The economic life of a business can be divided into artificial time periods. ____ 2. The business will continue in operation long enough to carry out its existing objectives. ____ 3. Assets should be recorded at their cost. ____ 4. Every entity can be separately identified and accounted for. ____ 5. Circumstances and events that make a difference to financial statement users should be disclosed. ____ 6. Only transaction data that can be accurately expressed in terms of money should be included in the accounting records.

Answer below. Learning objective 1.8 – Explain the accounting concepts, principles, qualitative characteristics and constraints underlying financial statements. 1. f 2. d 3. a

4. b 5. c 6. e

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Chapter 1: An introduction to accounting

Short-answer/essay questions 83. Explain the four steps in the accounting process. Answer below. Learning objective 1.2 Define accounting, describe the accounting process and define the diverse role of accountants. The accounting cycle consists of four steps. First, all relevant economic events (or transactions) must be identified. Relevant economic benefits are those that affect the assets and or liabilities of the business. Second, all transactions that have been identified in the first step have to be quantified in monetary terms. The third step is recording the transactions. This step must include analysing, recording, classifying and summarising transactions. Finally once these three steps have been performed the results can be communicated to users by preparing accounting reports, including an income statement, statement of financial position, statement of cash flows and statement of changes in equity.

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Chapter 2: The recording process

Chapter 2: The recording process Multiple-choice questions

1. The accounting equation can be used to analyse transactions for a: a. company. b. sole trader. c. not-for-profit entity. *d. all of the above. Answer: d Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: All business structures use a double entry accounting system. 2. Equity is increased by: a. dividends. *b. revenues. c. expenses. d. liabilities. Answer: b Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: Revenues increase equity; expenses and dividends reduce equity. 3. Which of the following items has no effect on equity? a. Expense. b. Dividends. *c. Land purchase. d. Revenue. Answer: c Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: Revenues increase equity; expenses and dividends reduce equity.

2.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. Purchase of $600 of supplies on credit: a. increases an asset $600; decreases an asset $600. *b. increases an asset $600; increases a liability $600. c. decreases a liability $600; increases Equity $600. d. decreases an asset $600; decreases a liability $600. Answer: b Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: A credit purchase of supplies increases an asset (Supplies) and increases a liability (Accounts payable). 5. If services are provided for credit, then: a. assets will decrease. b. liabilities will increase. *c. Equity will increase. d. liabilities will decrease. Answer: c Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of earning revenue on credit is to increase an asset (Receivables) and increase Equity. 6. If expenses are paid in cash, then: a. assets will increase. b. liabilities will decrease. c. Equity will increase. *d. assets will decrease. Answer: d Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of paying expenses in cash is to increase an expense (a decrease to Equity) and decrease an asset (Cash).

2.2

Chapter 2: The recording process

7. Shareholders paying cash to purchase shares in a company increases: *a. assets and equity. b. assets and liabilities. c. liabilities and equity. d. assets only. Answer: a Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect issuing shares for cash to shareholders is to increase an asset (Cash) and increase equity (Share capital). 8. The purchase of an asset for cash: a. increases assets and equity. b. increases assets and liabilities. c. decreases assets and increases liabilities. *d. leaves total assets unchanged. Answer: d Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of purchasing an asset for cash is to increase one asset (Equipment) and decrease another (Cash). The overall effect on total assets is zero. 9. The cash payment of a liability: a. decreases assets and equity. b. increases assets and decreases liabilities. c. decreases assets and increases liabilities. *d. decreases assets and liabilities. Answer: d Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of paying a liability with cash is to decrease a liability (Payables) and decrease an asset (Cash).

2.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. The sale of an asset on credit for what it cost: a. increases assets and liabilities. b. decreases assets and liabilities. *c. leaves total assets unchanged. d. decreases assets and increases liabilities. Answer: c Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of selling an asset on credit for its cost price is to increase an asset (Receivables) and reduce another asset (Vehicle). The net effect on total assets is zero. 11. A transaction to record earning revenue: a. increases assets and liabilities. *b. increases assets and Equity. c. increases assets and decreases equity. d. leaves total assets unchanged. Answer: b Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of earning revenue is to increase an asset (Cash or Receivables) and increase revenue (an increase to Equity). 12. A cash payment of a dividend: *a. decreases assets and equity. b. increases assets and equity. c. increases assets and decreases equity. d. decreases assets and increases equity. Answer: a Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of paying a cash dividend is to decrease an asset (Cash) and decrease retained earnings (Equity).

2.4

Chapter 2: The recording process

13. An expense incurred: a. decreases assets and liabilities. *b. decreases equity. c. leaves Equity unchanged. d. increases equity. Answer: b Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: The effect of incurring an expense is to decrease equity (Retained earnings) and either decrease an asset (Cash) or incur a liability (Payable). 14. For the basic accounting equation to stay in balance, each transaction recorded must: a. change no more than one account. *b. affect two or more accounts. c. always affect exactly two accounts. d. affect only one account. Answer: b Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. Feedback: Each transaction will affect two or more accounts ensuring the equality of the accounting equation. 15. The left side of an account is: a. blank. b. a description of the account. *c. the debit side. d. the balance of the account. Answer: c Learning objective 2.2 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount the left hand side is the debit side and the right hand side is the credit side.

2.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. Which one of the following is not a part of an account? a. credit side. *b. trial balance. c. debit side. d. title. Answer: b Learning objective 2.2 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount the left hand side is the debit side and the right hand side is the credit side. A trial balance is a list of account balances. 17. An account is a part of the accounting information system and has all of the following characteristics except: a. an account has a debit and credit side. *b. an account has only one side. c. an account consists of three parts. d. an account has a title. Answer: b Learning objective 2.2 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount the left hand side is the debit side and the right hand side is the credit side. 18. An account consists of: a. a title, a debit balance, and a credit balance. b. a title, a left side, and a debit balance. *c. a title, a debit side, and a credit side. d. a title, a right side, and a debit balance. Answer: c Learning objective 2.2 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount format the left hand side is the debit side and the right hand side is the credit side.

2.6

Chapter 2: The recording process

19. A T-account is: *a. a way of depicting the basic form of an account. b. a special account used instead of a journal. c. a special account used instead of a trial balance. d. used for accounts that have both a debit and credit balance. Answer: a Learning objective 2.2 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount the left hand side is the debit side and the right hand side is the credit side. 20. The double-entry system requires that each transaction must be recorded: *a. in at least two different accounts. b. in two sets of books. c. in a journal and in a ledger. d. first as a revenue and then as an expense. Answer: a Learning objective 2.3 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. Each transaction must affect two or more different accounts to keep the accounting equation in balance. This equality of debits and credits provides the basis for the double-entry accounting system. 21. The best interpretation of the word credit is the: a. offset side of an account. b. increase side of an account. *c. right side of an account. d. decrease side of an account. Answer: c Learning objective 2.2, 2.3 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount the left hand side is the debit side and the right hand side is the credit side.

2.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. An account will have a credit balance if the: *a. credits exceed the debits. b. first transaction entered was a credit. c. debits exceed the credits. d. last transaction entered was a credit. Answer: a Learning objective 2.2 - Explain what an account is and how it helps in the recording process. Feedback: An account is an individual record of increases and decreases in each specific asset, liability or equity item. An account may be represented in a T-account format. In a Taccount the left hand side is the debit side and the right hand side is the credit side. When each side is totaled and offset against each other an account will have a credit balance if credits exceed debits. 23. An accountant has debited an asset account for $1,000 and credited a liability account for $500. What can be done to complete the recording of the transaction? a. Nothing further must be done. b. Debit an equity account for $500. c. Debit another asset account for $500. *d. Credit a different asset account for $500. Answer: d Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Debiting an asset by $1,000 will increase the asset. The accounting equation must balance therefore the $500 increase in liabilities must be offset by decreasing a different asset account for $500 (e.g. Cash). 24. When a business has performed a service but has not yet received payment, it: *a. debits an asset and credits revenue. b. debits revenue and credits an asset. c. makes no entry until the cash is received. d. credits an asset and credits a liability. Answer: a Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: To record performing a service on credit, debit a receivable (asset) and credit revenue (an increase to equity).

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Chapter 2: The recording process

25. A business that receives cash in advance of performing a service will: a. debit cash and credit prepaid expenses. b. debit unearned revenue and credit accounts payable. *c. debit cash and credit unearned revenue. d. debit cash and credit accounts receivable. Answer: c Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: To record cash received in advance of earning revenue, debit Cash (asset) and credit Unearned revenue or Revenue received in advance (liability). 26. When a business receives an unpaid electricity account, it should: a. debit Electricity expense and credit Accounts receivable. *b. debit Electricity expense and credit Accounts payable. c. debit Accounts payable and credit Electricity expense. d. make no entry until the bill is paid. Answer: b Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: To record the consumption of a resource without payment of cash, debit an expense (a decrease to equity) and credit a liability (Payable). 27. When a service has been performed but no cash has been received, which of the following statements is true? a. No journal entry is made. b. The entry includes a debit to Accounts payable. c. The entry includes a credit to Unearned revenue. *d. The entry includes a debit to Accounts receivable. Answer: d Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: To record providing services on credit, debit a receivable (asset) and credit Revenue (an increase to equity).

2.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. A $20,000 machine is purchased by paying $5,000 cash and agreeing to pay for the remainder in 30 days' time, the journal entry should include a: *a. credit to Accounts payable. b. debit to Cash. c. credit to Revenue. d. credit to Machinery. Answer: a Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: To record the purchase, debit Machinery (asset) and credit Cash (asset) and credit the remaining $15,000 to Accounts payable (liability). 29. A credit is not the normal balance for which account listed below? a. Share capital account. b. Revenue account. c. Liability account. *d. Dividends account. Answer: d Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: A dividend is a distribution by a company to its shareholders. Dividends have a normal debit balances as dividends reduce retained earnings (equity). 30. Which of the following describes the classification and normal balance of the Retained earnings account? a. Asset, debit. *b. Equity, credit. c. Revenues, credit. d. Expense, debit. Answer: b Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: A dividend is a distribution by a company to its shareholders. Dividends have a normal debit balance as dividends reduce retained earnings (equity).

2.10

Chapter 2: The recording process

31. Which of the following describes the classification and normal balance of the Revenue received in advance (Unearned revenue) account? a. Asset, debit. *b. Liability, credit. c. Revenues, credit. d. Expense, debit. Answer: b Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Unearned revenue or Revenue received in advance is a liability. The normal balance of a liability is a credit. 32. A debit is not the normal balance for which account listed below? a. Dividends. b. Cash. c. Accounts receivable. *d. Service revenue Answer: d Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Assets, expenses and dividends all have a normal debit balance. Liabilities, revenues and equity all have a normal credit balance. 33. Which of the following accounts is increased with a debit? *a. Dividends. b. Legal fees earned. c. Rent payable. d. Share capital. Answer: a Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: A dividend is a distribution by a company to its shareholders. Dividends have a normal debit balance as dividends reduce retained earnings (Equity).

2.11

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. Which of the following accounts is increased with a credit? a. Supplies expense. b. Supplies. *c. Revenue. d. Dividends. Answer: c Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Asset, expense and dividend accounts have a normal debit balance. Liability, revenue and equity accounts have a normal credit balance. 35. A credit to which account will increase equity? a. Electricity payable. b. Prepaid insurance. *c. Revenue. d. Plant and equipment. Answer: c Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Asset, expense and dividend accounts have a normal debit balance. Liability, revenue and equity accounts have a normal credit balance. 36. Assets normally show: a. credit balances. *b. debit balances. c. debit and credit balances. d. both debit and credit balances. Answer: b Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Asset, expense and dividend accounts have a normal debit balance. Liability, revenue and equity accounts have a normal credit balance.

2.12

Chapter 2: The recording process

37. Which account below is not a sub-account of equity? a. Dividends paid. b. Revenues. c. Expenses. *d. Liabilities. Answer: d Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Equity is increased when revenue is earned and decreased when expenses are incurred and when dividends are declared. 38. When a company pays a dividend the: *a. Dividend paid account will increase with a debit. b. Dividends paid account will be increased with a credit. c. Retained earnings account will be directly increased with a credit. d. Dividends paid account will be decreased with a debit. Answer: a Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: To record the payment of a dividend, dividends paid account is debited and Cash account is credited. 39. The Dividends paid account: a. normally has a credit balance. b. increases equity. *c. is increased with debits and decreased with credits. d. is not a proper sub-account of equity. Answer: c Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: As dividends reduce equity, the Dividends paid account is increased with a debit and reduced with a credit.

2.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. A credit to a liability account: *a. indicates an increase in the amount owed to creditors. b. indicates a decrease in the amount owed to creditors. c. is an error. d. must be accompanied by a debit to an asset account. Answer: a Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Feedback: Asset, expense and dividend accounts have a normal debit balance. Liability, revenue and equity accounts have a normal credit balance. Liability accounts are increased by credits and reduced by debits. 41. The usual sequence of steps in the transaction recording process is: a. journal, analyse, ledger. *b. analyse, journal, ledger. c. journal, ledger, analyse. d. ledger, journal, analyse. Answer: b Learning objective 2.4 - Identify the basic steps in the recording process. Feedback: There are three basic steps in the recording process: (1) analyse each transaction in terms of its effect on the accounts, (2) enter the transaction information in a journal, and (3) transfer the journal information to the appropriate accounts in the ledger. 42. In recording accounting transactions, evidence that a transaction has taken place is obtained from: *a. source documents. b. the trial balance. c. the ledger. d. the journal. Answer: a Learning objective 2.4 - Identify the basic steps in the recording process. Feedback: Evidence of the transaction comes in the form of a source document.

2.14

Chapter 2: The recording process

43. After a business transaction has been analysed and entered in the journal, the next step in the recording process is to transfer the information to: a. the bank. b. the trial balance. *c. ledger accounts. d. financial statements. Answer: c Learning objective 2.4 - Identify the basic steps in the recording process. Feedback: There are three basic steps in the recording process: (1) analyse each transaction in terms of its effect on the accounts, (2) enter the transaction information in a journal, and (3) transfer the journal information to the appropriate accounts in the ledger. 44. The first step in the recording process is to: a. prepare financial statements. *b. analyse the transaction in terms of its effect on the accounts. c. post to a journal. d. prepare a trial balance. Answer: b Learning objective 2.4 - Identify the basic steps in the recording process. Feedback: There are three basic steps in the recording process: (1) analyse each transaction in terms of its effect on the accounts, (2) enter the transaction information in a journal, and (3) transfer the journal information to the appropriate accounts in the ledger. 45. Evidence that would not help with determining the effects of a transaction on the accounts would be a: a. cash register sales tape. b. purchase invoice. *c. advertising brochure. d. sales invoice. Answer: c Learning objective 2.4 - Identify the basic steps in the recording process. Feedback: There are three basic steps in the recording process: (1) analyse each transaction in terms of its effect on the accounts, (2) enter the transaction information in a journal, and (3) transfer the journal information to the appropriate accounts in the ledger. An advertising brochure does not evidence a business transaction.

2.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. The recording process occurs: a. once a year. b. once a month. *c. repeatedly during the accounting period. d. infrequently in a manual accounting system. Answer: c Learning objective 2.4 - Identify the basic steps in the recording process. Feedback: There are three basic steps in the recording process that occur repeatedly: (1) analyse each transaction in terms of its effect on the accounts, (2) enter the transaction information in a journal, and (3) transfer the journal information to the appropriate accounts in the ledger. 47. The final step in the recording process is to transfer the journal information to the: a. trial balance. b. financial statements. *c. ledger. d. file cabinets. Answer: c Learning objective 1.4 - Identify the basic steps in the recording process. Feedback: There are three basic steps in the recording process: (1) analyse each transaction in terms of its effect on the accounts, (2) enter the transaction information in a journal, and (3) transfer the journal information to the appropriate accounts in the ledger. 48. A journal provides: a. the balances for each account. b. information about a transaction in several different places. c. a list of all accounts used in the business. *d. a chronological record of transactions. Answer: d Learning objective 2.5 - Explain what a journal is and how it helps in the recording process. Feedback: Transactions are recorded in chronological order in a journal before they are transferred to the accounts.

2.16

Chapter 2: The recording process

49. The basic format of a journal would not include a: a. brief explanation. b. account title column. *c. T-account. d. date column. Answer: c Learning objective 2.5 - Explain what a journal is and how it helps in the recording process. Feedback: A journal has the following features: (1) the date column, (2) the accounts to be debited and credited, (3) the amounts for the debits and credits, (4) a brief explanation of the transaction, and (5) a posting reference column. 50. A complete journal entry does not show: a. the date of the transaction. *b. the new balance in the accounts affected by the transaction. c. a brief explanation of the transaction. d. the accounts and amounts to be debited and credited. Answer: b Learning objective 2.5 - Explain what a journal is and how it helps in the recording process. Feedback: A journal has the following features: (1) the date column, (2) the accounts to be debited and credited, (3) the amounts for the debits and credits, (4) a brief explanation of the transaction, and (5) a posting reference column. 51. The name given to entering transaction data in the journal is: a. chronicling. b. listing. c. posting. *d. journalising. Answer: d Learning objective 2.5 - Explain what a journal is and how it helps in the recording process. Feedback: Entering transactions in the journal is known as journalising.

2.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

52. Which of the following accounts probably would be listed before the others in a chart of accounts? *a. Accumulated depreciation - Buildings. b. Insurance expense. c. Dividends. d. Accounts payable. Answer: a Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A chart of accounts is a list of all accounts in the general ledger. Asset accounts are usually listed first in a chart of accounts. As Accumulated depreciation is a contra asset account it would appear in the asset section. 53. Typically the chart of accounts begins with: *a. asset accounts. b. liability accounts. c. revenue accounts. d. expense accounts. Answer: a Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A chart of accounts is a list of all accounts in the general ledger. Asset accounts are usually listed first in a chart of accounts. 54. The Unearned revenue (or Revenue received in advance) account is classified as a: a. asset account. b. revenue account. c. expense account. *d. liability account. Answer: d Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A chart of accounts is a list of all accounts in the general ledger.

2.18

Chapter 2: The recording process

55. Which of the following is an asset account? a. Service revenue account. b. Accounts payable account. c. Supplies expense account. *d. Prepaid rent account. Answer: d Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A chart of accounts is a list of all accounts in the general ledger. Prepaid rent is an asset. 56. A chart of accounts for a business: a. is a graph. b. indicates the amount of profit or loss for the period. *c. lists the accounts in the ledger. d. shows the balance of each account in the general ledger. Answer: c Learning objective 2.5 - Explain what a general ledger is and how it helps in the recording process. Feedback: chart of accounts is a list of all accounts in the general ledger. The trial balance lists the balances of all accounts in the chart of accounts. 57. The purpose of the ledger is to: a. record chronologically the day's transactions. b. keep a record of documentation to support each transaction. *c. keep in one place all information about changes in specific account balances. d. make sure that all assets and liability accounts have normal balances at all times. Answer: c Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A general ledger contains an account for all assets, liabilities and equity items. Increases and decreases to each account are recorded as debits or credits. Each account will have a debit or credit balance.

2.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

58. If you want to determine the balance of a particular account you should refer to the: *a. ledger. b. source document. c. chart of accounts. d. journal. Answer: a Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A general ledger contains an account for all assets, liabilities and equity items. Increases and decreases to each account are recorded as debits or credits. Each account will have a debit or credit balance. 59. Management could determine the total amounts due from customers by examining which ledger account? a. Service revenue. b. Accounts payable. *c. Accounts receivable. d. Supplies. Answer: c Learning objective 26 - Explain what a general ledger is and how it helps in the recording process. Feedback: A general ledger contains an account for all assets, liabilities and equity items. Increases and decreases to each account are recorded as debits or credits. Each account will have a debit or credit balance. 60. The ledger accounts should be arranged in: a. chronological order. b. alphabetical order. *c. order of the accounting equation. d. order of appearance in the journal. Answer: c Learning objective 2.6 - Explain what a general ledger is and how it helps in the recording process. Feedback: A general ledger contains an account for all assets, liabilities and equity items. Asset accounts are normally listed first, followed by liability accounts, equity accounts and equity sub accounts of revenues and expenses.

2.20

Chapter 2: The recording process

61. The procedure of recording journal entries to the ledger accounts is called: a. journalising. b. analysing. c. reporting. *d. posting or transferring. Answer: d Learning objective 2.7 - Explain what posting is and how it helps in the recording process. Feedback: The procedure of transferring journal entries to ledger accounts is called posting. 62. Posting: a. should be performed in account number order. *b. accumulates the effects of journalised transactions in the individual ledger accounts. c. involves transferring all debits and credits on a journal page to the trial balance. d. is accomplished by examining ledger accounts and seeing which ones need updating. Answer: b Learning objective 2.7 - Explain what posting is and how it helps in the recording process. Feedback: Posting accumulates the effects of journalised transactions in the individual asset, liability, equity, and equity sub accounts of revenues and expenses.

63. The principle purpose of posting is to: a. help identify errors made in the journal. *b. accumulate the effects of journalised transactions in the individual accounts. c. enter transactions directly into the ledger. d. help determine if the financial statements are ready to be prepared. Answer: b Learning objective 2.7 - Explain what posting is and how it helps in the recording process. Feedback: Posting accumulates the effects of journalised transactions in the individual asset, liability, equity, and equity sub accounts of revenues and expenses.

2.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

64. An awareness of the normal balances of accounts would help you spot the following as an error in recording? a. A debit balance in the Dividends Paid account. *b. A credit balance in an expense account. c. A credit balance in a liabilities account. d. A credit balance in a revenue account. Answer: b Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: The trial balance can facilitate the identification of a posting error that results in an account having a credit balance when it would normally have a debits balance and vice versa. 65. If a business has overdrawn its bank balance, then: a. its Cash account will show a debit balance. *b. its Cash account will show a credit balance. c. the Cash account debits will exceed the Cash account credits. d. it cannot be detected by observing the balance of the Cash account. Answer: b Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: The Cash account normally has a debit balance; however a credit balance in the Cash account indicates a liability to the bank, a bank overdraft. 66. A list of accounts and their balances at a given time is called a: a. journal. b. posting. *c. trial balance. d. profit and loss summary. Answer: c Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: A trial balance is a list of accounts and their balances at a given point in time.

2.22

Chapter 2: The recording process

67. If the sum of the debit column equals the sum of the credit column in a trial balance, it indicates: a. no errors have been made. b. no errors can be discovered. c. that all accounts reflect correct balances. *d. the mathematical equality of the accounting equation. Answer: d Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: The main purpose of a trial balance is to prove the mathematical equality of debits and credits after posting transactions from the journal. 68. A trial balance is a listing of: a. transactions in a journal. b. the chart of accounts. *c. general ledger accounts and balances. d. the totals from the journal pages. Answer: c Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: A trial balance is a list of accounts and their balances at a given point in time. 69. Customarily, a trial balance is prepared: a. at the end of each day. b. after each journal entry is posted. *c. at the end of an accounting period. d. only at the inception of the business. Answer: c Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: A trial balance is a list of accounts and their balances at a given point in time. It may be prepared at any time but it is always prepared at the end of the accounting period.

2.23

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

70. If the totals of a trial balance are not equal, it could be due to: a. a failure to record or to post a transaction. b. recording the same erroneous amount for both the debit and credit parts of a transaction. *c. an error in calculating the account balances. d. recording the transaction more than once. Answer: c Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: The main purpose of a trial balance is to prove the mathematical equality of debits and credits after posting. The trial balance will not balance when an error has been made in calculating the account balances. 71. Which of the following errors would cause the trial balance to be out of balance? *a. A payment of $148 to a creditor was posted as a debit to Accounts payable and a debit of $148 to Cash. b. Cash received from a customer on account was posted as a debit of $350 to Cash and as a credit of $350 to Accounts payable. c. A payment of $59 for supplies was posted as a debit of $95 to Supplies and a credit of $95 to Cash. d. A transaction was not posted. Answer: a Learning objective 2.8 - Explain the purpose of a trial balance. Feedback: The main purpose of a trial balance is to prove the mathematical equality of debits and credits after posting. The trial balance will not balance when an error has been made in posting. A debit to a liability account (Accounts payable) and a debit to an asset account (Cash) will not satisfy the equality of the accounting equation.

2.24

Chapter 2: The recording process

Exercises

72. Selected transactions for Kookaburra Ltd are listed below. List the number of the transaction and then describe the effect of each transaction on assets, liabilities, and equity. Sample: Made initial cash investment in the business. The answer would be — Increase in assets and increase in Equity. 1. 2. 3. 4. 5. 6. 7. 8. 9.

Paid monthly electricity bill. Purchased new display case for cash. Paid cash for repair work on security system. Invoiced customers for services performed. Received cash from customers invoiced in transaction 4. Dividends paid to owners. Incurred advertising expenses on account. Paid monthly rent. Received cash from customers when service was rendered.

Answers below. Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation. 1. 2. 3. 4. 5. 6. 7. 8. 9.

Decrease in assets and decrease in equity. No net change in assets. Decrease in assets and decrease in equity. Increase in assets and increase in equity. No net change in assets. Decrease in assets and decrease in equity. Increase in liabilities and decrease in equity. Decrease in assets and decrease in equity. Increase in assets and increase in equity.

2.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

73. Selected accounts from the ledger of Platypus Ltd appear below. For each account, indicate the following: In the first column at the right, indicate the nature of each account, using the following abbreviations: Asset - A Expense - E

Liability - L Revenues - R

None of the above - N

(b) In the second column, indicate the normal balance by inserting Dr. or Cr.

Type of Account

Normal Balance

1. Supplies ……………………………….. 2. Electricity payable ………………….… 3. Service revenue………………………. 4. Dividends………………………………. 5. Accounts payable…………………….. 6. Salaries expense……………………... 7. Share capital………………………….. 8. Accounts receivable…………………. 9. Equipment……………………………… 10. Loan receivable…………………….…

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Type of Normal Account Balance 1. Supplies ………………………………. A Dr. 2. Electricity payable ……………… L Cr. 3. Service revenue………………………. R Cr. 4. Dividends………………………………. N Dr. 5. Accounts payable…………………….. L Cr. 6. Salaries expense……………………… E Dr. 7. Share capital………………………… N Cr. 8. Accounts receivable………………….. A Dr. 9. Equipment…………………………….. A Dr. 10. Loan receivable……………………… A Dr.

2.26

Chapter 2: The recording process

74. For each item below, indicate whether a debit or credit applies. 1. Decrease in Loan payable 2. Increase in Dividends paid 3. Increase in Equity 4. Increase in Revenue received in advance (Unearned revenue) 5. Decrease in Interest payable 6. Increase in Prepaid insurance 7. Decrease in Wages expense 8. Decrease in Supplies 9. Increase in Revenues 10. Decrease in Accounts receivable

____ ____ ____

__ __ __

____ ____ ____ ____ ____ ____ ____

__ __ __ __ __ __ __

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions.

1. Decrease in Loan payable 2. Increase in Dividends paid 3. Increase in Equity 4. Increase in Revenue received in advance (Unearned revenue) 5. Decrease in Interest payable 6. Increase in Prepaid insurance 7. Decrease in Wages expense 8. Decrease in Supplies 9. Increase in Revenues 10. Decrease in Accounts receivable

____Dr.__ ____Dr.__ ____Cr.__ ____Cr.__ ____Dr.__ ____Dr.__ ____Cr.__ ____Cr.__ ____Cr.__ ____Cr.__

2.27

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

75. For each item below, indicate whether a debit or credit applies. 1. Decrease in Prepaid rent ____ __ 2. Increase in Revenues ____ __ 3. Decrease in Revenue received in advance (Unearned revenue) ____ __ 4. Increase in Dividends paid ____ __ 5. Decrease in Interest receivable ____ __ 6. Increase in Depreciation expense ____ __ 7. Decrease in Accounts payable ____ __ 8. Increase in Supplies ____ __ 9. Increase in Wage expense ____ __ 10. Decrease in Accounts receivable ____ __

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions.

1. Decrease in Prepaid rent 2. Increase in Revenues 3. Decrease in Unearned revenues (Unearned revenue) 4. Increase in Dividends paid 5. Decrease in Interest receivable 6. Increase in Depreciation expense 7. Decrease in Accounts payable 8. Increase in Supplies 9. Increase in Wage expense 10. Decrease in Accounts receivable

____Cr__ ____Cr__ ____Dr__ ____Dr__ ____Cr__ ____Dr__ ____Dr__ ____Dr__ ____Dr__ ____Cr__

2.28

Chapter 2: The recording process

76. Analyse the transactions described below and indicate their effect on the basic accounting equation. Use a plus sign (+) to indicate an increase and a minus sign (-) to indicate a decrease. 1. Received cash for services provided.

Assets = ________

Liabilities ________

Equity ________

2. Purchased office equipment on credit.

________

3. Paid employees' salaries.

________

4. Received cash from customer in payment of account.

________

5. Paid telephone account for the month.

________

6. Paid for office equipment purchased in transaction 2.

________

7. Purchased office supplies on credit.

________

8. Dividends were paid.

________

9. Obtained a loan from the bank.

________

10. Invoiced customers for services provided.

________

Answers below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process.

1. Received cash for services provided. 2. Purchased office equipment on credit. 3. Paid employees' salaries. 4. Received cash from customer in payment of account. 5. .Paid telephone account for the month. 6. Paid for office equipment purchased in transaction 2. 7. Purchased office supplies on credit. 8. Dividends were paid. 9. Obtained a loan from the bank. 10. Invoiced customers for services provided.

Assets + + -

Liabilities

Equity +

+ -

+ + + +

+ + +

2.29

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

77. Gwen Stefani decides to incorporate a company and open a pizza bar near the local university campus. Analyse the following transactions for the month of July in terms of their effect on the basic accounting equation. Record each transaction by increasing (+) or decreasing (-) the dollar amount of each item effected. Indicate the new balance of each item after a transaction is recorded. It is not necessary to identify the cause of changes in equity. Transactions (1) Gwen Stefani invests $25,000 cash in exchange for share capital to start a pizza bar business on July 1. (2) Purchased baking equipment for $5,000 paying $3,000 in cash and the remainder is due in 30 days. (3) Purchased cooking supplies for $1,200 cash. (4) Received an account from Campus News for $300 for advertising in the campus newspaper. (5) Cash receipts from customers for pizza sales amounted to $1,500. (6) Paid salaries of $200 to student workers. (7) Invoiced the Tiger Football Team $100 for pizzas ordered. (8) Paid $300 to Campus News for advertising that was previously invoiced in Transaction 4. (9) Gwen Stefani was paid dividends of $700. (10) Incurred electricity expenses for month on account, $200.

Cash

Accounts receivable

Cooking supplies

Baking equipment

Accounts payable

Share capital

Balance (1) Balance (2) Balance (3) Balance (4) Balance (5) Balance (6) Balance (7) Balance (8) Balance (9) Balance (10) Totals

2.30

Retained earnings

Chapter 2: The recording process

Answers below. Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation.

Transaction

Cash

Balance (1) Balance (2) Balance (3) Balance (4) Balance (5) Balance (6) Balance (7) Balance (8) Balance (9) Balance (10) Totals

$25,000

Accounts receivable

Baking equipment

Accounts payable

$20,800 +1,500 $22,300 -200 $22,100

$21,100

Cooking supplies

$25,000 -3,000 $22,000 -1,200 $20,800

$22,100 -300 $21,800 -700 $21,100

+ +

$5,000 $5,000

$2,000 $2,000

Share capital $25,000

+ +

$25,000

+ +

$1,200 $1,200

$5,000

$1,200

$5,000

$2,000 +300 $2,300

$1,200

$5,000

$2,300

$25,000

$1,200

$5,000

$2,300

$25,000

+ +

$100 $100

$1,200

$5,000

$25,000

$100

$1,200

$5,000

$2,300 -300 $2,000

$25,000

$100

$1,200

$5,000

$25,000

$100

$1,200

$5,000

$2,000 +200 $2,200

$25,000

Retained earnings

2.31

$300 $300 +1,500 $1,200 -200 $1,000 +100 $1,100 $1,100 -700 $400 -200 $200

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

78. Analyse the following transactions in terms of their effect on the basic accounting equation. Record each transaction by increasing (+) or decreasing (-) the dollar amount of each item affected. Indicate the new balance of each item after a transaction is recorded. 1. 2. 3. 4. 5. 6. 7.

Issued shares to investors for $12,000 in cash. Purchased supplies on credit for $700. Invoiced customers $400 for services provided. Paid for supplies purchased in transaction 2. Paid dividends of $300 cash to shareholders. Received half of amount owing by customers invoiced in transaction 3. Received and paid electricity bill for $50.

Transaction

Accounts receivable Supplies

Cash

Accounts

Retained

payable

capital

earnings

1 Balance 2 Balance 3 Balance 4 Balance 5 Balance 6 Balance 7 Totals

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Chapter 2: The recording process

Answers below. Learning objective 2.1 - Analyse the effect of accounting transactions and events on the basic accounting equation.

Transaction

Accounts receivable Supplies

Cash 1 Balance

12 000 12 000 700 700

12 000

3 Balance 4 Balance 5 Balance 6 Balance 7 Totals

Retained

payable

capital

earnings

12 000 12 000

2 Balance

Accounts

12 000 -700 11 300 -300 11 000 200 11 200 -50 11 150

400 400

700

400

700

400 -200 200 200

700 700

12 000 400 400

700 -700 0

12 000

700

12 000

700

12 000

100 -50

700

12 000

400 -300 100

2.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

79. The chart of accounts used by Taipan Ltd is listed below. You are to indicate the accounts to be debited and credited for the following transactions by writing the account number(s) in the appropriate boxes. Chart of Accounts 1 2 3 4 5 6 7

Cash 8 Share capital Accounts receivable 9 Retained earnings Paper supplies 10 Dividends paid Copy machines 11 Service revenue Accounts payable 12 Advertising expense Loan payable 13 Rent expense Revenue received in advance (Unearned revenue) Number(s) of account(s) debited

Number(s) of account(s) credited

Shareholders invest $90,000 cash to start the business. ___________________________________________________________________________________________ 2.

Purchased three photocopy machines for $200,000, paying $50,000 cash and signing a 5-year, 10% loan for the remainder. ___________________________________________________________________________________________ 3. Purchased $5,000 paper supplies on credit. ___________________________________________________________________________________________ 4. Cash received for photocopy services amounted to $7,000. ___________________________________________________________________________________________ 5. Paid $500 cash for radio advertising. ___________________________________________________________________________________________ 6.

Paid $800 on account for paper supplies purchased in transaction 3. ___________________________________________________________________________________________ 7. Dividends of $1,500 were paid to shareholders ___________________________________________________________________________________________ 8. Paid $1,200 cash for rent for the current month. ___________________________________________________________________________________________ 9.

Received $2,000 cash deposit from a customer for future copying. ___________________________________________________________________________________________ 10.

Invoiced a customer for $450 for photocopy services completed. ___________________________________________________________________________________________

2.34

Chapter 2: The recording process

Answers below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process.

Number(s) of account(s) debited

Number(s) of account(s) credited

Shareholders invest $90,000 cash to start the business. 1 8 ____________________________________________________________________________ 2.

Purchased three photocopy machines for $200,000, paying $50,000 cash and signing a 5-year, 10% loan for the remainder. 4 1,6 ____________________________________________________________________________ 3. Purchased $5,000 paper supplies on credit. 3 5 ____________________________________________________________________________ 4.

Cash received for photocopy services amounted to $7,000. 1 11 ____________________________________________________________________________ 5. Paid $500 cash for radio advertising. 12 1 ____________________________________________________________________________ 6.

Paid $800 on account for paper supplies purchased in transaction 3. 5 1 ____________________________________________________________________________ 7. Dividends of $1,500 were paid to shareholders. 10 1 ____________________________________________________________________________ 8. Paid $1,200 cash for rent for the current month. 13 1 ____________________________________________________________________________ 9.

Received $2,000 cash deposit from a customer for future copying. 1 7 ____________________________________________________________________________ 10.

Invoiced a customer for $450 for photocopy services completed. 2 11 ____________________________________________________________________________

2.35

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

80. Under a double-entry accounting system, show how the entry for each transaction listed is entered in the ledger by using debit or credit to indicate the increase or decrease in the effected account. Debit or Credit 1.

An increase in Salary expense.

____________________

A decrease in Accounts payable.

____________________

An increase in Prepaid insurance.

____________________

An increase in Share capital.

____________________

A decrease in Office supplies.

____________________

An increase in Dividends paid

____________________

An increase in Service revenue.

____________________

A decrease in Accounts receivable.

____________________

An increase in Rent expense.

____________________

10.

A decrease in Store equipment.

____________________

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. 1.

An increase in Salary expense.

Debit ________

A decrease in Accounts payable.

Debit ________

An increase in Prepaid insurance.

Debit ________

An increase in Share capital.

Credit _______

A decrease in Office supplies.

Credit _______

An increase in Dividends paid

Debit ________

An increase in Service revenue.

Credit _______

A decrease in Accounts receivable.

Credit _______

An increase in Rent expense.

Debit ________

10.

A decrease in Store equipment.

Credit _______

2.36

Chapter 2: The recording process

81. For the accounts listed below, indicate if the normal balance of the account is a debit or credit. Normal balance Accounts Debit or Credit 1. Service revenue _________________ 2. Rent expense _________________ 3. Accounts receivable _________________ 4. Accounts payable _________________ 5. Share capital _________________ 6. Office supplies _________________ 7. 8. 9. 10.

Insurance expense Dividends paid Office building Loan payable

_________________ _________________ _________________ _________________

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions.

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

Accounts Service revenue Rent expense Accounts receivable Accounts payable Share capital Office supplies Insurance expense Dividends paid Office building Loan payable

Normal balance Debit or Credit Credit Debit Debit Credit Credit Debit Debit Debit Debit Credit

2.37

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

82. During an accounting period, a business has numerous transactions affecting each of the following accounts. State for each account whether it is likely to have (a) debit entries only, (b) credit entries only, or (c) both debit and credit entries. (1) (2) (3) (4) (5)

Advertising expense Service revenue Accounts payable Accounts receivable Share capital

(6) (7) (8) (9) (10)

Dividends Cash Salaries expense Loan payable Insurance expense

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions.

(1) (2) (3) (4)

(a) (b) (c) (c)

(5) (6) (7) (8)

(b) (a) (c) (a)

(9) (10)

2.38

Chapter 2: The recording process

83. Eight transactions are recorded in the following T-accounts: CASH (1) (7)

35,000 22,500

ACCOUNTS RECEIVABLE

(2) (3) (4) (6) (8)

3,500 1,950 2,225 8,000 4,500

(5)

SUPPLIES (3)

(2)

SHARE CAPITAL

8,000

13,500

35,000

(2)

22,500

SERVICE REVENUE (5)

ACCOUNTS PAYABLE (6)

(7)

EQUIPMENT

1,950

(1)

27,500

DIVIDENDS 10,000

(8)

4,500

SALARIES EXPENSE (4)

2,225

Indicate for each debit and each credit: (a) whether an asset, liability, share capital, dividends, revenue, or expense account was affected and (b) whether the account was increased (+) or (-) decreased. Answers should be presented in the following chart form: Transaction Account debited Account credited No. Type Effect Type Effect ____________________________________________________________________________ (1) (Example) Asset + Share capital + ____________________________________________________________________________ (2) ____________________________________________________________________________ (3) ____________________________________________________________________________ (4) ____________________________________________________________________________ (5) ____________________________________________________________________________ (6) ____________________________________________________________________________ (7) ____________________________________________________________________________ (8)

2.39

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions.

Transaction Account debited Account credited No. Type Effect Type Effect ____________________________________________________________________________ (1) (Example) Asset + Share capital + ____________________________________________________________________________ (2) Asset + Asset Liability + ____________________________________________________________________________ (3) Asset + Asset ____________________________________________________________________________ (4) Expense + Asset ____________________________________________________________________________ (5) Asset + Revenue + ____________________________________________________________________________ (6) Liability Asset ____________________________________________________________________________ (7) Asset + Asset ____________________________________________________________________________ (8) Dividends + Asset -

2.40

Chapter 2: The recording process

84. For each of the following accounts indicate: (a) the type of account (asset, liability, equity, revenue, expense), (b) the debit and credit effects, and (c) the normal account balance. Example 0. Cash

a. Asset account b. Debit increases, credit decreases c. Normal balance - debit Accounts

1. 2. 3. 4.

Accounts payable Accounts receivable Share capital Dividends

5. 6. 7. 8.

Service revenue Insurance expense Loan payable Equipment

Answers below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions.

1. a. b. c. 2. a. b. c. 3. a. b. c. 4. a. b. c.

Liability account. Debit decreases, credit increases. Normal balance - credit. Asset account. Debit increases, credit decreases. Normal balance - debit. Equity account. Debit decreases, credit increases. Normal balance - credit. Equity account. Debit increases, credit decreases. Normal balance - debit.

a. b. c. a. b. c. a. b. c. a. b. c.

Revenue account. Debit decreases, credit increases. Normal balance - credit. Expense account. Debit increases, credit decreases. Normal balance - debit. Liability account. Debit decreases, credit increases. Normal balance - credit. Asset account. Debit increases, credit decreases. Normal balance - debit.

2.41

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

85. Journalise the following business transactions in general journal form. Identify each transaction by number. You may omit explanations of the transactions. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Shareholders invest $35,000 in cash in starting a real estate office operating as a company. Purchased $400 of office supplies on credit. Purchased office equipment for $6,000, paying $2,500 in cash and the remainder on credit. $3,500, loan Real estate commissions invoiced to clients amount to $4,000. Paid $700 in cash for the current month's rent. Paid $200 cash on account for office supplies purchased in transaction 2. Received an account for $500 for advertising for the current month. Paid $2,200 cash for office salaries. Paid $1,200 cash dividends to shareholders. Received a cheque for $3,000 from a client in payment on account for commissions invoiced in transaction 4.

Answers below. Learning Objective 2.5 - Explain what a journal is and how it helps in the recording process.

Cash .................................................................................................... 35,000 Share capital .............................................................................. 35,000

Office supplies ..................................................................................... 400 Accounts payable .......................................................................

400

Office equipment ................................................................................. 6,000 Cash ........................................................................................... 2,500 Accounts payable ...................................................................... 3,500

Accounts receivable ............................................................................ 4,000 Real estate commission revenue ................................................ 4,000

Rent expense ........................................................................................ 700 Cash ...........................................................................................

700

Accounts payable ................................................................................ 200 Cash ...........................................................................................

200

Advertising expense ............................................................................ 500 Accounts payable .......................................................................

500

Office salaries expense ........................................................................ 2,200 Cash ........................................................................................... 2,200

Dividends ............................................................................................. 1,200 Cash ........................................................................................... 1,200

10.

Cash .................................................................................................... 3,000 Accounts receivable ................................................................... 3,000 .

2.42

Chapter 2: The recording process

86. Journalise the following business transactions in general journal form. Identify each transaction by number. You may omit explanations of the transaction. 1. 2. 3. 4. 5.

Owner invested $30,000 in exchange for share capital of the company. Hired an employee to be paid $200 per week, starting tomorrow. Paid two years’ rent in advance, $7,200. Paid the worker’s weekly wage. Recorded revenue earned and received for the week, $1,500.

Answers below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process.

Cash

............................................................................................ 30,000 Share capital ....................................................................... 30,000

No entry

Prepaid rent ..................................................................................... 7,200 Cash.................................................................................... 7,200

4. Wage expense .................................................................................. 200 Cash.................................................................................... 5. Cash

200

............................................................................................ 1,500 Revenue ............................................................................. 1,500

2.43

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

87. Journalise the following business transactions in general journal form. Identify each transaction by number. You may omit explanations of the transactions. 1. Received $35,000 from shareholders. 2. Purchased equipment for $45,000, paying $15,000 in cash and the remainder is due in 30 days.. 3. Paid $3,000 rent for the month. 4. Recorded $12,500 of services provided on account. 5. Paid wages of $7,500. 6. Received $7,000 in cash for services provided. 7. Collected $2,000 from customers on account. Answers below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process.

1. Cash ............................................................................................ 35,000 Share capital ....................................................................... 35,000 2. Equipment ................................................................................... 45,000 Cash.................................................................................... 15,000 Accounts payable ............................................................... 30,000 3. Rent expense ............................................................................... 3,000 Cash.................................................................................... 3,000 4. Accounts receivable .................................................................... 12,500 Service revenue .................................................................. 12,500 5. Wage expense ............................................................................. 7,500 Cash.................................................................................... 7,500 6.

Cash............................................................................................ 7,000 Service revenue .................................................................. 7,000

7. Cash ............................................................................................ 2,000 Accounts receivable ........................................................... 2,000

2.44

Chapter 2: The recording process

88. Transactions for Wombat Ltd for the month of October are presented below. Journalise each transaction and identify each transaction by number. You may omit journal explanations. 1. 2. 3. 4. 5. 6.

Shareholders invested an additional $36,000 cash in the business. Purchased land costing $28,000 for cash. Purchased equipment costing $8,000 for $4,000 cash and the remainder on credit. Purchased supplies on account for $800. Paid $1,000 for a one-year insurance policy. Received $2,000 cash for services performed.

7. Received $4,000 for services previously performed on account. 8. Paid wages to employees for $2,500. 9. Paid dividends to shareholders of $400. Answers below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process.

1. Cash .................................................................................................. 36,000 Share capital ............................................................................ 36,000 2. Land ................................................................................................. 28,000 Cash ......................................................................................... 28,000 3. Equipment ........................................................................................ 8,000 Cash ......................................................................................... 4,000 Accounts payable .................................................................... 4,000 4. Supplies ............................................................................................ 800 Accounts payable ....................................................................

800

5. Prepaid insurance ............................................................................. 1,000 Cash ......................................................................................... 1,000 6. Cash .................................................................................................. 2,000 Service revenue ....................................................................... 2,000 7. Cash .................................................................................................. 4,000 Accounts receivable ................................................................ 4,000 8. Wages expense ................................................................................. 2,500 Cash ......................................................................................... 2,500 9. Dividends paid .................................................................................. 400 Cash .........................................................................................

400

2.45

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

89. The transactions of the Cockatoo Café Ltd are recorded in the general journal below. You are to post the journal entries to the accounts in the general ledger. After all entries have been posted, you are to prepare a trial balance on the form provided. General Journal _____________________________________________________________________________ Date Account Titles and Explanation Debit Credit _____________________________________________________________________________ 2015 Sept. 1 Cash 15,000 Share capital 15,000 (Shareholders invested cash in business) 4

Delivery trucks Cash Loan payable (Paid cash and took out a loan for delivery trucks)

30,000

Rent expense Cash (Paid September rent)

1,000

Prepaid insurance Cash (Paid one-year liability insurance) Cash

10,000 20,000

1,000

400 400

2,500 Service revenue (Received cash for delivery services)

2,500

Salaries expense Cash (Paid salaries for current period)

500

Electricity expense Accounts payable (Received a bill for September electricity)

100

Dividends paid Cash (Paid dividends)

750

Accounts receivable Service revenue (Invoiced customer for delivery service)

500

100

750

1,000 1,000

2.46

Chapter 2: The recording process

General Ledger Cash

Accounts receivable

Prepaid insurance

Delivery trucks

Accounts payable

Loan payable

Share capital

Dividends paid

Service revenue

Rent expense

Salaries expense

Electricity expense

2.47

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

________ _________

_____________________________________________________________________________

2.48

Chapter 2: The recording process

Answers below. Learning objective 2.7 - Explain what posting is and how it helps in the recording process.

General Ledger Cash Sept 1 Sept 18

15,000 2,500

Sept 30 Bal.

4,850

Accounts receivable Sept 4 Sept 8 Sept 15 Sept 20 Sept 30

10,000 1,000 400 500 750

Sept 30

1,000

Sept 30 Bal.

1,000

Prepaid insurance Sept 15 Sept 30 Bal.

Delivery trucks

400 400

Sept 4 30,000 Sept 30 Bal. 30,000

Accounts payable Sept 25 Sept 30 Bal.

Loan payable 100 100

Sept 4 20,000 Sept 30 Bal. 20,000

Share capital Sept 1 15,000 Sept 30 Bal. 15,000

Dividends paid Sept30 Sept 30 Bal.

Service revenue Sept 18 2,500 Sept 30 1,000 Sept 30 Bal. 3,500

Rent expense Sept 8

1,000

Sept 30 Bal.

1,000

Salaries expense Sept 20 Sept 30 Bal.

500 500

Electricity expense Sept 25 Sept 30 Bal.

750 750

100 100

2.49

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Cockatoo Cafe Ltd Trial Balance at 30 September 2015 _____________________________________________________________________________ Accounts Debit Credit _____________________________________________________________________________ Cash $ 4,850 Accounts receivable 1,000 Prepaid insurance 400 Delivery trucks 30,000 Accounts payable $ 100 Loan payable 20,000 Share capital 15,000 Dividends paid 750 Service revenue 3,500 Rent expense 1,000 Salaries expense 500 Electricity expense 100 Totals $38,600 $38,600 _____________________________________________________________________________

2.50

Chapter 2: The recording process

90. The accounts in the trial balance of Koala Ltd are shown below. Indicate in the space provided, whether the account balance is normally a debit (Dr) or a credit (Cr). KOALA LTD Trial Balance at 30 June 2016 _____________________________________________________________________________ Dr or Cr Cash .................................................................................................. Retained earnings…………………………………………………… Accounts receivable ......................................................................... Service revenue ................................................................................ Supplies ............................................................................................ Office equipment ............................................................................. Wages expense ................................................................................. Accounts payable ............................................................................. Revenue received in advance ……………………………………… Bank loan payable………………………………………………… . Share capital ..................................................................................... Dividends ......................................................................................... Repair expense .................................................................................

Answers below. Learning objective 2.8 - Explain the purposes of a trial balance.

KOALA LTD Trial Balance at 30 June 2016 _____________________________________________________________________________ Dr or Cr Cash .................................................................................................. Dr Retained earnings……………………………………………………… Cr Accounts receivable ......................................................................... Dr Service revenue ................................................................................ Cr Supplies ............................................................................................ Dr Office equipment ............................................................................. Dr Wages expense ................................................................................. Dr Accounts payable ............................................................................. Cr Revenue received in advance……………………………………… Cr Bank loan payable………………………………………………… . Cr Share capital ..................................................................................... Cr Dividends ......................................................................................... Dr Repair expense ................................................................................. Dr

2.51

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

91. The trial balance of Wallaby Ltd shown below does not balance. Wallaby Ltd Trial Balance at 30 June 2016 Cash .................................................................................................. Accounts receivable ......................................................................... Supplies ............................................................................................ Equipment ........................................................................................ Accounts payable ............................................................................. Share capital ..................................................................................... Dividends ......................................................................................... Service revenue ................................................................................ Wages expense ................................................................................. Repair expense ................................................................................. Totals .......................................................................................

Debit $ 2,600 7,600 600 8,300

Credit

$ 9,766 1,941 1,500 15,200 3,800 1,600 $26,000

$26,907

An examination of the ledger and journal reveals the following errors: 1.

Each of the above listed accounts has a normal balance per the general ledger.

Cash of $350 received from a customer on account was debited to Cash $530 and credited to Accounts receivable $530.

Dividends of $300 paid to shareholders were posted as a credit to Dividends, $300 and a credit to Cash $300.

Wages expense of $300 was omitted from the trial balance.

The purchase of equipment on account for $700 was recorded as a debit to Repair expense and a credit to Accounts payable for $700.

Services were performed on account for a customer, $510, for which Accounts receivable was debited $510 and Service revenue was credited $51.

A payment on account for $215 was credited to Cash for $215 and credited to Accounts payable for $251.

Instructions Prepare a correct trial balance.

2.52

Chapter 2: The recording process

Answers below. Learning objective 2.8 - Explain the purposes of a trial balance.

Wallaby Ltd Trial Balance at 30 June 2016 _____________________________________________________________________________ Debit Credit Cash [2,600 - 180 (2)] ....................................................................... $ 2,420 $ Accounts receivable [7,600 + 180 (2)] ............................................. 7,780 Supplies ............................................................................................. 600 Equipment [8,300 + 700 (5)] ............................................................ 9,000 Accounts payable [9,766 - 466 (7)] .................................................. 9,300 Share capital ...................................................................................... 1,941 Dividends [1,500 + 300 + 300 (3)] ................................................... 2,100 Service revenue [15,200 + 459 (6)] .................................................. 15,659 Wages expense [3,800 + 300 (4)] ..................................................... 4,100 Repair expense [1,600 - 700 (5)] ...................................................... 900 Totals ......................................................................................... $26,900 $26,900

2.53

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

92. Some of the following errors would cause the debit and credit columns of the trial balance to have unequal totals. For each of the four cases, state whether the error would cause unequal totals in the trial balance. If the error causes unequal totals, indicate the amount of difference between the columns and state whether the debit or credit is larger. Each case is to be considered independently of the others. 1.

A payment of $600 to a creditor was recorded by a debit to Accounts payable of $60 and a credit to Cash of $600.

A $480 payment for a printer was recorded by a debit to Computer equipment of $48 and a credit to Cash for $48.

An account receivable in the amount of $2,000 was collected in full. The collection was recorded by a debit to Cash for $2,000 and a debit to Accounts payable for $2,000.

An account payable was paid by issuing a cheque for $800. The payment was recorded by debiting Accounts payable $800 and crediting Accounts receivable $800.

Answers below. Learning objective 2.8 - Explain the purposes of a trial balance.

The trial balance totals will be unequal. The credit column will be $540 larger than the debit column.

The trial balance totals will be misstated but not unequal.

The trial balance totals will be unequal. The debit column will be $4,000 larger than the credit column.4. The trial balance totals will be misstated but not unequal.

2.54

Chapter 2: The recording process

93. Some of the following errors would cause the debit and credit columns of the trial balance to have unequal totals. For each of the four cases, state whether the error would cause unequal totals in the trial balance. If the error causes unequal totals, indicate the amount of difference between the columns and state whether the debit or credit is larger. Each case is to be considered independently of the others. 1. A collection on account of $300 was journalised and posted as a debit to Cash $300 and a credit to Service revenue $300. 2. A $950 purchase of supplies on account was recorded as a debit of $950 to Equipment and a credit of $950 to Accounts payable. 3. A purchase of equipment for $3500 on account was not recorded. 4. A $450 receipt on account was recorded as a $540 debit to Cash and a $450 credit to Accounts receivable.

Answers below. Learning objective 2.8 - Explain the purposes of a trial balance.

1. The trial balance totals will be misstated but not unequal. 2. The trial balance totals will be misstated but not unequal. 3. The trial balance totals will be misstated but not unequal. 4. The trial balance totals will be unequal. The debit column will be $90 larger than the credit column.

2.55

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Completion statements

94. Complete the following statements: 1.

A _______________ is an individual accounting record of increases and decreases in specific assets, liabilities, and equity items.

The act of entering an amount on the left side of an account is called _______________ the account, and making an entry on the right side is called _________________ the account.

_____________, ______________, and _______________ have debit normal account balances whereas _______________, ______________, and ________________ have credit normal account balances.

The five sub-accounts of equity are ______________, _______________, _________________, __________________, and _________________.

The basic steps in the recording process are: _______________ each transaction, enter the transaction in a ______________, and transfer the information to appropriate accounts in the ________________.

A sales slip, a cheque, and a cash register tape are examples of _______________ documents used as evidence that a transaction has taken place.

An accounting record where transactions are initially recorded in chronological order is called a ________________.

Posting is the procedure of transferring journal entries to ______________accounts.

The entire group of accounts and their balances maintained by a company is called the general ________________.

10.

A two column list of all accounts and their balances at a given time is a ______________ _________________.

Answers below. Learning objective 2.1 - 2.8. 1. ledger 2. debiting, crediting 3. assets, expenses, dividends, share capital, liabilities, revenues 4. share capital, retained earnings, dividends, revenues, expenses .

5. 6. 7. 8. 9. 10.

analyse, journal, ledger source journal ledger ledger trial balance

2.56

Chapter 2: The recording process

Matching

95. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Account Debit Credit Revenue account Ledger

F. G. H. I. J.

Journal Posting Chart of accounts Trial balance Source document

____

1. The entire group of accounts maintained by a business.

____

2. Transferring journal entries to ledger accounts.

____

3. The side which increases an asset account.

____

4. A list of all the accounts used by a business.

____

5. An accounting record of increases and decreases in individual specific assets, liabilities, and equity items.

____

6. Right side of an account.

____

7. Evidence that a transaction has taken place.

____

8. Shows the debit and credit effects of specific transactions.

____

9. A list of accounts and their balances at a given time.

____ 10. Has a credit normal balance

Answers below. Learning objective 2.1 - 2.8.

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

E G B H A C J F I D

2.57

Short-answer/essay questions 96. An account is an important accounting record where accounting information is stored until needed. Briefly explain (1) the nature of an account, (2) the different types of accounts, and (3) the manner in which an account is increased and decreased and its normal balance. Answer below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process. An account is an individual accounting record of increases and decreases in specific asset, liability, and equity accounts. An account may be represented in a T-account format. Each account consists of three parts: (1) the title of the account, (2) a left or debit side, and (3) a right or credit side (it resembles the letter T). Accounts are classified as asset, liability, equity, revenue, and expense. Accounts with a normal debit balance, are assets, expenses and dividends, are increased when debited and decreased when credited. Accounts with a normal credit balance: liabilities, revenues, and equity are increased when credited and decreased when debited.

97. Why is the dividends account increased by a debit? Explain in terms of its relationship to equity. Answer below. Learning objective 2.3 - Define debits and credits and explain how they are used to record accounting transactions. Dividends represent a decrease in equity. According to the rules of debit and credit, a decrease in equity is recorded as a debit.

98. Describe the function of a general journal and explain why transactions that are found in a general journal must be posted to ledger accounts. Answer below. Learning objective 2.5 - Explain what a journal is and how it helps in the recording process. The function of a general journal is to provide a chronological list of all of the transactions for a business. A chronological list of transactions on its own is of limited usefulness. Classifying and summarising the transactions by transferring (posting) them to ledger accounts improves the usefulness of information for business decision making.

Chapter 2: The Accounting Information System

99. Describe the process of preparing a trial balance. What is the purpose of preparing a trial balance? If a trial balance does not balance, identify what might be the reasons why it does not balance. If the trial balance does balance, does that insure that the ledger accounts are correct? Explain. Answer below. Learning objective 2.8 - Explain the purposes of a trial balance. The process of preparing a trial balance consists of (1) listing the account titles and their debit or credit balances in the order in which they appear in the general ledger, (2) totaling the debit and credit columns, and (3) proving the equality of the total debits and total credits. The primary purpose of the trial balance is to prove the equality of the debits and credits after posting. A trial balance also uncovers errors in journalising and posting because errors in journalising and posting cause a trial balance not to balance. A trial balance does not prove that all transactions have been recorded or that the ledger is correct. The trial balance may balance even when (1) an entire transaction is not journalised, (2) a correct journal entry is not posted, (3) a journal entry is posted twice, (4) incorrect accounts are used in journalising or posting, or (5) offsetting errors are made in recording the amount of a transaction or posting to the ledger. 100. Thomas Carlisle, Jr. was appointed the manager of Westbrook Properties, a recently formed company that manages residential rental properties. Maria Fremont is the accountant. She prepared a chart of accounts based on an analysis of the expenditures of the company. One of the largest expense categories is Travel and entertainment. Mr. Carlisle believes that it is important to maintain a presence in the social life of the city. In this, he sharply differs from his father, Thomas Carlisle, Sr. The elder Mr. Carlisle has set up Westbrook Properties in order to test his son's management skills before allowing him to manage a more lucrative commercial property business. Mr. Carlisle, Sr. provided the capital for Westbrook, and maintains close contact with the company. He allowed his son, however, to hire his own employees. Mr. Carlisle Jr. has asked Ms. Fremont to name the Travel and entertainment account Property development. He hopes to deflect his father's attention away from the amount he has spent on travel and entertainment until he has proven that his methods work. When Ms. Fremont resisted, he reminded her that he, not his father, hired her. He also reminded her that she had been enthusiastic about his business plans when she was hired. Required: 1.

Who are the stakeholders in this situation?

Should Ms. Fremont agree to the change in the Travel and entertainment account to Property development? Explain.

2.59

Testbank to accompany Accounting 3e by Carlon/Kimmel

Answer below. Learning objective 2.8 - Explain the purposes of a trial balance. 1.

The stakeholders in this situation include Mr. Carlisle, Jr. Maria Fremont Mr. Carlisle, Sr. Bankers and others who might rely on the financial statements

Ms. Fremont definitely should not agree to the name change. The intention of the person making the change is to deceive someone who has a right to know the affairs of the business, fully and completely. Though Ms. Fremont was hired by Mr. Carlisle, Jr., and though she may agree with his business methods, she cannot be a party to such deceit.

101. The following trial balance was obtained from Clover Ltd's computer system. RPT DPT PRIORITY RUN BY SEQUENCE

TR BAL ACC MGR 2 R.HAMES 997411

ACCOUNT

BAL

CASH SUPPLIES ACC PAY NOTE PAY SHARE CAPITAL DIVIDENDS SERVICE REVENUE SALARY EXP RENT EXP OTHER EXP BAL

17700 5600 750012005000500 150003500 900 500 0***TR BAL IS IN BALANCE***

Required: 1. What features make this trial balance difficult to read? 2. Prepare an improved Trial Balance.

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Chapter 2: The Accounting Information System

Answer below. Learning objective 2.8 - Explain the purposes of a trial balance.

1. The trial balance is difficult to read because a. The title is not explanatory b. Account abbreviations are used c. The numbers are not shown in standard currency format d. Debits and credits are not separately shown, but are indicated by a "-" for credits e. Extraneous information is provided.

Clover Ltd Trial Balance at 30 September 2016

Cash Supplies Accounts payable Promissory note payable Share capital Dividends Service revenue Salary expense Rent expense Other expenses

Debit $17,700 5,600

Credit

$ 7,500 1,200 5,000 500 15,000 3,500 900 500 $28,700

$28,700

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Chapter 3: Accrual accounting concepts

Chapter 3: Accrual accounting concepts Multiple-choice questions 1. Under the accrual basis of accounting: a. cash must be received before revenue is recognised. b. profit is calculated by matching cash outflows against cash inflows. *c. events that change an entity’s financial statements are recognised in the period they occur rather than in the period in which cash is paid or received. d. the ledger accounts must be adjusted to reflect a cash basis of accounting before financial statements are prepared. Answer: c Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: Accrual accounting records transactions and events in the accounting periods in which they occur rather than in the periods in which the entity receives or pays the related cash.

2. Using accrual accounting, expenses are recorded and reported only: *a. when they are incurred whether or not cash is paid. b. when they are incurred and paid at the same time. c. if they are paid before they are incurred. d. if they are paid after they are incurred. Answer: a Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: Using accrual accounting, expenses are recorded and reported only when they are incurred regardless of when cash is paid. 3. If an entity purchases a new delivery vehicle it doesn’t make sense to expense the full cost of the vehicle at the time it is purchased because: *a. it will be used for many subsequent periods. b. profit will be too low. c. vehicles wear out over time and it will be worth less each period. d. it will eventually be sold. Answer: a Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: The benefits from using the vehicle would be consumed by the business over many accounting periods. The cost of the vehicle (less final sale proceeds) should be spread over the periods when the benefits are consumed. .

3.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. The accounting period concept states that: a. a transaction can only affect one accounting period. b. estimates should not be made if a transaction affects more than one accounting period. c. adjustments to the enterprise's accounts can only be made in the accounting period when the business terminates its operations. *d. the economic life of a business can be divided into artificial time periods. Answer: d Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: The accounting period concept states that the economic life of a business can be divided into equal artificial time periods.

5. An accounting period that is one year in length is called: *a. a financial year. b. an interim period. c. the accounting period concept. d. a timely period. Answer: a Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: The accounting period concept states that the economic life of a business can be divided into equal artificial time periods. An accounting period that is one year in length is called a financial year.

6. In general, as the time period becomes shorter, the difficulty of making the proper adjustments to accounts: *a. is increased. b. is decreased. c. is unaffected. d. depends on if there is a profit or loss. Answer: a Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: The scope and difficulty of making appropriate adjustments to accounts is increased when the accounting time period is shorter.

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Chapter 3: Accrual accounting concepts

7. Which statement is false? a. Accrual based accounting records transactions in the period in which the transaction occurs. b. Applying accrual accounting results in a more accurate measure of profit for the period than cash based accounting. c. GAAP requires financial reports be prepared using accrual accounting. *d. None, all statements are true. Answer: d Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. Feedback: Accrual based accounting, where transactions are recorded when they occur, results in an improved measure of profit and it is therefore the required method of financial reporting under GAAP.

8. The Conceptual Framework prescribes that revenue should be recognised in the accounting records: a. when cash is received. *b. when it is earned. c. at the end of the month. d. in the period that income taxes are paid. Answer: b Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: Application of the Conceptual Framework revenue recognition criteria results in recording revenues when they have been earned.

9. In a service business, revenue is considered earned: a. at the end of the month. b. at the end of the year. *c. when the service is performed. d. when cash is received. Answer: c Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: Application of the Conceptual Framework revenue recognition criteria results in recording service revenue when the service has been performed.

3.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. Jim's Tune-Up Shop follows the revenue recognition principle. Jim services a car on 31 July. The customer picks up the vehicle on 1 August and mails the payment to Jim on 5 August. Jim receives the cheque in the mail on 6 August. When should Jim show that the revenue was earned? *a. 31 July. b. 1 August. c. 5 August. d. 6 August. Answer: a Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: Application of the Conceptual Framework revenue recognition criteria results in recording service revenue on the date the service was performed.

11. Which statement/s is/are false? a. The revenue recognition principle is a helpful guide in determining profit for a period. b. Revenue should be recognised only when it is probable that any future economic benefits associated with the revenue will flow to the entity. c. Revenue should only be recorded if it can be measured with absolutely certainty. *d. A and B. Answer: d Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: The revenue recognition criteria states that revenue should be recognised when (a) it is probable that future economic benefits associated with the revenue will flow to the entity, and (b) it can be measured reliably.

12. A company pays $10 million dollars for an office building. Over what period should the cost be written off? a. When the $10 million is expended in cash. b. All in the first year. *c. Over the useful life of the building. d. After $10 million in revenue is earned. Answer: c Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. Feedback: The benefits from occupying the building would be consumed by the company over many accounting periods. The cost of the building (less final sale proceeds) should be spread over the useful life of the building when the benefits are consumed.

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Chapter 3: Accrual accounting concepts

13. A dress shop makes a sale on credit for $1,000 on 30 November. The customer is sent a statement on 5 December and a cheque is received on 10 December. It is banked on 12 December. The dress shop follows GAAP and applies the revenue recognition principle. When is the $1,000 considered to be earned? a. 5 December. b. 10 December. *c. 30 November. d. 12 December. Answer: c Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: Application of the Conceptual Framework revenue recognition criteria results in recording revenue on the date the sale occurs.

14. A furniture factory's employees work overtime to finish an order that is sold on 28 February. The office sends a statement to the customer in early March and payment is received by mid-March. The overtime wages should be expensed in: *a. February. b. March. c. the period when the workers receive their cheques. d. either February or March depending on when the pay period ends. Answer: a Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: The overtime should be expensed in February, the period when the overtime was worked.

15. When wages are incurred in one period and paid in the next period, this leads to which of the following accounts appearing in the statement of financial position? a. Service Revenue. b. Accounts Receivable. *c. Wages payable. d. Wages expense. Answer: c Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: When wages are earned in one period and paid in the next period, the unpaid wages are a liability in the statement of financial position.

3.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. The difference between prepaid expenses and accrued expenses is that prepaid expenses have: a. been incurred and accrued expenses have not. b. not been paid and accrued expenses have. *c. been recorded and accrued expenses have not. d. not been recorded and accrued expenses have. Answer: c Learning objective 3.3 - Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: The difference between prepaid expenses and accrued expenses is that prepaid expenses have been recorded because a cash payment has been made. Accrued expenses have not been recorded because cash has not been paid. In both cases adjusting entries are required.

17. The general term for an expense that has not been paid or revenue that has not been received and has not yet been recorded in the accounts is: a. contra asset. b. prepayment. c. asset. *d. accrual. Answer: d Learning objective 3.3 - Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: The term “accrual” is used to describe an expense incurred but not paid and revenue earned but not received or recorded.

18. Adjusting entries are: a. not necessary if the accounting system is operating properly. *b. usually required before financial statements are prepared. c. made whenever management desires to change an account balance. d. made to Statement of Financial Position accounts only. Answer: b Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared because there are usually many timing differences between when revenues are earned and cash is received and when expenses are incurred and cash is paid.

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Chapter 3: Accrual accounting concepts

19. Adjusting entries are required when: *a. the expense will incurred with the passage of time. b. the entity’s profits are below its budget. c. expenses are recorded in the period in which they are incurred. d. revenues are recorded in the period in which they are earned. Answer: a Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: When cash is paid in advance of the expense being incurred (e.g. prepaid insurance, prepaid rent) adjusting entries are necessary to record the consumption of the economic benefit as time passes.

20. Which one of the following is not a justification for adjusting entries? a. Adjusting entries are necessary to ensure that revenue recognition principles are followed. b. Adjusting entries are necessary to ensure that the matching principle is followed. c. Adjusting entries are necessary to enable financial statements to conform with GAAP. *d. Adjusting entries are necessary to bring the general ledger accounts in line with the budget. Answer: d Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared due to timing differences between when revenues are earned and cash is received and when expenses are incurred and cash is paid. 21. An adjusting entry: a. affects two statement of financial position accounts. b. affects two income statement accounts. *c. affects a statement of financial position account and an income statement account. d. is not recorded in the ledger accounts. Answer: c Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared due to timing differences between when revenues are earned and cash is received and when expenses are incurred and cash is paid. Each adjusting entry will always affect an income statement account and a statement of financial position account.

3.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. Adjusting entries are: a. the same as correcting entries. *b. needed to ensure that the matching principle is followed. c. optional. d. rarely needed. Answer: b Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared due to timing differences between when revenues are earned and cash is received and when expenses are incurred and cash is paid. Adjusting entries match revenues earned in a period to expenses incurred in a period.

23. The preparation of adjusting entries is: a. straight forward because the accounts that need adjustment will be out of balance. *b. often an involved process requiring the skills of a professional. c. only required for accounts that do not have a normal balance. d. optional when financial statements are prepared. Answer: b Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared due to timing differences between when revenues are earned and cash is received and when expenses are incurred and cash is paid. The identification of accrual accounting adjustments often requires professional judgement.

24. If a resource has been consumed but an invoice has not been received at the end of the accounting period, then: a. an expense should be recorded when the invoice is received. b. an expense should be recorded when the cash is paid out. *c. an adjusting entry should be recorded to recognise the expense. d. it is optional whether to record the expense before the invoice is received. Answer: c Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: An adjusting entry for an accrued expense is required before financial statements are prepared. There is a timing difference between when the expense is incurred when and cash is paid.

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Chapter 3: Accrual accounting concepts

25. Which statement about adjusting entries is false? a. Adjusting entries are often made because some business events are not recorded as they occur. *b. Adjusting entries are recorded in the general journal but are not posted to the accounts in the general ledger. c. And adjusting entry would adjust a revenue transaction so it reported when the revenue is earned. d. Before an adjusting entry for prepaid expense is recorded, assets will be overstated and expenses will be understated. Answer: b Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared because of timing differences between when revenues are earned and the related cash is received and when expenses are incurred and the related cash is paid.

26. Which statement about accrual accounting is true? a. An adjusting entry always involves two statement of financial position accounts. b. Revenue received before it is earned and expenses paid before being used or consumed are both initially recorded as liabilities. c. The difference between revenue received in advance and accrued revenue is that accrued revenue has been recorded and needs adjusting whereas revenue received in advance has never been recorded. *d. None, all statements are false. Answer: d Learning objective 3.3 – Explain why adjusting entries are needed and identify the major types of adjusting entries. Feedback: Adjusting entries are required before financial statements are prepared because of timing differences between when revenues are earned and the related cash is received and when expenses are incurred and the related cash is paid.

27. An asset–expense relationship exists with: a. liability accounts. b. revenue accounts. *c. prepaid expense adjusting entries. d. accrued expense adjusting entries. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: A prepaid expense is initially recorded as an asset. As the benefits of that asset are consumed, an adjusting entry is required to recognise an expense. .

3.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. A law firm received $2,000 cash for legal services to be provided in the future. The full amount was credited to the liability account Revenue Received in Advance. If the legal services have been provided at the end of the accounting period and no adjusting entry is made, this would cause: a. expenses to be overstated. b. profit to be overstated. c. liabilities to be understated. *d. revenues to be understated. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Adjusting entries are required where there are timing differences between when revenues are earned and when cash is received. If the legal services had been performed at the end of the accounting period and no adjusting entry was made, then revenues would be understated and assets (receivables) would be understated.

29. Reese Ltd purchased office supplies costing $4,000 and debited Office Supplies for the full amount. At the end of the accounting period, a physical count of office supplies revealed $1,600 still on hand. The appropriate adjusting journal entry to be made at the end of the period would be: a. Debit Office Supplies Expense, $1,600; Credit Office Supplies, $1,600. b. Debit Office Supplies, $2,400; Credit Office Supplies Expense, $2,400. *c. Debit Office Supplies Expense, $2,400; Credit Office Supplies, $2,400. d. Debit Office Supplies, $1,600; Credit Office Supplies Expense, $1,600. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The purchase of supplies is an example of a prepaid expense. An adjusting entry is required to recognise the cost of supplies consumed (debit Supplies Expense) during the period the reduction in the asset (credit Supplies).

30. Which of the following accounts would not need to be adjusted at year end? a. Office Supplies. b. Revenue Received in Advance. c. Prepaid Advertising. *d. Cash. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The Cash account is debited when cash is received and credited when cash is paid. Adjusting entries are required because there are timing differences between when cash is received and revenue earned and when cash is paid and expenses incurred. Adjusting entries affect a revenue account or an expense account but not cash.

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Chapter 3: Accrual accounting concepts

31. An adjusting entry can include a debit to: a. an asset and a credit to a liability. b. a revenue and a credit to an asset. *c. a liability and a credit to a revenue. d. an expense and a credit to a revenue. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: An adjusting entry will always affect a revenue account or an expense account plus a liability account or an asset account. An adjusting entry for revenue received in advance will include a debit to a liability and a credit to a revenue account when the revenue is earned. A correcting entry may debit a revenue account and credit an asset account. 32. Accrued revenues are: a. received and recorded as liabilities before they are earned. b. earned and recorded as liabilities before they are received. *c. earned but not yet received or recorded. d. earned and already received and recorded. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Accrued revenue is revenue earned but not recorded in the daily recording of a business’s transactions. Accrued revenues may accumulate over time (e.g. interest earned) or result from services performed but neither recorded or received.

33. Prepaid expenses are: *a. paid and recorded in an asset account before they are used or consumed. b. paid and recorded in an asset account after they are used or consumed. c. incurred but not yet paid or recorded. d. incurred and already paid or recorded. Answer: a Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Prepayments provide benefits for more than one accounting period. When an expense is prepaid, an asset (e.g. prepaid insurance) is increased and cash is decreased.

3.11

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. Goods purchased for future short-term use in the business, such as supplies, are called: *a. current assets. b. revenues. c. equity. d. liabilities. Answer: a Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: When goods are purchased for future short-term use a current asset (e.g. supplies) is increased and cash is decreased. When the goods are consumed an adjusting entry is required to recognise the expense and reduce the asset.

35. Revenues received in advance or unearned revenues are: *a. received and recorded as liabilities before they are earned. b. earned and recorded as liabilities before they are received. c. earned but not yet received or recorded. d. earned and already received and recorded. Answer: a Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: When payment is received for services to be provided in a future accounting period, a liability is increased (revenues received in advance or unearned revenues) and cash is increased. When the service is provided, an adjusting entry is required to recognise the revenue earned and decrease the liability.

36.

A liability–revenue relationship exists with

a. prepaid expense adjusting entries. b. accrued expense adjusting entries. *c. unearned revenue adjusting entries. d. accrued revenue adjusting entries. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The receipt of cash for service not yet provided is initially recorded as a liability (revenue received in advance or unearned revenue). When the service is provided an adjusting entry is required to recognise the revenue earned and to decrease the liability.

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Chapter 3: Accrual accounting concepts

37. On 1 July the Winter Shoe Store paid $6,000 to Ace Realty for 6 month’s rent beginning 1 July. Prepaid Rent was debited for the full amount. If financial statements are prepared on 31 July, the adjusting entry to be made by the Winter Shoe Store is: a. Debit Rent Expense, $6,000; Credit Prepaid Rent, $1,000. b. Debit Prepaid Rent, $1,000; Credit Rent Expense, $1,000. *c. Debit Rent Expense, $1,000; Credit Prepaid Rent, $1,000. d. Debit Rent Expense, $6,000; Credit Prepaid Rent, $6,000. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If financial statements are prepared on 31 July, the adjusting entry to be made by the Winter Shoe Store is Debit Rent Expense, $1,000; Credit Prepaid Rent, $1,000. This is the amount of the benefit that has been consumed at 31 July ($6,000/6).

38. The balance in the Prepaid Rent account before adjustment at the end of the year is $12,000 and represents three month’s rent paid on 1 December. The adjusting entry required on 31 December is: a. Debit Prepaid rent, $4,000; Credit Rent expense $4,000. b. Debit Prepaid rent, $8,000; Credit Rent expense, $8,000. c. Debit Rent expense, $12,000; Credit Prepaid rent, $12,000. *d. Debit Rent expense, $4,000; Credit Prepaid rent, $4,000. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusting entry required on 31 December is Debit Rent Expense, $4,000; Credit Prepaid Rent, $4,000. This is the amount of the benefit that has been consumed at 31 December ($12,000/3).

39. Revenues received in advance is classified as an: a. asset account. b. revenue account. c. contra revenue account. *d. liability account. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: When cash is received for services to be provided in the future a liability (revenues received in advance or unearned revenues) is credited. An obligation exists to provide the service or goods in the future.

3.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. If a business received cash in advance of services performed and credits a liability account, the adjusting entry when the services are performed will be a debit to Revenues Received in Advance account (or unearned revenue) and a credit to: a. Cash. *b. Service revenue. c. Prepaid expense. d. Accounts receivable. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If a business received cash in advance of services performed and credits a liability account, the adjusting entry when services are performed will debit Revenue Received in Advance (or Unearned Revenue) and credit a Revenue account.

41. Accumulated depreciation is an: a. expense account. b. equity account. c. liability account. *d. contra asset account. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Accumulated depreciation is a contra account that is offset against the related noncurrent asset that is being depreciated.

42. The Harris Company Ltd purchased a computer for $3,000 on 1 December. It is estimated that annual depreciation on the computer will be $600. If financial statements are to be prepared on 31 December, the company should make the following adjusting entry: a. Debit Depreciation Expense, $600; Credit Accumulated Depreciation, $600. *b. Debit Depreciation Expense, $50; Credit Accumulated Depreciation, $50. c. Debit Office Equipment $2,400; Credit Accumulated Depreciation, $2,400. d. Debit Office Equipment, $3,000; Credit Accumulated Depreciation, $3,000. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusting entry required on 31 December is Debit Depreciation Expense, $50; Credit Accumulated Depreciation, $50. This is the amount of the benefit from the use of the computer that has been consumed at 31 December ($600/12).

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Chapter 3: Accrual accounting concepts

43. Which statement about depreciating non-current assets with a limited useful life is true? *a. The cost of a depreciable asset less accumulated depreciation is the carrying amount of the asset. b. The carrying a mount of a depreciable asset is always equal to its market value because depreciation is a valuation method. c. The balances of Accumulated Depreciation and Depreciation Expense should always be equal. d. None, all statements are false. Answer: a Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Depreciation is the process of allocating the cost of an asset (less final sale proceeds) to expense over its useful life. From an accounting point of view, the acquisition of depreciable noncurrent assets is essentially a long term prepayment for economic benefits. Therefore, there is a need to make adjusting entries for depreciation expense periodically.

44. McCloud Realty Company Ltd received a cheque for $21,000 on 1 July, which represents six month’s rent received in advance. Revenue Received in Advance account was credited with $21,000. Financial statements will be prepared on 31 July. McCloud Realty Company Ltd should make the following adjusting entry on 31 July: *a. Debit Revenue Received in Advance, $3,500; Credit Rental Revenue, $3,500. b. Debit Rental Revenue, $3,500; Credit Revenue Received in Advance, $3,500. c. Debit Revenue Received in Advance, $21,000; Credit Rental Revenue, $21,000. d. Debit Cash, $21,000; Credit Rental Revenue, $21,000. Answer: a Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusting entry required on 31 July is Debit Revenue Received in Advance, $3,500; credit Rental Revenue, $3,500. This entry records the amount of rental revenue earned in July ($21,000/6).

45. As prepaid expenses expire with the passage of time, the correct adjusting entry will be: a. Debit an asset account; Credit an expense account. *b. Debit an expense account; Credit an asset account. c. Debit an asset account; Credit an asset account. d. Debit an expense account; Credit an expense account. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: As prepaid expenses expire with the passage of time, the correct adjusting entry will be debit to an expense account and a credit to an asset account.

3.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. An entity usually determines the amount of supplies used during a period by: a. adding the supplies on hand to the balance of the Supplies account. b. totaling the amount of supplies purchased during the period. c. taking the difference between the supplies purchased and the supplies paid for during the period. *d. taking the difference between the balance of the Supplies account and the cost of supplies on hand. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: When supplies are purchased during the year the Supplies account is debited. Rather than record supplies expense as the supplies are used, many entities record supplies expense at the end of the period. At the end of the period the entity must count the remaining supplies. An adjusting entry is required for the difference between the balance of the Supplies account and the cost of supplies remaining.

47. If an entity fails to make an adjusting entry to record supplies expense, then: a. equity will be understated. *b. expenses will be understated. c. assets will be understated. d. profit will be understated. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If an entity fails to make an adjusting entry to record supplies expense, then expenses will be understated (and assets will be overstated).

48. If an entity fails to adjust a Prepaid Rent account for rent that has expired, what effect will this have on that month's financial statements? a. Failure to make an adjustment does not affect the financial statements. b. Expenses will be overstated and profit and equity will be understated. *c. Assets will be overstated and profit and equity will be understated. d. Assets will be overstated and profit and equity will be overstated. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If an entity fails to make an adjusting entry to record prepaid rent that has expired, then expenses will be understated, and equity will be overstated (and assets will be overstated).

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Chapter 3: Accrual accounting concepts

49. An entity fails to adjust the Revenue Received in Advance account for rent that has been earned, what effect will this have on the financial statements? a. Assets will be understated and revenues will be understated. b. Liabilities will be understated and revenues will be understated. *c. Liabilities will be overstated and revenues will be understated. d. Assets will be overstated and revenues will be understated. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If an entity fails to make an adjusting entry to record revenue received in advance now earned then liabilities will be overstated and revenues will be understated.

50. If an entity fails to adjust for accrued revenues: a. liabilities will be understated and revenues will be understated. b. liabilities will be overstated and revenues will be understated. c. assets will be overstated and revenues will be understated. *d. assets will be understated and revenues will be understated. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If an entity fails to make an adjusting entry to record revenue earned and not received or recorded then assets will be understated and revenues will be understated.

51. Adjusting entries affect at least: a. one revenue and one expense account. b. one asset and one liability account. c. one revenue and one statement of financial position account. *d. one income statement account and one statement of financial position account. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Adjusting entries are required before financial statements are prepared due to timing differences between when revenues are earned and cash is received and when expenses are incurred and cash is paid. Each adjusting entry will always affect an income statement account and a statement of financial position account.

3.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

52. At 31 December 2015, before any year-end adjustments, Hart Company's Insurance Expense account had a balance of $725 and its Prepaid Insurance account had a balance of $1,900. It was determined that $1,500 of the Prepaid Insurance had expired. The adjusted balance for Insurance Expense for the year would be: a. $1,500. b. $725. *c. $2,225. d. $1,175. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusted balance to Insurance Expense for the year would be $2,225 ($725 + $1,500).

53. At the end of the financial year, the usual adjusting entry for depreciation on equipment was omitted. Which of the following statements is true? *a. Profit will be overstated for the current year. b. Total assets will be understated at the end of the current year. c. The statement of financial position and income statement will be misstated but the statement of changes in equity will be correct for the current year. d. Total assets will be understated at the end of the current year. Answer: a Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If the usual adjusting entry for depreciation on equipment is omitted then depreciation expense will be understated therefore profit will be overstated (and net assets will be overstated).

54. The difference between the balance of a depreciable Asset account and its related Accumulated Depreciation account is termed: a. market value. b. contra asset. *c. carrying amount. d. liability. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The difference between the balance of a depreciable asset account and its related Accumulated Depreciation account is termed the “carrying amount”. The carrying amount is also referred to as “book value”.

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Chapter 3: Accrual accounting concepts

55. A new accountant working for Metcalf Ltd records $800 Depreciation Expense on store equipment by debiting Depreciation Expense $800 and crediting Cash $800. The effect of this entry is to: a. adjust the accounts to their proper amounts on 31 December. b. understate total assets on the Statement of Financial Position as of 31 December. *c. overstate the carrying amount of the depreciable assets at 31 December. d. understate the carrying amount of the depreciable assets as of 31 December. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusting entry to record depreciation expense requires a credit entry to the Accumulated Depreciation account. One effect of this error is to overstate the carrying amount of the depreciable asset.

56. From an accounting perspective, the acquisition of a depreciable non-current asset is essentially an: a. accrual of expense. b. accrual of revenue. c. accrual of unearned revenue. *d. prepayment for economic benefits to be provided to the entity. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: From an accounting standpoint, the acquisition of depreciable non-current assets is essentially a prepayment of future economic benefits to the entity.

57. If a business pays rent in advance and debits a Prepaid Rent account, the business receiving the rent payment will credit: a. Cash. b. Prepaid Rent. *c. Rent Received in Advance. d. Accrued Rent Revenue. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If a business pays rent in advance and debits a Prepaid Rent account, the business receiving the rent payment in advance will credit Rent Received in Advance (or Unearned Rent Revenue) account.

3.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

58. An accumulated depreciation account: a. is a contra liability account. b. increases on the debit side. c. is offset against total revenue on the income statement. *d. has a normal credit balance. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Accumulated depreciation is a contra account that is offset against the related noncurrent asset that is being depreciated. An asset has a normal debit balance therefore the related contra account will have a normal credit balance.

59. Which of the following would not result in revenue received in advance? a. Rent collected in advance from tenants. *b. Services performed on account. c. Sale of season tickets to football games. d. Sale of two-year magazine subscriptions. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Cash from services performed on account will be received after the revenue is earned. Cash from revenue received in advance will be received before the revenue is earned.

60. Failure to prepare an adjusting entry at the end of the period to record an accrued expense would cause: a. profit to be understated. b. an overstatement of assets and an overstatement of liabilities. *c. an understatement of expenses and an understatement of liabilities. d. an overstatement of expenses and an overstatement of liabilities. Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Failure to prepare an adjusting entry at the end of the period to record an accrued expense will cause an understatement of expenses and an understatement of liabilities (also equity will be overstated).

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Chapter 3: Accrual accounting concepts

61. Failure to prepare an adjusting entry at the end of a period to record an accrued revenue would cause: a. profit to be overstated. *b. an understatement of assets and an understatement of revenues. c. an understatement of revenues and an understatement of liabilities. d. an understatement of revenues and an overstatement of liabilities. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: Failure to prepare an adjusting entry at the end of the period to record accrued revenue will cause an understatement of revenues and an understatement of assets (also equity will be understated).

62. On 1 September Carlson Ltd borrowed $10,000 from the bank for three months at the annual interest rate of 9%. Principal and interest are payable to the bank on 1 December. If the company prepares monthly financial statements, the adjusting entry that the company should make for interest on 30 September, would be: a. Debit Interest Expense, $900; Credit Interest Payable, $900. b. Debit Interest Expense, $300; Credit Interest Payable, $300. c. Debit Promissory Note Payable, $900; Credit Cash, $900. *d. Debit Interest Expense, $75; Credit Interest Payable, $75. Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusting entry that the company should make for interest on 30 September, would be Debit Interest Expense, $75; Credit Interest Payable, $75 ($10,000 x 9% x 1/12).

63. An adjusting entry made to record accrued interest on a loan receivable due next year consists of a: a. Debit Interest Expense; Credit Interest Payable. *b. Debit Interest Receivable; Credit Interest Revenue. c. Debit Interest Receivable; Credit Interest Expense. d. Debit Interest Expense; Credit Cash. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: An adjusting entry to record accrued interest on a loan receivable due next year consists of a debit to Interest Receivable and a credit to Interest Revenue.

3.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

64. Jane Richards, CPA, has invoiced her clients for services performed. She subsequently receives payments from her clients. What entry will she make upon receipt of the payments? a. Debit Revenue Received in Advance; Credit Service Revenue. *b. Debit Cash; Credit Accounts Receivable. c. Debit Accounts Receivable; Credit Service Revenue. d. Debit Cash; Credit Service Revenue. Answer: b Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. Feedback: Upon receipt of the payments Jane will Debit Cash and credit Accounts Receivable.

65. On Friday 26 January Snell Tables paid employee wages up to the end of that day. The next payroll will be paid in February. There are three more working days in January (29-31). Employees work 5 days a week and the business pays $800 a day in wages. The adjusting entry to accrue wages expense at the end of January is: a.

Wages Expense ...........................................................................800 Wages Payable .............................................................

800

Wages Expense ...........................................................................4,000 Wages Payable ............................................................. 4,000

*c.

Wages Expense ...........................................................................2,400 Wages Payable .......................................................... 2,400 No adjusting entry is required.

Answer: c Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: The adjusting entry for an accrued expense increases an expense account and increases a liability account. The amount of this adjustment is $800 x 3.

66. At the end of the financial year, the usual adjusting entry for accrued salaries owed to employees was omitted. Which of the following statements is true? a. Salary Expense for the year is overstated. *b. Liabilities at the end of the year are understated. c. Assets at the end of the year are understated. d. Equity at the end of the year is understated. Answer: b Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: At the end of the financial year, the usual adjusting entry for accrued salaries owed to employees was omitted therefore liabilities at the end of the year are understated (and expenses are understated). .

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Chapter 3: Accrual accounting concepts

67. A business shows a balance in Salaries Payable of $40,000 at the end of the month. The next payroll amounting to $50,000 is to be paid in the following month. What will be the journal entry to record the payment of salaries? a. b. c. *d.

Salaries Expense ..........................................................................50,000 Salaries Payable .............................................................. 50,000 Salaries Expense ..........................................................................50,000 Cash .............................................................................. 50,000 Salaries Expense ..........................................................................10,000 Cash .............................................................................. 10,000 Salaries Expense ..........................................................................10,000 Salaries Payable ..........................................................................40,000 Cash .............................................................................. 50,000

Answer: d Learning objective 3.4 - Prepare adjusting entries for prepayments and accruals. Feedback: If the adjusting entries are not reversed the payment in the next accounting period must be split between the current period expense and the extinguishing the liability from the previous period.

68. An adjusted trial balance: a. is prepared after the financial statements are completed. *b. proves the equality of the total debit balances and total credit balances of ledger accounts after all adjustments have been made. c. is a required financial statement under generally accepted accounting principles. d. cannot be used to prepare financial statements. Answer: b Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. Feedback: An adjusted trial balance proves the equality of total debit balances and total credit balances in ledger accounts after all adjustments have been made. It is also the main basis for the preparation of the financial statements.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

69. After all adjusting entries have been journalised and posted another trial balance is prepared from the ledger accounts. This later trial balance is known as the: a. unadjusted trial balance. b. temporary trial balance. c. permanent trial balance. *d. adjusted trial balance. Answer: d Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. Feedback: An adjusted trial balance proves the equality of total debit balances and total credit balances of ledger accounts after all adjustments have been made. It is also the main basis for the preparation of the financial statements.

70. When a business closes its accounts at the end of a financial period, the only accounts remaining open are: *a. permanent accounts. b. temporary accounts. c. income statement accounts. d. revenue accounts. Answer: a Learning objective 3.6 – Explain the purpose of closing entries. Feedback: When a business closes its accounts at the end of a financial period, the only accounts remaining open are permanent accounts. Permanent accounts are all statement of financial position accounts (asset, liability and equity accounts).

71. Temporary accounts of a business include: a. assets, liabilities and equity accounts. b. assets only accounts. *c. revenue, expense and dividend accounts. d. retained earnings only account. Answer: c Learning objective 3.6 – Explain the purpose of closing entries. Feedback: Temporary accounts of a business include revenue, expense and dividend accounts. Temporary accounts relate to a given accounting period only.

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Chapter 3: Accrual accounting concepts

72. Closing entries: a. are prepared before the financial statements. b. reduce the number of permanent accounts. *c. cause the revenue and expense accounts to have zero balances. d. summarise the activity in every account. Answer: c Learning objective 3.6 – Explain the purpose of closing entries. Feedback: Closing entries cause the revenue and expense accounts to have zero balances. Revenue and expense accounts are temporary accounts and relate to a given accounting period only. 73. Which of the following is a true statement about closing the books of a business?

a. Expenses are closed to the Total Expense account. b. Only revenues are closed to the Profit and Loss Summary account. *c. Revenues and expenses are closed to the Profit and Loss Summary account. d. The Dividends Paid account is closed to the Profit and Loss Summary account. Answer: c Learning objective 3.6 – Explain the purpose of closing entries. Feedback: Revenue and expense accounts are closed to the Profit and Loss Summary account. The balance in the Profit and Loss Summary account is then closed to the Retained Earnings account. Dividends Paid account is closed to the Retained Earnings account.

74. The closing entry process consists of closing: a. all asset and liability accounts. b. the Retained Earnings account. c. all permanent accounts. *d. all temporary accounts. Answer: d Learning objective 3.6 – Explain the purpose of closing entries. Feedback: The closing entry process consists of closing all temporary accounts. Revenue, expense and the dividends paid account are temporary accounts and relate to a given accounting period only.

3.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

75. The purpose of the post-closing trial balance is to: a. prove that no mistakes were made. *b. prove the equality of the permanent account balances that are carried forward into the next accounting period. c. prove the equality of the temporary account balances that are carried forward into the next accounting period. d. list all the statement of financial position accounts in alphabetical order for easy reference. Answer: b Learning objective 3.6 – Explain the purpose of closing entries. Feedback: The purpose of the post-closing trial balance is to prove the equality of the permanent account balances that are carried forward into the next accounting period.

76. When preparing closing journal entries, the item Salaries Expense is closed: a. directly to the Retained Earnings account. b. directly to the Accumulated Expenses account. *c. to the Profit and Loss Summary account. d. to the Dividends Paid account. Answer: c Learning objective 3.6 – Explain the purpose of closing entries. Feedback: Revenue and expense accounts are closed to the Profit and Loss Summary account. The balance in the Profit and Loss Summary account is then closed to the Retained Earnings account. The Dividends Paid account is closed to the Retained Earnings account.

77. The closing entry process results in the balance of the Profit and Loss Summary account being closed to the: *a. Retained Earnings account. b. Total Assets account. c. Share Capital account. d. Total Liabilities account. Answer: a Learning objective 3.6 – Explain the purpose of closing entries. Feedback: Revenue and expense accounts are closed to the Profit and Loss Summary account. The balance in the Profit and Loss Summary account is then closed to the Retained Earnings account. The Dividends Paid account is closed to the Retained Earnings account.

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Chapter 3: Accrual accounting concepts

78. The accounting cycle begins with the analysis of transactions and ends with the: a. preparation of financial statements. b. posting of transactions to ledger accounts. c. journalising of adjusting entries. *d. preparation of a post-closing trial balance. Answer: d Learning objective 3.7 – Describe the required steps in the accounting cycle. Feedback: The accounting cycle begins with the analysis of transactions and ends with the preparation of a post-closing trial balance.

79. When is a reversing journal entry made? a. At the end of the financial year in which adjusting entries are made. *b. At the beginning of the next accounting period. c. At the end of the next accounting period. d. At the same time as the adjusting entries are made. Answer: b Learning objective 3.4 – Describe the required steps in the accounting cycle. Feedback: Reversing journal entries are an optional step in the accounting cycle and may be made at the beginning of the next accounting period.

80. A worksheet is: a. prescribed in the framework. b. only used in small businesses with few general ledger accounts. *c. prepared either manually or using a computer spreadsheet. d. not necessary if the financial statements are being prepared by an accountant. Answer: c Learning objective 3.8 – Describe the purpose and the basic form of a worksheet. Feedback: A worksheet is prepared either manually or using a computer spreadsheet. A worksheet is a multicolumn form that may be used in the adjustment process and in preparing financial statements.

3.27

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises 81. The Statement of Financial Position of Redmond Company Ltd includes the following:

Interest Receivable Supplies Wages Payable Revenue Received in Advance The income statement for 2013 shows the following: Interest Revenue Service Revenue Supplies Expense Wages Expense

31/12/16 $6,300 5,000 3,600 -0-

31/12/15 $ -03,500 3,800 4,000

$15,400 72,700 8,700 37,000

Calculate the following for 2016: 1. Cash received for interest. 2. Cash paid for supplies. 3. Cash paid for wages. 4. Cash received for revenue.

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Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. 1. Cash received for interest = Interest Revenue Less: Interest Receivable Cash Received

$ 9,100 $15,400 6,300 $ 9,100

2. Cash paid for supplies = Supplies Expense Less: Supplies (2015)

$10,200 $ 8,700 3,500 5,200 5,000 $10,200

Add: Supplies (2016) Cash Paid 3. Cash paid for wages = Wages Expense Add: Wages Payable (2015)

$37,200 $37,000 3,800 40,800 3,600 $37,200

Less: Wages Payable (2016) Cash Paid 4. Cash received for revenue = Service Revenue Less: Revenue Received in Advance (2015) Cash Received

$68,700 $72,700 4,000 $68,700

3.29

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

82. The 2016 Income Statement for Berring Ltd showed rent expense of $5,500 and salary expense of $5,600. The related Statement of Financial Position account balances at year end 2015 and 2016 were as follows: 2016 2015 Prepaid Rent $800 $200 Salaries Payable 200 400 Calculate the following for 2013: 1. Cash paid for rent. 2. Cash paid for wages.

Answers below. Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. 1. Cash paid for rent = Rent Expense Less: Prepaid Rent (2015)

$6,100 $5,500 200 5,300 800 $6,100

Add: Prepaid Rent (2016) Cash Paid 2. Cash paid for wages = Wages Expense Add: Wages Payable (2015)

$5,800 $5,600 400 6,000 200 $5,800

Less: Wages Payable (2016) Cash Paid

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Chapter 3: Accrual accounting concepts

83. Ronson Ltd prepared the following Income Statement using the cash basis of accounting: RONSON LTD Income Statement, Cash Basis for the year ended 31 December 2016 Service revenue (does not include $40,000 of services provided on account because the collection will not be made until 2017) ........................................... Expenses (does not include $25,000 of expenses on account because payment will not be made until 2017) ................................................................ Profit .........................................................................................................................

$370,000 220,000 $150,000

Additional data: 1. Depreciation on a company motor vehicle for the year amounted to $8,000. This amount is not included in the expenses above. 2. On 1 January 2016, Ronson paid for a two-year insurance policy on the motor vehicle amounting to $1,800. The total amount is included in the expenses above. Instructions (a) (b)

Recast the above Income Statement on the accrual basis in conformity with generally accepted accounting principles. Show computations and explain each change. Explain which basis (cash or accrual) provides a better measure of profit.

3.31

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 3.1 – Differentiate between the cash basis and the accrual basis of accounting. (a) RONSON LTD Income Statement for the year ended 31 December 2016 Service revenue ................................................................................................. Expenses ............................................................................................................ Profit ..................................................................................................................

$410,000 252,100 $157,900

Service revenue should include the $40,000 for services performed on account. The accrual basis states that revenue is to be recognised in the period when the service is performed. ($370,000 + $40,000 = $410,000). Expenses should include the $25,000 for expenses incurred but not yet paid. The accrual basis states that expenses should be recognised in the period when incurred. The expenses also should only include half of the $1,800 insurance premium since $900 applies to the 2016 year. The other $900 is an asset and should be reflected on the Statement of Financial Position as prepaid insurance. ($220,000 + $25,000 - $900 + $8,000 = $252,100). (b) The accrual basis of accounting provides a better measure of profit than the cash basis. The accrual basis is required under generally accepted accounting principles and recognises revenues when earned and expenses when incurred. Revenues and expenses recognised under the accrual basis are related to the economic environment in which they occur and thus allow trends to be more meaningfully interpreted. The cash basis often fails to recognise revenue in the period when earned and expenses when incurred. Additionally, expenses are not matched with revenues when earned; therefore, the matching principle is violated.

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Chapter 3: Accrual accounting concepts

84. Before month-end adjustments are made, the 28 February trial balance of Joe's Gardening Services contains revenue of $9,000 and expenses of $4,400. Adjustments are necessary for the following items: Depreciation for February is $1,300. Revenue earned but not yet invoiced or received is $2,800. Accrued interest expense is $700. Revenue collected in advance that is now earned is $3,500. Portion of prepaid insurance expired during February is $400. Calculate the correct profit for Joe's Income Statement for February.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. Profit before adjustments ($9,000 - 4,400) Add: Revenue received in advance now earned Accrued Revenues

$3,500 2,800

Subtract: Depreciation Expense Interest Expense Insurance Expense

1,300 700 400

Profit after adjustments

$ 4,600 6,300 10,900

2,400 $ 8,500

3.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

85. For each of the following oversights, state whether total assets will be understated (U), overstated (O), or no affect (NA). _____ 1. Failure to record revenue earned but not yet received. _____ 2. Failure to record expired prepaid rent. _____ 3. Failure to record accrued interest revenue on a loan receivable. _____ 4. Failure to record depreciation. _____ 5. Failure to record accrued wages. _____ 6. Failure to recognise the earned portion of revenue received in advance.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. 2. 3. 4. 5. 6.

U O U O NA NA

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Chapter 3: Accrual accounting concepts

86. On 31 December 2016, Lance Ltd prepared an Income Statement and a Statement of Financial Position but failed to take into account three adjusting entries. The incorrect Income Statement showed a profit of $40,000. The Statement of Financial Position showed total assets, $120,000; total liabilities, $50,000; and equity, $70,000. The data for the three adjusting entries were: (1)

Depreciation of $7,000 was not recorded on equipment.

(2)

Wages amounting to $8,000 for the last two days in December were not paid and not recorded. The next payroll will be in January.

(3)

Rent of $12,000 was paid for two months in advance on 31 December. The entire amount was debited to Rent Expense when paid.

Complete the following tabulation to correct the financial statement amounts shown (indicate deductions with parentheses): Item Incorrect balances Effects of: Depreciation

Profit $ 40,000

Total Assets $120,000

Total Liabilities $ 50,000

Equity $ 70,000

Wages Rent Correct Balances

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. Item Incorrect balances Effects of: Depreciation Wages Rent Correct Balances

Profit $40,000

Total Assets $120,000

Total Liabilities Equity $50,000 $70,000

(7,000) (8,000) 6,000 $31,000

(7,000)

(7,000) (8,000) 6,000 $61,000

8,000 6,000 $119,000

$58,000

3.35

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

87. Ellis Ltd accumulates the following adjustment data at 31 December. 1. Revenue of $800 collected in advance has now been earned. 2. Salaries of $600 are unpaid. 3. Prepaid rent totaling $450 has expired. 4. Supplies of $550 have been used. 5. Revenue earned but not yet invoiced totals $750. 6. Electricity expenses of $200 are unpaid. 7. Interest of $250 has accrued on a note payable. (a) For each of the above items indicate: 1. The type of adjustment (prepaid expense, revenue received in advance, accrued revenue, or accrued expense). 2. The account relationship (asset/liability, liability/revenue, etc.). 3. The status of account balances before adjustment (understatement or overstatement). 4. The adjusting entry. (b) Assume profit before the adjustments listed above was $16,500. What is the adjusted profit? Prepare your answer in the tabular form presented below.

Type of Adjustment

Account Relationship

Account Balances Before Adjustment (Understatement or Overstatement) Adjusting Entry Profit effect

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Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a) Type of Account Adjustment Relationship 1. Revenue received L/R in advance 2. Accrued expense 3. Prepaid expense 4. Prepaid expense 5. Accrued revenue 6. Accrued expense 7. Accrued expense

E/L E/A E/A A/R E/L E/L

Codes: A = Asset L = Liability E = Expense

(b)

Account Balances Before Adjustment (Understatement or Overstatement) Liab. O Rev. U

Adjusting Entry Rev Rec’d in Adv. Service Revenue

Exp. U Liab. U

Salary Expense Salaries Payable

(600)

Exp. U Asset O

Rent Expense Prepaid Rent

(450)

Exp. U Asset O

Supplies Expense Supplies

(550)

Asset U Rev. U

Accounts Receivable Service Revenue

750

Exp. U Liab. U

Electricity Expense Accounts Payable

(200)

Exp. U Liab. U

Interest Expense Interest Payable

(250)

Profit Effect Increase (Decrease) 800

R = Revenue O = Overstatement U = Understatement

Profit before adjustments ............................................................... Add: Revenue received in advance now earned (1) .................... Accrued revenue (5) ........................................................... Less: Accrued salaries (2) ........................................................... Prepaid rent expired (3) ..................................................... Supplies used (4) ................................................................ Accrued electricity (6) ....................................................... Accrued interest (7) ............................................................ Adjusted profit ...............................................................................

$16,500 $800 750 600 450 550 200 250

1,550 18,050

2,050 $16,000

3.37

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

88. The adjusted trial balance of Nance Ltd includes the following Statement of Financial Position accounts that frequently require adjustment. For each account, indicate (a) the type of adjusting entry (prepaid expenses, revenues received in advance, accrued revenues, or accrued expenses) and (b) the related account in the adjusting entry. (a) (b) Statement of Financial Position account Type of adjusting entry Related account 1. Supplies 2. Accounts Receivable 3. Prepaid Insurance 4. Accumulated Depreciation— Equipment 5. Interest Payable 6. Salaries Payable 7. Revenue Received in Advance

Answers below. Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. (a) (b) Statement of Financial Position account Type of adjusting entry Related account 1. Supplies Prepaid Expense Supplies Expense 2. Accounts Receivable 3. Prepaid Insurance 4. Accumulated Depreciation— Equipment 5. Interest Payable 6. Salaries Payable 7. Revenue received in advance

Accrued Revenue Prepaid Expense

Service Revenue Insurance Expense

Prepaid Expense Accrued Expense Accrued Expense Revenue Recd in Adv

Depreciation Exp Interest Expense Salaries Expense Service Revenue

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Chapter 3: Accrual accounting concepts

89. State whether each situation is a prepaid expense (PE), revenue received in advance (RRA), accrued revenue (AR) or an accrued expense (AE). 1. 2. 3. 4.

Unrecorded interest earned on investment bonds is $245. Rates that have been incurred but have not yet been paid or recorded amount to $300. Legal fees of $1,000 were collected in advance. By year end 60 per cent were still unearned. Prepaid insurance had a $500 balance prior to adjustment. By year end, 40 percent was still unexpired. 5. Unpaid salaries earned by year end but not yet paid or recorded amounted to $1,200.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. 2. 3. 4. 5.

AR AE RRA PE AE

3.39

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

90. Match the statements below with the appropriate terms by entering the appropriate letter code in the spaces provided. TERMS: A. Prepaid Expenses B. Revenue Received in Advance C. Accrued Revenues D. Accrued Expenses STATEMENTS: ____ 1. A revenue not yet earned; collected in advance. ____ 2. Office supplies on hand that will be used in the next period. ____ 3. Rent revenue collected; not yet earned. ____ 4. Interest earned; not yet collected. ____ 5. An expense incurred; not yet paid or recorded. ____ 6. A revenue earned; not yet collected or recorded. ____ 7. An expense not yet incurred; paid in advance. ____ 8. Interest expense incurred; not yet paid.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. 2. 3. 4. 5. 6. 7. 8.

B A B C D C A D

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Chapter 3: Accrual accounting concepts

91. The Strikers, a semi-professional cricket team, prepare financial statements on a monthly basis. Their season begins in November, but in October the team engaged in the following transactions: (a)

Paid $150,000 to Cooma Council as advance rent for use of Cooma Stadium for the sixmonth period of 1 November through 30 April.

(b)

Collected $300,000 cash from sales of season tickets for the team's 20 home games. This amount was credited to Revenue Received in Advance.

During the month of November, the Strikers played four home games and five away games. Instructions Prepare the adjusting entries required at 30 November for the transactions above.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a) Rent Expense ................................................................................... Prepaid Rent .......................................................................... ($150,000 / 6 = $25,000)

25,000

(b) Revenue Received in Advance ........................................................ Ticket Revenue ..................................................................... ($300,000 / 20 = $15,000; $15,000 x 4 = $60,000)

60,000

25,000

60,000

3.41

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

92. Prepare adjusting entries for the following transactions. Omit explanations. 1. 2. 3. 4. 5.

Depreciation on equipment is $840 for the accounting period. Interest of $175 is owing on a loan payable. There was no beginning balance of supplies. During the period $400 of office supplies were purchased. At the end of the period $70 of supplies were on hand. Prepaid rent had a $1,000 normal balance prior to adjustment. By year end $300 had expired. Accrued salaries at the end of the period amounted to $900.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. Depreciation Expense ....................................................................... Accumulated Depreciation—Equipment .................................

840

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

175

3. Supplies Expense .............................................................................. Supplies .................................................................................... (400-70)

330

4. Rent Expense .................................................................................... Prepaid Rent .............................................................................

300

900

Salaries Expense ............................................................................ Salaries Payable .........................................................................

840

175

330

300

900

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Chapter 3: Accrual accounting concepts

93. Prepare adjusting entries for the following transactions. Omit explanations. 1. 2. 3. 4. 5.

Unrecorded interest receivable that has accrued on investment bonds is $270. Rates incurred but not paid or recorded amount to $700. Legal service revenues of $3,000 were collected in advance. By year end $600 was earned. Prepaid insurance had a $400 debit balance prior to adjustment. By year end, 40 percent was still unexpired. Salaries incurred by year end but not yet paid or recorded amounted to $950.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. Interest Receivable ........................................................................... Interest Revenue........................................................................

270

2. Rates Expense ................................................................................... Rates Payable ...........................................................................

700

3. Revenue Received in Advance .......................................................... Legal Revenues ........................................................................

600

4. Insurance Expense ............................................................................ Prepaid Insurance .....................................................................

240

5. Salaries Expense ............................................................................... Salaries Payable .........................................................................

950

270

700

600

240

950

3.43

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

94. Prepare year-end adjustments for the following transactions. Omit explanations. 1. 2. 3. 4. 5. 6. 7.

Accrued interest on notes receivable, $85. Revenues received in advance now earned, $1,000. Three years rent, totalling $36,000, was paid in advance at the beginning of the year. Services totalling $2,100 had been performed but not yet invoiced at the end of the year. Depreciation on equipment totaled $4,500 for the year. Supplies for use totaled $690. By year end, only $100 in supplies remained. Salaries owed to employees at the end of the year total $1,000.

2. Revenue Received in Advance .......................................................... Revenues ..................................................................................

1,000

Rent Expense ................................................................................... Prepaid Rent .......................................................................... ($36,000 / 3 = $12,000)

12,000

Services Receivable .......................................................................... Services Revenue ...................................................................

2,100

Depreciation Expense—Equipment ................................................. Accumulated Depreciation—Equipment ...............................

4,500

6. Supplies Expense .............................................................................. Supplies ....................................................................................

590

Salaries Expense .............................................................................. Salaries Payable .....................................................................

1,000

12,000

2,100

4,500

590 1,000 1,000

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Chapter 3: Accrual accounting concepts

95. Allen Coat Ltd purchased a delivery truck on 1 June for $18,000, paying $8,000 cash and signing a 12%, 2-month note payable for the remaining balance. The truck is expected to depreciate $3,000 each year. Allen Coat Ltd prepares monthly financial statements. (a)

Prepare the general journal entry to record the acquisition of the delivery truck on 1 June.

(b)

Prepare any adjusting journal entries that should be made on 30 June

(c)

Show how the delivery truck will be reflected on Allen Coat Ltd's Statement of Financial Position on 30 June.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a) 1 June

(b) 30 June

30 June

Delivery Truck ................................................................ Cash ........................................................................ Note Payable .......................................................... (To record acquisition of delivery truck and signing of a 2-month, 12% note)

18,000

Depreciation Expense ..................................................... Accumulated Depreciation—Delivery Truck ........ (To record monthly depreciation) $3,000 / 12 = $250/month

250

Interest Expense .............................................................. Interest Payable ...................................................... (To accrue interest on note payable) $10,000 x 12% x 1/12 = $100

100

8,000 10,000

250

100

$18,000 250 $17,750

3.45

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

96. Watson Ltd prepares monthly financial statements. Below are listed some selected accounts and their balances on the 30 September trial balance before any adjustments have been made for the month of September. WATSON LTD Trial Balance (Selected Accounts) 30 September 2016 _____________________________________________________________________________ Debit Credit Office Supplies ........................................................................................$ 2,700 Prepaid Insurance .................................................................................... 4,725 Office Equipment .................................................................................... 16,200 Accumulated Depreciation—Office Equipment ..................................... $ 900 Revenue Received in Advance ............................................................... 1,200 (Note: Debit column does not equal credit column because this is a partial listing of selected account balances.) An analysis of the account balances by the company's accountant provided the following additional information: 1. A physical count of office supplies revealed $1,200 on hand on 30 September. 2. A two-year insurance policy was purchased on 1 June for $5,400. 3. Office equipment depreciates $5,400 per year. 4. The amount of rent received in advance that remains unearned at 30 September is $500. Using the above additional information, prepare the adjusting entries that should be made by Watson Ltd on 30 September.

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Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. Office Supplies Expense ................................................................... Office Supplies ......................................................................... (To record the amount of office supplies used)

1,500

2. Insurance Expense ............................................................................ Prepaid Insurance ..................................................................... (To record insurance expired $5,400 / 24)

225

3. Depreciation Expense ....................................................................... Accumulated Depreciation—Office Equipment ...................... (To record monthly depreciation $5,400 / 12)

450

4. Revenue Received in Advance ......................................................... Rent Revenue ........................................................................... (To record rent revenue earned)

700

1,500

225

450

700

3.47

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

97. Prepare the required end-of-period adjusting entries for each independent case listed below. Case 1 Thomas Ltd began the year with a $3,000 balance in the Office Supplies account. During the year, $8,500 worth of additional office supplies was purchased. A physical count of office supplies on hand at the end of the year revealed that $6,400 worth of office supplies had been used during the year. No adjusting entry has been made. Case 2 Carson Ltd has a calendar year-end accounting period. On 1 July, the company purchased office equipment for $28,800. It is estimated that the office equipment will depreciate $400 each month. No adjusting entry has been made. Case 3 Yates Realty is in the business of renting several apartment buildings and prepares monthly financial statements. It has been determined that 3 tenants in $600 per month apartments and one tenant in the $1,000 per month apartment had not paid their December rent as of 31 December.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. Case 1—31 December Office Supplies Expense ..................................................... Office Supplies ........................................................ (To record office supplies used during the year) Case 2—31 December Depreciation Expense .......................................................... Accumulated Depreciation—Office Equipment ...... (To record depreciation expense for six months) $400 x 6 months = $2,400 Depreciation Case 3—31 December Rent Receivable ................................................................... Rent Revenue .......................................................... (To accrue rent earned but not yet received)

6,400 6,400

2,400 2,400

2,800 2,800

3.48

98. The Reality Insurance Agency prepares monthly financial statements. Presented below is an Income Statement for the month of June that is correct on the basis of information supplied. REALITY INSURANCE AGENCY Income Statement for the month ended 30 June _____________________________________________________________________________ Revenues Premium Commission Revenues .................................................. $40,000 Expenses Salary expense .............................................................................. $6,000 Advertising expense ...................................................................... 800 Rent expense ................................................................................. 4,200 Depreciation expense .................................................................... 2,800 Total expenses ............................................................................... 13,800 Profit ............................................................................................... $26,200 Additional Data: When the Income Statement was prepared, the agency accountant neglected to take into consideration the following information: 1. An electricity invoice for $2,000 was received on the last day of the month for electric and gas service for the month of June. 2. A company insurance salesman sold a life insurance policy to a client for a premium of $28,000. The agency invoiced the client for the policy and is entitled to a commission of 20%. 3. Supplies on hand at the beginning of the month were $3,000. The agency purchased additional supplies during the month for $2,500 in cash and $2,200 of supplies were on hand at 30 June. 4. The agency purchased a new car at the beginning of the month for $16,800 cash. The car will depreciate $4,200 per year. 5. Salaries owed to employees at the end of the month total $5,300. The salaries will be paid on July 5. Prepare a corrected Income Statement.

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. REALITY INSURANCE AGENCY Income Statement for the month ended 30 June _____________________________________________________________________________ Revenues Premium Commission Revenues ($40,000 + $5,600) ................... $45,600 Expenses Salary expense ($6,000 + $5,300) ................................................. $11,300 Advertising expense ...................................................................... 800 Rent expense ................................................................................. 4,200 Depreciation expense ($2,800 + $350) ......................................... 3,150 Electricity expense ($0 + $2,000) ................................................. 2,000 Supplies expense ($0 + $3,300) .................................................... 3,300 Total expenses ...................................................................... 24,750 Profit ............................................................................................... $20,850

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Chapter 3: Accrual accounting concepts

99. One part of an adjusting entry is given below. Instructions Indicate the account title for the other part of the entry. 1. Revenue Received in Advance is debited. 2. Prepaid Rent is credited. 3. Accounts Receivable is debited. 4. Depreciation Expense is debited. 5. Electricity Expense is debited. 6. Interest Payable is credited. 7. Service Revenue is credited (give two possible debit accounts). 8. Interest Receivable is debited.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. Service Revenue 2. Rent Expense 3. Service Revenue 4. Accumulated Depreciation

5. Electricity Payable 6. Interest Expense 7. Accounts Receivable or Revenue Received in Advance 8. Interest Revenue

3.51

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

100. The following ledger accounts are used by the Crawford Greyhound Park: Accounts Receivable Prepaid Printing Prepaid Rent Admissions Revenue Received in Advance Printing Expense Rent Expense Admissions Revenue Concessions Revenue Cash Note Payable Interest Expense Interest Payable Commissions Revenue For each of the following transactions below, prepare the journal entry (if one is required) to record the initial transaction and then prepare the adjusting entry, if any, required on 30 September, the end of the financial year. (a) (b)

(e)

On 1 September, paid rent on the track facility for three months, $180,000. On 1 September, sold season tickets for admission to the racetrack. The racing season is year-round with 25 racing days each month. Season ticket sales totaled $900,000. On 1 September, borrowed $150,000 from First National Bank by issuing a 12% promissory note payable due in three months. On 5 September paid $3,000 cash for racing schedules for 20 racing days in September, 25 racing days in October, and 15 racing days in November. The accountant for the concessions company reported that gross receipts for September were $140,000. Ten per cent is due to Crawford and will be remitted by October 10.

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Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a) Journal Entry Prepaid Rent ............................................................................ Cash ................................................................................

180,000

Adjusting Entry Rent Expense .......................................................................... Prepaid Rent ...................................................................

60,000

(b) Journal Entry Cash ......................................................................................... Revenue Received in Advance .......................................

900,000

Adjusting Entry Revenue Received in Advance ............................................... Admissions Revenue ...................................................... ($900,000 / 12 = $75,000)

(c) Journal Entry Cash ......................................................................................... Note payable .................................................................. Adjusting Entry Interest Expense ...................................................................... Interest Payable .............................................................. ($150,000 x .12 x 1/12 = $1,500)

(d) Journal Entry Prepaid Printing ...................................................................... Cash ................................................................................ Adjusting Entry Printing Expense ..................................................................... Prepaid Printing ............................................................. ($3,000 / 60 x 20 = $1,000)

180,000

60,000

900,000

75,000 75,000

150,000 150,000

1,500 1,500

3,000 3,000

1,000 1,000

(e) Journal Entry None Adjusting Entry Accounts Receivable ............................................................... Concessions Revenue .....................................................

14,000 14,000

3.53

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

101. Cambridge Ltd has an accounting financial year which ends on 30 June. The company also has a policy of paying the weekly payroll on Friday. Payroll records indicate the following salary costs were incurred. Date Amount Monday 28 June $3,000 Tuesday 29 June 3,800 Wednesday 30 June 2,400 Thursday 1 July 3,000 Friday 2 July 2,400 (a) Prepare any necessary adjusting journal entries that should be made at year ended on 30 June. (b) Prepare the journal entry to record the payment of the weekly payroll on 2 July.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a) 30 June

(b) 2 July

Salaries Expense ............................................................ Salaries Payable .................................................... (To accrue salaries incurred but not yet paid)

9,200

Salaries Payable ............................................................. Salaries Expense ............................................................ Cash ....................................................................... (To record payment of July 2 payroll)

9,200 5,400

9,200

14,600

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Chapter 3: Accrual accounting concepts

102. On Friday of each week, Nunez Ltd pays its factory personnel weekly wages amounting to $40,000 for a five-day work week. (a) Prepare the necessary adjusting entry at year end, assuming 31 December falls on Wednesday. (b) Prepare the journal entry for payment of the week's wages on the payday which is Friday, January 2 of the next year.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a) 31 Dec.

(b) 2 Jan.

Wages Expense .............................................................. Wages Payable ......................................................

24,000

Wages Payable ............................................................... Wages Expense .............................................................. Cash .......................................................................

24,000 16,000

24,000

40,000

3.55

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

103. Presented below is the Trial Balance and Adjusted Trial Balance for Jim Lankford Ltd on 31 December. JIM LANKFORD LTD Trial Balances 31 December _____________________________________________________________________________ Before Adjustment

After

Adjustment Cash Accounts Receivable Prepaid Rent Supplies Motor vehicle Accumulated Depreciation— Motor vehicle Accounts Payable Notes Payable Interest Payable Salaries Payable Revenue Received in Advance Share capital Retained earnings Dividends paid Service Revenue Salaries Expense Electricity Expense Rent Expense Supplies Expense Depreciation Expense— Motor vehicle Interest Expense Totals

Dr. $ 2,000 2,800 2,100 1,200 18,000

Cr.

Dr. $ 2,000 3,900 1,500 800 18,000

$ 1,300 2,700 10,000

$ 1,500 3,000 10,000 120 600 4,360 6,000 1,200

4,460 6,000 1,200 3,200

3,200 8,000

2,060 1,800 500

$33,660

9,200 2,660 2,100 1,100 400

$33,660

200 120 $35,980

$35,980

Prepare, in journal form with explanations, the adjusting entries that explain the changes in the balances from the trial balance to the adjusted trial balance.

3.56

Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. Accounts Receivable .............................................................................. Service Revenue ............................................................................ (To record revenue earned but not yet collected)

1,100

Rent Expense ......................................................................................... Prepaid Rent .................................................................................. (To record expiration of prepaid rent)

600

Supplies Expense ................................................................................... Supplies ......................................................................................... (To record supplies used)

400

Depreciation Expense—Motor vehicle .................................................. Accumulated Depreciation—Motor vehicle ................................. (To record depreciation expense)

200

Salaries Expense .................................................................................... Salaries Payable ............................................................................ (To record salaries owed, not yet paid)

600

Interest Expense ..................................................................................... Interest Payable ............................................................................. (To record accrued interest payable)

120

Revenue Received in Advance .............................................................. Service Revenue ............................................................................ (To record revenue earned)

100

Electricity Expense ................................................................................ Accounts Payable .......................................................................... (To record receipt of electricity invoice)

300

1,100

600

400

200

600

120

100

300

3.57

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

104. The National Koala Park operates a tourist attraction in Pennant Hills. The entity adjusts its accounts at the end of each month. The selected accounts appearing below reflect balances after adjusting entries were prepared on 30 April. The adjusted trial balance shows the following: Prepaid Rent $ 8,000 Fencing 30,000 Accumulated Depreciation—Fencing 5,500 Ticket Revenue Received in Advance 500 Other data: 1. Three months' rent had been prepaid on 1 April. 2. The fencing is being depreciated at $6,000 per year. 3. The revenue received in advance represents tickets sold for future park visits. The tickets were sold at $4.00 each on 1 April. During April, twenty-five of the tickets were used by customers.

Instructions (a)

(b)

Calculate the following: 1. Monthly rent expense. 2. The age of the fencing in months. 3. The number of tickets sold on 1 April. Prepare the adjusting entries that were made by the National Koala Park on 30 April.

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. (a)

$4,000. The $8,000 balance on the adjusted trial balance reflects two months remaining on the prepaid lease. This indicates that the monthly lease is $4,000.

The fencing is 11 months old. By dividing annual depreciation ($6,000) by 12, the monthly depreciation expense is $500. The accumulated depreciation account shows $5,500 which means that depreciation has been taken for 11 months.

150 tickets were originally sold. Twenty-five tickets were used in April at $4.00 each. The adjusted trial balance shows a balance of $500 indicating that 125 tickets are still outstanding. By adding the 25 used in April to the 125 still remaining to be used, 150 tickets must have been sold on 1 April.

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Chapter 3: Accrual accounting concepts

(b)

1. Rent Expense .......................................................................... Prepaid Rent ...................................................................

4,000

2. Depreciation Expense ............................................................. Accumulated Depreciation—Fencing ............................

500

100

Ticket Revenue Received in Advance .................................... Ticket Revenue .............................................................. (25 X $4 = $100)

4,000

500

100

3.59

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

105. The adjusted trial balance of AMBER Ltd appears below. Using the information from the adjusted trial balance, prepare for the month ending 31 December: 1. an Income Statement 2. a Statement of Changes in Equity 3. a Statement of Financial Position AMBER Ltd Adjusted Trial Balance 31 December _____________________________________________________________________________ Debit Credit Cash ........................................................................................................ $ 6,400 Accounts Receivable .............................................................................. 2,200 Office Supplies ....................................................................................... 1,800 Office Equipment ................................................................................... 15,000 Accumulated Depreciation—Office Equipment .................................... $ 4,000 Accounts Payable ................................................................................... 4,000 Revenue Received in Advance .............................................................. 5,000 Share Capital ........................................................................................... 12,000 Retained Earnings .................................................................................. 4,400 Dividends Paid ....................................................................................... 2,500 Service Revenue ..................................................................................... 3,500 Office Supplies Expense ........................................................................ 600 Depreciation Expense ............................................................................ 2,500 Rent Expense ......................................................................................... 1,900 $32,900 $32,900

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Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. 1.

AMBER Ltd Income Statement for the month ended 31 December _____________________________________________________________________________

Revenues Service Revenue ............................................................................ Expenses Depreciation Expense ................................................................... Rent Expense ................................................................................ Office Supplies Expense ............................................................... Total Expenses ........................................................................ Loss ..................................................................................................

$ 3,500 $2,500 1,900 600 5,000 $(1,500)

2. AMBER Ltd Statement of Changes in Equity for the month ended 31 December _____________________________________________________________________________ Retained earnings, 1 December ............................................................. Less: Loss ............................................................................................ Dividends paid ............................................................................ Retained earnings, 31 December ...........................................................

$4,400 $1,500 2,500

4,000 $ 400

3. AMBER Ltd Statement of Financial Position 31 December _____________________________________________________________________________ Assets Cash ........................................................................................................ $ 6,400 Accounts Receivable .............................................................................. 2,200 Office Supplies ....................................................................................... 1,800 Office Equipment ................................................................................... $15,000 Less: Accumulated Depreciation — Office Equipment ......................... 4,000 11,000 Total Assets ................................................................................... $21,400 Liabilities and Equity Liabilities Accounts Payable .......................................................................... Revenue Received in Advance ..................................................... Total Liabilities ....................................................................... Equity Share capital ................................................................................... Retained earnings .......................................................................... Total Liabilities and Equity ....................................................

$4,000 5,000 $ 9,000 12,000 400 $21,400

3.61

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Completion statements

106. Complete the following statements: 1.

The __________ period concept states that the economic life of a business can be divided into artificial time periods.

The __________ recognition principle gives accountants guidance as to when revenue is to be recorded.

In a service company, revenue is earned when the service is _______________.

Accrual-based accounting attempts to match ______________ with ______________.

Expenses paid and recorded in an asset account before they are used or consumed are called __________ expenses. Revenue received and recorded as a liability before it is earned is referred to as revenue ____________.

Failure to adjust a prepaid expense account for the amount expired will cause _______________ to be understated and ________________ to be overstated.

Depreciation is an __________________ concept, not a ________________ concept.

An adjusting entry recording accrued salaries for a period indicates that Salaries Expense has been ________________ but has not yet been ________________ or recorded.

An adjusted trial balance proves the ______________ of the total debit and credit balances after all ______________ entries have been made.

10.

In addition to updating Retained Earnings, ______________ entries produce a zero balance in each ______________ account.

11.

After all closing entries are journalised and posted, a _________________ trial balance is prepared from the ledger.

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Chapter 3: Accrual accounting concepts

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. 2. 3. 4. 5. 6.

time revenue performed expenses, revenues prepaid, received in advance expenses, assets

7. 8. 9. 10. 11.

allocation, valuation incurred, paid equality, adjusting closing, temporary post-closing

3.63

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Matching

107. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Accounting period concept Cash basis Revenue recognition principle Prepaid expenses Matching principle

F. G. H. I. J.

Accrued revenues Depreciation Post-closing trial balance Accrued expenses Carrying amount

____

1. Events recorded only in periods the company receives or pays cash

____

2. Expenses paid before they are incurred

____

3. Cost less accumulated depreciation

____

4. The economic life of a business can be divided into artificial time periods

____

5. Efforts are related to accomplishments

____

6. Includes only permanent — Statement of Financial Position — accounts

____

7. Revenue is recognised when earned

____

8. Revenues earned but not yet received

____

9. Expenses incurred but not yet paid

____ 10. A cost allocation process

Answers below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. 1. 2. 3. 4. 5.

B D J A E

6. 7. 8. 9. 10.

H C F I G

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Chapter 3: Accrual accounting concepts

Short-answer/essay questions

108. The Income Statement is an important financial statement used by individuals who are interested in the operations of a business. Explain how the accounting period concept and the revenue and expense recognition criteria provide guidance to accountants in preparing the Income Statement. Answer below. Learning objective 3.2 - Explain criteria for revenue recognition and expense recognition. The accounting period concept assumes that the life of an accounting entity can be broken up into arbitrary time periods. The revenue and expense recognition criteria are the basic rules for allocating revenues and expenses to these arbitrary time periods under the accrual basis of accounting. The revenue recognition principle dictates the time period to which revenue is to be allocated and recognised, that is, on which Income Statement the revenue is to be reported. The expense recognition principle dictates the time period to which costs are allocated and recognised as expenses, that is, on which Income Statement the expenses are to be reported and matched against revenues in the determination of profit.

109. Explain the purpose of preparing adjusting entries. Answer below. Learning objective 3.3 - Explain why adjusting entries are needed and identify the major types of adjusting entries. Adjusting entries are needed to ensure the revenue and expense recognition principles are followed. The use of adjusting entries makes it possible to match expenses incurred during a period to revenues earned. Accrual accounting requires an adjusting entry when there is a timing difference between the accounting period when revenue is earned and cash is received and when there a timing difference between the accounting period when an expense is incurred and cash is paid. Accrual accounting provides a more accurate measure of profit than cash accounting.

110. Briefly distinguish between a prepayment and an accrual. Answer below. Learning objective 3.4 - Explain criteria for revenue recognition and expense recognition. A prepayment occurs when cash is received before revenue is earned or when cash is paid before the expense is incurred. An accrual occurs when revenue is earned but not recorded and cash will be received in the next period or when an expense has been incurred and cash will be paid in the next period.

3.65

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

111. In developing an accounting information system, it is important to establish procedures whereby all transactions that affect the components of the accounting equation are recorded. Why then, is it often necessary to adjust the accounts before financial statements are prepared even in a properly designed accounting system? Identify the major types of adjustments that are frequently made and give a specific example of each. Answer below. Learning objective 3.3 - Explain why adjusting entries are needed and identify the major types of adjusting entries. Account balances must be adjusted before financial statements are prepared, even in a properly designed accounting system, because (1) some of the recorded transactions affect future accounting periods and (2) some affects on components of the accounting equation have not been recorded. Prepayments (deferrals) are adjustments of recorded transactions that must be allocated to future periods as well as the current period. Examples of prepayment adjustments are prepaid rent, prepaid insurance, and revenue received in advance. Accruals are adjustments of unrecorded transactions that must be recognised in the current period. Examples of accrual adjustments are salaries and wages payable, interest payable, and interest receivable.

112. Ethics: Claiborne and Jencks Ltd is a manufacturing company that specialises in writing instruments. The past year was a difficult one for the company, as it sought to retain its share in a market in which the largest competitors were also rapid innovators. Claiborne and Jencks introduced a new product late in the year, even though testing was not complete. It was a pen designed with two cartridges: one supplying ink and the other correction fluid. A person could then switch easily between writing and correcting errors. It was priced fairly high, and was never heavily advertised. Even so, the Correct-O-Pen, as the product was named, was an overwhelming success. The success of the product has Fern Donald, the manager of the New Products division, worried, however. She was concerned that quality problems would begin occurring, since the longevity of the pen and stability of the correction fluid formulation had not been tested. She did not want sales personnel to get the bonuses that appeared to be indicated, since they might aggressively promote a product that would fail in use. She preferred to complete testing of the pen first, so that more confidence could be placed in the results. Top management, however, declined the tests. Ms. Donald then instructed you, the accountant, not to prorate insurance and rent expense for the rest of the year, but to show them as current expenses in total. In this way, the new product would appear to be only slightly profitable. Required: 1. Describe the alternatives that you as an accountant would have in this situation. 2. Indicate which alternative is best.

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Chapter 3: Accrual accounting concepts

Answer below. Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. The choices include: 1. Follow the manager's instructions. 2. Explain to the manager why you cannot follow her instructions. 3. Report the manager's actions to her superior. 4. Resign. There are probably other alternatives as well. Students should be able to come up with at least #1 and #2. Of the choices, #1 is unethical because it will cause the financial statements to be misleading. #3 and #4 are rather drastic measures that do not seem to be indicated, at least not yet. #2, therefore, is the best choice.

113. Communication: A new sales representative, Eddy Evans, has just received his copy of the month-end financial reports. He is puzzled by the term ‘unearned revenue’. He left the following email message for you on the company's bulletin board system: What is this??? Creative Accounting, or what??? Line item 12 on year-to-date financials shows over $25Gs in Unearned Revenue!!! Come on, guys! Either we earned it, or we didn't . . . Right??! Is this how you guys lower our commissions? Reply to e.wehrl@sbd.acctg.com Required: Write a response to send to Eddy.

3.67

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answer below. Learning objective 3.5 – Describe the nature and purpose of the adjusted trial balance. Since the answer is being prepared for a ‘bulletin board’ type system, it can be in informal language and can respond in kind to the humour. However, proper grammar and spelling are essential, as is the message about what unearned revenue really is. A proposed message follows: Eddy — What a pleasant surprise to hear from you! Maybe you can teach those other guys in your department something about living in the present! Do you know some of them still write me notes on paper??? Unbelievable, right??! Now to your question. Your unearned revenue, also known as revenue received in advance, is the sales you made that us smart guys in accounting didn't figure you had earned, so we just took it away from you! Might as well save the company some dough for our own bonuses, right?? Seriously, Eddy — unearned revenue is the result of you getting customers of the kind we like — they pay in advance! Unearned revenue is also known in accounting as revenue received in advance. When they pay before we can even get their products made or shipped, we can't count the cash they pay us as revenue. What we actually have is a liability — an obligation to make and ship products. So that's how us (smart guys) in accounting count it — as a liability. You have about 25% of your sales that fit in that category. When production can catch up with orders, you'll get credit for the sales. (Take heart — It'll seem like Christmas all over again) Thanks again for actually using the system. Talk to me again sometime . . .

3.68

Chapter 4: Inventories

Chapter 4: Inventories Multiple-choice questions 1. Which of the following merchandising businesses would be most likely to use a perpetual inventory system? *a. Jewellery dealer. b. Supermarket. c. Clothing store. d. Grain company. Answer: a Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: Perpetual inventory systems have traditionally been used by businesses that sell inventories with high unit values, however many large merchandising businesses are investing in computerised perpetual inventory systems. 2. Merchandising businesses that sell to retailers are known as: a. brokers. *b. wholesalers. c. companies. d. service firms. Answer: b Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: Merchandising businesses that sell inventory to retailers are known as wholesalers.

3. A merchandiser that sells directly to the consumers is a: a. broker. b. wholesaler. *c. retailer. d. service enterprise. Answer: c Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: Merchandising businesses that sell inventory to consumers are known as retailers.

4.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. Two categories of expenses in all merchandising companies are: a. cost of sales and financing expenses. b. operating expenses and sales. c. sales and cost of sales. *d. cost of sales and operating expenses. Answer: d Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: All merchandising businesses will have “cost of sales” and “operating expense” categories in the income statement.

5. The operating cycle of a merchandising company is: a. always one year in length. *b. ordinarily longer than that of a service company. c. about the same as that of a service company. d. ordinarily shorter than that of a service company. Answer: b Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: The operating cycle of a merchandising business ordinarily is longer than that of a service business because there are more steps in the cycle.

6. The primary source of revenue for a wholesaler is: *a. the sale of merchandise. b. service revenue. c. investment income. d. the sale of plant assets the business owns. Answer: a Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: The main source of revenue for merchandising businesses is the sale of inventory (merchandise) to retailers.

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Chapter 4: Inventories

7. Sales revenue less cost of sales is called: *a. gross profit. b. profit (loss). c. operating expense. d. net sales. Answer: a Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: Sales revenue less cost of sales is called gross profit. Gross profit is the profit from trading activities.

8. After gross profit is calculated, operating expenses are deducted to determine: a. gross margin. b. gross profit on sales. *c. profit (loss). d. sales margin. Answer: c Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: Operating expenses are deducted from gross profit to determine the profit or loss for a period of time.

9. The primary difference between a periodic and perpetual inventory system is that a periodic system: a. keeps a record showing the inventory on hand at all times. b. provides better control over inventories. c. records the cost of the sale on the date the sale is made. *d. determines the inventory on hand only at the end of the accounting period. Answer: d Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: In a periodic inventory system, detailed inventory records of the goods on hand are not kept throughout the period. The cost of sales sold is determined only at the end of the accounting period after a physical count of inventory on hand.

4.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. A perpetual inventory system would most likely be used by a: a. juice bar. b. hardware store. *c. motor vehicle dealership. d. supermarket. Answer: c Learning objective 4.1 - Identify the differences between a service business and a merchandising business. Feedback: Perpetual inventory systems have traditionally been used by businesses that sell inventories with high unit values, however many large merchandising businesses are now investing in computerised perpetual inventory systems.

11. Under a perpetual inventory system, which of the following accounts would be used to record purchases? a. Sales. b. Purchases. c. Cost of Sales. *d. Inventory. Answer: d Learning objective 4.2 – Explain the recording of purchases under a perpetual inventory system. Feedback: In a perpetual inventory system, purchases of goods for resale are recorded in the Inventory account. In contrast, under a periodic system, the cost of goods purchases are debited to a Purchases account.

12. Under a perpetual inventory system, acquisition of merchandise for resale is debited to: a. the Cost of Sales account. b. the Purchases account. c. the Supplies account. *d. the Inventory account. Answer: d Learning objective 4.2 – Explain the recording of purchases under a perpetual inventory system. Feedback: In a perpetual inventory system, purchases of goods for resale are recorded in the Inventory account. In contrast, under a periodic system, the cost of goods purchases are debited to a Purchases account.

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Chapter 4: Inventories

13. A company using a perpetual inventory system that returns goods to the supplier that were previously purchased on credit would: a. debit Cash and credit Accounts Payable. b. debit Sales and credit Accounts Payable. *c. debit Accounts Payable and credit Inventory. d. debit Inventory and credit Accounts Payable. Answer: c Learning objective 4.2 – Explain the recording of purchases under a perpetual inventory system. Feedback: In a perpetual inventory system, the return of goods purchased on credit for resale would result in a debit to Accounts Payable and a credit to Inventory. The credit to Inventory continuously updates records of the movement of inventory as they occur. 14. Billy’s Boots purchased inventory with an invoice price of $5,000 and credit terms of 2/10, n/30. What is the net cost of the goods if Billy’s Boots pays within the discount period? a. $5,000. b. $5,100. c. $4,800. *d. $4,900. Answer: d Learning objective 4.2 – Explain the recording of purchases under a perpetual inventory system. Feedback: Credit terms of 2/10, n/30 means that a 2% cash discount may be deducted from the invoice price if payment is made within 10 days of the invoice date; otherwise the invoice price is due 30 days from the invoice date ($5,000 x .98 = $4,900).

15. Freight costs incurred by a seller on merchandise sold to customers will cause an increase: a. in the selling expenses of the buyer. *b. in operating expenses for the seller. c. to the cost of sales of the seller. d. to a discount received account of the seller. Answer: b Learning objective 4.2 – Explain the recording of purchases under a perpetual inventory system. Feedback: Freight costs incurred by the seller on outgoing inventory are an operating expense to the seller.

4.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. The credit terms offered to a customer by a business are 2/10, n/30, which means: a. the customer must pay the bill within 10 days. b. the customer can deduct a 2% discount if the bill is paid between the 10th and 30th day from the invoice date. *c. the customer can deduct a 2% discount if the bill is paid within 10 days of the invoice date. d. two sales returns can be made within 10 days of the invoice date and no returns thereafter. Answer: c Learning objective 4.2: Explain the recording of purchases under a perpetual inventory system. Feedback: Credit terms of 2/10, n/30 means that a 2% cash discount will be deducted from the invoice price if payment is made within 10 days of the invoice date; otherwise the invoice amount is due 30 days from the invoice date.

17. Sales revenues are usually considered earned when: a. cash is received from credit sales. b. an order is received. c. goods are invoiced to the customer. *d. goods are transferred from the seller to the buyer. Answer: d Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: Sales revenues are recognised when the inflow of economic benefits is probable and can be measured reliably. These are the criteria under AASB 118 in Australia. Typically, this means revenue is recorded when the goods are transferred from the seller to the buyer.

18. The journal entry to record a credit sale is: a. Cash Inventory b. Cash Service Revenue c. Accounts Receivable Cost of Sales *d. Accounts Receivable Sales Answer: d Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: To record a credit sale of inventory the journal entry is a debit to Accounts Receivable and a credit to Sales. Note that a second journal entry is required to record the cost of the sale and the reduction to inventory. .

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Chapter 4: Inventories

19. Sales revenue: a. is only recorded after cash is collected. b. will always equal cash collections in a month. c. only results from credit sales. *d. may be recorded before cash is collected. Answer: d Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: Sales revenues are recognised when the inflow of economic benefits is probable and can be measured reliably. These are the criteria under AASB 118 in Australia. Typically, this means revenue is recorded when the goods are transferred from the seller to the buyer.

20. When sales of merchandise are made for cash, the transaction should be recorded by the following entry: a. debit Sales Revenue; credit Cash. *b. debit Cash; credit Sales Revenue. c. debit Sales Revenue; credit Cash Discounts. d. debit Sales Revenue; credit Sales Returns and Allowances. Answer: b Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: To record a credit sale of inventory the journal entry is a debit to Accounts Receivable and a credit to Sales Revenue. Note a second journal entry is required to record the cost of the sale and the reduction in inventory.

21. The Sales Returns and Allowances account is classified as an: a. asset account. b. contra asset account. c. expense account. *d. contra revenue account. Answer: d Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: Sales Returns and Allowances is a contra revenue account to Sales Revenue. Sales Returns and Allowances are deducted from Sales Revenue to give net sales revenue.

4.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. A sales invoice is prepared when goods: a. are sold for cash. b. are faulty and written-down. c. sold on credit are returned. *d. are sold on credit. Answer: d Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: When goods are sold on credit a sales invoice is prepared.

23. As an incentive for customers to pay their accounts promptly, a business may offer its customers: *a. a cash discount. b. a trade discount. c. a sales allowance. d. a sales return. Answer: a Learning objective 4.3 – Explain the recording of sales revenue under a perpetual inventory system. Feedback: The seller may offer the customer a settlement (or sales) discount for the prompt payment of the balance due. The discount is recorded as a debit to Discount Allowed expense account.

24. Gross profit is the difference between sales and: a. operating expenses. *b. cost of sales. c. profit. d. cost of sales plus operating expenses. Answer: b Learning objective 4.4 – Prepare a fully classified income statement. Feedback: Sales minus the cost of sales is gross profit. Gross profit is the profit from trading activities.

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Chapter 4: Inventories

25. Expenses that are associated with sales are classified as: a. financial expenses. b. other expenses. *c. selling expenses. d. administrative expenses. Answer: c Learning objective 4.4 – Prepare a fully classified income statement. Feedback: Selling expenses are those associated with making sales. Selling expenses are reported in the income statement as category of operating expenses.

26. Interest expense would be classified on an income statement under the heading: a. other expenses. *b. financial expenses. c. selling expenses. d. cost of sales. Answer: b Learning objective 4.4 – Prepare a fully classified income statement. Feedback: Financial expenses are those associated with the financing of the businesses’ operations and debt collection. Use the following information to answer questions 27 and 28 Financial information is presented below: Operating expenses $ 45,000 Sales returns and allowances 13,000 Sales discount 6,000 Sales revenue 150,000 Costs of sales 77,000 27. The amount of net sales on the income statement would be: a. $131,000. *b. $137,000. c. $144,000. d. $150,000. Answer: b Learning objective 4.4 – Prepare a fully classified income statement. Feedback: Sales returns and allowance, a contra revenue account, is deducted from sales in the income statement to arrive at net sales ($150,000 - $13,000 = $137,000).

4.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. The amount of gross profit on the income statement would be: *a. $60,000. b. $54,000. c. $76,000. d. $73,000. Answer: a Learning objective 4.4 – Prepare a fully classified income statement. Feedback: Cost of sales is deducted from net sales to determine gross profit ($150,000 $13,000 - $77,000 = $60,000).

29. The operating expenses to sales ratio is computed by dividing: a. operating expenses by gross profit. b. operating expenses by selling expenses. *c. operating expenses by net sales. d. sales by operating expenses. Answer: c Learning objective 4.5 – Use ratios to analyse profitability. Feedback: The operating expenses to sales ratio is computed by dividing operating expenses by net sales.

30. Gross profit ratio is computed by dividing gross profit by: a. financial expenses. b. cost of sales. *c. net sales. d. operating expenses. Answer: c Learning objective 4.5: Use ratios to analyse profitability. Feedback: An entity’s gross profit may be expressed as a percentage by dividing the amount of gross profit by net sales. The gross profit ratio is determined by the mark-up applied to the cost of goods sold.

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Chapter 4: Inventories

31. Which of the following does not affect the gross profit: a. selling products with a lower mark up. *b. an increase in rental of storage space c. being forced to pay higher prices for inventory d. increased competition resulting in having to lower selling prices Answer: b Learning objective 4.5: Use ratios to analyse profitability. Feedback: A decline in an entity’s gross profit might have several causes such as starting to sell products with a lower mark up, increased competition resulting in a lower selling price and being forced to pay higher prices to suppliers.

32. When a retailer makes a sale to a customer, the amount of GST that needs to be remitted to the Australian Taxation Office from the sale is determined by taking the total sale amount including GST and: a. multiplying by 11 *b. dividing by 11 c. subtracting 10% d. adding 10% Answer: b Learning objective 4.6 – Understand the basic process and main features of the goods and services tax (GST). Feedback: To calculate the amount of GST levied, the total selling price including GST is divided by 11.

33. Consumers are not required to pay goods and services tax on the following item: a. luxury motor vehicles. b. imported textiles. c. commercial rents. *d. basic foods. Answer: d Learning objective 4.6 – Understand the basic process and main features of the goods and services tax (GST). Feedback: Basic foods are classified as GST-free supplies.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. Hammer Hardware sold goods to James Brown on credit at a price of $2,750.00 including GST. What is the correct accounting entry to record this transaction in Hammer Hardware’s books? a. Debit Accounts Receivable $2,750; credit Sales $2,750. *b. Debit Accounts Receivable $2,750; credit Sales $2,500; credit GST Collections $250. c. Debit Accounts Receivable $2,500; credit Sales $2,500. d. Debit Accounts Receivable $2,500; debit GST Collections $250; credit Sales $2,750. Answer: b Learning objective 4.7 – Complete journal entries to record GST. Feedback: The correct accounting entry is debit Accounts Receivable $2,750; credit Sales $2,500; credit GST Collections $250. The credit to GST collections represents an amount owing the Australian Tax Office.

35. Under the perpetual inventory system what is the correct entry for the credit purchase of 5 washing machines at $300 per washing machine plus GST of $30 each? a. Debit Inventory $1,650; credit accounts payable $1,500, credit GST $150 b. Debit Inventory $1,650; credit Accounts Payable $1,650. c. Debit Accounts Payable $1,650; credit Inventory $1,500, credit GST $150. *d. Debit Inventory $1,500, debit GST $150; credit Accounts Payable $1,650 Answer: d Learning objective 4.7 – Complete journal entries to record GST. Feedback: The correct accounting entry is debit Inventory $1,500, debit GST $150; credit Accounts Payable $1,650. The GST on the purchase is not part of the cost of inventory.

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Chapter 4: Inventories

Completion Statements

36. Complete the following statements: 1.

A _________________ company buys and sells merchandise rather than performing services as their primary source of revenue.

Cost of sales is deducted from net sales revenue for the period in order to determine ________________.

Inventory on hand can be obtained from detailed inventory records when a ________________ inventory system is maintained.

The acquisition of inventory is debited to the ____________ account when a perpetual inventory system is used.

The freight costs incurred by a seller on outgoing merchandise are an ________________ to the seller.

When a customer returns undamaged merchandise previously purchased on credit, the entry to record the return requires a debit to the ___________________ account and a credit to the ________________ account.

Every credit purchase should be supported by _________________ that provides written evidence of the transaction.

Sales Returns and Allowances is an ______________ account and normally has a _______________ balance.

Gross profit is obtained by subtracting ________________ from ________________.

10.

A useful measure for evaluating operating expenses is the ratio of operating expenses to _____________.

11.

A manufacturer acts as a GST collecting agent for the _____________________.

12.

The amount of goods and services tax collected by a business is recorded in an _____________ account.

Answers below. Learning objective 4.1 – 4.7.

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

merchandising gross profit perpetual Inventory operating expense Sales Returns and Allowances, Accounts Receivable

7. 8. 9. 10. 11. 12.

invoice contra revenue, debit cost of sales, net sales net sales Australian Taxation Office liability

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises

37. Your friend owns a small business supplying restaurants with fresh, organically grown produce. She prepares her own financial statements and has asked you to review the income statement she prepared for the financial year ended 30 June 2016: Olivia’s Organic Produce Ltd Income Statement 30 June 2016 Revenues Sales Less: Freight out Discount allowed Net sales Other revenues (net) Total revenues

$351,000 $5,000 5,650

Expenses Cost of sales Selling expenses Administrative expenses Financial expenses Dividends Total expenses Profit

10,650 340,350 650 341,000

235,000 50,000 24,500 500 6,000 316,000 25,000

As an experienced accountant, you review the statement and determine the following facts: 1. Sales include $5,000 of deposits from customers for future sales orders. 2. Other revenues contain two items: interest expense $2,000 and interest revenue $2,650. 3. Selling expenses consist of sales salaries $38,000; advertising $5,000; depreciation on storage equipment $3,750; and sales commissions expense $3,250. 4. Administrative expenses consist of office salaries $9,500; electricity expense $4,000; rent expense $8,000; and insurance expense $3,500. Insurance expense includes $600 of prepaid insurance. 5. Financial expenses consist of $500 bank charges. Required: Prepare a corrected fully classified income statement. You do not need to calculate income taxes.

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Chapter 4: Inventories

Answers below. Learning objective 4.1 – 4.7. Olivia’s Organic Produce Ltd Income Statement 30 June 2016 Operating Revenue Sales revenue: Gross sales revenue Less: sales returns and allowances Net sales revenue Less: Cost of sales Gross Profit Other operating revenue: Interest revenue Total operating revenue

$346,000 0 346,000 235,000 111,000 2,650

2,650 113,650

Operating Expenses: Selling expenses: Advertising Depreciation expense - storage equipment Freight out Sales commissions expense Sales salaries expense

3,750 5,000 3,250 38,000

55,000

Administrative expenses: Insurance expense Office salaries expense Rent expense – office space Electricity expense

2,900 9,500 8,000 4,000

15,850

5,650 2,000 500

8,150

Financial expenses: Discount allowed Interest expense Bank charges Total operating expenses Profit before income tax

5,000

79,000 34,650

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

38. Metal Music Ltd is a retail store specialising in musical instruments and consumables for rock and metal musicians. At the beginning of February 2016, the ledger of Metal Music Ltd showed Cash $2,500; Inventory $1,700; and Share Capital $4,200. The following transactions were completed during February: Feb.

6 7 8 10 11 13 14 15 17 18 20 21 27 28

Purchased electric guitars from Guitars R Us Ltd $840, terms 3/7, n/30. Paid freight on Guitars R Us Ltd purchase $40. Sold inventory to customers $900, terms n/30. The inventory cost $600. Received credit of $84 from Guitars R Us Ltd for a guitar that was returned. Purchased guitar strings from Strings N Things for cash $300. Paid Guitars R Us Ltd in full. Purchased Guitar straps and leads from Musical Importers Ltd $500, terms 2/7, n/60. Received cash refund of $50 from Strings N Things for damaged inventory that was returned. Paid freight on Musical Importers Ltd purchase $30. Sold inventory to customers $900, terms n/30. The cost of the inventory was $530. Received $500 in cash from customers in settlement of their accounts. Paid Strings N Things Ltd in full. Granted an allowance of $30 to a customer for a guitar strap that was faulty. Received cash payments on account from customers $500.

The chart of accounts for Metal Music Ltd includes Cash, Accounts Receivable, Inventory, Accounts Payable, Share Capital, Sales, Sales Returns and Allowances, and Cost of Sales. Required: (a) (b) (c) (d)

Journalise the February transactions (ignore GST). Using T-accounts, enter the beginning balances in the ledger accounts and post the April transactions Prepare a trial balance on 28 February 2016. Prepare an income statement up to Gross Profit.

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Chapter 4: Inventories

Answers below. Learning objective 4.1 – 4.7. (a) Date Feb

General Journal

Account Titles Inventory Accounts Payable

Debit 840

840

Inventory Cash

Accounts Receivable Sales

900

Cost of Sales Inventory

600

Accounts Payable Inventory

Inventory Cash

300

900

600

300

Accounts Payable ($840 - $84) 756 Discount received ($756 x 3%) (or inventory) Cash

23 733

Inventory Accounts Payable

500 500

Cash

50 Inventory

Credit

Inventory Cash

Accounts Receivable Sales

900

Cost of Sales Inventory

530

Cash

500

900

530

4.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Accounts Receivable 21

500

Accounts Payable 500 Discount received ($500 x 2%) (or inventory) Cash

10 490

Sales Returns and Allowances Accounts Receivable

30 30

Cash

500 Accounts Receivable

500

(b)

15-Feb 20- Feb

Cash Opening balance 2,500 Inventory 50 Accounts receivable 500

30- Feb

Accounts receivable

6-Feb 7-Feb 11-Feb 14-Feb 17-Feb

Inventory Inventory Accounts payable

40 300 733

17- Feb 21- Feb

Inventory Accounts payable

30 490

Closing balance

1,957 3,550

Cash Sales returns Cash Closing balance

500 30 500 770 1,800

COGS Accounts payable Cash COGS

600 84 50 530

Closing balance

2,146 3,410

3,550 1,957

Opening balance

8- Feb

500

7- Feb 11- Feb 13- Feb

Accounts Receivable 900 20- Feb 900 27- Feb 28- Feb

Sales Sales

Opening balance

1,800 770

Opening balance Accounts payable Cash Cash Accounts payable Cash

Inventory 1,700 8-Feb 840 10-Feb 40 15-Feb 300 18-Feb 500 30

Opening balance

3,410 2,146

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Chapter 4: Inventories

10-Feb 13-Feb 21-Feb

Inventory Discount and cash Discount and cash

28-Feb

Closing balance

Accounts Payable 84 6-Feb 756 14-Feb 500

Inventory Inventory

1,340

840 500

Opening balance

1,340 0

Opening balance

4,200

Accounts receivable Accounts receivable

900 900

Opening balance

1,800 1,800

Share capital

Sales 8-Feb 18-Feb 28-Feb

27-Feb

28-Feb

8-Feb 18-Feb

Closing balance

1800 1,800

Sales returns and allowances Accounts receivable 30

Discount received 13-Feb 21-Feb 33 33

Closing balance

Accounts payable Accounts payable

23 10

Opening balance

33 33

COGS 600 530

Inventory Inventory

Closing balance 1,130 1,130

Opening balance

1,130 1,130

4.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Cash Accounts receivable Inventory Accounts payable Share capital Sales Sales returns and allowances Discount received Cost of sales

Debit 1,957 770 2,146

Credit

4,200 1,800 30 33 1,130 6,033

6,033

(d) Metal Music Limited Income Statement (Partial) For the Month Ended 28, February 2016 Sales revenues Sales .......................................................................................................$1,800 Less: Sales returns and allowances ...................................................... 30 Net sales .................................................................................................$1,770 Cost of sales .................................................................................................... 1,130 Gross profit ..................................................................................................... $ 640

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Chapter 4: Inventories

Matching

39. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E. F.

Net sales Cash discount Credit terms Periodic inventory system Gross profit ratio Contra revenue

G. H. I. J. K. L.

Freight-out Gross profit Sales invoice Business Activity Statement Input tax credit Purchase discount

___

1. A reduction given by the seller for prompt payment of a credit sale.

___

2. Provides evidence of a credit sale.

___

3. Gross profit divided by net sales.

___

4. Sales less sales returns and allowances and cash discounts.

___

5. These specify the amount of cash discount and the time period during which it is offered.

___

6. Net sales less cost of sales.

___

7. Cost to deliver goods to customers reported as a selling expense.

___

8. Requires a physical count of goods on hand to compute cost of sales.

___

9. A cash discount claimed by a buyer for prompt payment of a balance due.

___

10. An account that is offset against a revenue account on the income statement.

___

11. A credit received by registered suppliers for all the GST paid on goods purchased.

___

12. A report used to provide GST information to the Australian Taxation Office.

Answers below. Learning objective 4.1 – 4.7. 1. 2. 3. 4. 5. 6.

B I E A C H

7. 8. 9. 10. 11. 12.

G D L F K J

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions 40. A merchandising company frequently has a need to use a contra account related to the sale of goods. Identify the contra account that has a normal debit balance and explain why this account is not considered an expense.

Answer below. Learning objective 4.1 – 4.7. The contra account related to the sale of goods that has a normal debit balance is Sales Returns and Allowances. This account has a debit balance but is not an expense because it records adjustments to sales, not selling, administrative or financial expenses. It is an adjustment of the inflow from sale of goods rather than a cost used to help earn revenue.

41. Distinguish between cost of sales and operating expenses, describing the nature of these two items and their placement on the income statement.

Answer below. Learning objective 4.1 – 4.7. Cost of sales includes the cost of obtaining goods that are held for resale; it is deducted directly from net sales on the income statement. Operating expenses, on the other hand, includes selling, administrative, and financial expenses, and appears directly below the gross profit on the income statement.

42. The income statement for a merchandising company presents two items that are not shown on a service company income statement. Identify and briefly explain the two unique items.

Answer below. Learning objective 4.1 – 4.7. The items reported for a merchandising company that are not reported for a service company are cost of sales, and gross profit. Cost of sales represents the total cost of merchandise sold during the period. Gross profit is the excess of net sales over the cost of sales.

43. The gross profit is generally considered to be more informative than the gross profit amount when expressing the relationship between gross profit and net sales. Provide the gross profit ratio, and briefly explain why it is considered more informative than the amount.

Answer below. Learning objective 4.1 – 4.7. Gross profit is expressed as a percentage by dividing the amount of gross profit by the amount of net sales. In this way, the gross profit shows the rate of profit earned relative to the net sales generated by an enterprise and is more useful than simply stating either the amount of gross profit or the amount of net sales. For example, X Company may have generated net sales of $1,000,000. In isolation, this amount has limited usefulness. Does it represent an efficient operation? Is it better (or worse) than last year’s sales level? Does it result in a profit (or a loss)? Is it favourable compared to similar businesses? Gross profit allows a more meaningful comparison to be made.

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Chapter 4: Inventories

44. The goods and services tax is commonly described as a broad-based tax. Explain the meaning of the term ‘broad-based’ tax.

Answer below. Learning objective 4.1 – 4.7. A tax may be based on a specific item, for instance tax that is levied on income, or it may apply to a broader set of items. The goods and services tax is levied on the value-added by a business at each stage in the production and distribution chain. Also, a business is broadly defined as including any profession, trade, religious institution and charitable organisation. The application of the goods and services tax to items at any stage within the production/distribution chain, across all businesses, makes it a ‘broad-based’ tax. 45. Ethics: Glasco Ltd manufactures electronic components for use in many consumer products. Their raw materials are purchased literally from all over the world. Depending on the country involved, purchase terms vary widely. Some suppliers, for example, require full prepayment, while others are content to receive payment within six months of receipt of the goods. Because of this situation, Glasco never closes its books until at least ten days after month end. In this way, it can sort out ownership of goods in transit, and document which goods were received by month end, and which were not. Annie Reilly, a new accountant, was asked to record about $50,000 in inventory as having been received before month end. She argued that the shipping documents clearly showed that the goods were actually received on the 8th of the current month. Her boss, busy with month end reports, curtly tells Annie to check the shipping terms. She did so, and found the notation "FOB (free on board) shipper's dock" on the document. She hadn't seen that particular notation before, but she reasoned that if the selling company considered it shipped when it reached their dock, Glasco should consider it received when it reached Glasco's dock. She did not record the sale until after month end. Required: 1. Why are accountants concerned with the timing in the recording of purchases? 2. Was there a violation of ethical standards here? Explain.

Answer below. Learning objective 4.1 – 4.7. 1. Accountants are concerned with timing because they seek to make sure that sales are recorded in the proper period so that revenues and expenses are properly matched; to make sure that goods recorded as owned by the company actually are owned as of the last date of the period; and to make certain that sales recorded have been actually completed. 2. The only ethical principle that may be involved is one of competence. Annie does not appear to know enough about reading shipping documents to make a proper determination of ownership. The goods were owned by Glasco as soon as they left the shipper's dock. Otherwise, the goods would have been owned by no one while in transit. It does not appear that Annie compromised her integrity or that she sought some sort of gain from her mistake. It does seem likely that she should have known better how to interpret the shipping documents.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. Communication: Jacqui Marx and Melissa Clark, two salespersons in adjoining territories, regularly compete for bonuses. During the last month, their dollar volume of sales, on which the bonuses are based, was nearly equal. On the last day of the month, both made a large sale. Both orders were shipped on the last day of the month and both were received by the customer on the fifth day of the following month. Jacqui's sale was FOB shipping point (ownership passes to buyer at time of shipping), and Melissa's was FOB destination (ownership passes to buyer at time of receipt). The company ‘counts’ sales for purposes of calculating bonuses on the date that ownership passes to the purchaser. Jacqui's sale was therefore counted in her monthly total of sales, Melissa's was not. Melissa is quite upset. She has asked you to just include it, or to take Jacqui's off as well. She also has told you that you are being unethical for allowing Jacqui to get a bonus just for choosing a particular shipping method. Write a memo to Melissa. Explain your position.

Answer below. Learning objective 4.1 – 4.7. MEMO TO:

Melissa Clark

FROM: Martha King, Accounting RE:

Sales Bonuses

DATE:

June 15, 2016

As you know, sales bonuses are based upon the revenue generated by each salesperson. Your total sales for the month were $100,000. This total does not include the $20,000 sale you made May 31 because of the policy to count sales on the date that title transfers to the customer. I can understand your being upset that this large sale was not counted, while someone else's sale on the same date was counted, because of the shipping terms. However, I am sure you agree that the policy is not unethical, but it is instead more fair than our trying to make a determination in the midst of month-end closing. I do understand your disappointment, but this sale does count in June — and it just may make the difference in June's bonus. Please call me if I can be of further help. (Signature)

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Chapter 5: Reporting and analysing inventory

Chapter 5: Reporting and analysing inventory Multiple-choice questions

1. The journal entry to record a return of inventory purchased on account under a periodic inventory system would be: a. Inventory Accounts Payable b. Purchase Returns and Allowances Accounts Payable c. Accounts Payable Inventory *d. Accounts Payable Purchase Returns and Allowances Answer: d Learning objective 5.1 – Record purchases and sales of inventory under a periodic inventory system. Feedback: The Purchase Returns and Allowances account is credited to record all returns and allowances rather than directly crediting the Purchases account. This treatment provides information to management of the magnitude of returns and allowances. The Purchases and Returns Allowance account is a contra account to Purchases.

2. Which of the following accounts has a normal credit balance? a. Purchases. *b. Discount Received. c. Freight-in. d. Sales Returns and Allowances. Answer: b Learning objective 5.1 – Record purchases and sales of inventory under a periodic inventory system. Feedback: Discount Received is a revenue account whose normal balance is a credit.

5.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

3. Under a periodic inventory system, acquisition of inventory is debited to the: *a. Purchases account. b. Cost of sales account. c. Inventory account. d. Accounts Payable account. Answer: a Learning objective 5.1 – Record purchases and sales of inventory under a periodic inventory system. Feedback: Under a periodic inventory system, purchases of inventory are recorded in the Purchases account rather than the Inventory account under the perpetual inventory system.

4. The respective normal balances of Purchases, Discount Received, and Freight-in are: a. credit, credit, debit. *b. debit, credit, debit. c. debit, credit, credit. d. debit, debit, debit. Answer: b Learning objective 5.1 – Record purchases and sales of inventory under a periodic inventory system. Feedback: Purchases is a temporary account whose normal balance is a debit; Discount Received is a revenue account whose normal balance is a credit; Freight-in is a temporary account whose normal balance is a debit.

5. Which of the following statements about a periodic inventory system is true? a. Under the periodic inventory system purchases of inventory are typically credited to the Purchases account. b. Available discounts taken by the customer for early payment of an invoice are termed discount received by the seller. c. Freight-in is an account that is subtracted from the Purchases account to arrive at the net cost of goods purchased. *d. Under the periodic inventory system, allowances granted by the supplier to the merchandiser are credited to the Purchases Returns and Allowances account. Answer: d Learning objective 5.1 – Record purchases and sales of inventory und a periodic inventory system. Feedback: Purchases of goods are debited to the purchases account, discounts taken up by customers are termed Discount Allowed and Freight-in is added to determine the net cost of purchases. B is true.

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Chapter 5: Reporting and analysing inventory

6. Cost of goods available for sale consists of the: *a. cost of beginning inventory and the cost of goods purchased during the year. b. cost of ending inventory and the cost of goods purchased during the year. c. cost of beginning inventory and the cost of ending inventory. d. difference between the cost of goods purchased and the cost of sales during the year. Answer: a Learning objective 5.3 – Determine the cost of sales under a periodic inventory system. Feedback: Cost of goods purchased is added to the cost of goods on hand at the beginning of the period to obtain the cost of goods available for sale.

7. Which of the following items will increase inventory costs for the buyer of goods? a. Purchase returns and allowances granted by the seller. b. Discount received taken by the purchaser. *c. Freight charges paid by the purchaser. d. Freight charges paid by the seller. Answer: c Learning objective 5.2 – Determine cost of sales under a periodic inventory system. Feedback: Freight-in paid by the purchaser is added to the purchase price of inventory by the purchaser. Freight-in is added to net purchases to arrive at cost of goods purchased.

8. The cost of goods available for sale is allocated to the cost of sales and the: a. beginning inventory. b. gross profit. c. cost of goods purchased. *d. ending inventory. Answer: d Learning objective 5.3 – Determine cost of sales under a periodic inventory system. Feedback: The cost of goods available for sale is allocated to the cost of sales and the ending inventory.

5.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

9. Under a periodic inventory system inventory losses are included as a part of: *a. cost of sales. b. purchase allowances. c. purchase returns. d. purchase costs. Answer: a Learning objective 5.3 – Determine the cost of sales under a periodic inventory system. Feedback: Under a periodic inventory system inventory losses cannot be determined and are therefore included as a part of cost of sales. The inability to identify inventory losses is a disadvantage of the periodic inventory system.

10. Net purchases plus freight-in determines the: *a. cost of goods purchased. b. cost of goods available for sale. c. cost of sales. d. total goods available for sale. Answer: a Learning objective 5.2 – Determine cost of sales under a periodic inventory system. Feedback: Because freight charges are a necessary cost incurred to acquire inventory, freight-in is added to net purchases to arrive at cost of goods purchased.

11. The factor which determines whether or not goods should be included in a physical count of inventory is: *a. legal title. b. physical possession. c. management's judgment. d. whether or not the purchase price has been paid. Answer: a Learning objective 5.3 – Describe the steps in determining inventory quantities. Feedback: The legal title to the goods determines whether or not goods should be included in a physical count of inventory.

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Chapter 5: Reporting and analysing inventory

12. If goods in transit are shipped FOB destination: *a. the seller has legal title to the goods until they are delivered. b. the buyer has legal title to the goods until they are delivered. c. the transportation company has legal title to the goods while the goods are in transit. d. no one has legal title to the goods until they are delivered. Answer: a Learning objective 5.3 – Describe the steps in determining inventory quantities. Feedback: When the terms of sale are FOB destination, ownership of the goods remains with the seller until the goods reach the buyer.

13. Westcoe Company Ltd's goods in transit at 31 December include sales made (1) FOB destination and (2) FOB shipping point. Which items should be included in Westcoe's inventory at 31 December? *a. (1) only. b. (2) only. c. Both (1) and (2). d. None of these goods. Answer: a Learning objective 5.3 – Describe the steps in determining inventory quantities. Feedback: When the terms of sale are FOB destination, ownership of the goods remains with the seller until the goods reach the buyer. When the terms are FOB shipping point, ownership of the goods passes to the buyer when the delivery entity accepts the goods from the seller.

14. Goods held on consignment are: *a. never owned by the consignee. b. included in the consignee’s ending inventory. c. kept for sale on the premises of the consignor. d. not included in either the consignee’s or the consignor’s ending inventory. Answer: a Learning objective 5.3 – Describe the steps in determining inventory quantities. Feedback: Consigned goods are held and sold on behalf of other parties, usually for a fee, but without taking ownership of the goods.

5.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

15. Beginning inventory plus the cost of goods purchased equals: a. cost of sales. b. total goods purchased. c. net purchases. *d. cost of goods available for sale. Answer: d Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Add the cost of goods purchased to the cost of goods on hand at the beginning of the period (beginning inventory) to obtain the cost of goods available for sale.

16. Greenfields Ltd has the following account balances. The net cost of goods purchased for the period is: Purchases $35,000 Sales Returns and Allowances 6,000 Discount on sales 2,100 Freight-in 2,500 Freight-out 1,750 *a. $37,500. b. $41,000. c. $36.750. d. $39,250. Answer: a Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Cost of goods purchased = $35,000 + $2,500 = $37,500.

17. Assuming the periodic inventory method is used, cost of sales is calculated from the following equation: a. beginning inventory - cost of goods purchased + ending inventory. b. sales - cost of goods purchased + beginning inventory - ending inventory. c. sales + gross profit - ending inventory + beginning inventory. *d. beginning inventory + cost of goods purchased - ending inventory. Answer: d Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Determine cost of sales under a periodic inventory system. Beginning inventory + cost of goods purchased - ending inventory = cost of sales.

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Chapter 5: Reporting and analysing inventory

18. Assuming the periodic inventory method is used for the current period, the following data were taken from the ledger. Purchases $55,000 Purchases Returns and Allowances $950 Discount Received $1,100 Freight-in $800 Beginning inventory was $12,000 and ending inventory was $15,000. What was cost of goods purchased? a. $55,000. b. $54,050. *c. $54,850. d. $52,950. Answer: c Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Cost of net purchases = $55,000 – 950 + 800 = $54,850.

19. Assuming the periodic inventory method is used for the current period, the following data were taken from the ledger. Purchases $40,000 Purchases Returns and Allowances $600 Discount Received $300 Freight-in $200 Beginning inventory was $8,000 and ending inventory was $13,000. What was cost of sales? a. $39,600. b. $39,300. c. $47,300. *d. $34,600. Answer: d Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Cost of sales = ($40,000 – 600 + 200) + $8,000 - $13,000 = $34,600. Note that Discount Received is reported as a revenue item.

5.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

20. Assuming the periodic inventory method is used on the income statement, the beginning inventory is added to the cost of goods purchased to yield the: a. costs of sales. *b. cost of goods available for sale. c. profit from operations. d. gross profit. Answer: b Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Beginning inventory + purchases = cost of goods available for sale.

21. Assuming the periodic inventory method is used for the current year, the following data were taken from the accounting records: Sales $900,000 Sales Returns and Allowances $30,000 Purchases $500,000 Purchase Returns and Allowances $8,000 Discount Received $4,000 Freight-in $2,000 Beginning Inventory $90,000 Ending Inventory $130,000 What was the cost of goods available for sale? a. $620,000. b. $530,000. c. $580,000. *d. $584,000. Answer: d Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Cost of goods available for sale = $500,000 – 8,000 + 2,000 + 90,000 = $584,000.

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Chapter 5: Reporting and analysing inventory

22. Assuming the periodic inventory method is used for the current year, the following data were taken from the accounting records: Sales $450,000 Sales Returns and Allowances $15,000 Purchases $250,000 Purchase Returns and Allowances $4,000 Discount Received $2,000 Freight-in $1,000 Beginning Inventory $45,000 Ending Inventory $65,000 What was the amount for net purchases? a. $245,000. *b. $246,000. c. $435,000. d. $292,000. Answer: b Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Net purchases = $250,000 – 4,000 = $246,000.

23. Assuming the periodic inventory method is used for the current year, the following data were taken from the accounting records: Sales $900,000 Sales Returns and Allowances $30,000 Purchases $500,000 Purchase Returns and Allowances $8,000 Discount Received $4,000 Freight-in $2,000 Beginning Inventory $90,000 Ending Inventory $130,000 Net sales are? a. $858,000. b. $862,000. c. $900,000. *d. $870,000. Answer: d Learning objective 5.4 – Identify the unique features of the statement of profit or loss for a merchandising business under a periodic inventory system. Feedback: Net sales = $900,000 – 30,000 = $870,000.

5.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

24. A company just starting in business purchased three inventory items at the following prices: first purchase $110; second purchase $115; third purchase $120. If the company sold two units for a total of $300 and used FIFO costing, the gross profit for the period would be: a. $65. b. $60. *c. $75. d. $70. Answer: c Learning objective 5.5. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Gross profit = $300 – (110 + 115) = $75.

25. Inventory costing methods place primary reliance on assumptions about the flow of: a. goods. *b. costs. c. resale prices. d. values. Answer: b Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Because specific identification is often impractical, other cost flow methods are used that assume flows of costs are unrelated to the physical flow of goods.

26. The LIFO inventory method assumes that the cost of the latest units purchased are: a. the last to be allocated to cost of sales. b. the first to be allocated to ending inventory. *c. the first to be allocated to cost of sales. d. not allocated to cost of sales or ending inventory. Answer: c Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: The LIFO method assumes that the last goods to be purchased are the first to be sold. LIFO is not permitted in Australia or New Zealand.

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Chapter 5: Reporting and analysing inventory

Use the following information for questions 27-29. A company just starting business made the following four inventory purchases in June: June 1 150 units $ 780 June 10 200 units 1,170 June 15 200 units 1,260 June 28 150 units 990 $4,200 A physical count of inventory on June 30 reveals that there are 250 units on hand.

27. Using the LIFO inventory method, the value of the ending inventory on June 30 is a. $2,835. b. $1,620. c. $2,580. *d. $1,365. Answer: d Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Value of the ending inventory = $780 + [($1,170/200)] x 100) = $1,365.

28. Using the FIFO inventory method, the amount allocated to cost of sales for June is a. $1,620 b. $2,290 *c. $2,580 d. $2,835 Answer: c Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: There are 700 units available for sale minus 250 units in ending inventory equals 450 units sold. Therefore, the cost of sales = $780 + 1,170 + (($1,260/200) x 100) = $2,580.

29. Using the average cost method, the amount allocated to the ending inventory on June 30 is: a. $4,200. b. $2,700. c. $1,150. *d. $1,500. Answer: d Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: – $4,200/700 units = $6.00 per unit. 250 x $6.00 = $1,500. .

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

30. A company purchased inventory as follows: 200 units at $9 300 units at $10 The average unit cost for inventory is: a. $9.00. b. $9.50. *c. $9.60. d. $10.00. Answer: c Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: ((200 x $9) + (300 x $10))/500 = $9.60 per unit.

Use the following inventory information for the month of July to answer questions 31 to 35. July 1 Beginning inventory July 7 Purchases July 22 Purchases

20 units at $19 70 units at $20 10 units at $22

$ 380 1,400 220 $2,000

A physical count of inventory on July 30 reveals that there are 35 units on hand.

31. Using the average cost method, the value of ending inventory is: *a. $700. b. $711.67. c. $1,300. d. $1,321.67. Answer: a Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: The weighted average unit cost is $2,000/100 units = $20 per unit. $20 x 35 units = $700.

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Chapter 5: Reporting and analysing inventory

32. Using the FIFO inventory method, the amount allocated to cost of sales for July is: a. $680 b. $720 *c. $1,280 d. $1,320 Answer: c Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: The cost of the 65 units sold is therefore: (20 x $19) + (45 x $20) = $1,280.

33. Using the FIFO inventory method, the amount allocated to ending inventory for July is: a. $680. *b. $720. c. $1,280. d. $1,320. Answer: b Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Under FIFO the amount of ending inventory is: (10 x $22) + (25 x $20) = $720.

34. Using the LIFO inventory method, the amount allocated to cost of sales for July is: a. $680. b. $720. c. $1,280. *d. $1,320. Answer: d Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Under LIFO the cost of the 65 units sold is: (10 x $22) + (55 x $20) = $1,320.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

35. Using the LIFO inventory method, the amount allocated to ending inventory for July is: *a. $680. b. $720. c. $1,280. d. $1,320. Answer: a Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: The cost of the 35 units of inventory on hand at the end of July is: (20 x $19) + (15 x $20) = $680.

36. The selection of an appropriate inventory cost flow assumption for an individual company is made by: a. the external auditors. b. the SEC. c. the internal auditors. *d. management. Answer: d Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: The selection of the appropriate cost flow method is made by management and depends on many factors including the type of inventory, cost and information needs.

37. Which of the following is not an acceptable method under IAS2/AASB102 for use in costing inventory? a. First-in, first-out. b. Specific identification. *c. Last-in, first-out. d. Average cost. Answer: c Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory costing methods under a periodic inventory system. Feedback: There are three main methods acceptable for valuing inventories under IAS2/AASB102: (1) specific identification (2) first-in, first-out and (3) average cost.

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Chapter 5: Reporting and analysing inventory

38. Which of the following statements is true regarding inventory cost flow assumptions? *a. A company may use more than one costing method concurrently. b. A company must comply with the method specified by industry standards. c. A company must use the same method for domestic and foreign operations. d. A company may never change its inventory costing method once it has chosen a method. Answer: a Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Accounting standards require a business to use the same costing method for all inventories of a similar nature but permit different costing methods for inventories that have a different nature or use.

39. The specific identification method of costing inventories is used when the: a. physical flow of units cannot be determined. *b. company sells a limited quantity of high-unit cost items. c. company sells large quantities of relatively low cost heterogeneous items. d. company sells large quantities of relatively low cost homogeneous items. Answer: b Learning objective 5.5 - Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Specific identification is possible when a business sells a limited variety of highunit-cost items that can be identified from the time of purchase to the time of sale.

40. Which of the following statements is correct with respect to inventories? a. The FIFO method assumes that the costs of the earliest goods acquired are the last to be sold. b. It is generally good business management to sell the most recently acquired goods first. *c. Under FIFO, the ending inventory is based on the latest units purchased. d. FIFO seldom coincides with the actual physical flow of inventory. Answer: c Learning objective 5.5 – Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. Feedback: Under FIFO, since it is assumed that the first goods purchased were the first goods sold, ending inventory is based on the costs of the most recent units purchased.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

41. The inventory method which results in the highest gross profit for June in periods of inflation is: a. not determinable. b. the LIFO method. c. the weighted average unit cost method. *d. the FIFO method. Answer: d Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: In periods of inflation (rising prices), FIFO produces a higher profit because the lower unit costs of the first units purchased are matched against revenues.

42. In a period of declining prices, which of the following inventory methods generally results in the lowest value of ending inventory? a. Average cost method. b. LIFO method. *c. FIFO method. d. Need more information to answer. Answer: c Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: In a period of declining prices, the FIFO method will generally report a lower value of ending inventory.

43. In a period of rising prices, which of the following inventory methods generally results in the lowest gross profit figure? a. Average Cost Method. *b. LIFO method. c. FIFO method. d. Need more information to answer. Answer: b Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: In a period of inflation, LIFO will generally result in the lower gross profit figure.

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Chapter 5: Reporting and analysing inventory

44. Which inventory method generally results in costs allocated to ending inventory that will approximate their current cost? a. LIFO. *b. FIFO. c. Average cost method. d. Whichever method that produces the highest ending inventory figure. Answer: b Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: A major advantage of the FIFO method is that the reported ending inventory figure will generally approximate the current cost.

45. Two companies report the same cost of goods available for sale but each employs a different inventory costing method. If the cost of goods has increased during the period, then the company using: a. LIFO will have the highest ending inventory. b. FIFO will have the highest cost of sales. *c. FIFO will have the highest ending inventory. d. LIFO will have the lowest cost of sales. Answer: c Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: In periods of inflation, FIFO will report the highest ending inventory.

46. The managers of Tong Company Ltd receive performance bonuses based on the profit of the company. Which inventory costing method are they likely to favour in periods of declining prices? *a. LIFO. b. Average cost. c. FIFO. d. Physical inventory method. Answer: a Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: In periods of declining prices LIFO will report the lowest cost of sales and therefore the highest profit therefore it will be favoured by managers who receive a performance bonus based on profit.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

47. In periods of inflation, illusory or paper profits may be reported as a result of using the: a. perpetual inventory method. *b. FIFO costing assumption. c. LIFO costing assumption. d. periodic inventory method. Answer: b Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: In periods of inflation FIFO allows an entity to report paper or illusory profits.

48. Selection of an inventory costing method by management does not usually depend on: *a. the financial year end. b. income statement effects. c. Statement of financial position effects. d. tax effects. Answer: a Learning objective 5.6 – Explain the financial statement effects of each of the inventory cost flow methods. Feedback: The use of inventory cost flow methods varies among businesses and each method has varying effects of (1) the income statement, (2), the Statement of financial position, and (3) taxation.

49. The main basis for recording and reporting inventory is: *a. cost. b. gross selling price. c. book value. d. current replacement cost. Answer: a Learning objective 5.7 – Explain the lower of cost and net realisable value basis of accounting for inventories. Feedback: Cost is the main basis for recording and reporting most assets, including inventory.

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Chapter 5: Reporting and analysing inventory

50. The lower of cost and net realisable value basis of valuing inventories is an example of: *a. conservatism. b. the cost principle. c. comparability. d. consistency. Answer: a Learning objective 5.7 – Explain the lower of cost and net realisable value basis of accounting for inventories. Feedback: The lower of cost and net realisable value is an example of the accounting principle of conservatism and it represents a departure of the cost basis of accounting.

51. The following information relates to product J: Cost $9.00 Expected selling price $12.50 Marketing & delivery cost $1.40 Replacement cost $9.50 The net realisable value (NRV) of product J is *a. $11.10. b. $12.50. c. $9.50. d. $13.90. Answer: a Learning objective 5.7 – Explain the lower of cost and net realisable value basis of accounting for inventories. Feedback: Net realisable value is defined as the estimated selling price in the ordinary course of business less, where applicable, estimated further costs to be incurred in completing, marketing, selling and distributing to customers. Therefore NRV is $12.50 $1.40 = $11.10. 52. Which of the following is the same as ‘net realisable value’ of inventory? a. Gross selling price. *b. Proceeds of sale less all further marketing, selling and distribution costs. c. Average cost. d. Replacement price. Answer: b Learning objective 5.7 – Explain the lower of cost and net realisable value basis of accounting for inventories. Feedback: Net realisable value is defined as the estimated selling price in the ordinary course of business less, where applicable, estimated further costs to be incurred in completing, marketing, selling and distributing to customers.

5.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

53. A high inventory turnover indicates: a. a high level of funds tied up in inventory. *b. a low level of funds tied up in inventory. c. inventory consists of mostly high value products. d. inventory consists of mostly low value products. Answer: b Learning objective 5.8 – Calculate and interpret inventory turnover. Feedback: High inventory turnover or low days in inventory indicates the entity is tying up little of its funds in inventory as it has a minimal amount of inventory on hand at any one time.

54. Inventory turnover is calculated by dividing cost of sales by: a. beginning inventory. b. ending inventory. *c. average inventory. d. 365 days.

Answer: c Learning objective 5.8 – Calculate and interpret inventory turnover. Feedback: Inventory turnover is calculated as cost of sales divided by average inventory.

55. Days in inventory is calculated by dividing 365 days by: a. average inventory. b. beginning inventory. c. ending inventory. *d. inventory turnover. Answer: d Learning objective 5.8 – Calculate and interpret inventory turnover. Feedback: Days in inventory is calculated as 365 days divided by inventory turnover. Days in inventory indicates how quickly a merchandiser sells its goods.

5.20

Chapter 5: Reporting and analysing inventory

56. When using the LIFO method under a perpetual inventory system, the latest units purchased before a sale are allocated to: *a. cost of sales. b. beginning inventory. c. ending inventory. d. average inventory. Answer: a Learning objective 5.9 – Apply the inventory cost flow methods to perpetual inventory record. Feedback: Under the LIFO method using a perpetual inventory system, the costs of the most recent purchases are allocated to the cost of sales for the most recent sale. The cost of sales under the perpetual and periodic inventory systems will differ under LIFO as the periodic inventory system does not take into account the timing of the sale.

57. An overstatement of the beginning inventory results in: a. no effect on the period’s profit. b. an overstatement of profit. *c. an understatement of profit. d. a need to adjust purchases. Answer: c Learning objective 5.10 – Indicate the effect of inventory errors on the financial statements. Feedback: An overstatement of the beginning inventory results in an understatement of profit.

5.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises 58. On October 1, Cycle Mania, a bicycle store had an inventory of 15 twelve-speed bicycles at a cost of $150 each. During the month of October the following transactions occurred. Oct.

Purchased 25 bicycles at a cost of $150 each from the Lyons Bicycle Company Ltd; terms n/30.

Sold 12 bicycles to Team Australia at $250 each; terms 2/10, n/30.

Received credit from the Lyons Bicycle Company Ltd for the return of 2 defective bicycles.

Issued a credit to Team Australia for the return of one defective bicycle.

Purchased 10 bicycles from Huffy Bicycle Company Ltd at a cost of $125; terms 2/10, n/30.

Paid freight of $80 on the October 19 purchase.

Prepare the journal entries to record the transactions assuming the company uses a periodic inventory system.

Answers below. Learning objective 5.1 – 5.11. Oct.

Purchases ............................................................................... Accounts Payable .........................................................

3,750

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

3,000

Accounts Payable .................................................................. Purchase Returns and Allowances ...............................

300

Sales Returns and Allowances .............................................. Accounts Receivable ....................................................

250

Purchases ............................................................................... Accounts Payable .........................................................

1,250

Freight-in ............................................................................... Cash ..............................................................................

3,750

3,000

300

250

1,250

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Chapter 5: Reporting and analysing inventory

59. Lakeland Ltd uses a periodic inventory system. During April, the following transactions and events occurred: April 3

Purchased $1,500 of inventory; terms 2/10, n/60.

Returned $300 of the inventory purchased on April 3.

Paid Freight charges of $150 on goods purchased on April 3.

Paid for the goods purchased on April 3.

Sold goods on credit for $1,000; terms 1/10, n/30.

The customer of April 13 returned $200 of the goods.

Received payment from the customer of April 13.

Prepare the journal entries to record the transactions.

Answers below. Learning objective 5.1 – 5.11. April

Purchases………………………………………………………… 1,500 Accounts Payable…………………………………………

1,500

Accounts Payable…………………………………………………. 300 Purchase Returns and Allowances……………………..

300

Freight-in…………………………………………………………… 150 Cash……………………………………………………….

150

Accounts Payable………………………………………………… 1,200 Discount received (or inventory)…………………………………….. 24 Cash ……………………………………………………… 1,176

Accounts Receivable…………………………………………….. 1,000 Sales………………………………………………………

Sales Returns and Allowances………………………………… Accounts Receivable…………………………………..

200

Cash……………………………………………………………… Discount allowed…………………………………………………. Accounts Receivable………………………………….

792 8

1,000

200

800

5.23

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

60. Continental Wholesale Ltd uses a periodic inventory system. During September, the following transactions and events occurred: Sept.

Purchased 35 backpacks at $25 each from Jenner Ltd; terms 2/10, n/30.

Received credit of $100 for the return of 4 backpacks purchased on September 3 that were defective.

Sold 20 backpacks for $35 each to Macer Books; terms 2/10, n/30.

Paid Jenner Ltd in full.

Journalise the September transactions for Continental Wholesale Ltd.

Answers below. Learning objective 5.1 – 5.11. Sept.

Purchases ............................................................................ Accounts Payable ......................................................

875

Accounts Payable ............................................................... Purchase Returns and Allowances ............................

100

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

700

Accounts Payable ($875 - $100) ........................................ Discount Received (or inventory) (775 × .02) .......... Cash............................................................................

775

875

100

700

15.50 759.50

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Chapter 5: Reporting and analysing inventory

61. The Calendar Company Ltd entered into the following transactions during the month of June: June

Purchased $800 of inventory on credit; terms 2/10,n/30.

Returned $100 of the goods purchased on June 3.

Paid freight charges of $70 on goods purchased on June 3.

Paid for the goods purchased on June 3.

Prepare the journal entries to record the transactions assuming they use a periodic inventory system.

Answers below. Learning objective 5.1 – 5.11.

June

Purchases............................................................................. Accounts Payable .......................................................

800

Accounts Payable ................................................................ Purchase Returns and Allowances .............................

100

Freight-in............................................................................. Cash............................................................................

Accounts Payable ................................................................ Discount Received (or inventory) .............................. Cash............................................................................

700

800

100

14 686

5.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

62. The income statement of Pine Supplies Ltd includes the items listed below: Net sales Gross profit on sales Beginning inventory Discount received Purchase returns and allowances Freight-in Operating expenses Purchases

$800,000 320,000 100,000 15,000 8,000 10,000 300,000 520,000

Use the appropriate items listed above as a basis for determining: (a) Cost of sales. (b) Cost of goods available for sale. (c) Ending inventory.

Answers below. Learning objective 5.1 – 5.11. (a)

Net sales - Cost of sales = Gross profit $800,000 - Cost of sales = $320,000 Cost of sales = $480,000

(b)

Beginning inventory Purchases Less: Purchase returns and allowances Net Purchases Add: Freight-in Cost of goods purchased Cost of goods available for sale

(c)

$100,000 $520,000 8,000 512,000 10,000 522,000 $622,000

Cost of goods available for sale - Ending inventory = Cost of sales $622,000 - Ending inventory = $480,000 Ending inventory = $142,000

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Chapter 5: Reporting and analysing inventory

63. Given the following information, prepare in good form the cost of sales section of an income statement. Freight-in Beginning inventory Ending inventory Purchases Discount received Purchase returns and allowances

$ 4,000 15,000 16,000 38,000 500 1,800

Answers below. Learning objective 5.1 – 5.11. Beginning inventory Purchases Less: Purchase returns and allowances Net Purchases Freight-in Cost of goods purchased Cost of goods available for sale Ending inventory Cost of sales

$15,000 $38,000 $1,800 36,200 4,000 40,200 55,200 16,000 $39,200

5.27

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

64. Three items are missing in each of the following columns and are identified by letter. Sales Sales returns and allowances Discount allowed Net sales Beginning inventory Cost of goods purchased Ending inventory Cost of sales Gross profit

(a) 15,000 10,000 450,000 (b) 200,000 170,000 250,000 (c)

$860,000 20,000 15,000 (d) 325,000 (e) 303,000 575,000 (f)

Calculate the missing amounts and identify them by letter.

Answers below. Learning objective 5.1 – 5.11. (a) (b) (c)

$475,000 $220,000 $200,000

(d) (e) (f)

$840,000 $553,000 $265,000

5.28

Chapter 5: Reporting and analysing inventory

65. Castle Packaging Ltd has just completed a physical inventory count at year-end (31 December). All items on the shelves, in storage, and in the receiving area were counted and costed on the FIFO basis. The inventory amounted to $95,000. During the audit of the inventory count, the independent auditor discovered the following additional information: (a) There were goods in transit on 31 December from a supplier with terms FOB destination, costing $10,000. Because the goods had not arrived, they were excluded from the physical inventory count. (b) On 27 December, a regular customer purchased goods for cash amounting to $1,000 and left them for pickup on 4 January. Kemp Ltd had paid $500 for the goods and, because they were on hand, included them in the physical inventory count. (c) Kemp Ltd, on the date of the inventory count, received notice from a supplier that goods ordered earlier at a cost of $4,000, had been delivered to the transportation company on 28 December. The terms were FOB shipping point. Because the shipment had not arrived on 31 December, it was excluded from the physical inventory. (d) On 31 December there were goods in transit to customers, with terms FOB shipping point, amounting to $800 (expected delivery on January 8). Because the goods had been shipped, they were excluded from the physical inventory count. (e) On 31 December, Kemp Ltd shipped $2,500 worth of goods to a customer, FOB destination. The goods arrived to the customer on 5 January. Because the goods were not on hand, they were not included in the physical inventory count. (f) Kemp Ltd, as the consignee, had goods on consignment that cost $3,000. Because these goods were on hand as of 31 December they were included in the physical inventory count. Analyse the above information and calculate a corrected amount for the ending inventory. Explain the basis for your treatment of each item.

Answers below. Learning objective 5.1 – 5.11. Start with

$95,000

Item (a)

(Because the goods were shipped FOB destination the title will pass to Kemp upon arrival. Properly excluded.)

Item (b)

- 500

(Goods should be excluded. The customer owns them.)

Item (c)

+ 4,000

Item (d)

(Goods belong to Kemp. Title passed when supplier delivered the goods to the transportation company.) (Because the goods were shipped FOB shipping point Kemp no longer has title to these goods. Properly excluded.)

Item (e)

+ 2,500

(Goods were shipped FOB destination. Kemp retains title until the customer receives them.)

Item (f)

- 3,000

(These goods are owned by the consignor, not the consignee, and should not be included in Kemp's inventory.)

Corrected inventory

$98,000

5.29

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

66. Harley Clothing Store employs the periodic inventory system and prepares monthly financial statements. All accounts have been adjusted except for inventory. A physical count of inventory on 30 November indicates that $22,000 was on hand. A partial listing of account balances follows: Accounts receivable Inventory, 1 November Commissions expense Freight-in Purchase returns and allowances Sales returns and allowances Purchases Sales

$ 9,000 30,000 600 2,000 3,500 1,800 28,000 65,000

Prepare a partial income for the Hanley Clothing Store for the month ended 30 November. The income statement should show all items through to gross profit.

Answers below. Learning objective 5.1 – 5.11. HARLEY CLOTHING STORE (Partial) Income Statement for the month ended 30 November _____________________________________________________________________________ Sales Revenues Sales .............................................................................. Less: Sales returns and allowances ............................... Net sales ........................................................................ Cost of sales Inventory, 1 November ................................................ Purchases....................................................................... Less: Purchase returns and allowances ........................ Net purchases ................................................................ Add: Freight-in............................................................. Cost of goods purchased ............................................... Cost of goods available for sale .................................... Inventory, 30 November .............................................. Cost of sales ............................................................ Gross profit ............................................................................

$65,000 1,800 $63,200

$30,000 $28,000 3,500 24,500 2,000 26,500 56,500 22,000 34,500 $28,700

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Chapter 5: Reporting and analysing inventory

67. Barbara’s Book Store employs the periodic inventory system and prepares monthly financial statements. All accounts have been adjusted except for inventory. A physical count of inventory on 30 September indicates that $2,000 was on hand. A partial listing of account balances follows: Accounts receivable Inventory, 1 September Freight-in Purchase returns and allowances Sales returns and allowances Purchases Sales Operating expenses

$8,000 1,500 2,500 1,500 750 25,000 50,000 17,500

Instructions Prepare an income statement for Barbara’s Book Store for the month ended 30 September.

Answers below. Learning objective 5.1 – 5.11. BARBARA’S BOOK STORE Income Statement for the month ended 30 September _____________________________________________________________________________ Sales Revenues Sales .............................................................................. Less: Sales returns and allowances ............................... Net sales ........................................................................ Cost of sales Inventory, 1 September ................................................ Purchases....................................................................... Less: Purchase returns and allowances ........................ Net purchases ................................................................ Add: Freight-in............................................................. Cost of goods purchased ............................................... Cost of goods available for sale .................................... Inventory, 30 September .............................................. Cost of sales ............................................................ Gross profit ............................................................................ Operating expenses ............................................................... Profit .................................................................................

$50,000 750 $49,250

$1,500 $25,000 1,500 23,500 2,500 26,000 27,500 2,000 25,500 23,750 17,500 $6,250

5.31

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

68. McGuire Metals Ltd uses the periodic inventory method and had the following inventory information available: Units Unit Cost Total Cost 1/1 Beginning Inventory 100 $4 $ 400 1/20 Purchase 500 $5 2,500 7/25 Purchase 100 $7 700 10/20 Purchase 300 $8 2,400 1,000 $6,000 A physical count of inventory on 31 December revealed that there were 350 units on hand. Answer the following independent questions and show computations supporting your answers. 1. Assume that the company uses the FIFO method. The value of the ending inventory at 31 December is $__________. 2. Assume that the company uses the average cost method. The value of the ending inventory on 31 December is $__________. 3. Assume that the company uses the LIFO method. The value of the ending inventory on 31 December is $__________. 4. Determine the difference in the amount of income that the company would have reported if it had used the FIFO method instead of the LIFO method. Would income have been greater or less?

5.32

Chapter 5: Reporting and analysing inventory

Answers below. Learning objective 5.1 – 5.11. 1. FIFO: Ending inventory $2,750 300 units @$8 = $2,400 50 units @$7 = 350 330 units $2,750 2. Average Cost: Ending inventory $2,100 $6,000 / 1,000 = $6.00 per unit x 350 units = $2,100 3. LIFO: Ending Inventory $1,650 100 units @$4 = $ 400 250 units @$5 = 1,250 350 units $1,650 4. FIFO: Cost of sales $3,250 100 units @$4 = 500 units @$5 = 50 units @$7 = 650 units

$ 400 2,500 350 $3,250

LIFO: Cost of sales $4,350 300 units @$8 100 units @$7 250 units @$5 650 units

$2,400 700 1,250 $4,350

Income would have been $1,100 ($4,350 vs. $3,250) greater if the company used FIFO instead of LIFO.

5.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

69. Harlow Ltd uses the periodic inventory method and had the following inventory information available: Units Unit Cost Total Cost 1/1 Beginning Inventory 15 $4.00 $ 60 20/1 Purchase 60 $4.40 264 25/7 Purchase 30 $4.20 126 20/10 Purchase 45 $4.80 216 150 $666 A physical count of inventory on 31 December revealed that there were 50 units on hand. Instructions Answer the following independent questions and show computations supporting your answers. 1. Assume that the company uses the FIFO method. The value of the ending inventory at 31 December is $__________. 2. Assume that the company uses the Average Cost method. The value of the ending inventory on 31 December is $__________. 3. Assume that the company uses the LIFO method. The value of the ending inventory on 31 December is $__________. 4. Assume that the company uses the FIFO method. The value of the cost of sales at 31 December is $__________.

Answers below. Learning objective 5.1 – 5.11. 1. FIFO: Ending inventory $237 45 units @$4.80 = 5 units @$4.20 = 50 units

216 21 $237

2. Average Cost: Ending inventory $222 $666 / 150 = $4.44 per unit x 50 units = $222 3. LIFO: Ending Inventory $214 15 units @$4.00 = 35 units @$4.40 = 50 units

$ 60 154 $214

4. FIFO: Cost of sales $429 15 units @$4.00 = 60 units @$4.40 = 25 units @$4.20 = 100 units

$ 60 264 105 $ 429

5.34

Chapter 5: Reporting and analysing inventory

70. The following information is gathered in relation to sales and purchases of inventory during a year. January May

December

1 1

Beginning Inventory Purchases

150 items @ $3 = $ 450 450 items @ $6 = $2,700

Total

600 items

Total Sales Ending Inventory

300 items 300

$3,150

Calculate the cost to be assigned to ending inventory for each of the methods indicated below given the information about purchases and sales during the year.

Cost assigned on an average basis to ending inventory

$__________

Cost assigned on a FIFO basis

$__________

Costs assigned on a LIFO basis

$__________

Answers below. Learning objective 5.1 – 5.11. 1. 2. 3.

$1,575 (3150/600x300) $1,800 (300x6) $1,350 ((150x3)+(150x6))

5.35

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

71. Delta Ltd sells many products. Alpha is one of its popular items. Below is an analysis of the inventory purchases and sales of alpha for the month of March. Delta Ltd uses the periodic inventory system. Purchases Units Unit Cost price/unit 1/3 Beginning inventory 3/3 Purchase 4/3 Sales 10/3 Purchase 16/3 Sales 19/3 Sales 25/3 Sales 30/3 Purchase

100 60 200

Units

Sales Sale

$60 $75 70

$120

80 80 50

$130 $130 $130

$82

$90

(a) Using the FIFO assumption, calculate the amount charged to cost of sales for March. (Show computations) (b) Using the average method, calculate the amount assigned to the inventory on hand on 31 March. (Show computations) (c) Using the LIFO assumption, calculate the amount assigned to the inventory on hand on 31 March. (Show computations)

5.36

Chapter 5: Reporting and analysing inventory

Answers below. Learning objective 5.1 – 5.11.

Units Price/Unit 1/3 Beginning inventory 3/3 Purchase 4/3 Sales 10/3 Purchase 16/3 Sales 19/3 Sales 25/3 Sales 30/3 Purchase

(a)

Purchases Unit Cost

100 60

$60 $75

200

$82

40 400

Units

Sales Selling

$120

80 80 50

$130 $130 $130

$90 280

Using FIFO - the earliest units purchased were the first sold. 1/3 100 @ $60 = $ 6,000 3/3 60 @ 75 = 4,500 10/3 120 @ 82 = 9,840 280 units $20,340 = Cost of sales

(b) Calculate the average unit cost: $30,500 / 400 = $76.25 $76.25 x units in ending inventory (400 available less 280 sold = 120) $76.25 x 120 = $9,150

(c) There are 120 units in ending inventory. They are comprised of the first units purchased when LIFO is assumed. 3/1 100 @ $60 = $6,000 3/3 20 @ $75 = 1,500 120 units $7,500 = Ending inventory

5.37

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

72. The following information is available for Barnes Ltd for the year. Barnes Ltd uses the LIFO inventory method. Beginning inventory Ending inventory Cost of sales Sales

$ 650,000 750,000 6,000,000 8,000,000

Answers below. Learning objective 5.1 – 5.11. (a) Calculate inventory turnover and days in inventory for Barnes Ltd based on LIFO.

Solution 15

(10 min.)

(a) Inventory turnover

= $6,000,000 ÷ [($650,000 + $750,000) ÷ 2] = $6,000,000 ÷ $700,000 = 8.6 times

Days in inventory = 365 days ÷ 8.6 = 42.4 days

5.38

Chapter 5: Reporting and analysing inventory

73. Bell’s Pharmacy reported cost of sales as follows:

Beginning inventory Cost of goods purchased Cost of goods available for sale Ending inventory Cost of sales

2015 $ 54,000 847,000 901,000 64,000 $837,000

2016 $ 64,000 891,000 955,000 55,000 $900,000

Bell’s made two errors: (1) 2015 ending inventory was overstated by $3,000. (2) 2016 ending inventory was understated by $9,000. Assuming the errors had not been corrected, indicate the dollar effect that the errors had on the items appearing on the financial statements listed below. Also indicate if the amounts are overstated (O) or understated (U). Amount

2015 Overstated/ Understated

Amount

2016 Overstated/ Understated

Total assets

$_________

_______

$_________

_______

Equity

$_________

_______

$_________

_______

Cost of sales

$_________

_______

$_________

_______

Profit

$_________

_______

$_________

_______

Amount

2016 Overstated/ Understated

Answers below. Learning objective 5.1 – 5.11. 2015 Overstated/ Amount Understated Total assets

$3,000

$9,000

Equity

$3,000

$9,000

Cost of sales

$3,000

$12,000

Profit

$3,000

$12,000

Correct cost of sales: 2015 $ 54,000 847,000 901,000 61,000 $840,000

Beginning inventory Cost of goods purchased Cost of goods available for sale Ending inventory Cost of sales

2016 $ 61,000 891,000 952,000 64,000 $888,000

5.39

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Completion Statements

74. Please complete the following statements: 1.

In a manufacturing company, goods that are ready to be sold to customers are referred to as __________ goods, whereas in a retail business they are generally referred to as _______________.

The acquisition of inventory is debited to a Purchases account when a _______________ inventory system is used.

Net purchases are calculated by subtracting ________ ______ and allowances from Purchases.

The cost of goods purchased during a period plus the beginning inventory is the amount of goods ___________ for sale during the period.

When the terms of sale are FOB __________ point, ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.

Cost of goods available for sale must be allocated between cost of goods ___________ and ____________ inventory.

The specific ______________ method tracks the actual physical flow of each unit of inventory available for sale; however, management may be able to manipulate ______________ by using this method.

If the unit cost of inventory has continuously increased, the ______________, first-out inventory valuation method will result in a higher valued ending inventory than if the ______________, first-out method had been used.

Under the LCM basis, market is defined as net ______________ price.

10.

____________ turnover is calculated as cost of sales divided by average inventory.

Answers below. Learning objective 5.1 – 5.11. 1. 2. 3. 4. 5.

finished, merchandise periodic Purchase Returns available shipping

6. 7. 8. 9. 10.

sold, ending identification, profit first-in, last-in selling Inventory

5.40

Chapter 5: Reporting and analysing inventory

Matching 75. Match the items below by entering the appropriate code letter in the space provided. A. Inventory B. Work in process C. FOB shipping point D. FOB destination E. Specific identification method

F. G. H. I.

First-in, first-out (FIFO) method Last-in, first-out (LIFO) method Average cost method Inventory turnover

____

1. Tracks the actual physical flow for each inventory item available for sale.

____

2. Goods that are only partially completed in a manufacturing company.

____

3. Cost of sales consists of the most recent inventory purchases.

____

4. Goods ready for sale to customers by retailers and wholesalers.

____

5. Title to the goods transfers when the public carrier accepts the goods from the seller.

____

6. Ending inventory valuation consists of the most recent inventory purchases.

____

7. The same unit cost is used to value ending inventory and cost of sales.

____

8. Title to goods transfers when the goods are delivered to the buyer.

____

9. Measures the number of times inventory was sold during the period.

Answers below. Learning objective 5.1 – 5.11. 1. 2. 3. 4. 5.

E B G A C

6. 7. 8. 9.

F H D I

5.41

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions 76. The periodic and the perpetual inventory systems are two methods that merchandisers use to account for inventories. Briefly describe the major features of each system and explain why a physical inventory count is necessary under both systems. Answer below. Learning objective 5.1 – 5.11. When a periodic inventory system is used, the Inventory account remains the same throughout the period. Separate accounts, such as Purchases, Purchases returns and allowances, Freight-in are used to record the transactions. Cost of sales is determined by the following formula: Beginning inventory + Net Purchases - Ending inventory The determination of ending inventory is made by a physical count. When a perpetual inventory system is used, the purchase and sale of goods is recorded directly in the Inventory account, which eliminates the need for separate accounts. Cost of sales is recognised for each sale by debiting the Cost of sales account and crediting Inventory. At the end of the period, the ending account balance should equal Inventory's ending balance. However, a merchandiser should conduct a physical inventory count, at least once a year, because differences could result from spoilage, theft, or errors.

77. FIFO and LIFO are two cost flow assumptions made in costing inventories. The amounts assigned to the same inventory items on hand may be different under each cost flow assumption. If a company has no beginning inventory, explain the difference in ending inventory values under the FIFO and LIFO cost bases when the price of inventory items purchased during the period have been (1) increasing, (2) decreasing, and (3) remained constant. Answer below. Learning objective 5.1 – 5.11. The FIFO method determines the ending inventory by the cost of the most recent purchase. The LIFO method determines the ending inventory by the cost of the earliest purchase. Therefore, if the FIFO method is used and the prices during the period are increasing, the ending inventory under FIFO will be greater than under LIFO. Likewise, if the FIFO method is used and the prices during the period are decreasing, the ending inventory under FIFO will be less than under LIFO. If prices remain constant and the company has no beginning inventory, then there will be no difference in ending inventory.

5.42

Chapter 5: Reporting and analysing inventory

78. Ethics: Lucia Kraus and Trent Lee are department managers in the housewares and shoe departments, respectively, for Hillards, a large department store. Trent has observed Lucia taking inventory from her own department home, apparently without paying for it. He hesitates confronting Lucia because he is due to be promoted, and needs Lucia's recommendation. He also does not want to notify the company management directly, because he doesn't want an ethics investigation on his record, believing that it will give him a “goodygoody” image. This week, Lucia tried on several pairs of expensive running shoes in his department before finding a pair that suited her. She did not, however, buy them. That very pair was missing this morning. Hillards recently replaced its old periodic inventory system with a perpetual inventory system using scanners and bar codes. In addition, the annual inventory is to be replaced by a monthly inventory conducted by an independent firm. On hearing the news of the changes, Trent relaxes. "The system will catch Lucia now," he says to himself. Required: 1. Is Trent's attitude justified? Why or why not? 2. What, if any, action should Trent take now? Answer below. Learning objective 5.1 – 5.11. 1. Trent's attitude is not justified. The system will only be able to detect that inventory is missing. It cannot determine who took the inventory. 2. Trent should notify his superiors at once. He has knowledge of what may be criminal acts. Trent's apparent fear of not being promotable because of a “goody-goody” image seems unjustified. It would seem more likely that Trent's refusal to accept unethical (and illegal) acts by others would make him a more valuable manager. He may even be jeopardising his career with Hillards if someone else reports Lucia's actions. The resulting investigation may implicate Trent because of his failure to notify the proper authorities in a timely manner.

5.43

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

79. Communication: Vu Mobutu, a new employee of Crafter's Paradise, recorded $1,000 in consigned goods received as part of the firm's inventory. The goods were received one day after the end of the financial period, but Vu reasoned that the goods should be included in inventory sooner because Crafter's paid the freight. The mistake was brought to his attention by the purchasing department who said the goods should not have been recorded as Crafter’s inventory at all. Vu told Sun Ying, the purchasing supervisor, that nobody needed to worry, because the mistake would cancel itself out the following month. In Vu's opinion, there was no reason to get everyone excited over nothing, especially since it was monthly, and not annual, financial statements that were affected. Sun Ying has reported the problem to the accounting department. Required: You are Vu's supervisor. Write a memo to Vu explaining why the error should have been corrected. Answer below. Learning objective 5.1 – 5.11.

MEMO

TO:

Vu Mobutu, Accounting Department

FROM: Martha King, Supervisor DATE: March 12 It has come to my attention that $1,000 in consigned goods were included in the inventory reported in our January financial statements. You were informed that this amount should be removed from inventory, which you did not do, apparently believing that February's entries would correct the error. The error would have been corrected in February if it were only a matter of your recording inventory in the wrong month. January's inventory and expenses would have been overstated, and February's understated, but the net effect would have been zero. Since the $1,000 is a fairly large amount, however, that still would not have been appropriate. The error you made, however, was to enter into inventory goods that the company did not own, and will not own. Consigned goods are owned by the consignors until purchased by customers. We only provide our shops for the consignors to sell their goods, and we collect a fee for doing so. Please correct the error at once. We may need to notify some of the other departments of the error as well. Please arrange to meet with me in my office as soon as possible to discuss the matter. (Signature)

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Chapter 6: Accounting information systems

Chapter 6: Accounting information systems True-false statements

1. Most small businesses commence their operations using manual accounting systems. Learning objective 6.1 – Identify the basic principles of accounting information systems. Answer: This statement is true.

2. A cash payments journal is an example of a general journal. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is false.

3. The starting point in the development of an accounting system is the implementation stage where systems are installed and made operational. Learning objective 6.2 - Explain the major phases in the development of an accounting system. Answer: This statement is false.

4. After an accounting information system has been implemented the effectiveness of the system can be checked by monitoring it for weaknesses. Learning objective 6.2 - Explain the major phases in the development of an accounting system. Answer: This statement is true.

5. During the analysis stage of development of an accounting information system, the information needs of internal and external users are determined. Learning objective 6.2 - Explain the major phases in the development of an accounting system. Answer: This statement is true.

6. An effective way to process a large number of transactions is to use control accounts and subsidiary ledgers. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is true.

6.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

7. The accounts receivable subsidiary ledger is also called the creditors ledger. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is false.

8. Detailed data from a control account are summarised in a subsidiary ledger account. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is false.

9. A subsidiary ledger is a group of accounts with a common characteristic such as accounts payable. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is true.

10. A subsidiary ledger is not part of the general ledger and is not used in preparing a trial balance. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is true.

11. A schedule of accounts receivable is a list of all accounts and their balances in a debtors’ subsidiary ledger. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is true.

12. If a transaction cannot be recorded in a special journal, it is not necessary to record it at all. Learning objective 6.10 - Explain how special journals are used in recording transactions. Answer: This statement is false.

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Chapter 6: Accounting information systems

13. A special journal is used to record similar types of transactions such as all cash receipts. Learning objective 6.10 - Explain how special journals are used in recording transactions. Answer: This statement is true.

14. Each entry in a credit sales journal results in one entry at selling price and another entry at cost. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is true.

15. The sum of the subsidiary ledger balances must equal the balance in the control account in the general ledger. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is true. 16. The recording of small payments in the form of currency is known as ‘petty cash’. Learning objective 6.5 - Identify the principles and limitations of internal control. Answer: This statement is true. 17. Entries in a special purchases journal are made from suppliers’ invoices. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is true. 18. The symbol ‘CP1’ used as a posting reference indicates that the transaction has been posted from page 1 of the general journal. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is false.

6.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

19. Special journals for sales, purchases and cash can substantially increase the number of entries that are made in the general journal. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is false.

20. In a manual accounting system each of the steps in the process is performed by hand. Learning objective 6.1 - Identify the basic principles of accounting information systems. Answer: This statement is true.

21. When posting special journal entries there must be a dual posting, once to the control account and once to the subsidiary account. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is true.

22. In a computerised accounting system, there are programs for performing journalising and posting of transactions. Learning objective 6.13 - Identify the advantages and disadvantages of computerised accounting systems. Answer: This statement is true.

23. In a fully integrated accounting system, data are entered into one module must be manually updated in all other integrated modules. Learning objective 6.11 - Understand the basic features of computerised accounting systems including an introduction to MYOB. Answer: This statement is false.

24. Integrated accounting systems are made up of subsystems for functions such as inventory, non-current assets and accounts receivable and payable. Learning objective 6.12 - Appreciate the role and use of non-integrated systems. Answer: This statement is true.

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Chapter 6: Accounting information systems

25. Electronic spreadsheets are commonly used to develop budgets and calculate depreciation on non-current assets. Learning objective 6.12 - Appreciate the role and use of non-integrated systems. Answer: This statement is true.

26. In a computerised accounting system, transaction posting to ledgers is performed manually. Learning objective 6.11 - Understand the basic features of computerised accounting systems including an introduction to MYOB. Answer: This statement is false.

27. A major advantage of a computerised accounting system is the ability to process numerous transactions quickly. Learning objective 6.13 - Identify the advantages and disadvantages of computerised accounting systems. Answer: This statement is true.

28. Computerised accounting systems are much more susceptible to human error than are manual accounting systems. Learning objective 6.13 - Identify the advantages and disadvantages of computerised accounting systems. Answer: This statement is false.

29. Computerised accounting systems can be programmed to automatically produce accounting documents including invoices and financial statements. Learning objective 6.13 - Identify the advantages and disadvantages of computerised accounting systems. Answer: This statement is true.

30. The high cost of computerised accounting systems may make them less accessible to small business. Learning objective 6.11 - Understand the basic features of computerised accounting systems including an introduction to MYOB. Answer: This statement is true.

6.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

31. If the accounting system is cost-effective, provides useful output and has the flexibility to meet future needs, it can contribute to both individual and organisational goals. Learning objective 6.2 - Explain the major phases in the development of an accounting system. Answer: This statement is true.

32. A major disadvantage of using a computerised accounting system is the need to have people with the skills to operate the system. Learning objective 6.13 - Identify the advantages and disadvantages of computerised accounting systems. Answer: This statement is true.

33. A subsidiary ledger replaces the need for a general ledger. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is false.

34. If the balances in the subsidiary ledger are correct then the corresponding balances in the general ledger must also be correct. Learning objective 6.9 - Describe the nature and purpose of control accounts and subsidiary ledgers. Answer: This statement is false.

35. The cash receipts journal is only used to record collections of accounts receivable. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is false.

36. The sales journal is only used to record sales of inventory on account. Learning objective 6.14 - Record transactions for sales, purchases, cash receipts and cash payments in special journals. Answer: This statement is true.

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Chapter 6: Accounting information systems

Multiple-choice questions

1. Which of the following statements is false? a. the same basic principles of accounting apply whether the accounting information system is manual or computerised. *b. generally small entities require much more sophisticated accounting systems than large entities. c. cost-effectiveness is a basic principle underpinning efficient and effective accounting information systems. d. cost-effectiveness means that the costs of providing information are less than the benefits from use of that information. Answer: b Learning objective 6.1 – Identify the basic principles of accounting information systems. Feedback: Generally, small entities require less sophisticated accounting systems than large entities.

2. Which of the following statements is true? a. the starting point in the development of an accounting system is the implementation stage where systems are installed and made operational. *b. during the analysis stage of development of an accounting information system, the information needs of internal and external users are determined. c. after an accounting information system has been implemented the effectiveness of the system is assured. d. none, all the statement are false. Answer: b Learning objective 6.2 – Explain the major phases in the development of an accounting system. Feedback: The starting point in the development of an accounting system is the analysis where the information needs of internal and external users are determined. After implementation the accounting system must be monitored for weaknesses.

6.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

3. The principles of effective accounting systems include: a. conservatism. *b. flexibility. c. accrual accounting. d. solvency. Answer: b Learning objective 6.1 – Identify the basic principles of accounting information systems. Feedback: Efficient and effective accounting information systems are based on the principles of (1) cost-effectiveness, (2) usefulness and (3) flexibility.

4. Generally, an accounting information system is developed in the following order: a. design, implementation, analysis, follow-up. b. analysis, follow-up, implementation, design. *c. analysis, design, implementation, follow-up. d. implementation, design, follow-up, analysis. Answer: c Learning objective 6.2 – Explain the major phases in the development of an accounting system. Feedback: Generally, an accounting information system is developed in four phases; (1) analysis, (2) design, (3) implementation, and (4) follow-up.

5. Implementation of an accounting information system requires that: a. the system is monitored for weaknesses. b. the information needs of internal users be identified. *c. documents, procedures and processing equipment be installed and made operational. d. the job descriptions are prepared and the reports are formatted. Answer: c Learning objective 6.2 – Explain the major phases in the development of an accounting system. Feedback: Implementation of an accounting information system requires that documents, procedures and processing equipment be installed and made operational.

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Chapter 6: Accounting information systems

6. Which one of the following is not an objective of a system of internal controls? *a. Overstate liabilities in order to be conservative b. Safeguard company assets c. Enhance the accuracy and reliability of accounting records d. Reduce the risks of errors Answer: a Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Internal controls incorporate policies to safeguard assets, enhance the completeness, accuracy and reliability of accounting records and reduce the risk of errors.

7. Each of the following is a feature of internal control except: a. recording of all transactions. b. safe-guard its assets from theft. c. separation of duties. *d. an extensive marketing plan. Answer: d Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: An extensive marketing plan is part of business planning; it is not a feature of internal control.

8. All of the following are examples of internal control procedures except: a. using pre-numbered documents. *b. customer satisfaction surveys. c. reconciling the bank statement. d. insistence that employees take vacations. Answer: b Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Customer satisfaction surveys are one means to evaluate performance but they are not an internal control procedure.

6.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

9. Each of the following is a feature of internal control except: a. limited access to assets. *b. adequate design of documents. c. authorisation of transactions. d. independent internal verifications. Answer: b Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Adequate document design is not a feature of internal control but the use of pre-numbered documents is a feature of internal control.

10. Internal controls are concerned with: *a. safeguarding assets. b. the extent of government regulations. c. only manual systems of accounting. d. preparing income tax returns. Answer: a Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Internal controls include a focus on safeguarding assets and enhancing the completeness, accuracy, and reliability of accounting records.

11. Internal control is defined, in part, as a plan that safeguards: a. all statement of financial position accounts. b. liabilities. *c. assets. d. capital. Answer: c Learning objective 6.3 – Define internal control. Feedback: Internal controls include a focus on safeguarding assets and also enhancing the completeness, accuracy, and reliability of accounting records.

12. Internal controls are not designed to safeguard assets from: *a. natural disasters. b. employee theft. c. robbery. d. unauthorised use. Answer: a Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Internal controls are not designed to safeguard assets from natural disasters.

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Chapter 6: Accounting information systems

13. Having one person responsible for the related activities of ordering merchandise, receiving goods, and paying for them: a. is an example of good internal control. b. decreases the potential for errors and fraud. *c. increases the potential for errors and fraud. d. is a good example of safeguarding the company's assets. Answer: c Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Segregation of duties is indispensable in a system of internal control. The responsibility for related activities (ordering, receiving and paying for merchandise) should be assigned to different employees.

14. Internal auditors: a. are external consultants hired to audit business firms. b. are employees of the ATO who evaluate the internal controls of companies filing tax returns. *c. evaluate the system of internal controls for the companies that employ them. d. cannot evaluate the system of internal controls of the company that employs them because they are not independent. Answer: c Learning objective 6.4 – Appreciate management’s responsibility in relation to internal control. Feedback: Internal auditors are employees of the business who continuously evaluate the effectiveness of a system of internal controls.

15. The custodian of a company asset should: a. have access to the accounting records for that asset. b. be someone outside the company. *c. not have access to the accounting records for that asset. d. be an accountant. Answer: c Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Segregation of duties is indispensable in a system of internal control. The responsibility for keeping the records of an asset should be separate from the physical custody of that asset.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. When two or more people get together for the purpose of circumventing prescribed controls, it is called: a. a fraud committee. b. a division of duties. *c. collusion. d. bonding of employees. Answer: c Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: A good system of internal control may become ineffective when two or more individuals collude or work together to avoid prescribed controls. Collusion can eliminate the anticipated protection from the segregations of duties.

17. The principle of establishing responsibility does not include: a. one person being responsible for one task. b. authorisation of transactions. *c. independent internal verification. d. approval of transactions. Answer: c Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Establishment of responsibility is concerned with the assignment of responsibility for a task to a specific employees and the appointment of supervisors to monitor compliance with procedures. Independent internal verification occurs when the supervisor reviews, compares or reconciles data prepared by the responsible employee.

18. Two individuals at a retail store work the same cash register. You evaluate this situation as: *a. a violation of establishment of responsibility. b. a violation of separation of duties. c. supporting the establishment of responsibility. d. supporting internal independent verification. Answer: a Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: When two individuals work at the same cash register it violates the establishment of responsibility.

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Chapter 6: Accounting information systems

19. The control principle related to not having the same person authorise and pay for goods is known as: a. establishment of responsibility. b. independent internal verification. *c. segregation of duties. d. rotation of duties. Answer: c Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Segregation of duties does not have the same person authorise and pay for goods.

20. Related selling activities do not include: a. shipping the goods. b. making a sale. *c. ordering the merchandise. d. billing the customer. Answer: c Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: Ordering the merchandise is not related to selling activities, it is related to purchasing activities.

21. An accounts payable officer has access to the approved supplier master file for purchases. The control principle of: a. establishment of responsibility is violated. b. independent internal verification is violated. c. documentation procedures is violated. *d. segregation of duties is violated. Answer: d Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: If one person has access to a supplier master file and is responsible for making payments to those suppliers the control principle of segregation of duties is violated.

6.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. Related buying activities include: *a. ordering, receiving, paying. b. ordering, selling, paying. c. ordering, shipping, billing. d. selling, shipping, paying. Answer: a Learning objective 6.5 – Identify the principles and limitations of internal. Feedback: Ordering, receiving and paying are related buying activities.

23. Physical controls to safeguard assets do not include: a. locked warehouses. b. vaults. c. safety deposit boxes. *d. cashier department supervisors. Answer: d Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: A supervisor is not a physical control.

24. In large companies, the independent internal verification procedure is often assigned to: a. computer operators. b. management. *c. internal auditors. d. outside accounting firms. Answer: c Learning objective 6.4 – Appreciate management’s responsibility in relation to internal control. Feedback: Internal auditors often provide an independent internal verification for large companies.

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Chapter 6: Accounting information systems

25. A system of internal control: a. is infallible. *b. can be rendered ineffective by employee collusion. c. invariably will have costs exceeding benefits. d. is premised on the concept of absolute assurance. Answer: b Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: A system of internal control can be rendered ineffective by employee collusion because it eliminates the anticipated benefits of segregation of duties.

26. Maximum benefit from independent internal verification is obtained when: a. it is made on a pre-announced basis. *b. discrepancies are reported to management. c. it is done by the employee possessing custody of the asset. d. it is done at the time of the audit. Answer: b Learning objective 6.5 – Identify the principles and limitations of internal control. Feedback: The maximum benefit from independent internal verification is obtained when discrepancies are reported to management.

27. A business handles a large volume of similar transaction data by using: a. one general ledger. *b. control accounts and subsidiary ledgers. c. worksheets. d. financial statements. Answer: b Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: An efficient and effective way for businesses to process a large number of transactions is to use control accounts and subsidiary ledgers.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. The design of an accounting information system requires that: a. the information needs of external users are identified. *b. the forms and documents are designed and the methods and procedures are selected. c. the personnel are closely supervised during training. d. the sources of the data collection are identified. Answer: b Learning objective 6.2 – Explain the major phases in the development of an accounting system. Feedback: A new accounting system must be designed from the ground up – forms and documents designed and methods and procedures selected.

29. Which of the following is not a common example of a subsidiary ledger? a. accounts receivable b. accounts payable *c. sales journal d. debtors’ ledger Answer: c Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: The sales journal is a journal, not a subsidiary ledger.

30. The general ledger account that summarises subsidiary ledger data is called: a. a general account. *b. a control account. c. a summary account. d. a temporary account. Answer: b Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: A control account is a general ledger account that summarises the detail from the subsidiary ledger.

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Chapter 6: Accounting information systems

31. A subsidiary ledger is a group of: a. financial statements with a common reporting date. b. worksheets with a common reporting date c. ledgers with a common characteristic. *d. accounts with a common characteristic. Answer: d Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: A subsidiary ledger is a group of accounts with a common characteristic (e.g. all accounts receivable). The subsidiary ledger frees the general ledger of the details of individual balances.

32. Each general ledger control account balance must equal the total balance of the accounts in the: a. trial balance. b. statement of financial position. c. income statement. *d. related subsidiary ledger. Answer: d Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: Each general ledger control account balance must equal the composite balance of the individual accounts in the related subsidiary ledger at the end of an accounting period.

33. The accounts receivable account control account in the general ledger can also be called the: a. purchases control account. *b. debtors’ control account. c. creditors’ subsidiary ledger. d. sales control account. Answer: b Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: Accounts receivable is also known as “debtors”.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. If Supreme Ltd has the following opening account balances for its debtors of: $6 000, $7 000, $4 000; and cash received from debtors during the period amounted to $5 000 and if no additional sales on account were made to the debtors during the period, then the closing balance of the control account for accounts receivable is: a. $17 000. *b. $12 000. c. $22 000. d. $4 000. Answer: b Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: The opening account balance of the debtors’ ledger, plus new charges during the period, minus cash collections from customers equals the closing balance of accounts receivable i.e.: (6,000 + 7,000 + 4,000) + 0 – 5,000 = 12,000.

35. A list of all accounts and their balance in the accounts payable subsidiary ledger is also known as a: a. trial balance. *b. schedule of creditors. c. control account. d. statement of financial position. Answer: b Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: A schedule of creditors (or accounts payable) is a list of all accounts and their balances in the subsidiary ledger for accounts payable at a particular date.

36. When control and subsidiary accounts are included in an accounting information system there must be a dual posting, once to the: a. control account and once to the general journal. *b. control account and once to the subsidiary account. c. special journal and once to the cash account. d. general ledger and once to the trial balance. Answer: b Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: When an accounting information system included control and subsidiary accounts postings are made to the control account and the subsidiary account.

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Chapter 6: Accounting information systems

37. The sum of the account balances in a subsidiary ledger must equal the balance in the: a. general journal. b. trial balance. c. special journal. *d. related control account Answer: d Learning objective 6.9 – Describe the nature and purpose of control accounts and subsidiary ledgers. Feedback: Each general ledger control account must equal the composite balance of the individual accounts in the related subsidiary ledger at the end of the accounting period.

38. A two-column journal that is used to record a variety of different transactions is also known as a: *a. general journal. b. special journal. c. final journal. d. worksheet. Answer: a Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: A general journal is used to record transactions that cannot be entered in a special journal, including correcting, adjusting and closing entries.

39. A general journal is used for the recording of: a. adjusting entries. b. closing entries. *c. transactions that cannot be entered in a special journal. d. cash payments. Answer: c Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: A general journal is used to record transactions that cannot be entered in a special journal, including correcting, adjusting and closing entries.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. A sales journal is used for the recording of all: a. cash received including cash from debtors. b. cash paid including cash to creditors. c. purchases of inventory whether for cash or on account. *d. sales of inventory on account. Answer: d Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: A sales journal is used ONLY to record sales of inventory on account.

41. Which of the following is not an example of a special purpose journal? a. sales journal. b. cash receipts journal. c. cash payments journal. *d. general journal. Answer: d Learning objective 6.10 - Explain how special journals are used in recording transactions. Feedback: If a transaction cannot be recorded in a special journal, it is recorded in the general journal.

42. A cash payments journal is used to record: a. sales of inventory on account. b. purchases of inventory on credit. c. correcting and adjusting entries. *d. all cash paid out including for cash purchases of inventory. Answer: d Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: All payments are entered in a cash payments journal.

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Chapter 6: Accounting information systems

43. Cash sales of inventory are entered in the: a. cash payments journal. b. sales journal. c. purchases journal. *d. cash receipts journal. Answer: d Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: All receipts of cash, regardless of the source of cash, are recorded in the cash receipts journal.

44. Credit sales of assets other than inventory are recorded in the: *a. general journal. b. cash receipts journal. c. sales journal. d. purchases journal. Answer: a Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: The credit sale of assets is recorded in the general journal as it does not belong in the sales journal (which is only for the credit sale of inventory) or the cash receipts journal (as it was a credit sale not a cash sale).

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

45. Using a perpetual inventory system, inventory that is sold on account for $9,000 and which had a cost of $6,500 would be recorded using the following entry? a.

Dr Cr

Accounts receivable $9,000 Sales $9,000

Dr Cr

Accounts receivable $6,500 Cost of sales $6,500

*c.

Dr Cr Dr Cr

Accounts receivable $9,000 Sales $9,000 Cost of sales $6,500 Inventory $6,500

Dr Accounts receivable $9,000 Cr Sales $9,000 Dr Inventory $6,500 Cr Cost of Sales $6,500

Answer: c Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: Sales of inventory on account require a debit to Accounts Receivable and a credit to Sales at the selling price AND a debit to COS and a credit to inventory at cost.

46. The total of the sales on account column recorded in the sales journal is posted using the following entry: a. b. c. *d.

Dr Cr Dr Cr Dr Cr Dr Cr

General journal Special journal Sales Inventory Sales Cost of sales Accounts receivable Sales

Answer: d Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: Sales of inventory on account require a debit to Accounts Receivable and a credit to Sales at the selling price AND if a perpetual inventory system is used, a debit to COS and a credit to inventory at cost ALSO.

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Chapter 6: Accounting information systems

47. The total of the cost of sales on account column recorded in the sales journal, is posted using the following entry: *a. b. c. d.

Dr Cr Dr Cr Dr Cr Dr Cr

Cost of sales Inventory Sales Accounts receivable Inventory Cost of sales Cost of sales Sales

Answer: a Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: Sales of inventory on account require a debit to Accounts Receivable and a credit to Sales at the selling price AND if a perpetual inventory system is used, a debit to COS and a credit to inventory at cost ALSO.

48. A cash receipts journal will always include the following column: *a. cash. b. accrued expenses. c. unpaid liabilities. d. depreciation. Answer: a Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: A cash receipts journal will always have a “Cash” column. Other columns are determined by the frequency of the transaction.

49. All receipts of cash are recorded in: a. the general journal. b. a cash payments journal. *c. a cash receipts journal. d. the sales journal. Answer: c Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: All cash receipts, regardless of their source, are recorded in the cash receipts journal.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

50. In a cash receipts journal, the amount deducted by a customer for paying within the credit terms is entered in the: a. cash column. b. total sales column. c. bank column. *d. discount allowed column. Answer: a Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: In a cash receipts journal discounts allowed are entered into the column titled “discount allowed”.

51. All purchases of inventory are recorded: a. only in a cash payments journal. *b. in the purchases journal. c. only in the general journal. d. directly in the ledger accounts. Answer: b Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: The purpose of the purchases journal is to record the purchase of inventory on credit only.

52. Entries in the purchases journal for inventory are made from the following source documents: a. debtors invoices. b. cash register receipts. *c. creditors invoices. d. ledger accounts. Answer: c Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: Creditors’ invoices are used to record inventory entries in the purchases journal.

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Chapter 6: Accounting information systems

53. Credit purchases of equipment or supplies are recorded in the: a. purchases journal. *b. general journal. c. cash payments journal. d. sales journal. Answer: b Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: When a single column purchases journal is used credit purchases of equipment or supplies are recorded in the general journal.

54. In a cash receipts journal the total of the accounts receivable column is posted as a credit to: a. the cost of sales. b. the individual customer’s accounts. *c. the accounts receivable control account in the general ledger. d. discount allowed. Answer: c Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: In a cash receipts journal the total of the accounts receivable column is posted as a credit to the accounts receivable control account in the general ledger.

55. Which of the following symbols is an appropriate reference to indicate that the postings found in ledger accounts are from page 1 of the purchases journal? a. CR1 b. CP1 c. GJ1 *d. P1 Answer: d Learning objective 6.14 – Record transactions for sales, purchases, cash receipts and cash payments in special journals. Feedback: Posting found in ledger accounts from page 1 of the purchases journal are denoted by P1 (page one).

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

56. Transactions that cannot be entered in a special journal are: a. not recorded. *b. recorded in a general journal. c. deferred until the next reporting period. d. entered directly into the ledger accounts instead. Answer: b Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: All transactions that cannot be entered in a special journal are recorded in a general journal.

57. Special journals for sales, purchases and cash: a. significantly increase the number of entries in a general journal. b. totally eliminate the need for a general journal. *c. substantially reduce the number of entries in the general journal. d. are only able to be used in a manual accounting information system. Answer: c Learning objective 6.10 – Explain how special journals are used in recording transactions. Feedback: Entries to the general journal are greatly reduced by using special journals.

58. In a multicolumn journal, the amounts for debit and credit: *a. must be equal. b. need not be equal. c. will always be different. d. will not be the same. Answer: a Learning objective 6.15 – Understand how multi-column special journals are posted. Feedback: In a multi-column journal, the amounts for debit and credit must equal. This is the foundation of double entry bookkeeping.

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59. The total amount of a column labelled as ‘other’ in a cash receipts journal is: a. posted as a debit. b. posted as a credit. c. posted once to the cash account and once to accounts receivable. *d. never posted. Answer: d Learning objective 6.15 – Understand how multi-column special journals are posted. Feedback: In a cash receipts journal the column labelled ‘other’ is never posted – the individual amounts are posted as credits.

60. The amounts recorded in the accounts payable column in a cash payments journal are posted: *a. individually on a daily basis to the subsidiary ledger. b. individually on a daily basis to the purchases journal. c. only in total at the end of the reporting period to the income statement. d. only in total at the end of the reporting period to the statement of financial position. Answer: a Learning objective 6.15 – Understand how multi-column special journals are posted. Feedback: In a cash payments journal the individual amounts recorded in the accounts payable column are posted daily to the subsidiary ledger.

61. Where credit purchases of items other than inventory are numerous which of the following journals is expanded into a multicolumn journal to record the purchases? a. general journal. b. cash payments journal. *c. purchases journal. d. sales journal. Answer: c Learning objective 6.15 – Understand how multi-column special journals are posted. Feedback: The purchases journal can be expanded into a multicolumn journal to record numerous credit purchases of non-inventory items.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

62. In a computerised accounting information system the steps of journalising, posting and preparing a trial balance are performed: a. by employees who enter transactions by hand. b. at low speed by employees. *c. automatically by the computer. d. manually. Answer: c Learning objective 6.11 & 6.12– Understand the basic features of computerised accounting systems; & appreciate the role and use of non-integrated systems. Feedback: In a computerised accounting information system the computer performs the journalising, posting and trial balance preparation automatically.

63. In a fully integrated accounting information system, data entered into one module: a. are not automatically updated into other modules within the system. *b. are automatically updated in all other relevant modules. c. are recorded only as a single entry, either debit or credit. d. also need to be entered into all other subsystems. Answer: b Learning objective 6.11 & 6.12– Understand the basic features of computerised accounting systems; & appreciate the role and use of non-integrated systems. Feedback: A fully integrated accounting information system automatically updates all relevant modules with new data.

64. Which of the following would not be regarded as an advantage in an integrated computerised accounting information system? *a. fast processing time. b. quick report production. c. error reduction. d. slow processing time. Answer: a Learning objective 6.13 – Identify the advantages and disadvantages of computerised accounting systems. Feedback: Fast processing time is an advantage of an integrated computerised accounting information system.

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Chapter 6: Accounting information systems

65. Which of the following would be regarded as a disadvantage of an integrated computerised accounting information system? a. reduction in processing time. *b. not making full use of the system’s capabilities. c. flexible report production. d. virtually error-free posting. Answer: b Learning objective 6.13 – Identify the advantages and disadvantages of computerised accounting systems. Feedback: An integrated computerised accounting information system does not make full use of the system’s capabilities.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises

66. Below are descriptions of internal control problems. In the space to the left of each item, enter the code letter of the best internal control principle that is related to the problem described. Internal Control Principles A. Establishment of responsibility B. Segregation of duties C. Physical, mechanical, and electronic control devices D. Documentation procedures E. Independent internal verification F. Other controls ____

1. The same person opens incoming mail and posts the accounts receivable subsidiary ledger.

____

2. Three people handle cash sales from the same cash register drawer.

____

3. A clothing store is experiencing a high level of inventory shortages because people try on clothing and walk out of the store without paying for the merchandise.

____

4. The person who is authorised to sign cheques approves purchase orders for payment.

____

5. Some cash payments are not recorded because cheques are not prenumbered.

____

6. Cash shortages are not discovered because there are no daily cash counts by supervisors.

____

7. The treasurer of the company has not taken a holiday for over 20 years.

Answers below. Learning objective 6.1 – 6.15. 1. 2. 3. 4.

B A C B

5. D 6. E 7. F

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Chapter 6: Accounting information systems

67. Indicate whether each of the business practices listed below strengthens (S) or weakens (W) a company’s system of internal control. ____ ____ ____ ____ ____

a. b. c. d. e.

Cheques require only one signature. All payments are made with cheques. Discouraging employees from taking paid holidays. Two people handle cash sales from the same cash register drawer. Using pre-numbered sales tickets.

Answers below. Learning objective 6.1 – 6.15. a. b. c. d. e.

W S W W S

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

68. Sam Hill has worked for Dr. Lee Chang for several years in the administration of De Chang’s medical practice. Sam demonstrates a loyalty that is rare among employees. He hasn't taken a holiday in the last three years. One of Sam's primary duties at the medical office is to open the mail and list the cheques received. He also takes cash from patients when they leave. At times it is so hectic that Sam doesn't bother with giving patients a receipt for the cash paid on their accounts. He assures them he will see to it that they receive the proper credit. When the traffic is slow in the office Sam offers to help Mary post the payments to the patients' accounts receivable. She is always happy to receive his help, because he is a very conscientious worker. Identify any principles of internal control that may be violated in this medical office situation.

Answers below. Learning objective 6.1 – 6.15. Violations: 1. It is Mary's responsibility to post payments to patient accounts. In allowing Sam to assist her, the establishment of responsibility principle is violated. 2. Although it appears to be a small office, it is not appropriate that Sam opens the mail, receives and records cash receipts from patients, and also appears to have custody of cash. This situation violates the segregation of duties principle. By posting to patients' accounts it would be possible to post credits to patient accounts and pocket the cash. 3. The documentation principle is violated when patients are not given cash receipts. Although many professional offices do not have cash registers, computerised or manual receipts are customary and necessary. 4. Independent internal verification is also being violated. There is no independent counting of the cash and comparison to total receipts. 5. Other controls are being violated. Personnel should be required to take holidays.

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Chapter 6: Accounting information systems

69. Kosta Ltd uses both special journals and a general journal. The Accounts Receivable control account had an opening debit balance of $225 000 and the Accounts Payable control account had an opening credit balance of $65 000. The transactions for the next month of operations are summarised below. —————————————————————————————————— (1) Sales journal Total sales $195 000 —————————————————————————————————— (2) Purchases journal Total purchases $70 000 —————————————————————————————————— (3) Cash receipts journal Accounts receivable column $175 000 —————————————————————————————————— (4) Cash payments journal Accounts payable column $55 000 —————————————————————————————————— Required: (a) (b) (c) (d)

Name the account that the total of $195 000 in the Sales journal is posted as a credit to. Name the account that the total of the Accounts Payable column in the Cash Payments journal is posted as a credit to. What is the balance of the Accounts Receivable control account after the postings for the month? What is the balance of the Accounts Payable control account after the postings for the month?

Answers below. Learning objective 6.1 – 6.15. (a) (b) (c) (d)

Accounts Receivable Control account Accounts Payable Control account $245 000 ($225 000 + $195 000 - $175 000) $80 000 ($65 000 + $70 000 - $55 000)

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

70. On 1 August the balance of the Accounts Receivable Control account for Young Rental Company was $10 500. The customers’ subsidiary ledger contained account balances as follows: Anton Carmine Fenech Muro

$3 000 $4 500 $1 000 $2 000

At the end of August the special journals contained the following information: Sales journal

Sales to: Anton Carmine Fenech Muro

Cash Receipts journal

$ 800 $ 300 $1 200 $1 900

Cash received from: Muro $2 000 Anton $1 500 Fenech $ 500 Carmine $4 800

Required: (a) (b)

Set up control and subsidiary ledger accounts and post the necessary data from the journals to the ledger accounts Prepare a schedule of customers and check the total against the balance of the control account

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Chapter 6: Accounting information systems

Answers below. Learning objective 6.1 – 6.15. (a) Accounts Receivable Control 1 Aug Op. Bal. 31 Aug Sales

10 500 4 200

31 Aug Cash 31 Aug Cl. Bal

8 800 5 900

1 Aug Op. Bal. 31 Aug Sales

3 000 800

31 Aug Cash 31 Aug Cl. Bal.

1 500 2 300

1 Aug Op. Bal 31 Aug Sales

4 500 300

31 Aug Cash 31 Aug Cash

4 800 Nil

1 Aug Op. Bal. 31 Aug Sales

1 000 1 200

31 Aug Cash 31 Aug Cash

500 1 700

1 Aug Op. Bal. 31 Aug Sales

2 000 1 900

31 Aug Cash 31 Aug Cash

2 000 1 900

Anton

Carmine

Fenech

Muro

(b)

Schedule of customers at 31 August Anton Carmine Fenech Muro Total

2 300 0 1 700 1 900 5 900

Check against closing balance of Accounts Receivable Control $5 900

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

71. Identify the journal in which each of the following transactions is recorded. (a) (b) (c) (d) (e) (f) (g)

Cash sales Credit sales Purchase of inventory on account Cash sale of buildings Payment of cash for supplies Payment of cash for prepaid rent Sale of property on account

Answers below. Learning objective 6.1 – 6.15. (a) (b) (c) (d) (e) (f) (g)

Cash receipts journal Sales journal Purchases journal Cash receipts journal Cash payments journal Cash payments journal General journal

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Chapter 6: Accounting information systems

72. May’s Calendar Shop use a perpetual inventory system and had the following transactions in the month of September. September terms

1 10 17 23

Sold inventory on account to J Jurb, invoice no. 201 for $350, n/30. The cost of the inventory was $290. Sold inventory on account to T Wyse, invoice no. 202 for $580, terms n/30. The cost of the inventory was $430. Sold inventory to P Donald for $1 000 cash. The cost of the goods sold was $670. Sold inventory on account to J Raffe, invoice no. 203 for $2 800, terms n/30. The cost of the inventory was $1 700.

Record the transactions that should be included in a properly drawn up sales journal.

Answers below. Learning objective 6.1 – 6.15. May’s Calendar Shop Sales Journal S1 Date Sep 1

Invoice no.

Account debited

A/c Rec Sales

DR COS DR CR Inventory CR

J Jurb

201

350

290

Sep 10 T Wyse

202

580

430

Sep 23 J Raffe

203

2 800

1 700

3 730

2 420

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

73. Sloan Caps and Bags Company had the following transactions during June. 1.

Received a cash refund from a creditor for goods returned.

Made a payment to a creditor.

Purchased inventory on account.

Purchased inventory for cash.

Purchased supplies of goods for use in the office, for cash.

Paid cash for equipment to be used in the office.

Purchased office equipment on account.

The Sloan Caps and Bags Company use special purpose journals and a general journal. Identify the appropriate journal for the record of each of the transactions above.

Answers below. Learning objective 6.1 – 6.15. Journal 1. Cash receipts 2. Cash payments 3. Purchases 4. Cash payments 5. Cash payments 6. Cash payment 7. General journal

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Chapter 6: Accounting information systems

74. Presented below is a trial balance for the Rand Company at December 31. Rand Company Trial balance at 31 December Cash Accounts receivable control Prepayments Accounts payable control Bank loan Share capital Retained earnings Revenue Expenses

27 000 50 000 20 000 30 000 15 000 12 000 10 000 40 000 10 000

The following transactions had not been recorded at 31 December. 1. Gave a credit of $1 000 to a customer who returned damaged goods. 2. Sold goods on credit for $9 000. The goods cost $6 000 3. Purchased goods on account for $4 000. Determine the effect on the trial balance after these transactions have been posted and ensure that the trial balance is in balance.

Answers below. Learning objective 6.1 – 6.15. Rand Company Adjusted trial balance Cash Accounts receivable control Inventory Accounts payable control Bank loan Share capital Retained earnings Revenue Expenses Total

Unadjusted 27 000 50 000 20 000 30 000 15 000 12 000 10 000 40 000 10 000

Adjustments -$1000, +$9000 -$6000, +$4000 +$4000

-$1 000, +$9000 +$6000

Adjusted $27 000DR $58 000DR $18 000DR $34 000CR $15 000CR $12 000CR $10 000CR $48 000CR $16 000DR

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

75. Listed below are some typical transactions incurred by the Eldon Fitness Centre. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Receipts from customers. Payment of creditors. Purchase of goods from creditors on account. Sales of goods to customers on credit. Depreciation on property. Purchase of supplies on account. Sales on goods (not inventory) on account. Closing journal entries. Transfer of revenue and income to profit and loss summary. Owner makes a payment of capital to the business.

For each transaction indicate whether it would normally be recorded in a cash receipts journal, cash payment journal, sales journal, single-column purchases journal, or a general journal.

Answers below. Learning objective 6.1 – 6.15. 1. Cash receipts journal 2. Cash payments journal 3. Purchases journal 4. Sales journal 5. General journal 6. General journal 7. General journal 8. General journal 9. General journal 10. Cash receipts journal

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Chapter 6: Accounting information systems

76. Gregory’s Glass Repairs had the following transactions involving the receipt of cash. Jan 1 The owner, Gregory Glenister, invested cash of $20,000 in the business. Jan 2 Purchased inventory on account for $5,000. Jan 5 Sold goods for $6,000 credit, the goods cost $2,500. Jan 8 Paid wages of $1,200. Jan 15 Purchased inventory for cash, $500. Jan 19 Sold goods on credit for $8,000. The goods cost $3,200. Jan 22 Paid wages of $1,200. Jan 27 Sold goods on credit for $7,000. The goods cost $1,500. Jan 28 Customer returned faulty goods and received a full credit of $1,000. The goods had originally cost $200. Required: (a) Identify the journal in which each transaction is recorded. (b) Calculate the total of the accounts receivable in the sales journal and the total of the accounts payable in the purchases journal for the month of January.

Answers below. Learning objective 6.1 – 6.15. (a) & (b)

Cash receipts Cash payments Journal journal

Jan 1 Jan 2 Jan 5 Jan 8 Jan 15 Jan 19 Jan 22 Jan 27 Jan 28

+$20,000

Sales journal

Purchases journal

+$5,000 +$6,000 -$1,200 -$ 500 +$8,000 -$1,200 +$7,000 - $1,000 $20,000

$5,000

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

77. In the space below, list four advantages of an accounting information system that uses subsidiary ledgers. Advantages 1 2 3 4

Answers below. Learning objective 6.1 – 6.15. Advantages 1 Subsidiary ledgers show transactions affecting one customer or one creditor in a single account thus providing up-to-date information on specific account balances. 2 Subsidiary ledgers free the general ledger of excessive detail. As a result, a trial balance of the general ledger does not contain vast numbers of individual accounts. 3 Subsidiary ledgers 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 Subsidiary ledgers make it possible to segregate the duties of employees in posting. One employee can post to the general ledger while another employee can post to the subsidiary ledgers. Segregation of duties improves control over the recording process.

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Chapter 6: Accounting information systems

Completion statements

78. Please complete the following statements: 1.

Internal control consists of the related methods and measures adopted within a business to ____________ its assets and enhance the ______________ and ______________ of its accounting records.

The principle of internal control that prevents one individual from being responsible for all the related activities of a given task is ______________ of duties.

The ______________ of an asset should not have access to the accounting records of that asset.

Employees of a company who evaluate the effectiveness of the company's system of internal controls on a year-round basis are called ______________ auditors.

Using _______________ documents is a control measure that helps to prevent a transaction from being recorded more than once or to prevent the transactions from not being recorded.

Employees who handle cash should be given compulsory ______________ in order to rotate their jobs and protect against misappropriation of assets by dishonest employees.

Two limitations of systems of internal control are the concept of ___________ assurance and the ______________ element.

Whether a manual or a computerised accounting information system is used in maintaining accounting records, certain ____________ and _____________ apply.

To understand how computerised accounting systems operate, you need to understand how _____________ _____________ systems work.

10.

If an accounting information system is effective, it provides __________ output and has the _______________ to meet future needs.

11.

The starting point in developing an effective accounting system is to determine the needs of ___________ and ____________ users.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Implementation of a new or revised accounting system requires that ___________, procedures and processing equipment be installed and made ________________.

13.

An efficient and effective way for businesses to process a large volume of transactions is to use ____________ accounts and ______________ ledgers.

14.

A common subsidiary ledger is the accounts ____________ ledger which collects transaction data of individual creditors.

15.

A _________________ of accounts receivable is a list of all accounts and their ____________ in the subsidiary ledger for accounts receivable at a particular date.

16.

A special journal is used to record ____________ types of transactions.

17.

A _________ journal is used to record sales of ____________ on account.

Answers below. Learning objective 6.1 – 6.15. 1. safeguard, accuracy, reliability 2. segregation 3. custodian 4. internal 5. pre-numbered 6. holidays 7. reasonable, human 8. principles, procedures 9. manual, accounting 10. useful, flexibility 11. internal, external 12. documents, operational 13. control, subsidiary 14. payable 15. schedule, balances 16. similar 17. sales, inventory

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Chapter 6: Accounting information systems

Matching

79. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E. F G. H. I. J K. L. M.

Sales journal Special journal Control account Subsidiary ledger Cash payments journal Integrated accounting system Manual accounting system Purchases journal Schedule of accounts receivable Pre-numbered documents Collusion Television monitors, garment sensors and burglar alarms are examples Custody of an asset should be kept separate from the record-keeping for that asset

_____ 1. Segregation of duties. _____ 2. Two or more employees circumventing prescribed procedures. ____ 3. Prevent a transaction from being recorded more than once. ____

4. Mechanical and electronic control devices

_____ 5. A list of all accounts and their balances in the accounts receivable subsidiary ledger. _____ 6. A group of accounts with a common characteristic, the total of which should equal the balance in the related general ledger control account. _____ 7. A special journal used to record all cash payments. _____ 8. A computerised accounting package consisting of several modules which perform different accounting functions. _____ 9.A special journal used to record all purchases of inventory on account. . _____ 10. A special journal used to record all sales of inventory on account _____ 11. A system in which each of the steps in the accounting cycle is performed by hand. _____ 12. A journal that is used to record similar types of transactions, such as all credit sales.

6.45

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

_____ 13. An account in the general ledger that is supported by the detail of a subsidiary ledger.

Answers below. Learning objective 6.1 – 6.15. 1. 2. 3. 4. 5.

M K J L I

6. 7. 8. 9. 10.

D E F H A

11. G 12 B 13 C

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Chapter 6: Accounting information systems

Short-answer essay questions 80. Important objectives of a system of internal controls are to safeguard assets and to enhance the accuracy and reliability of the accounting records. Briefly discuss how (1) cost-benefit considerations, (2) the human element, and (3) the size of the business affect the implementation of a system of internal controls.

Answer below. Learning objective 6.1 – 6.15. The implementation of a system of internal controls is affected by cost-benefit considerations, the human element, and the size of the business. A company's system of internal control can provide reasonable assurance, but not absolute assurance, that assets are properly safeguarded and that the accounting records are reliable. The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit. A very costly set of safeguards may produce something approaching absolute assurance, but the value of the benefits received would not come close to outweighing the costs. The human element can cause a good system of internal control to become ineffective due to employee fatigue, carelessness, or indifference. Additionally, collusion between two or more employees to circumvent prescribed controls may significantly impair the effectiveness of the system. The size of a business impacts internal control because a smaller business may not have the necessary resources available to affect the implementation of desirable controls.

6.47

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

81. An integrated accounting information system is an optional method for the management and administration of a business’s transaction and event data. In deciding to switch from a manual to an integrated system consider the steps that should be followed in order to develop an efficient and effective of accounting system. Answer below. Learning objective 6.1 – 6.15. Good accounting systems are carefully planned, designed, installed and managed. Management regularly obtains feedback and review and modifies their systems to improve usability and business practices and processes. Generally an accounting system is developed in the following four phases. (1) Analysis, which is the starting point in the determination of the needs of internal and external users of the information. (2) Design which is the development of documents, methods, processes, controls and the formatting of reports. (3) Implementation is the stage during which newly designed documents and processes are made operational. (4) Follow-up or review is the final stage in which the system is monitored and weaknesses are identified and corrected.

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Chapter 6: Accounting information systems

82. Journalising and posting closing entries is a required step in the accounting cycle. Discuss why it is necessary to use more than one journal to capture the details of transactions in larger businesses.

Answer below. Learning objective 6.1 – 6.15. The use of special journals in addition to the general journal presents a more effective way of capturing a large number of transactions and efficiently processing those transactions. It is efficient because many of the transactions can be grouped according to similar characteristics and summarised for the purposes of posted to the ledgers. This process reduces processing time and simplifies the records necessary for the potentially large numbers of customers and clients involved with a business.

6.49

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

83. Ethics: Under Protection provides underground storage facilities for companies desiring off-site storage of sensitive documents, computer records, and other items. They have developed a sophisticated surveillance and security system which they initially used in their own facilities, and have recently started to market elsewhere as well. The underground storage facilities are made from natural caves in some instances (reinforced and modified as appropriate) and from excavations of natural rock formations in others. The land was purchased over twenty years ago for a total of $1.5 million. The modifications have cost approximately $10 million more. The company no longer records the storage facilities in its accounting system because the market value of the property is too difficult to determine. Presently, the market price could be anywhere between zero and $40 million. Samantha Davis, a new accounting manager, questioned this accounting policy. Mark Johnson, the financial controller, has told her that she needn't worry about it. For one thing, he says, this is really a special form of asset which should not be recorded as it has been fully depreciated in the past. For another, this is a privately held company, and so they don't need to worry about misleading investors. All the owners know about and approve the accounting policy. Required: What are the ethical issues in this situation?

Answer below. Learning objective 6.1 – 6.15. The ethical issue is one of integrity. Even though the storage facilities are fully depreciated that does not mean that they do not represent economic value to the business. The accounting system should be able to produce reports of assets that are held by the business and do not appear in the financial statements. The statement of financial position is being understated and is potentially misleading. It is possible that harm may be incurred by outside parties because of the misrepresentation in the financial statements. Even though the owners know about the (lack of) recording, they may still use their ownership of this resource as a means by which to secure loans. Private investors and bankers should be able to rely on the financial statements. Another issue is that of the integrity of the accountants themselves. If they are being asked to ignore the existence of a valuable resource owned by the business, they should certainly ask themselves what lies ahead.

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Chapter 6: Accounting information systems

84. Ethics: Taylor Instruments is a rapidly growing manufacturer of medical devices. As a result of its growth, the company's management recently modified several of its procedures and practices to improve internal control. Some employees are upset with the changes. They have complained that all these changes just show that the company no longer trusts them. Required: ‘Internal controls exist because most people can't be trusted.’ Is this true? Explain.

Answer below. Learning objective 6.1 – 6.15. Internal controls exist, not because most people can't be trusted, but to protect the company's assets from those few who can't be trusted. If it was a perfect world, and everyone could be trusted, internal controls would not be needed. However, it does not follow that internal controls indicate the opposite. It is true that anyone is capable of practically any action, if motivation and opportunity are both present. Since it is extremely difficult to measure motivation to directly or indirectly harm the company, let alone to monitor changes in motivation, a company's best recourse is to prevent opportunity. Rather than feel threatened by internal control measures, honest employees should feel grateful. When responsibility for all activities is clearly defined and when access to company assets is carefully controlled, the honest employees can demonstrate their honesty. When all employees are considered to be honest, on the other hand, and no controls exist, all employees are unfairly tainted when one among them is dishonest.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

85. Communication: Clinix is a medical office management franchise. There are currently twenty-five medical offices managed by a Clinix franchisee. One of the services provided to franchisees is assistance in training various staff members. Clinix is preparing a manual for the front office staff to use as a reference guide. It will be used in training new employees as well. One of the reasons the manual is being prepared is to stress the importance of strong internal controls. Required: Prepare a short paragraph, to be included in the training materials, describing the benefits of sound internal control, from the viewpoint of the employee.

Answer below. Learning objective 6.1 – 6.15. All the controls discussed in this manual may seem unnecessary to you. It may also seem that management trusts no one. However, these practices and procedures actually benefit you, the employee. First, internal control policies outline who is to be responsible for various activities, such as making the daily deposit of cash in the bank. If a problem arises regarding a deposit, it is very clear to whom the company should turn to resolve the problem. If correct procedures were not followed, blame is not placed on all employees. Only those who did not follow correct procedures are held accountable for their actions. Also, strong internal controls discourage many opportunistic people, who find such opportunities to harm the company are extremely limited. All these systems, practices, and procedures result in a well-managed company that is less likely to suffer losses, and a much better place for you to work and build a career.

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Chapter 6: Accounting information systems

86. Communication: You have recently started to work for Lloyd Beaton, manufacturers of stone monuments. During your first month at work, you inadvertently recorded $30,000 of accounts receivable as accounts payable. The financial statements had been released within the company when you discovered your error. The month-end closing had not been completed, however, and you were able to correct the accounts without incident. Required: Prepare a short note to accompany the re-released financial statements explaining the mistake.

Answer below. Learning objective 6.1 – 6.15.

MEMO TO:

Department Managers

FROM: Martha King, Accounting RE:

Month-End Reports

****ATTACHED FINANCIAL STATEMENTS REPLACE THOSE ISSUED JULY 5**** *****DESTROY ALL EARLIER COPIES OF JUNE 30 FINANCIAL STATEMENTS**** An error was made in the recording of accounts receivable and accounts payable. This error was detected by comparing computer-generated reports of the total of the general ledger control accounts for Accounts Receivable and Accounts Payable against the relevant subsidiary ledgers. As a result, Accounts Receivable has now been restated (increased) by $30,000 and Accounts Payable has been decreased by the same amount. This error was detected on a timely basis as a result of the newly implemented accounting information systems.

(Signature)

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Chapter 7: Reporting and analysing cash and receivables

Chapter 7: Reporting and analysing cash and receivables Multiple-choice questions

1. From an internal control standpoint, the asset most susceptible to improper diversion and use is: a. prepaid insurance. *b. cash. c. buildings. d. land. Answer: b Learning objective 7.3 – Explain the application of internal control principles to handing cash. Feedback: Cash is most liquid asset and therefore the most susceptible to improper diversion and misappropriation from an internal control point.

2. Cash equivalents do not include: a. money market accounts. b. commercial paper. c. Treasury bills. *d. bill receivable in 6 months. Answer: d Learning objective 7.1 – Identify the effect of business transactions on cash. Feedback: Cash equivalents are highly liquid investments that can be quickly converted to cash.

3. Which one of the following items would not be considered cash? a. coins. b. money orders. c. currency. *d. postdated cheques. Answer: d Learning objective 7.1 – Identify the effect of business transactions on cash. Feedback: Cash consists of coins and paper money, cash at bank and cash equivalents (highly liquid investments). Postdated cheques are not considered cash.

7.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. The reconciliation of the cash register tape with the cash in the register is an example of: a. other controls. b. establishment of responsibility. *c. independent internal verification. d. segregation of duties. Answer: c Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: The reconciliation of the cash register tape and cash in the register is an example of an independent internal verification.

5. Which of the following is not an internal control procedure for cash? *a. Payments should be made with cash. b. There should be limited access to cash. c. The amount of cash on hand should be kept to a minimum. d. Cash should be deposited daily. Answer: a Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: Generally, internal control over cash payments is more effective when payments are made by using a bank account rather than cash on hand, except for incidental amounts that are paid out of petty cash.

6. Which of the following is not a suggested procedure to establish internal control over cash disbursements? *a. Anyone can sign the cheques. b. Different individuals approve and make the payments. c. Blank cheques are stored with limited access. d. The bank statement is reconciled monthly. Answer: a Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: One suggested procedure to establish internal control over cash disbursements is to have only authorised persons such as a manager sign the cheques.

7.2

Chapter 7: Reporting and analysing cash and receivables

7. Control over cash disbursements is generally more effective when: a. all bills are paid in cash. b. disbursements are made by the accounts payable subsidiary clerk. c. all purchases are made on credit. *d. payments are made by cheque. Answer: d Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: Generally, internal control over cash payments is more effective when payments are made by using a bank account rather than cash on hand, except for incidental amounts that are paid out of petty cash.

8. Supervisors counting cash receipts daily is an example of: a. other controls. *b. independent internal verification. c. establishment of responsibility. d. segregation of duties. Answer: b Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: The reconciliation of the cash register tape and cash in the register is an example of an independent internal verification.

9. Which of the following is not an internal control procedure for cash? a. Only designated personnel are authorised to handle cash. *b. The same individual receives the cash and pays the bills. c. Surprise audits of cash on hand should be made occasionally. d. Access to cash is limited. Answer: b Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: Having the same individual receive the cash and pay the bills is not an internal control procedure for cash.

7.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. The use of pre-numbered cheques is an example of: a. segregation of duties b. independent internal verification c. establishment of responsibility *d. documentation procedures Answer: d Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: Using pre-numbered cheques is an example of documentation.

11. An exception to disbursements being made by cheque is acceptable when cash is paid: a. to an owner. b. to employees as wages. *c. from petty cash. d. to employees as loans. Answer: c Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: Generally, internal control over cash payments is more effective when payments are made by using a bank account rather than cash on hand, except for incidental amounts that are paid out of petty cash.

12. An employee authorised to sign cheques should not record: a. owner cash contributions. b. mail receipts. *c. cash disbursement transactions. d. sales transactions. Answer: c Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: An employee who is authorised to sign cheques should not record cash disbursement transactions. The responsibility for related duties should be assigned to different individuals.

7.4

Chapter 7: Reporting and analysing cash and receivables

13. Allowing only the financial controller to sign cheques is an example of: a. documentation procedures. b. separation of duties. c. other controls. *d. establishment of responsibility. Answer: d Learning objective 7.3 – Explain the application of internal control principles for handing cash. Feedback: Allowing only the financial controller to sign cheques is an example of the establishment of responsibility. 14. Which one of the following would not cause a bank to debit a depositor’s account? a. Bank service charge. *b. Collection of a note receivable. c. EFT of funds to other locations. d. Cheques marked NSF. Answer: b Learning objective 7.1 – Identify the effect of business transactions on cash. Feedback: A debit to a depositor’s account decreases the depositor’s account balance. The collection of a note receivable will increase the depositor’s account and will cause a credit.

15. A bank statement: a. let’s a depositor know the financial position of the bank as of a certain date. b. is a credit reference letter written by the depositor’s bank. c. is a bill from the bank for services rendered. *d. shows the activity that increased or decreased the depositor’s account balance. Answer: d Learning objective 7.4 – Prepare a bank reconciliation. Feedback: A bank statement shows the activities that caused changes to the depositor’s bank balance.

7.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. A company maintains the asset account, Cash, on its books, while the bank maintains a reciprocal account that is: a. a contra asset account. *b. a liability account. c. also an asset account d. an equity account Answer: b Learning objective 7.3 – Explain the application of internal control principles for handling cash. Feedback: If a company maintains an asset account, Cash, then the bank maintains a reciprocal account that is a liability account.

17. Which of the following would be added to the balance as per bank statement in a bank reconciliation? a. Outstanding cheques. *b. Outstanding deposits. c. Notes collected by the bank. d. Service charges. Answer: b Learning objective 7.4 – Prepare a bank reconciliation. Feedback: Outstanding deposits (deposits in transit) are added to the balance as per bank statement.

18. A deposit made by a company will appear on the bank statement as a: a. debit. *b. Credit. c. debit memorandum. d. credit memorandum Answer: b Learning objective 7.4 – Prepare a bank reconciliation. Feedback: A deposit made by a company will appear on the bank statement as a credit.

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Chapter 7: Reporting and analysing cash and receivables

19. Which of the following would be added to the balance of the cash at bank account in the books on a bank reconciliation? a. Outstanding cheques. b. Outstanding deposits. *c. Notes collected by the bank. d. Service charges. Answer: c Learning objective 7.8 – Describe how to value accounts receivable. Feedback: Notes collected by the bank are added to the book balance in a bank reconciliation.

20. Which of the following would be deducted from the balance per bank statement in a bank reconciliation? a. Notes collected by the bank. b. Outstanding deposits. *c. Outstanding cheques. d. Service charges. Answer: c Learning objective 7.4 – Prepare a bank reconciliation. Feedback: Outstanding cheques are deducted from the bank balance in a bank reconciliation.

21. Outstanding deposits (or deposits in transit): *a. have been recorded on the company's books but not yet by the bank. b. have been recorded by the bank but not yet by the company. c. have not been recorded by the bank or the company. d. are customers’ cheques that have not yet been received by the company. Answer: a Learning objective 7.4 – Prepare a bank reconciliation. Feedback: Outstanding deposits (deposits in transit) have been recorded on the company’s books but not yet by the bank.

7.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. Which of the following would be added to the balance per bank on a bank reconciliation? a. Outstanding cheques. *b. Outstanding deposits. c. Notes collected by the bank d. Service charges. Answer: b Learning objective 7.4 – Prepare a bank reconciliation. Feedback: Outstanding deposits (deposits in transit) are added to the bank balance on a bank reconciliation.

23. A bank reconciliation should be prepared: a. whenever the bank refuses to lend the company money. b. when an employee is suspected of fraud. *c. to explain any difference between the depositor's balance per books with the balance per bank. d. by the person who is authorised to sign cheques. Answer: c Learning objective 7.4 – Prepare a bank reconciliation. Feedback: A bank reconciliation should be prepared on a regular basis to explain any difference between the depositor’s balance per books and the balance per bank.

24. In preparing a bank reconciliation, outstanding cheques are: a. added to the balance per bank. b. deducted from the balance per books. c. added to the balance per books. *d. deducted from the balance per bank. Answer: d Learning objective 7.4 – Prepare a bank reconciliation. Feedback: In preparing a bank reconciliation, outstanding cheques are deducted from the balance per bank statement.

7.8

Chapter 7: Reporting and analysing cash and receivables

25. If a cheque correctly written and paid by the bank for $354 is incorrectly recorded on the company's books for $345, the appropriate treatment on the bank reconciliation would be to: a. add $9 to the bank's balance. b. add $9 to the cash at bank book balance. c. deduct $9 from the bank's balance. *d. deduct $9 from the cash at bank book balance. Answer: d Learning objective 7.4 – Prepare a bank reconciliation. Feedback: The appropriate treatment in this situation is to deduct $9 from the cash at bank book balance.

26. A cheque for $157 is incorrectly recorded by a company as $175. On the bank reconciliation, the $18 error should be: *a. added to the balance per books. b. deducted from the balance per books. c. added to the balance per bank. d. deducted from the balance per bank. Answer: a Learning objective 7.4– Prepare a bank reconciliation. Feedback: In this situation the $18 error should be added to the balance per books.

27. For which of the following errors should the appropriate amount be added to the balance per bank on a bank reconciliation? a. Cheque for $93 recorded as $39. b. A returned $400 cheque recorded by bank as $40. c. Cheque for $68 recorded as $86. *d. Deposit of $350 recorded by bank as $35. Answer: d Learning objective 7.4 – Prepare a bank reconciliation. Feedback: A deposit recorded by the bank as less than it actually is would be added to the balance per bank on a bank reconciliation.

7.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. Which of the following items on a bank reconciliation would require an adjusting entry on the company’s books? a. An error by the bank *b. A bank service charge c. Outstanding cheques d. An outstanding deposit Answer: b Learning objective 7.4 – Prepare a bank reconciliation. Feedback: A bank service charge would require an adjusting entry following a bank reconciliation.

29. Which of the following is not a basic principle of cash management? a. Increase collection of receivables. *b. Keep inventory levels high. c. Don’t pay liabilities earlier than expected. d. Invest idle cash. Answer: b Learning objective 7.5 – Discuss the basic principles of cash management. Feedback: Maintaining high inventory levels is not a principle of cash management.

30. Management of cash is the responsibility of the company: a. accountant. *b. finance director or finance manager. c. president. d. chief executive officer. Answer: b Learning objective 7.5 – Discuss the basic principles of cash management. Feedback: Cash management is usually the responsibility of the finance director or finance manager.

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Chapter 7: Reporting and analysing cash and receivables

31. Which of the following is not a basic principle of cash management? a. Increase collection of receivables. b. Keep inventory levels low. *c. Pay all liabilities late. d. Invest idle cash. Answer: c Learning objective 7.5 – Discuss the basic principles of cash management. Feedback: Paying liabilities no earlier than when expected, i.e. not late and not early, is a principle of cash management.

32. The ratio of cash to daily cash expenses is calculated by dividing: a. cash by total expenses. *b. cash and cash equivalents by average daily cash expenses. c. cash and cash equivalents by total expenses. d. cash by daily cash expenses. Answer: b Learning objective 7.6 – Assess the adequacy of cash. Feedback: The ratio of cash to daily cash expenses is calculated by dividing cash and cash equivalents by average daily cash expenses.

33. The following information is available for Chancellor Company: profit $3.600 million; net cash provided by operating activities $1,250 million; total expenses $2,500 million; depreciation expense $350 million; cash dividends $400 million; capital expenditures $650 million; and cash and cash equivalents $900 million. Chancellor’s cash to daily cash expenses ratio is calculated as: a. $1,250 ÷ ($2,500 ÷ 365) *b. $900 ÷ [($2,500 - $350) ÷ 365] c. $900 ÷ ($2,500 ÷ 365) d. $1,250 ÷ [($2,500 - $350) ÷ 365] Answer: b Learning objective 7.6 – Assess the adequacy of cash. Feedback: The ratio of cash to daily cash expenses is calculated by dividing cash and cash equivalents by average daily cash expenses.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. The following information is available for Grosvenor Company: profit $2,200 million; net cash provided by operating activities $1,200 million; total expenses $1,700 million; depreciation expense $275 million; cash dividends $330 million; capital expenditures $750 million; and cash and cash equivalents $700 million. Grosvenor’s cash to daily cash expenses ratio is calculated as: a. $1,200 ÷ ($1,700 ÷ 365) b. $700 ÷ ($1,700 ÷ 365) *c. $700 ÷ [($1,700 - $275) ÷ 365] d. $1,200 ÷ [($1,700 - $275) ÷ 365] Answer: c Learning objective 7.6 – Assess the adequacy of cash. Feedback: The ratio of cash to daily cash expenses is calculated by dividing cash and cash equivalents by average daily cash expenses.

35. Receivables are claims that are expected to be met in: *a. cash. b. inventory. c. liabilities. d. shares. Answer: a Learning objective 7.7 – Identify the different types of receivables. Feedback: Receivables are claims that are expected to be met in cash.

36. Accounts receivable includes: a. non-trade receivables. *b. amounts owed by customers on account. c. interest receivable. d. loans to company officers. Answer: b Learning objective 7.7 – Identify the different types of receivables. Feedback: Receivables are amount owed by customers on account and they are expected to be met in cash.

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Chapter 7: Reporting and analysing cash and receivables

37. Accounts receivable are reported on the statement of financial position as a/an: a. liability. b. equity. *c. asset. d. revenue. Answer: c Learning objective 7.9 – Describe how receivables are reported in financial statements. Feedback: Accounts receivable that mature within the current operating cycle are reported as a current asset in the balance sheet or statement of financial position.

38. Under the direct write-off method, when a particular account is considered to be uncollectible, the loss is charged to: a. revenue. b. accounts receivable. c. allowance for doubtful debts. *d. bad debts expense. Answer: d Learning objective 7.8 – Describe how to value receivables. Feedback: Under the direct write-off method, when a particular account is considered to be uncollectible, the loss is charged to bad debts expense.

39. The method being used to determine the amount of the allowance for doubtful debts that relies on a schedule in which customers balances are classified by the length of time they have been unpaid, is known as the: a. direct write-off method. b. net realisable method. *c. aged accounts receivable method. d. conservatism method. Answer: c Learning objective 7.8 – Describe how to value receivables. Feedback: Ageing the accounts receivable allows the allowance for doubtful debts to be determined.

7.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. Receivables that mature within the entity’s operating cycle are classified in the statement of financial position as: a. equity. b. liabilities. *c. current assets. d. non-current assets. Answer: c Learning objective 7.9 – Describe how receivables are reported in financial statements. Feedback: Receivables that mature within the entity’s operating cycle are classified in the statement of financial position as current assets.

41. The recoverable amount of trade receivables is shown in the: a. income statement. *b. statement of financial position. c. statement of changes in equity. d. statement of cash flows. Answer: b Learning objective 7.9 – Describe how receivables are reported in financial statements. Feedback: The recoverable amount of receivables is shown in the statement of financial position as an asset.

42. Managing accounts receivable involves five steps of which the following occurs first: *a. determine to whom to extend credit. b. accelerate cash receipts from receivables. c. establish a payment period. d. monitor the collections. Answer: a Learning objective 7.10 – Analyse and manage receivables. Feedback: The management of accounts receivable firstly involves the determination of whom to extend credit to.

7.14

Chapter 7: Reporting and analysing cash and receivables

43. The credit risk ratio is calculated by dividing the allowance for doubtful debts by: a. total sales. b. total assets. *c. accounts receivable. d. 365 days. Answer: c Learning objective 7.10 – Analyse and manage receivables. Feedback: The credit risk ratio is calculated by dividing the allowance for doubtful debts by accounts receivable.

44. Receivables turnover is used to assess the liquidity of the: a. *b. c. d.

customer. receivables. business. assets.

Answer: b Learning objective 7.10 – Analyse and manage receivables. Feedback: Receivables turnover is used to assess the liquidity of the receivables.

45. Which of the following will not help minimise potential losses resulting from credit customers: a. Letters of credit/bank guarantees. b. Cash on delivery. c. bank/supplier references. *d. Extended payment period Answer: d Learning objective 7.10– Analyse and manage receivables. Feedback: An extended payment period will not minimise potential losses from credit customers.

7.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. A factor is used to: a. borrow money b. apply for credit *c. accelerate cash receipts d. increase sales Answer: c Learning objective 7.10 – Analyse and manage receivables. Feedback: A factor is one way of accelerating cash receipts.

7.16

Chapter 7: Reporting and analysing cash and receivables

Exercises 47. Listed below are seven errors or problems that might occur in the processing of cash transactions. Also shown is a list of internal control principles. Evaluate each possible error and cite a principle that is listed that would reduce the probability of the error occurring. If none of the principles given will correct the problem, write ‘None’. If you think more than one principle is appropriate, list all principles that apply. Possible Errors or Problems 1. An employee steals the cash collected from a customer for an account receivable and conceals this theft by issuing a credit memorandum indicating that the customer returned the merchandise. 2. A small fire destroys 3 days of cash receipts. 3. The official designated to sign cheques is able to steal blank cheques and issue them without fear of detection. 4. A sales person, when serving customers, often rings up a sale for less than the actual amount and then keeps the additional cash collected from the customer. 5. Three cashiers use one cash register drawer and the cash in the drawer is often short of the balance kept on hand. 6. Each cashier counts their own register drawer each day and verbally reports the results to the supervisor. 7. Cashiers with over 5-years’ experience are not required to take holidays. Internal Control Principles a. Establishment of responsibility b. Segregation of duties c. Physical, mechanical, and electronic control devices d. Documentation procedures e. Independent internal verification f. Other controls

Answers below. Learning objective 7.1 – 7.11. 1. 2. 3. 4.

b c and f c and d c

5. a and e 6. d and e 7. f

7.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

48. Using the following information, prepare a bank reconciliation for Everest Ltd for 31 July. a. b. c. d. e. f.

The bank statement balance is $2,306. The cash account balance is $2,930 Outstanding cheques totalled $585. Outstanding deposit $1,175. The bank service charge is $25. A cheque for $98 for supplies was recorded as $89 in the ledger.

Answers below. Learning objective 7.1 – 7.11. Everest Ltd Bank Reconciliation 31 July Cash balance per bank Add: (d) Outstanding deposit

$ 2,306 1,175 3,481 585 $ 2,896

Less: (c) Outstanding cheques Adjusted cash balance per books Cash balance per books Less: (f) Accounts payable error (e) Bank service charge Adjusted cash balance per books

$ 2,930 $ 9 25

34 $ 2,896

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Chapter 7: Reporting and analysing cash and receivables

49. Using the following information, prepare a bank reconciliation for Mont Blanc Ltd for 31 May. a. The bank statement balance is $9,100. b. The cash account balance is $7,412 c. Outstanding cheques totalled $1,600. d. Outstanding deposit $300. e. The bank service charge is $12. f. Collection of a note receivable by bank, $400.

Answers below. Learning objective 7.1 – 7.11. Mont Blanc Ltd Bank Reconciliation 31 May

Cash balance per bank Add: (d) Outstanding deposit

$ 9,100 300 9,400 1,600 $ 7,800

Less: (c) Outstanding cheques Adjusted cash balance per books Cash balance per books Add: (f) Collection of a note receivable

$ 7,412 400 7,812 12 $ 7,800

Less: (e) Bank service charge Adjusted cash balance per books

7.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

50. Given the following information, determine the adjusted cash balance per books from the following information: a. b. c. d. e. f.

Balance per books as of 30 June, $7,600. Outstanding cheques, $600. NSF cheque returned with bank statement, $120. Deposit mailed the afternoon of 30 June, $300. Cheque printing charges, $15. Interest earned on cheque account, $40.

Answers below. Learning objective 7.1 – 7.11. $7,505 (7,600 - 120 - 15 + 40)

7.20

Chapter 7: Reporting and analysing cash and receivables

51. The Tarragon Trading Company's bank statement for the month of November showed a balance per bank of $7,000. The company's Cash account in the general ledger had a balance of $5,659 at 30 November. Other information is as follows: (1) Cash receipts for 30 November recorded on the company's books were $5,200 but this amount does not appear on the bank statement. (2) The bank statement shows a debit memorandum for $40 for cheque printing charges. (3) Cheque No. 119 payable to Burns Company was recorded in the cash payments journal and cleared the bank for $248. A review of the accounts payable subsidiary ledger shows a $36 credit balance in the account of Burns Company and that the payment to them should have been for $284. (4) The total amount of cheques still outstanding at 30 November amounted to $5,800. (5) Cheque No. 138 was correctly written and paid by the bank for $409. The cash payment journal reflects an entry for Cheque No. 138 as a debit to Accounts Payable and a credit to Cash in Bank for $490. (6) The bank returned a dishonoured cheque from a customer for $560. (7) The bank included a credit memorandum for $1,260, which represents collection of a customer's note by the bank for the company; principal amount of the note was $1,200 and interest was $60. Interest has not been accrued. Required: (a) Prepare a bank reconciliation for the Tarragon Trading Company at 30 November. (b) Prepare any adjusting entries necessary as a result of the bank reconciliation.

7.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 7.1 – 7.11.

(a)

TARRAGON TRADING COMPANY Bank Reconciliation 30 November

Cash balance per bank Add: (1) Outstanding deposit

$ 7,000 5,200 12,200 5,800 $ 6,400

Less: (4) Outstanding cheques Adjusted cash balance per books Cash balance per books Add: (5) Accounts Payable Error (7) Collect $1,200 note and interest $60 Less: (2) Cheque printing (6) Dishonoured Cheque Adjusted cash balance per books

$ 5,659 $

81 1,260

1,341 7,000

40 560

600 $ 6,400

Note: Item (3) is not a reconciling item. (b) Nov. 30

Cash ................................................................................. Accounts Payable ..................................................... (To correct error in recording Cheque No. 138)

Cash ................................................................................... Notes Receivable ..................................................... Interest Earned ......................................................... (To record collection of note receivable and interest by the bank)

1,260

Miscellaneous Expense ..................................................... Cash .......................................................................... (To record cheque printing charges)

Accounts Receivable ......................................................... Cash .......................................................................... (To record NSF cheque)

560

1,200 60

560

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Chapter 7: Reporting and analysing cash and receivables

52. Using the code letters below, indicate how each of the items listed would be handled in preparing a bank reconciliation. Enter the appropriate code letter in the space to the left of each item. Code A Add to cash balance per books B Deduct from cash balance per books C Add to cash balance per bank D Deduct from cash balance per bank E Does not affect the bank reconciliation Items: ____ 1. Outstanding cheques ____

2. Bank service charge

____

3. Cheque for $320 correctly written and paid by the bank but incorrectly entered in the cash payments journal for $230

____

4. Outstanding deposit (deposit in transit)

____

5. Bank returns deposited cheque marked NSF

____

6. Bank collects notes receivable and interest for depositor

____

7. Bank debit memorandum for cheque printing fees

____

8. Petty cash custodian has $86 in paid petty cash vouchers that have not been reimbursed.

____

9. Bank charged a cheque against the company, which should have been charged to another company.

____ 10. A cheque for $236 was correctly paid by the bank but was incorrectly entered in the cash payments journal for $263

Answers below. Learning objective 7.1 – 7.11. 1. 2. 3. 4. 5.

D B B C B

6. 7. 8. 9. 10.

A B E C A

7.23

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

53. K2 Limited received a notice with its bank statement that the bank had collected a note receivable for $8,000 plus $400 of interest. The bank had credited these amounts to K2's account less a collection fee of $10. K2 Ltd had already accrued the interest for this note on its books. (a) How will these items affect K2’s bank reconciliation? (b) Prepare the journal entry that K2 Ltd will make to record this information on its books.

Answers below. Learning objective 7.1 – 7.11. (a)

K2 Ltd must add the amount of the note plus interest less the collection charge to its cash balance per books on the bank reconciliation. Add: Collection of note receivable $8,390

(b)

Cash ............................................................................................... Miscellaneous Expense ................................................................. Note Receivable ................................................................... Interest Receivable ...............................................................

8,390 10 8,000 400

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Chapter 7: Reporting and analysing cash and receivables

54. The cash records of the Kilimanjaro Ltd show the following: 1. The 30 June bank reconciliation indicated that deposits in transit totalled $390. During July the general ledger account, Cash shows deposits of $9,700, but the bank statement indicates that only $9,540 in deposits were received during the month. 2. The 30 June bank reconciliation also reported outstanding cheques of $800. During the month of July, Kilimanjaro’s books show that $11,170 of cheques were issued, yet the bank statement showed that $11,500 of cheques cleared the bank in July. There were no bank debit or credit memoranda and no errors were made by either the bank or Kilimanjaro Ltd. Answer the following questions: (a) What were the outstanding deposits (deposits in transit) at 31 July? (b) What were the outstanding cheques at 31 July?

Answers below. Learning objective 7.1 – 7.11. (a)

Outstanding deposits: Deposits per books in July ............................................. Deposits per the bank in July ......................................... Less: 30 June outstanding deposits ................................ July receipts deposited in July ....................................... Outstanding deposits, 31 July .......................................

(b)

$ 9,700 $ 9,540 390 9,150 $ 550

Outstanding Cheques: Cheques per books in July ............................................. Cheques clearing the bank in July ................................. Less: Outstanding cheques, 30 June ............................ July cheques clearing in July ......................................... Outstanding cheques, 31 July ........................................

$11,170 $11,500 800 10,700 $ 470

7.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

55. Siew Lan uses the allowance method to record bad debts expense. When accounts receivable is aged at the end of December, it is estimated that 2% of Siew Lan’s accounts receivable will be uncollectable. Accounts receivable at 31 December are $300,000 and the Allowance for doubtful debts has a credit balance of $5,000.

Required (a) (b)

Prepare the adjusting journal entry to record bad debts expense for the year ended 31 December. Determine the amount of the bad debts expense if the balance in the Allowance account is a debit of $500 instead of a credit of $5,000.

Answers below. Learning objective 7.1 – 7.11. (a)

Dr Cr

Bad debts expense .................................................. $1,000 Allowance for bad and doubtful debts ................. $1,000

(b)

$6,500 ($6,000 + $500)

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Chapter 7: Reporting and analysing cash and receivables

Completion statements

56. Please complete the following statements: 1.

Internal control over cash disbursements is more effective when payments are made by ______________, rather than by ______________.

A disbursement system that uses wire, telephone, computers, etc. to transfer cash from one location to another is referred to as ______________.

A debit memorandum issued by the bank ______________ the cash balance in the depositor's account.

The difference between the cash in bank balance shown on the company's books and the cash balance shown on the bank statement may be caused by ______________ in recording transactions by either party.

In preparing a bank reconciliation, outstanding cheques are ______________ from the cash balance per ______________.

A cheque correctly written for $350 was incorrectly entered in the cash payments journal for $530. In preparing a bank reconciliation, $____________ must be ______________ the cash balance per ______________.

A basic principle of cash management is to delay payment of _____________.

A __________________ fund is used to pay relatively small expenditures.

A debit balance in Cash Over and Short is reported in the income statement as ______________.

10.

One method of accounting for ________ debts involves estimating uncollectible accounts at the end of each period and recognising an _____________ account as a contra account.

11.

A ______________ note is a written promise to pay a specified amount on a defined date.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 7.1 – 7.11. 1. cheque, cash 2. electronic funds transfer (EFT) 3. reduces 4. errors 5. deducted, bank 6. $180, added to, books 7. liabilities 8. petty cash 9. miscellaneous expense 10. doubtful, allowance 11. promissory

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Chapter 7: Reporting and analysing cash and receivables

Matching

57. Match the items below by entering the appropriate code letter in the space provided. A. B C. D. E. F. G. H. I. J.

Direct write-off method Cash Receivables turnover Aged accounts receivable Invest idle cash Cancelled cheques NSF cheques Outstanding cheques Petty cash receipt Cash equivalents

1. __ A measure that computes the allowance for doubtful debts. 2. __ Cheques which have been returned by the maker's bank for lack of funds. 3___ Cheques which have been paid by the depositor's bank. 4. __ A measure of the liquidity of receivables, calculated by dividing net credit sales by average net receivables. 5. __ Anything that a bank will accept for deposit. 6. __ A basic principle of cash management. 7. __ A method of accounting for bad debts that involves expensing accounts receivable at the time they are determined to be uncollectible. 8. __ Document indicating the purpose of a petty cash expenditure. 9. __ Issued cheques that have not been paid by the bank. 10. _ Highly liquid investments.

Answers below. Learning objective 7.1 – 7.11. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

D G F C B E A I H J

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay Questions

58. The preparation of a bank reconciliation is an important cash control procedure. If a company deposits cash receipts daily and makes all cash disbursements by cheque, explain why the cash balance per books might not agree with the cash balance shown on the bank statement. Identify specific examples that may cause differences between the cash balance per books and the cash balance per bank.

Answer below. Learning objective 7.1 – 7.11. The cash balance per books will not agree with the cash balance shown on the bank statement due to time lags and errors by either party. A time lag could mean the bank records a transaction in a period later than the company records it (outstanding cheques, deposits-in-transit) or the company records a transaction in a period later than the bank records it (Dishonoured cheque, collection of a note, etc.).

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Chapter 7: Reporting and analysing cash and receivables

59. Comparative analysis problem: Computershare’s financial statements can be accessed via the investor relations link on the website www.computershare.com.au. Data3’s financial statements can be accessed via the investor relations link on the website www.data3.com.au. Required (a) Based on the information contained in the most recent financial statements, calculate the following ratios for each company: (1) accounts receivable turnover ratio (2) average collection period for receivables. (b) What conclusions concerning the management of accounts receivable can be drawn from these data?

Answers below. Learning objective 7.1 – 7.11. (a)

1. Accounts receivable turnover ratio NOTE: Only trade related debtors have been included 2. Average collection period for receivables

Computershare 2011

Data3 2011

1 598 932 (177 701 + 179 282)/2

586 354 + 109 804 (82 037 + 85 286)/2

= 8.96 times

= 8.32 times

365 8.96 = 41 days

365 8.32 = 44 days

Note: financial reports do not report the cash and credit breakdown of sales. Data3’s sales include revenue from both sales and services.

(b) The average receivables collection period is 41 days for Computershare and 44 days for Data3. Assuming both companies’ terms of sales is 30 days; Data3 is slightly slower in collecting its receivables than Computershare, with both taking in excess of 10 days over the time specified in the sales term. Overall, both companies need to be more efficient in the collection of accounts receivable.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

60. Interpreting financial statements – a global focus: NAB saw its share price fall by more than 12% after it announced provisions for a potential loss of $830 million on debt-related investments due to the global credit crisis and fall in the US housing market. The $830 million was in addition to the $181 million NAB had already provided for to cover risky investments. NAB chief executive John Stewart said that the losses were likely due to rapidly increasing mortgage defaults, stating, ‘Unfortunately the behaviour of the housing market in the US leads us to believe that the worst case scenario may not be too far away from the most likely scenario’. Numbers indicating US home sales have fallen to a 10-year low and Ford booking a record loss of $US9.1 billion in its latest quarterly results sparked a steep decline on the US share market. Required (a) Viewing the most recent annual report available on its website (www.nab.com.au), identify how NAB determines impaired receivables. (b) Compare NAB’s policy with Barclays’. (You can access Barclays’ most recent annual report via www.barclays.com.)

Answers below. Learning objective 7.1 – 7.11. (a)

National Australia Bank does not specifically address how impaired receivables are determined in its annual report. However, the bank does provide details of how impairment of financial assets (which covers receivables) is estimated.

(b) When addressing this question lecturers should be using some of the following points for discussion: • Do they impair assets receivables individually or as a group? • If as a group how do they determine what is grouped together? • What triggers an assessment of impairment for both companies? • Do both companies apply the requirements in IFRS?

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Chapter 7: Reporting and analysing cash and receivables

61: Exploring the web: To learn more about factoring from the website of a business that provides factoring services. Address: www.tradedebtorfinance.com.au Steps: Go to the website and answer the following questions. Required: (a) What are some of the benefits of factoring? (b) What is the range of the percentages of the typical discount rate? (c) If a business factors its receivables, what percentage of the value of the receivables can it expect to receive from the factor in the form of cash, and how quickly will it receive the cash?

Answers below. Learning objective 7.1 – 7.11. (a)

Benefits of factoring receivables

Factoring is a flexible financial solution where a business sells all or part of their debtors’ ledger (Unpaid Invoices) to a financier to raise working capital (Cash) for expenses, wages or fuel. It can help a business be more competitive while improving cash flow, credit rating and supplier discounts. Some of the benefits of factoring include: • • • •

Trade Debtor Finance offers the business flexibility, as the following benefits illustrate: Funds are readily available: credit sales are converted into cash normally within 48 hours. With cash in the bank, the client can negotiate better trading terms with suppliers, including early settlement discounts and the ability to buy in bulk. Eliminate the need to offer settlement discounts to customers. InvoiceDiscounting fees are usually cheaper than settlement discounts. With InvoiceFinance, the client knows with certainty when they will receive the cash.

(b)

Different Factoring lenders charge different fees based upon setup structure, size and risk. The average cost of debtor-finance is 3% per month; however this will vary depending on your debtors’ payment terms. The longer it takes for them to pay the higher the cost.

(c)

The Factoring Financier would advance up to 80% of the un paid invoices value within 24-48 hours. The remaining 20% is advanced after the invoice is paid less a small fee of about 1-3% to the factoring financier.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

62. Ethics case: The financial officer of Suit Ltd believes that the yearly allowance for impaired receivables for Shirt Ltd should be $185 000. The CEO of Suit Ltd, nervous that the shareholders might expect the business to sustain its 10% growth rate, suggests that the financial controller increase the allowance for impairment to $285 000. The CEO thinks that the lower profit, which reflects a 7% growth rate, will be a more sustainable rate for Suit Ltd. Required (a) Who are the stakeholders in this case? (b) Does the CEO’s request pose an ethical dilemma for the controller? (c) Should the financial controller be concerned with Suit Ltd’s growth rate in estimating the allowance? Explain your answer.

Answers below. Learning objective 7.1 – 7.11. (a)

The stakeholders in this situation are: • • •

The CEO of Suit Co. The financial controller of Suit Co. The shareholders.

(b)

Yes. The controller is posed with an ethical dilemma — should he/she follow the CEO’s ‘suggestion’ and prepare misleading financial records (understated net profit) or should he/she attempt to stand up to and possibly anger the CEO by preparing a fair (realistic) income statement.

(c)

Suit Co.’s growth rate should be a product of fair and accurate financial records, not vice versa. That is, one should not prepare financial records 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.

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Chapter 8: Reporting and analysing non-current assets

Chapter 8: Reporting and analysing non-current assets Multiple-choice questions

1. Which of the following is not properly classified as property, plant and equipment? a. Building used as a factory. b. Land used in ordinary business operations. c. Land improvement, such as parking lots and fences. *d. A truck held for resale by an automobile dealership. Answer: d Learning objective 8.2 – Describe how the cost principle applies to property, plant and equipment assets. Feedback: Property, plant and equipment are assets that have physical substance, are used in the operations of the entity for more than one period and are not intended for sales to customers.

2. Which of the following would not be included in the Equipment account? a. Installation costs. b. Freight costs. c. Cost of trial runs. *d. Electricity used by the machine. Answer: d Learning objective 8.2 – Describe how the cost principle applies to property, plant and equipment assets. Feedback: Electricity used by the machine would be accounted for as an expense of the period. All other expenditures listed are costs necessarily incurred to make the asset ready for its intended use.

3. Which of the following is not a characteristic of a plant asset? *a. Plant assets are intangible. b. Plant assets are used in the operations of a business. c. Plant assets are expected to provide future economic benefits for a number of years. d. Not currently used in the business but held for future use. Answer: d Learning objective 8.2 – Describe how the cost principle applies to property, plant and equipment assets. Feedback: Property, plant and equipment are assets that have physical substance, are used in the operations of the entity for more than one period and are not intended for sales to customers.

8.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. The cost of land does not include: a. real estate brokers' commission. b. cash price of property. *c. annual rates and taxes. d. title fees. Answer: c Learning objective 8.2 – Describe how the cost principle applies to property, plant and equipment assets. Feedback: Annual rates and taxes are an expense for a period and therefore not included in the cost of land.

5. Which of the following assets does not decline in service potential over the course of its useful life? a. Equipment. b. Furnishings. c. Fixtures. *d. Land. Answer: d Learning objective 8.2 – Describe how the cost principle applies to property, plant and equipment assets. Feedback: Except for land, the future economic benefits (service potential) of property, plant and equipment decline over the useful life of the asset.

6. The Land account would include all of the following costs except: a. drainage costs. *b. the cost of building a fence. c. commissions paid to real estate agents. d. the cost of tearing down a building. Answer: b Learning objective 8.2 – Describe how the cost principle applies to property, plant and equipment assets. Feedback: The cost of the fence is accounted for as “Land Improvements”. The fence has a limited useful life and therefore is depreciated.

8.2

Chapter 8: Reporting and analysing non-current assets

7. Wisemans Winery purchases land for $200,000 cash. Wisemans Winery assumes $2,500 in rates and taxes due on the land. The title and legal fees totaled $2,750. Wisemans Winery has the land graded for $5,000 and fenced for $20,000. What amount does Wisemans Winery record as the cost for the land? a. $200,000 b. $230,250 *c. $210,250 d. $202,750 Answer: c Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: The cost for the land is $210,250 ($200,000 + $2,500 + $2,750 + $5,000).

8. Endevour Enterprises acquires land for $250,000 cash. Additional costs are as follows: Removal of old building $ 10,000 Salvage of building materials from old building $1,500 Filling and grading 2,500 Broker commission 3,300 Paving of parking lot 30,000 Stamp duty 7,000 Endevour Enterprises will record the acquisition cost of the land as: *a. $268,000 b. $250,000 c. $298,000 d. $269,500 Answer: a Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: The cost for the land is $268,000 [$250,000 + (10,000 - 1,500) + 2,500 + 7,000).

8.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

9. Warners Warehouse installs a new parking lot. The paving cost $45,000 and the lights to illuminate the new parking area cost $15,000. Which of the following statements is true with respect to these additions? a. $45,000 should be debited to the Land account. *b. $60,000 should be debited to Land Improvements. c. $60,000 should be debited to the Land account. d. $15,000 should be debited to Land Improvements. Answer: b Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: The cost of paving and installing lights are both classified as Land Improvements each will be depreciated over their separate useful lives.

10. General Molding is building a new plant that will take three years to construct. The construction will be financed in part by funds borrowed during the construction period. There are significant architect fees, excavation fees and building permit fees. Which of the following statements is true? a. Excavation fees are capitalised but building permit fees are not. b. Architect fees are capitalised but building permit fees are not. *c. Interest is capitalised during the construction as part of the cost of the building. d. The capitalised cost is equal to the contract price to build the plant less any interest on borrowed funds. Answer: c Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: During the construction phase of a building, interest costs are capitalised as part of the total cost of the building.

11. Trentham Transport purchases a new delivery truck for $80,000. The stamp and transfer duty is $3,000. The logo of the company is painted on the side of the truck for $500. The truck registration is $700 and a 12 month accident insurance policy is $1100. The truck undergoes safety testing for $330. What does Trentham Transport record as the cost of the new truck? a. $85,630. *b. $83,830. c. $80,000. d. $83,000. Answer: d Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: The cost of the new truck is $83,850 ($80,000 + 3,000 + 500 + 330). The costs of registration and insurance are treated as expenses. .

8.4

Chapter 8: Reporting and analysing non-current assets

12. Which of the following is included in the cost of constructing a new building? a. Cost of paving a parking lot. b. Cost of repairing vandalism damage during construction. *c. Interest incurred during construction. d. Cost of removing the demolished building existing on the land when it was purchased. Answer: c Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: During the construction phase of a building, interest costs are capitalised as part of the total cost of the building. Option A is a land improvement, option B is repairs & maintenance and option D is part of the cost of the land.

13. All leases are classified as either: a. capital leases or long-term leases. b. capital leases or operating leases. *c. operating leases or finance leases. d. long-term leases or current leases. Answer: c Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: Leases will either be classified as operating leases or finance leases. If the lease is classified as a finance lease both the leased asset and the lease obligation are recognised on the statement of financial position.

14. Interest may be included in the acquisition cost of a plant asset: a. if the asset acquisition is financed by a long-term note payable. b. if the asset is purchased on credit. *c. during the construction period of a self-constructed asset. d. if it is a part of a lump-sum purchase. Answer: c Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: When a new building is being constructed the interest costs may be included in the acquisition cost of the asset during the construction phase.

8.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

15. Land improvements should be depreciated over the useful life of the: a. land. *b. land improvements. c. land or land improvements, whichever is longer. d. buildings on the land.

Answer: b Learning objective 8.3 – Explain the concept of depreciation. Feedback: Land improvements should be depreciated over the useful life of the land improvements.

16. Which of the following statements regarding accounting for the acquisition of property, plant and equipment is incorrect? a. Asset acquisition costs that are not expensed immediately are referred to as capital expenditures. b. Capital expenditures are expenditures that increase the company’s investment in productive facilities c. When the construction of a building is complete, the cost of interest is recorded as interest expense. *d. When purchasing land, the cost for clearing, draining, filling and grading should be charged to a Land Improvements account. Answer: d Learning objective 8.2 - Describe how the cost principle applies to property, plant and equipment assets. Feedback: When land is purchased all necessary costs incurred to make the land ready for its intended use are recorded as an increase in the cost of the land. All other statements are correct.

17. Which of the following statements regarding depreciation is true? a. All property, plant and equipment assets must be depreciated. b. Recording deprecation on plant assets affects the income statement only. c. In calculating depreciation expense both the cost of the asset and its residual value are estimates. *d. Depreciable amount is the cost of the asset less its residual value. Answer: d Learning objective 8.3 – Explain the concept of depreciation. Feedback: Land is not depreciated as its useful life is not limited, depreciation also affects the statement of financial position and the cost of an asset is not an estimate.

8.6

Chapter 8: Reporting and analysing non-current assets

18. The balance in the Accumulated Depreciation account represents the: a. cash fund to be used to replace plant assets. b. amount to be deducted from the cost of the plant asset to arrive at its fair market value. c. amount charged to expense in the current period. *d. amount charged to expense since the acquisition of the plant asset. Answer: d Learning objective 8.3 – Explain the concept of depreciation. Feedback: The balance in the accumulated depreciation account represents the total amount of the PPE asset’s cost that has been charged to depreciation expense account since the acquisition of the PPE asset. 19. The term applied to the periodic expiration of a plant asset’s cost is: a. amortisation. b. depletion. *c. depreciation. d. cost expiration. Answer: c Learning objective 8.3 – Explain the concept of depreciation. Feedback: Depreciation is the process of allocating the cost of a PPE asset to depreciation expense over its useful life in a rational and systematic manner.

20. Which one of the following items is not a consideration when recording periodic depreciation expense on plant assets? a. Residual value. *b. Cash needed to replace the plant asset. c. Estimated useful life. d. Cost. Answer: b Learning objective 8.3 – Explain the concept of depreciation. Feedback: When recording the periodic depreciation expense on plant assets one should consider the cost of the asset, its residual value and its estimated useful life. The replacement cost is not relevant.

8.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

21. The cost of a non-current asset is expensed: a. when it is paid for. *b. as the asset benefits the company. c. in the period in which it is acquired. d. in the period in which it is disposed of. Answer: b Learning objective 8.3 – Explain the concept of depreciation. Feedback: The cost of a non-current asset is expensed as the asset benefits the company in accordance with the period concept.

22. Depreciation is the process of allocating the cost of a plant asset over its useful life in an: *a. systematic and rational manner. b. accelerated and accurate manner. c. equal and equitable manner. d. conservative market-based manner. Answer: a Learning objective 8.3 – Explain the concept of depreciation. Feedback: Depreciation is the process of allocating the cost of a PPE asset to depreciation expense over its useful life in a rational and systematic manner.

23. The carrying amount of an asset is equal to the: a. the market value of the asset less its historical cost. *b. the cost of the asset less accumulated depreciation. c. replacement cost of the asset. d. book value relied on by secondary markets. Answer: b Learning objective 8.3 – Explain the concept of depreciation. Feedback: The carrying amount is equal to the cost of the asset less the accumulated depreciation.

24. Recording depreciation each period is necessary in accordance with the: a. going concern principle. b. cost principle. *c. period concept. d. asset valuation principle. Answer: c Learning objective 8.3 – Explain the concept of depreciation. Feedback: The cost of a non-current asset is expensed as the asset benefits the company in accordance with the period concept. .

8.8

Chapter 8: Reporting and analysing non-current assets

25. Depreciation is a process of: a. asset devaluation. b. cost accumulation. *c. cost allocation. d. asset valuation. Answer: c Learning objective 8.3 – Explain the concept of depreciation. Feedback: It is important to understand that depreciation is an allocation process not a valuation process. The carrying amount of an asset may differ significantly from its market value.

26. In computing depreciation, the residual value is: a. the fair market value of a plant asset on the date of acquisition. b. subtracted from accumulated depreciation to determine the plant asset's depreciable cost. *c. an estimate of a plant asset's value at the end of its useful life. d. ignored in all the depreciation methods. Answer: c Learning objective 8.3 – Explain the concept of depreciation. Feedback: Residual value is an estimate of the asset’s value at the end of its useful life. The value may be based on the asset’s estimated worth as scrap, salvage or trade-in.

27. When estimating the useful life of an asset, accountants do not consider: *a. the cost to replace the asset at the end of its useful life. b. vulnerability to obsolescence. c. expected repairs and maintenance. d. the intended use of the asset. Answer: a Learning objective 8.3 – Explain the concept of depreciation. Feedback: The cost to replace a PPE asset at the end of its useful life is ignored when estimating the useful life of that asset.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. Equipment was purchased for $45,000. Freight charges amounted to $500 and there was a cost of $2,500 for building a foundation and installing the equipment. It is estimated that the equipment will have a $8,000 residual value at the end of its 5-year useful life. Depreciation expense each year using the straight-line method will be: a. $9,600. *b. $8,000. c. $9,000. d. $7,400. Answer: b Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: Annual depreciation expense will be ((45,000 + 500 + 2,500 – 8,000)/5) = $8,000.

29. Equipment with a cost of $160,000 has an estimated residual value of $10,000 and an estimated life of 4 years or 12,000 hours. It is to be depreciated by the straight-line method. What is the amount of depreciation expense for the first full year, during which the equipment was used 3,300 hours? a. $40,000. *b. $37,500. c. $41,250. d. $42,500. Answer: b Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: ((160,000 – 10,000)/4) = $37,500.

30. Equipment with a cost of $160,000 has an estimated residual value of $10,000 and an estimated life of 4 years or 12,000 hours. It is to be depreciated by the units-of-production method. What is the amount of depreciation expense for the first full year, during which the equipment was used 3,300 hours? a. $40,000. *b. $41,250. c. $42,500. d. $37,500. Answer: b Learning objective 8.4– Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: ((160,000 – 10,000)/12,000) = $12.50 x 3,300 = $41,250.

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Chapter 8: Reporting and analysing non-current assets

31. Equipment with a cost of $160,000 has an estimated residual value of $10,000 and an estimated life of 4 years or 12,000 hours. It is to be depreciated by the diminishing value method with a constant depreciation rate of 37.5%. What is the amount of depreciation expense for the first full year, during which the equipment was used 3,300 hours? *a. $60,000. b. $80,000. c. $56,250. d. $55,500. Answer: a Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: $160,000 x 37.5% = $60 000.

32. A truck was purchased for $15,000 and it was estimated to have a $3,000 residual value at the end of its useful life. Monthly depreciation expense of $250 was recorded using the straight-line method. The annual depreciation rate is: a. 20%. *b. 25%. c. 8%. d. 2%. Answer: b Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: Annual depreciation = $250 x 12 = $3,000. ($15,000 – 3,000)/3,000 = 4 years therefore depreciation rate = 25%.

33. A company purchased factory equipment on April 1, 2016, for $48,000. It is estimated that the equipment will have a $6,000 residual value at the end of its 10-year useful life. Using the straight-line method of depreciation, the amount to be recorded as depreciation expense at 31 December, 2016, is: a. $4,800. *b. $3,150. c. $4,200. d. $3,600. Answer: b Learning objective 8.3 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: Depreciation expense per year = (48,000 – 6,000)/10 = $4,200. April 1 to December 31 = 9 months, therefore depreciation expense to December 31, 2016 = (4,200/12) x 9 = $3,150.

8.11

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. Which of the following methods of computing depreciation is production based? a. Straight-line. b. Diminishing-balance. *c. Units-of-production. d. None of these. Answer: c Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: The units-of-production method (also known as units of service method) is a production (service) based method of calculating depreciation expense.

35. The depreciation method that applies a constant percentage to depreciable amount in calculating depreciation is: *a. straight-line. b. units-of-production. c. diminishing-balance. d. none of these. Answer: a Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: The straight-line method of depreciation applies a constant percentage to depreciable amount. The depreciable amount is the cost of the asset less its residual value.

36. A plant asset was purchased on 1 January for $30,000 with an estimated residual value of $6,000 at the end of its useful life. The current year's depreciation expense is $3,000 calculated on the straight-line basis and the balance of the Accumulated Depreciation account at the end of the year is $15,000. The remaining useful life of the plant asset is: a. 10 years. b. 8 years. c. 5 years. *d. 3 years. Answer: d Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: ($30,000 – $6,000)/x = $3,000. x = 8 years, $15,000/3,000 = 5 years. The remaining useful life is: 8 – 5 years = 3 years.

8.12

Chapter 8: Reporting and analysing non-current assets

37. The depreciation method that applies a constant percentage to the carrying amount at the end of year in calculating depreciation is: a. straight-line. b. units-of-production. *c. diminishing-balance. d. none of these. Answer: c Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: The straight-line method of depreciation applies a constant percentage to depreciable amount. The depreciable amount is the cost of the asset less its residual value.

38. A change in the estimated useful life of equipment requires: a. a retroactive change in the amount of periodic depreciation recognised in previous years. b. that no change be made in the periodic depreciation so that depreciation amounts are comparable over the life of the asset. *c. that the amount of periodic depreciation be changed in the current year and in future years. d. that profit for the current year be increased. Answer: c Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: If the estimated useful life of an asset changes then the amount of periodic depreciation in the current and future years will also change.

39. Jeff's Copy Shop purchased equipment for $18,000 on 1 January, 2016. Jeff estimated the useful life to be 3 years with no residual value, and the straight-line method of depreciation will be used. On 1 January, 2017, Jeff decides that the business will use the equipment for a total of 5 more years. What is the revised depreciation expense for 2016? a. $6,000. b. $3,000. *c. $2,400. d. $4,500. Answer: c Learning objective 8.3 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: The carrying amount on 1/1/2017 is ($18,000 - $6,000) $12,000. $12,000/5 years = $2,400 per year for the remaining 5 years.

8.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. Vickers Company use the units-of-production method in computing depreciation expense. A new plant asset is purchased for $18,000 that will produce an estimated 100,000 units over its useful life. Estimated residual value at the end of its useful life is $2,000. What is the depreciation cost per unit? *a. $0.16. b. $1.80. c. $1.60. d. $0.18. Answer: a Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: The depreciation expense per unit of production is: $18,000 - $2,000 = $16,000/100,000 = $0.16 per unit.

41. Units-of-production method is an appropriate depreciation method to use when: a. it is impossible to determine the productivity of the asset. b. the asset's use will be constant over its useful life. *c. the productivity of the asset varies significantly from one period to another. d. the company is a manufacturing company. Answer: c Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: It is appropriate to use the units-of-production method when the productivity of the asset varies significantly from one period to another.

42. The carrying value of a plant asset is the difference between the: a. replacement cost of the asset and its historical cost. b. cost of the asset and the amount of depreciation expense for the year. *c. cost of the asset and the accumulated depreciation to date. d. proceeds received from the sale of the asset and its original cost. Answer: c Learning objective 8.4 – Calculate depreciation using various methods and contrast the expense patterns of the methods. Feedback: The carrying value of a plant asset is the difference between the cost of that asset and its accumulated depreciation to date.

8.14

Chapter 8: Reporting and analysing non-current assets

43. Which of the following is not true of ordinary repairs? a. They primarily benefit the current accounting period. b. They reduce profit in the current accounting period. c. They maintain the expected productive life of the asset. *d. They increase the productive capacity of the asset. Answer: d Learning objective 8.5 – Account for subsequent expenditures. Ordinary repairs maintain the productive capacity of the asset. Feedback: They are usually small amounts that are incurred frequently throughout the life of the asset.

44. Expenditures that maintain the operating efficiency and expected productive life of a plant asset are generally: *a. expensed when incurred. b. capitalised as a part of the cost of the asset. c. debited to the Accumulated Depreciation account. d. not recorded until they become material in amount. Answer: a Learning objective 8.5 – Account for subsequent expenditures. Feedback: Expenditures that maintain the operating efficiency and expected productive life of a plant asset are generally expensed when they are incurred.

45. Additions and improvements: a. occur frequently during the ownership of a plant asset. *b. should be capitalised and depreciated over the remaining useful life of the related PPE asset. c. normally involve immaterial expenditures. d. typically only benefit the current accounting period. Answer: b Learning objective 8.5 – Account for subsequent expenditures. Feedback: Additions and improvements increase the efficiency, productive capacity or useful life of a PPE asset. They are usually material in amount and occur infrequently during the life of the asset.

8.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. An impairment loss is calculated as the amount by which the: *a. carrying amount of an asset exceeds its recoverable amount. b. carrying amount of an asset is lower than its recoverable amount. c. carrying amount value of an asset exceeds its original cost. d. book value of an asset is lower than its original cost. Answer: a Learning objective 8.6 – Account for asset impairment. Feedback: An impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount.

47. The first step in the revaluation of an asset is to: a. transfer the balance of accumulated depreciation to the income statement. *b. record depreciation up to the date of the asset revaluation. c. record the revaluation. d. write-off the accumulated depreciation balance. Answer: b Learning objective 8.7– Account for the revaluation of property, plant and equipment assets. Feedback: Recording the depreciation expense up to the date of the asset revaluation is the first step in the revaluation of an asset.

48. Value in use is the: a. book value of net cash flows. b. nominal value of net cash flows. *c. present value of net cash flows. d. face value of net cash flows. Answer: c Learning objective 8.6 – Account for asset impairment. Feedback: The present value of the net cash flows from using the asset is referred to as the value in use.

8.16

Chapter 8: Reporting and analysing non-current assets

49. Cole Company buys land for $50,000 on 31/12/16. As of 31/3/17, the land has appreciated in value to $50,500. On 31/12/17, the land has an appraised value of $51,800. By what amount must the Land account be increased in 2016? *a. $0. b. $500. c. $1,300. d. $1,800. Answer: a Learning objective 8.7 – Account for the revaluation of property, plant and equipment assets. Feedback: Land revaluation increments are recognised at the time of the revaluation, therefore the land value in 2016 is the purchase price.

50. Accountants do not attempt to measure the change in a plant asset's market value during ownership because: a. losses would have to be recognised. b. plant assets cannot be sold. *c. the assets are not held for resale. d. it is management's responsibility to determine fair values. Answer: c Learning objective 8.7 – Account for the revaluation of property, plant and equipment assets. Feedback: The change in a plant asset’s market value throughout its useful life is not measured as the assets are held for their operational use not their resale. Non-current assets such as inventory are held for resale.

51. A truck costing $12,000 and on which $9,000 of accumulated depreciation has been recorded was discarded as having no value. The entry to record this event would include a: a. gain of $3,000. *b. loss of $3,000. c. credit to accumulated depreciation for $9,000. d. credit to accumulated depreciation for $12,000. Answer: b Learning objective 8.8 – Account for the disposal of property, plant and equipment assets. Feedback: The truck would have a carrying amount of $3,000. This amount would be recorded as a loss on disposal.

8.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

52. In a period subsequent to a revaluation increment, if the revaluation reverses, the original revaluation should be: a. added to the revaluation reserve account. b. added to the income statement. c. offset against equity. *d. offset against the previous revaluation. Answer: d Learning objective 8.7 – Account for the revaluation of property, plant and equipment assets. Feedback: Revaluation increments and decrements are offset.

53. A truck that cost $12,000 and on which $9,000 of accumulated depreciation has been recorded was disposed of for $2,000 cash. The entry to record this event would include a: a. gain of $1,000. *b. loss of $1,000. c. credit to Truck account for $3,000. d. credit to Accumulated Depreciation for $9,000. Answer: b Learning objective 8.8 – Account for the disposal of property, plant and equipment assets. Feedback: The truck would have a carrying amount of $3,000. Therefore the difference between the carrying amount and the sales proceeds would be recorded as a loss on disposal.

54. The carrying amount of an asset will equal its fair market value at the date of sale if: a. a gain on disposal is recorded b. the plant asset is fully depreciated *c. no gain or loss on disposal is recorded d. a loss on disposal is recorded Answer: c Learning objective 8.8 – Account for the disposal of property, plant and equipment assets. Feedback: If no gain or loss on disposal is recorded this means the carrying amount of an asset is equal to its fair market value.

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Chapter 8: Reporting and analysing non-current assets

55. A truck costing $35,000 was destroyed when its engine caught fire. At the date of the fire, the accumulated depreciation on the truck was $16,000. An insurance cheque for $40,000 was received based on the replacement cost of the truck. The entry to record the insurance proceeds and the disposition of the truck will include a: a. Gain on Disposal of $5,000. b. debit to the Truck account of $19,000. c. credit to the Accumulated Depreciation account for $16,000. *d. Gain on Disposal of $21,000. Answer: d Learning objective 8.8 – Account for the disposal of property, plant and equipment assets. Feedback: At the date of the fire the carrying amount of the truck was $19,000. If the insurance pays $40,000 then the difference between carrying amount and proceeds is recorded as a gain on disposal, in this case $21,000.

56. A plant asset with a cost of $30,000 and accumulated depreciation of $27,500 is sold for $3,500. What is the amount of the gain or loss on disposal of the plant asset? a. $2,500 loss. b. $1,000 loss. *c. $1,000 gain. d. $2,500 gain. Answer: c Learning objective 8.8 – Account for the disposal of property, plant and equipment assets. Feedback: The gain on disposal is $1,000. The carrying amount is ($30,000 - $27,500) = $2,500 which is $1,000 less than the sales proceeds, therefore a gain is recorded.

57. On July 1, 2016, Waters Kennels sells equipment for $22,000. The equipment originally cost $60,000, had an estimated 5-year life and an expected residual value of $10,000. The Accumulated Depreciation account had a balance of $35,000 on 1 January, 2016, using the straight-line method. The gain or loss on disposal is: a. $3,000 gain. b. $2,000 loss. c. $3,000 loss. *d. $2,000 gain Answer: d Learning objective 8.8 – Account for the disposal of property, plant and equipment assets. Feedback: The equipment would have a carrying amount of $20,000 on July 1 2016 as depreciation is $10,000 each year. Therefore the gain on disposal is $2,000.

8.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

58. An asset register is: *a. an internal control procedure designed to manage and protect non-current assets. b. a list of the market prices of an entity’s assets c. a list of the maintenance conducted on current assets during the year. d. a schedule of all intangible assets sold during the year. Answer: a Learning objective 8.9 – Describe the use of an asset register. Feedback: An asset register is an internal control procedure designed to manage and protect non-current assets.

59. Typically the details contained in an asset register include all of the following except: a. date of purchase. b. details of registration. c. depreciation method and rate. *d. current selling price. Answer: d Learning objective 8.9 – Describe the use of an asset register. Feedback: An asset register would not typically include the current selling price.

60. On July 1, 2016, Marlin Company purchased the copyright to Bodine Educational Tutorials for $81,000. It is estimated that the copyright will have a useful life of 5 years with an estimated residual value of $6,000. The amount of Amortisation Expense recognised to 31 December 2016 would be: a. $16,200. *b. $7,500. c. $15,000. d. $8,100. Answer: b Learning objective 8.10 – Identify the basic issues related to reporting intangible assets. Feedback: The annual amortisation expense is ($81,000 - $6,000)/5 years = $15,000. The six months of copyright ownership to 31 December 2016 incurs a $7,500 amortisation expense.

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Chapter 8: Reporting and analysing non-current assets

61. Cost allocation of an intangible asset is referred to as: *a. amortisation. b. depreciation. c. accretion. d. capitalisation. Answer: a Learning objective 8.10– Identify the basic issues related to reporting intangible assets. Feedback: The cost allocation of an intangible asset is referred to as amortisation. The same accounting treatment applies as is used for depreciation of property, plant and equipment assets.

62. Which of the following is not an intangible asset arising from a government grant? *a. Goodwill. b. Patent. c. Trademark. d. Trade name. Answer: a Learning objective 8.10 – Identify the basic issues related to reporting intangible assets. Feedback: Goodwill is not an intangible asset arising from a government grant. Goodwill arises from operating in business over time. Goodwill is only recorded when there is an exchange transaction that involves the purchase of a business. Goodwill is not amortised but is subject to an annual impairment test.

63. Goodwill can be recorded: a. when customers keep returning because they are satisfied with the company's products b. when the company acquires a good location for its business c. when the company has exceptional management *d. only when there is an exchange transaction involving the purchase of an entire business Answer: d Learning objective 8.10 – Identify the basic issues related to reporting intangible assets. Feedback: Goodwill arises from operating in business over time. Goodwill is only recorded when there is an exchange transaction that involves the purchase of a business. Goodwill is not amortised but is subject to an annual impairment test.

8.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

64. Which of the following is not considered an intangible asset? a. Goodwill. *b. An oil well. c. A franchise. d. A Patent. Answer: b Learning objective 8.10 – Identify the basic issues related to reporting intangible assets. Feedback: An oil well is considered a tangible asset.

65. A patent: a. has a legal life of 20 years. *b. is nonrenewable. c. can be renewed indefinitely. d. is rarely subject to litigation because it is an exclusive right. Answer: b Learning objective 8.10 – Identify the basic issues related to reporting intangible assets. Feedback: Patents exist for a period of time and are nonrenewable.

66. If a company incurs legal costs in successfully defending its patent, these costs are recorded by debiting: a. Legal Expense. *b. the Patent account. c. an Intangible Loss account. d. a Revenue Expenditure account. Answer: b Learning objective 8.11 – Describe the common types of intangible assets. Feedback: Legal costs that arise from the successful defense of a patent are recorded in the patent account.

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Chapter 8: Reporting and analysing non-current assets

67. Copyrights are granted by the federal government: a. for the life of the creator or 70 years, whichever is longer. *b. for the life of the creator plus 70 years. c. for the life of the creator or 70 years, whichever is shorter. d. and therefore cannot be amortised. Answer: b Learning objective 8.11 – Describe the common types of intangible assets. Feedback: Copyrights are granted by the government for the life of the creator plus 70 years.

68. Goodwill: a. is only recorded when generated internally. b. can be subdivided and sold in parts. *c. can only be identified with the business as a whole. d. can be defined as normal earnings less accumulated amortization. Answer: c Learning objective 8.11 – Describe the common types of intangible assets. Feedback: Goodwill arises from operating in business over time and is identified with the business as a whole. Goodwill is only recorded when there is an exchange transaction that involves the purchase of a business. Goodwill is not amortised but is subject to an annual impairment test.

69. When recording the acquisition cost of an entire business: *a. goodwill is recorded as the excess of cost over the fair value of identifiable net assets. b. assets are recorded at the seller's book values. c. goodwill, if it exists, is never recorded. d. goodwill is recorded as the excess of cost over the book value of identifiable net assets. Answer: a Learning objective 8.11– Describe the common types of intangible assets. Feedback: Goodwill arises from operating in business over time and can only be identified with the business as a whole. Goodwill is only recorded when there is an exchange transaction that involves the purchase of a business. It is the excess of cost of the fair value of identifiable net assets. Goodwill is not amortised but is subject to an annual impairment test.

8.23

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

70. Research costs: a. are classified as intangible assets. *b. must be expensed when incurred under generally accepted accounting principles. c. should be included in the cost of the patent they relate to. d. are capitalised and then amortised over a period not to exceed 40 years. Answer: b Learning objective 8.11 – Describe the common types of intangible assets. Feedback: Research costs must be expensed when incurred under GAAP.

71. An IT company has $3,000,000 in research costs. Before accounting for these costs the profit of the company is $2,200,000. What is the amount of profit or loss after these research costs are accounted for? a. $2,200,000 profit. *b. $800,000 loss. c. $0. d. Cannot be determined from the information provided. Answer: b Learning objective 8.11 – Describe the common types of intangible assets. Feedback: After accounting for research costs the company will report a loss of $800 000.

72. Which of the following is not an intangible asset that can be reported on the statement of financial position? a. Goodwill. b. Trademarks. *c. Employees. d. Copyrights. Answer: c Learning objective 8.11 – Describe the common types of intangible assets. Feedback: Employees do not meet the definition of an asset, either tangible or intangible.

8.24

Chapter 8: Reporting and analysing non-current assets

73. An agricultural activity is the management by an entity of the biological transformation of: a. agricultural produce into biological assets. *b. biological assets into agricultural produce. c. harvested produce into biological assets. d. processed goods into harvested goods. Answer: b Learning objective 8.12 – Explain the nature and measurement of agricultural assets. Feedback: An agricultural activity is the management by an entity of the biological transformation of biological assets into agricultural produce. For example, a sheep is the biological asset and wool is the agricultural produce.

74. Biological assets cannot be recognised unless the assets can be reliably measured and: a. the products are the result of harvesting. *b. it is probable that the future economic benefits will eventuate c. the asset can be sold into an active market. d. the cost of the asset is zero. Answer: b Learning objective 8.12 – Explain the nature and measurement of agricultural assets. Feedback: Biological assets cannot be recognised unless they can be reliably measured and it is probable that the future economic benefits will eventuate.

75. The amortisation process applied to natural resources is also called: a. depreciation. b. disintegration. *c. depletion. d. degradation. Answer: c Learning objective 8.13 – Account for the acquisition and depletion of natural resources. Feedback: Another term for the amortisation applied to natural resources is depletion.

8.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

76. Natural resources are regarded as a special type of asset because they: a. are wasting assets. *b. are not regenerating. c. have no market value. d. are not living animals or plant. Answer: b Learning objective 8.13 – Account for the acquisition and depletion of natural resources. Feedback: Natural resources are regarded as a special type of asset because they are not regenerating.

77. Trademarks are generally shown on the statement of financial position under: *a. Intangibles. b. Investments. c. Property, Plant, and Equipment. d. Current Assets. Answer: a Learning objective 8.14 – 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. Feedback: A trademark is generally shown on the statement of financial position as an intangible asset.

78. Intangible assets: a. are not reported on the statement of financial position because they lack physical substance. *b. should be reported under the heading non-current assets on the statement of financial position. c. should be reported as Current Assets on the statement of financial position. d. should be reported as a separate classification on the statement of financial position. Answer: b Learning objective 8.14 – 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. Feedback: Intangible assets should be reported as non-current assets on the statement of financial position.

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Chapter 8: Reporting and analysing non-current assets

79. Waters Filtration Equipment has obtained the following data from its accounting records: Average cost of PPE assets Annual depreciation expense Accumulated depreciation

$850,000 $125,000 $340,000

The average useful life of PPE assets is: a. 2.5 years b. 2.72 years *c. 6.8 years d. Cannot be determined from the data provided. Answer: c Learning objective 8.14 – 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. Feedback: The average useful life of PPE assets can be calculated as: Average cost of PPE assets/annual depreciation expense. $850,000/125,000 = 6.8 years.

80. Plant assets are ordinarily presented in the statement of financial position: a. at current market values. b. at replacement costs. *c. at cost less accumulated depreciation. d. in a separate section along with intangible assets. Answer: c Learning objective 8.14– 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. Feedback: Plant assets are ordinarily presented in the statement of financial position at their cost less accumulated depreciation.

8.27

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises

81. Delta Ltd purchased factory equipment with an invoice price of $50,000. Other costs incurred were freight costs, $1,300; installation wiring and foundation, $2,200; material and labor costs in testing equipment, $700; oil lubricants and supplies to be used with equipment, $500; fire insurance policy covering equipment, $1,400. The equipment is estimated to have a $5,000 residual value at the end of its 8-year useful life. Required: (a) Calculate the acquisition cost of the equipment. Clearly identify each element of cost. (b) If the straight-line method of depreciation was used, the annual rate applied to the depreciable cost would be __________.

Answers below. Learning objective 8.1 – 8.14. (a)

Invoice cost Freight costs Installation wiring and foundation Material and labor costs in testing Acquisition cost

(b)

If the straight-line method of depreciation was used, the annual rate applied to the depreciable cost would be 12.5% (100% ÷ 8 years).

$50,000 1,300 2,200 700 $54,200

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Chapter 8: Reporting and analysing non-current assets

82. Miller Ltd purchased land adjacent to its plant to improve access for trucks making deliveries. Expenditures incurred in purchasing the land were as follows: purchase price, $40,000; agent’s fees, $7,000; title search and other fees, $6,000; demolition of an old building on the property, $3,700; grading, $1,200; digging foundation for the road, $3,000; laying and paving driveway, $25,000; lighting $7,500; signs, $1,500. List the items and amounts that should be included in the Land account.

Answers below. Learning objective 8.1 – 8.14. Purchase price Broker’s fees Title search and other fees Demolition of old building Grading Land acquisition cost

$40,000 7,000 6,000 3,700 1,200 $57,900

8.29

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

83. Indicate whether each of the following expenditures should be classified as land (L), land improvements (LI), buildings (B), equipment (E), or none of these (X). _____ 1. Parking lots _____ 2. Electricity used by a machine _____ 3. Sewage system cost _____ 4. Interest on building construction loan _____ 5. Cost of trial runs for machinery _____ 6. Drainage costs _____ 7. Cost to install a machine _____ 8. Fences _____ 9. Unpaid (past) rates and taxes assumed _____10. Cost of tearing down a building when land and a building on it are purchased

Answers below. Learning objective 8.1 – 8.14. 1. 2. 3. 4. 5.

LI X L B E

6. 7. 8. 9. 10.

L E LI L L

8.30

Chapter 8: Reporting and analysing non-current assets

84. For each entry below make a correcting entry if necessary. (a) The $50 cost of repairing a printer was charged to Computer Equipment. (b) The $5,500 cost of a major engine overhaul was debited to Repair Expense. The overhaul is expected to increase the operating efficiency of the truck. (c) $6,000 of stamp duty costs associated with the acquisition of land were debited to Legal Expense. (d) A $400 charge for transportation expenses on new equipment purchased was debited to Freight-In.

Answers below. Learning objective 8.1 – 8.14. (a)

(b)

(c)

(d)

Repair Expense .............................................................................. Computer Equipment ............................................................

Truck .............................................................................................. Repair Expense .....................................................................

5,500

Land ............................................................................................... Legal Expense .......................................................................

6,000

Equipment ...................................................................................... Freight-In ..............................................................................

400

5,500

6,000

400

8.31

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

85. Americanos Ltd was incorporated on 1 January. During the first year of operations, the following expenditures and receipts were recorded in random order in the Land account. Debits 1. Cost of real estate purchased as a plant site (land and building) 2. Accrued property rates paid at the time of the purchase of the real estate 3. Cost of demolishing building to make land suitable for construction of a new building 4. Architect's fees on building plans 5. Excavation costs for new building 6. Cost of filling and grading the land 7. Insurance premium during construction of building 8. Cost of repairs to building under construction caused by a small fire 9. Interest paid during the year, of which $52,000 relates to the construction period 10. Full payment to building contractor 11. Cost of parking lots and driveways 12. Property rates paid for the current year on the land Total Debits

$ 120,000 4,000 12,000 14,000 24,000 5,000 6,000 7,000 64,000 960,000 36,000 4,000 $1,256,000

Credits 13. Insurance proceeds for fire damage 14. Proceeds from salvage of demolished building Total Credits

$3,000 3,500 $6,500

Required: Analyse the foregoing transactions using the following tabular arrangement. Insert the number of each transaction in the Item space and insert the amounts in the appropriate columns. Item

Land

Building

Other

Account Title

Answers below. Learning objective 8.1 – 8.14. Item 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Totals

Land $120,000 4,000 12,000

Building

Other

Account Title

$ 7,000 12,000

Fire Loss Interest Expense

36,000 4,000 (3,000)

Land Improvements Rates Expense Fire Loss

$ 14,000 24,000 5,000 6,000 52,000 960,000

(3,500) $137,500

__ _____ $1,056,000

$56,000

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Chapter 8: Reporting and analysing non-current assets

86. Radiata Ltd purchased equipment on 1 January, 2013, at a cost of $60,000. The equipment was originally estimated to have a salvage value of $5,000 and an estimated life of 10 years. Depreciation has been recorded through 31 December, 2016, using the straight-line method. On 1 January, 2017, the estimated residual value was revised to $6,000 and the useful life was revised to a total of 8 years. Determine Radiata Ltd’s Depreciation Expense for 2017.

Answers below. Learning objective 8.1 – 8.14. Calculate the Carrying Amount at the time of the revision: $60,000 - $5,000 = $5,500 annual depreciation expense 10 years

4 years have been depreciated: $5,500 x 4 = $22,000 Carrying amount at the time of the revision: $60,000 - $22,000 = $38,000 Calculate the revised annual depreciation: $38,000 - $6,000 = $8,000 revised annual depreciation 4 years remaining

The Depreciation Expense for 2017 is $8,000.

8.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

87. Kauri Ltd purchased equipment on 1 January, 2015, at a cost of $75,000. The equipment was originally estimated to have a residual value of $5,000 and an estimated life of 10 years. Depreciation has been recorded through 31 December, 2017, using the straight-line method. On 1 January, 2018, the estimated salvage value was revised to $6,000 and the useful life was revised to a further 8 years. Instructions Determine the Depreciation Expense for 2018.

Answers below. Learning objective 8.1 – 8.14. Calculate the Carrying Amount at the time of the revision: $75,000 - $5,000 = $7,000 annual depreciation expense 10 years

3 years have been depreciated: $7,000 x 3 = $21,000 Book Value at the time of the revision: $75,000 - $21,000 = $54,000 Calculate the revised annual depreciation: $54 000 - $6 000 8 years remaining

= $6 000 revised annual depreciation

The Depreciation Expense for 2018 is $6 000.

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Chapter 8: Reporting and analysing non-current assets

88. Indicate whether each of the following expenditures should be classified as land (L), land improvements (LI), buildings (B), equipment (E), or none of these (X). _____ 1. Computer installation cost _____ 2. Driveway cost _____ 3. Architect’s fee _____ 4. Surveying costs _____ 5. Grading costs _____ 6. Cost of lighting for parking lot _____ 7. Insurance and freight on equipment purchased _____ 8. Material and labor costs incurred to construct factory _____ 9. Cost of tearing down a warehouse on land just purchased _____10. Electricity cost during first year

Answers below. Learning objective 8.1 – 8.14. 1. 2. 3. 4. 5.

E LI B L L

6. 7. 8. 9. 10.

LI E B L X

8.35

89. Matai Ltd purchased a machine on 1 January, 2015. In addition to the purchase price paid, the following additional costs were incurred: (a) sales tax paid on the purchase price, (b) transportation and insurance costs while the machinery was in transit from the seller, (c) personnel training costs for initial operation of the machinery, (d) installation costs necessary to secure the machinery to the building flooring, (e) major overhaul to extend the life of the machinery, (f) lubrication of the machinery gearing before the machinery was placed into service, (g) lubrication of the machinery gearing after the machinery was placed into service, and (h) annual operating license fee. Indicate whether the items (a) through (h) are capital or revenue expenditures in the spaces provided: C = Capital, R = Revenue. (a)_____________

(b)______________

(c)______________

(d)______________

(e)_____________

(f)______________

(g)______________

(h)______________

(d) Capital (h) Revenue

Answers below. Learning objective 8.1 – 8.14. (a) Capital (e) Capital

(b) Capital (f) Capital

Chapter 8: Reporting and analysing non-current assets

90. Nelson Word Processing Service Ltd uses the straight-line method of depreciation. The company's financial year end is 31 December. The following transactions and events occurred during the first three years. 2016 July

Nov. 3 Dec. 31

Purchased an IBM computer from the Computer Centre for $6,500 cash plus sales tax of $500, and delivery costs of $250. Incurred ordinary repair costs of $440. Recorded 2016 depreciation on the basis of a four year life and estimated residual value of $1,250.

2017 Dec. 31

Recorded 2016 depreciation.

2018 Jan.

Paid $1,800 for a major upgrade of the computer. This expenditure is expected to increase the operating efficiency and capacity of the computer.

Prepare the necessary entries. (Show computations.)

Answers below. Learning objective 8.1 – 8.14. 2016 July

Nov. 3 Dec. 31

2017 Dec. 31 2018 Jan.

Computer Equipment ................................................ Cash ..................................................................

7,250

Repairs Expense ........................................................ Cash ..................................................................

440

Depreciation Expense ............................................... Accumulated Depreciation ............................... [($7,250 - $1,250) / 4 x 1/2]

750

Depreciation Expense ............................................... Accumulated Depreciation ($6,000 / 4) ...........

1,500

Computer Equipment ................................................ Cash ..................................................................

1,800

7,250 440 750

1,500 1,800

8.37

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

91. Identify the following expenditures as capital expenditures or revenue expenditures. (a) Replacement of worn out gears on factory machinery. (b) Construction of a new wing on an office building. (c) Painting the exterior of a building. (d) Oil change on a company truck. (e) Replacing a Pentium chip with a core 2 Duo chip, which increases productive capacity. No extension of useful life expected. (f) Overhaul of a truck motor. One year extension in useful life is expected. (g) Purchased a wastebasket at a cost of $10. (h) Painting and lettering of a used truck upon acquisition of the truck.

Answers below. Learning objective 8.1 – 8.14. (a) (b) (c) (d)

revenue capital revenue revenue

(e) (f) (g) (h)

capital capital revenue capital

8.38

Chapter 8: Reporting and analysing non-current assets

92. On 1 January, 2016, Rata Ltd purchased and installed a telephone system at a cost of $20,000. The equipment was expected to last five years with a salvage value of $3,000. On 1 January, 2017, more telephone equipment was purchased to tie-in with the current system for $8,000. The new equipment is expected to have a useful life of four years. Through an error, the new equipment was debited to Telephone Expense. Rata Ltd uses the straight-line method of depreciation. Prepare a schedule showing the effects of the error on Telephone Expense, Depreciation Expense, and Net profit for each year and in total beginning in 2016 through the useful life of the new equipment. Telephone Expense Depreciation Expense Profit Overstated Overstated Overstated Year (Understated) (Understated) (Understated) _____________________________________________________________________________ 2017 2018 2019 2020

Answers below. Learning objective 8.1 – 8.14. Telephone Expense Depreciation Expense Profit Overstated Overstated Overstated Year (Understated) (Understated) (Understated) _____________________________________________________________________________ 2017 $8,000 $(2,000) $(6,000) 2018

(2,000)

2,000

2019

(2,000)

2,000

2020

(2,000)

2,000

$(8,000)

-0-

Total

$8,000

8.39

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

93. (a) Barnes Ltd purchased equipment on 1 January, 2010 for $80,000 and estimated an $8,000 salvage value at the end of the equipment's 10-year useful life. At 31 December, 2016, there was $50,400 in the Accumulated Depreciation account for this equipment using the straight-line method of depreciation. On March 31, 2017, the equipment was sold for $21,000. Prepare the appropriate journal entries to remove the equipment from the books of Barnes Ltd on March 31, 2017. (b) Lanne Manufacturing sold a delivery truck for $11,000. The delivery truck originally cost $25,000 in 2002 and $6,000 was spent on a major overhaul in 2007 (charged to Delivery Truck account). Accumulated Depreciation on the delivery truck to the date of disposal was $20,000. Prepare the appropriate journal entry to record the disposition of the delivery truck. (c) Crown Travel Ltd sold office equipment that had a carrying amount of $4,500 for $6,000. The office equipment originally cost $15,000 and it is estimated that it would cost $19,000 to replace the office equipment. Prepare the appropriate journal entry to record the disposition of the office equipment.

Answers below. Learning objective 8.1 – 8.14. (a)

(b)

(c)

Depreciation Expense .................................................................... 1,800 Accumulated Depreciation—Equipment .............................. (To record depreciation expense for the first 3 months of 2017) $80,000 – 8,000 = $72,000/10 = $7,200 x 1/4 = $1,800) Cash ............................................................................................. Loss on Disposal ............................................................................ Accumulated Depreciation—Equipment ($50,400 + $1,800) ....... Equipment ............................................................................. (To record sale of equipment at a loss)

21,000 6,800 52,200

Cash ................................................................................................ Accumulated Depreciation—Delivery Truck ................................ Delivery Truck ...................................................................... (To record disposition on delivery truck at book value)

11,000 20,000

Cash ............................................................................................. Accumulated Depreciation—Office Equipment ............................ Office Equipment .................................................................. Gain on Disposal ................................................................... (To record disposal of office equipment at a gain)

6,000 10,500

1,800

80,000

31,000

15,000 1,500

8.40

Chapter 8: Reporting and analysing non-current assets

94. Prepare the journal entries to record the following transactions for the Nobles Company, which has a financial year end of 31 December and uses the straight-line method of depreciation. (a) On 30 September, 2016, the company sold old delivery equipment for $9,000. The delivery equipment was purchased on 1 January, 2014, for $21,000 and was estimated to have a $3,000 residual value at the end of its 5-year life. Depreciation on the delivery equipment has been recorded through 31 December, 2015. (b) On 30 June, 2016, the company sold old office equipment for $18,000. The office equipment originally cost $24,000 and had accumulated depreciation to the date of disposal of $10,000.

Answers below. Learning objective 8.1 – 8.14. (a) 30 September, 2016 Depreciation Expense ................................................................. Accumulated Depreciation — Delivery Equipment ........... (To record depreciation expense for the first 9 months of 2016. $18,000 / 5 years = $3,600 x 9/12 = $2,700) Cash ................................................................................................ Accumulated Depreciation — Delivery Equipment ($7,200 + $2,700) Loss on Disposal ($11,100 - $9,000) .............................................. Delivery Equipment ........................................................... (To record sale of delivery equipment at a loss) (b) 30 June, 2016 Cash ........................................................................................... Accumulated Depreciation — Office Equipment ....................... Office Equipment ............................................................... Gain on Disposal ($18,000 - $14,000) ............................... (To record sale of office equipment at a gain)

2,700 2,700

9,000 9,900 2,100 21,000

18,000 10,000 24,000 4,000

8.41

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

95. a. A machine that cost $18,000 and on which $13,000 of depreciation had been recorded was disposed of for $5,200. Indicate whether a gain or loss should be recorded, and for what amount. b. Assume that the machine in Part A above was instead discarded. Indicate whether a gain or loss should be recorded, and for what amount. c. Assume that the machine in Part A above was instead sold for $4,800. Indicate whether a gain or loss should be recorded, and for what amount.

Answers below. Learning objective 8.1 – 8.14. a. $200 gain (18000 - 13,000 = 5000 carrying amount; 5,200 - 5000 = 200 gain) b. $5,000 loss (18000 - 13,000 = 5000 carrying amount, all loss) c. $200 loss (18000 - 13,000 = 5000 carrying amount; 4,800 - 5000 = 200 loss)

8.42

Chapter 8: Reporting and analysing non-current assets

96. Presented below are selected transactions for Ronnen Products Ltd for 2016. Jan.

Retired a piece of machinery that was purchased on 1 January, 2006. The machine cost $80,000 on that date, and had a useful life of 10 years with no residual value.

April 30

Sold a printing machine for $50,000 that was purchased on 1 January, 2013. The printer cost $90,000, and had a useful life of 5 years with no residual value.

Dec. 31

Discarded a business automobile that was purchased on September 1, 2011. The car cost $20,000 and was depreciated on an 8-year useful life with a residual value of $800.

Journalise all entries required as a result of the above transactions. Ronnen Products Ltd uses the straight-line method of depreciation and has recorded depreciation through 31 December, 2016.

Answers below. Learning objective 8.1 – 8.14. Jan.

April 30

Dec. 31

Accumulated Depreciation — Machinery ............................ Machinery ....................................................................

80,000

Depreciation Expense ........................................................... Accumulated Depreciation — Machinery ................... ($90,000//5 = $18,000 x 4/12 = $6,000)

6,000

80,000

6,000

Cash ....................................................................................... 50,000 Accumulated Depreciation - Machinery ($18,000 x 3 + $6,000) 60,000 Printing Machine .......................................................... Gain on Disposal ($50,000 - $30,000) .........................

90,000 20,000

Depreciation Expense ........................................................... Accumulated Depreciation — Vehicle ........................

2,400 2,400

Accumulated Depreciation - Vehicle ($2,400 x 5 + 800) ..... Loss on Disposal ................................................................... Motor vehicle ...............................................................

12,800 7,200

20,000

8.43

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

97. Winningham Ltd sold the following two machines in 2016: Machine A $84,000 1 July 2012 8 years $4,000 Straight-line 1 July 2016 $37,000

Cost Purchase date Useful life Residual value Depreciation method Date sold Sales proceeds

Machine B $60,000 1 Jan 2013 5 years $3,000 Straight-line 1 Aug 2016 $22,000

Journalise all entries required to update depreciation and record the sales of the two assets in 2016. The company has recorded depreciation on the machine through 31 December, 2015.

Answers below. Learning objective 8.1 – 8.14. July 1 Depreciation Expense ................................................................. Accumulated Depreciation — Machine A ......................... ($84,000 - $4,000)  8 years x 6/12 = $5,000

5,000

Cash .......................................................................................... Accumulated Depreciation — Machine A* ................................ Loss on Disposal ($44,000 - $37,000) ........................................ Machine A ..........................................................................

37,000 40,000 7,000

5,000

84,000

* Total accumulated depreciation at date of disposal = $40,000 ($84,000 - $4,000)  8 years = $10,000 x 4 years

Aug. 1 Depreciation Expense ................................................................. Accumulated Depreciation — Machine B ......................... ($60,000 - $3,000)  5 years x 7/12 = $6,650

6,650

Cash .......................................................................................... Accumulated Depreciation — Machine B** .............................. Machine B .......................................................................... Gain on Disposal ($22,000 - $19,150) ...............................

22,000 40,850

6,650

60,000 2,850

** Total accumulated depreciation at date of disposal = $40,850 ($($60,000 - $3,000)  5 years = $11,400 x 3 + $6,650

8.44

Chapter 8: Reporting and analysing non-current assets

98. The following information is available from the 2016 annual reports of Fresh Food and Food for Cheap: (Amounts in millions) Fresh Food Food for Cheap Profit $ 565 $ 1,271 Sales 22,653 33,812 Total Assets 22,088 36,167 Accumulated Depreciation 2,701 4,359 Depreciation Expense 381 697 Plant Assets 7,715 10,237

Required: (a) Based on the preceding information, calculate the following values for each company: 1. Average useful life of plant assets 2. Average age of plant assets 3. Asset turnover (b) What conclusion concerning the management of plant assets can be drawn from these data?

Answers below. Learning objective 8.1 – 8.14. (a)

Fresh Food $7,715 ÷ $381 = 20.2 years

Food for Cheap $10,237 ÷ $697 = 14.7 years

2. Average age of plant assets

$2,701 ÷ $381 = 7.1 years

$4,359 ÷ $697 = 6.3 years

3. Asset turnover

$22,653 ÷ $22,088 = 1.03 times

$33,812 ÷ $36,167 = .93 times

1. Average useful life of plant assets

(b)

Fresh Food’s plant assets have a significantly longer useful life (20.2 years vs. 14.7) and remaining life (13.1 remaining years vs. 8.4 years) than Food for Cheap’s plant assets. In addition, Fresh Food’s asset turnover is 11% higher than Food for Cheap’s turnover ratio. It can be concluded that Fresh Food has plant assets that will last longer than Food for Cheap’s assets and it is utilising these plant assets more efficiently than Food for Cheap.

8.45

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

99. (a) A company purchased a patent on 1 January, 2016, for $2,500,000. The patent's legal life is 20 years but the company estimates that the patent's useful life will only be 5 years from the date of acquisition. On 30 June, 2016, the company paid legal costs of $162,000 in successfully defending the patent in an infringement suit. Prepare the journal entry to amortise the patent at year end on 31 December, 2016. (b) The Walker Company purchased a franchise from the Tasty Food Company for $400,000 on 1 January, 2016. The franchise is for an indefinite time period and gives the Walker Company the exclusive rights to sell Tasty Wings in a particular territory. Prepare the journal entry to record the acquisition of the franchise and any necessary adjusting entry at year end on 31 December, 2016. The franchise is expected to have value for a period of 20 years. (c) Dawson Company incurred research and development costs of $500,000 in 2016 in developing a new product. Prepare the necessary journal entries during 2016 to record these events and any adjustments at year end on 31 December, 2016.

Answers below. Learning objective 8.1 – 8.14. (a)

31 December, 2016 Patent Amortisation Expense ......................................................... Accumulated Amortisation - Patent ...................................... (To record patent amortisation) $2,500,000 / 5 years $500,000 $162,000 / 54 months = $3,000 x 6 18,000 $518,000

(b) 1 January, 2016 Franchise ........................................................................................ Cash ....................................................................................... (To record acquisition of Tasty Food franchise) 31 December, 2016 Franchise Amortisation Expense ($400,000 / 20) .......................... Accumulated Amortisation - Franchise ................................ (To record amortisation of franchise for the current year) (c)

2016 Research and Development Expense ............................................. Cash ....................................................................................... (To record research and development expense for the current year)

518,000 518,000

400,000 400,000

20,000 20,000

500,000 500,000

8.46

Chapter 8: Reporting and analysing non-current assets

100. A patent that was acquired for $800,000 at the beginning of the current year expires in 20 years and is expected to have value for 4 years. Present the adjusting entry to amortise the patent for the current year.

Answers below. Learning objective 8.1 – 8.14. Amortisation expense — Patents…………………………… Accumulated Amortisation - Patents…………………

200,000 200,000

8.47

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

101. For each item listed below, enter a code letter in the blank space to indicate the allocation terminology for the item. Use the following codes for your answer: A — Amortisation

D — Depreciation

N — None of these

____ 1. Goodwill

___

6. Research and Development Costs

____ 2. Land

___

7. Equipment

____ 3. Buildings

___

8. Franchises

____ 4. Patents

___

9. Licenses

____ 5. Trademarks

___ 10. Land Improvements

Answers below. Learning objective 8.1 – 8.14. 1. 2. 3. 4. 5.

N N D A A

6. 7. 8. 9. 10.

N D A A D

8.48

Chapter 8: Reporting and analysing non-current assets

102. For the following transaction, (a) determine the amount of the amortisation for the current year, and (b) present the adjusting entries required to record amortisation at year end. (1) Costs of $1,000 were incurred on 1 January to obtain a patent. Shortly thereafter, $29,000 was spent in legal costs to successfully defend the patent against competitors. The patent has an estimated legal life of 12 years.

Answers below. Learning objective 8.1 – 8.14. (a)

Legal costs to successfully defend a patent are capitalised. (b)

Patent Expense ...................................................................... Accumulated Amortisation - Patent .......................... ($30,000/12 years = $2,500)

2,500 2,500

8.49

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

103. During the current year Fairly Ltd incurred several expenditures. Briefly explain whether the expenditures listed below should be recorded as an operating expense or as an intangible asset. If you view the expenditure as an intangible asset, indicate the number of years over which the asset should be amortised. Explain your answer. (a) Spent $30,000 in legal costs in a patent defence suit. The patent was unsuccessfully defended. (b) Purchased a trademark from another company. The trademark can be renewed indefinitely. Fairly Ltd expects the trademark to contribute to revenue indefinitely. (c) Fairly Ltd acquires a patent for $2,000,000. The company selling the patent has spent $1,000,000 on the research and development of it. The patent has a remaining life of 15 years. (d) Fairly Ltd is spending considerable time and money in developing a different patent for another product. So far $3,000,000 has been spent this year on research. Fairly Ltd is very confident they will obtain this patent in the next few years.

Answers below. Learning objective 8.1 – 8.14. (a) Operating Expense. Only successful patent defence costs can be capitalised. (b) Intangible Asset. Trademarks are renewable. Intangibles with indefinite lives are not amortised. (c) Intangible Asset. The patent cost of $2,000,000 should be amortised over its remaining useful life of 15 years. (d) Operating Expense. Research costs are required to be expensed.

8.50

Chapter 8: Reporting and analysing non-current assets

104. Presented below is information related to plant assets and intangible assets at year end on 31 December, 2016, for Kline Ltd: Buildings Goodwill Patents Land Accumulated Depreciation

$1,080,000 420,000 480,000 390,000 670,000

Instructions Prepare a partial statement of financial position for Kline Ltd that shows how the above listed items would be presented.

Answers below. Learning objective 8.1 – 8.14. KLINE LIMITED Statement of Financial Position (Partial) 31 December, 2016 Non-current Assets Property, Plant, and Equipment Buildings Less: Accumulated Depreciation Land Total Property, Plant, and Equipment Intangible Assets Goodwill Patents Total Intangibles

$1,080,000 670,000

$410,000 390,000 $800,000

$420,000 480,000 $900,000

8.51

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

105. Indicate in the blank spaces below, the section of the statement of financial position where the following items are reported. Use the following code to identify your answer: PPE I O N/A

Property, Plant, and Equipment Intangibles Other Not on the statement of financial position

____ 1. Goodwill

____ 6. Research and Development Costs

____ 2. Land Improvements

____ 7. Land

____ 3. Buildings

____ 8. Franchises

____ 4. Accumulated Depreciation

____ 9. Licenses

____ 5. Trademarks

____ 10. Equipment

Answers below. Learning objective 8.1 – 8.14. 1. 2.

I PPE

Goodwill Land Improvements

6. 7.

N/A Research and Development Costs PPE Land

3. 4. 5.

PPE PPE I

Buildings Accumulated Depreciation Trademarks

8. 9. 10.

I Franchises I Licenses PPE Equipment

8.52

Chapter 8: Reporting and analysing non-current assets

106. Pine Ltd purchased a truck for $40,000. The company expected the truck to last four years or 100,000 miles, with an estimated residual value of $4,000 at the end of that time. During the second year the truck was driven 27,500 miles. Calculate the depreciation for the second year under each of the methods below and place your answers in the blanks provided. Straight-line

Units-of-production

Diminishing balance at 25% p.a.

Answers below. Learning objective 8.1 – 8.14. Straight-line (40,000 - 4,000/4 = 9,000)

9,000

Units-of-production (40,000 - 4,000/100,000*27,500 = 9,900)

9,900

Diminishing balance at 25% p.a. (year 1 — 40,000 x .25 = 10,000) (year 2 — (40,000 - 10,000) x .25 = 10,000)

7 500

8.53

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

107. The Tolbert Corporation purchased equipment on 1 January, 2016, for $60,000. It is estimated that the equipment will have a $5,000 residual value at the end of its 5-year useful life. It is also estimated that the equipment will produce 100,000 units over its 5-year life. Required: Answer the following independent questions. 1. Calculate the amount of depreciation expense for the year ended 31 December, 2016, using the straight-line method of depreciation. 2. If 16,000 units of product are produced in 2016 and 24,000 units are produced in 2017, what is the carrying amount of the equipment at 31 December, 2017? The company uses the units-of-production depreciation method.

Answers below. Learning objective 8.1 – 8.14. 1. Straight - line method :

C - S $60,000 - $5,000 = = $11,000 per year. Years 5

2. Units - of - production method : 2016 16,000 units x $.55 2017 24,000 units x $.55 Accumulated Depreciation

C - S $60,000 - $5,000 = = $.55 per unit Units 100,000 units = = =

$ 8,800 13,200 $22,000

Cost of asset $60,000 Less: Accumulated Depreciation 22,000 Carrying amount at 31 December, 2013 $38,000

8.54

Chapter 8: Reporting and analysing non-current assets

108. A plant asset acquired on October 1, 2016, at a cost of $400,000 has an estimated useful life of 10 years. The residual value is estimated to be $30,000 at the end of the asset's useful life. Determine the depreciation expense for the first two years using the: (a) straight-line method. (b) diminishing balance method (where the constant rate is 23%).

Answers below. Learning objective 8.1 – 8.14. (a)

Straight-line method Year 1

$400,000 - $30,000 = $37,000 x 3  12 = $9.250 10 years

Year 2 (b)

$37,000

Diminishing balance method Year 1 Year 2

$400,000 x 23% x 3 / 12 = $23,000 $400,000 – 23,000 = 377,000 x 23% = $86,710

8.55

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

109. The Hang-Out, a popular pizza hang-out, has a thriving delivery business. The HangOut has a fleet of three delivery vehicles and they use the units of production (kilometer) method of depreciation. Prior to making the entry for this year's depreciation expense, the asset register for the fleet is as follows:

Operated Car Cost 1 $18,000 2 15,000 3 20,000

Residual Value $3,000 2,400 2,500

Estimated Life in Kms 50,000 60,000 70,000

Accumulated Depr.—Beg. of the Year $2,100 1,890 2,000

Kms During Year 20,000 22,000 19,000

Required: (a) Determine the depreciation rates per kilometre for each car. (b) Determine the depreciation expense for each car for the current year. (c) Make one compound journal entry to record the annual depreciation expense for the fleet.

Answers below. Learning objective 8.1 – 8.14. Car 1 —

$18,000 − $3,000 = .30 per km 50,000 Kms

Car 2 —

$15,000 - $2,400 = .21 per km 60,000 Km

Car 3 —

$20,000 - $2,500 = .25 per km 70,000 Km

(b)

Car 1 — Car 2 — Car 3 —

20,000 kms x .30 = $6,000 22,000 kms x .21 = $4,620 19,000 kms x .25 = $4,750

(c)

Depreciation Expense .................................................................... Accumulated Depreciation — Car 1 ..................................... Accumulated Depreciation — Car 2 ..................................... Accumulated Depreciation — Car 3 .....................................

(a)

15,370 6,000 4,620 4,750

8.56

Chapter 8: Reporting and analysing non-current assets

110. The Donovan Medical Centre purchased a new surgical laser for $64,000. The estimated residual value is $4,000. The laser has a useful life of six years and the clinic expects to use it 10,000 hours. It was used 1,600 hours in year 1; 2,100 hours in year 2; 2,400 hours in year 3; 1,400 hours in year 4; 2,000 hours in year 5; 500 hours in year 6. Instructions (a) Calculate the annual depreciation for each of the six years under each of the following methods: (1) straight-line. (2) units-of-production (service) (b) If you were the administrator of the clinic, which method would you select as the most appropriate? Justify your answer. (c) Which method would result in the lowest reported profit in the first year? Which method would result in the lowest total reported profit over the six-year period?

Answers below. Learning objective 8.1 – 8.14. (a)

(1)

Straight-line method:

$64,000 − $4,000 = $10,000 per year 6 years

(2)

Units-of-production:

$64,000 − $4,000 = $6.00 / hour 10,000 hours

Year 1 2 3 4 5 6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Total

1,600 2,100 2,400 1,400 2,000 500

x x x x x x

$6.00 6.00 6.00 6.00 6.00 6.00

Straight-line $10,000 10,000 10,000 10,000 10,000 10,000 $60,000

= $ 9,600 = 12,600 = 14,400 = 8,400 = 12,000 = 3,000 Units of Activity $ 9,600 12,600 14,400 8,400 12,000 3,000 $60,000

(b) The units-of-production method can be justified based on the variable usage the laser will receive during its useful life. The straight-line method provides the highest depreciation expense for the first year, and therefore the lowest first year profit. Over the six-year period, both methods result in the same total depreciation expense ($60,000) and, therefore, the same total profit.

8.57

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

111. Outback Airlines purchased a 747 aircraft on 1 January, 2016, at a cost of $30,000,000. The estimated useful life of the aircraft is 20 years, with an estimated residual value of $4,000,000. Calculate the accumulated depreciation and carrying amount at 31 December, 2016, 2017 and 2018 using the straight-line method and the diminishing value method and a rate of 10%.

Answers below. Learning objective 8.1 – 8.14.

Year 2016 2017 2018

Depreciable Depreciation Amount × Rate $26,000,000 5% $26,000,000 5% $26,000,000 5%

Straight-line (Rate = 1/20 or 5%) A nnual Accumulated = Depreciation Depreciation $1,300,000 $1,300,000 $1,300,000 2,600,000 $1,300,000 3,900,000

Diminishing value Carrying amount Depreciation Annual Beginning Year × Rate = Depreciation $30,000,000 10% $3,000,000 27,000,000 10% 2,700,000 24,300,000 10% 2,430,000

Accumulated Depreciation $3,000,000 5,700,000 8,130,000

Carrying Amount $28,700,000 27,400,000 26,100,000

Book Value $27,000,000 24,300,000 21,870,000

8.58

Chapter 8: Reporting and analysing non-current assets

112. Chuck's Timber Mill sold two machines in 2016. The following information pertains to the two machines: Purchase Useful Residual Depreciation Sales Machine Cost Date Life Value Method Date Sold Price #1 $86,000 1 Jul 12 5 yrs. $6,000 Straight-line 30 June 16 $20,000 #2 $50,000 1 Jul 14 5 yrs. $5,000 Diminishing31 Dec 16 $32,000 Balance 40% Required: (a) Calculate the depreciation on each machine to the date of disposal. The financial year ends 31 December. (b) Prepare the journal entries in 2016 to record 2016 depreciation and the sale of each machine.

Answers below. Learning objective 8.1 – 8.14. (a) Machine #1 12 months to 30 June 2016: $86,000 – 6,000 = 80,000/5 = $16,000 x 6/12 = $8,000. Machine #2 Carrying amount Year Beginning of Year 2015(6 months) $50,000 2016 40,000

(b) Depreciation Expense Accumulated Depreciation Cash Loss on Sale of Equipment Accumulated Depreciation Equipment Gain on Sale of Equipment

Rate 40% 40%

Annual Depreciation $20,000 x .5 = 10,000 16,000

Machine 1 16,000

Accumulated Depreciation $10,000 26,000

Machine 2 6,000 16,000

20,000 2,000* 64,000

6,000 32,000 -026,000

86,000 -0-

50,000 8,000**

*$86,000 - $64,000 = $22,000; $22,000 - $20,000 = $2,000. **$32,000 - ($50,000 - $26,000) = $8,000.

8.59

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Completion statements

113. Complete the following statements: 1.

The _______________ price is equal to the fair market value of the asset given up or the fair market value of the asset received.

With the exception of land, plant assets experience a ______________ in service potential over their useful lives.

When vacant land is acquired, expenditures for clearing, draining, filling, and grading should be charged to the ______________ account.

The cost of demolishing an old building on land that has been acquired so that a new building can be constructed should be charged to the ______________ account.

The cost of paving, fencing, and lighting a new company parking lot is charged to a ______________ account.

Equipment with an invoice price of $20,000 was purchased and freight costs were $600. The cost of the equipment would be $______________.

______________ is the process of allocating the cost of a plant asset to expense over its service life in a rational and systematic manner.

The carrying amount of a plant asset is obtained by subtracting ______________ from the ______________ of the plant asset.

Three factors that affect the calculation of periodic depreciation expense are (1) _______________, (2) _______________, and (3) _________________.

10.

The ________________ method of calculating depreciation expense results in an equal amount of periodic depreciation throughout the useful life of the plant asset.

11.

The diminishing balance method of computing depreciation is known as an _____________ depreciation method.

12.

Ordinary repairs that maintain operating efficiency and expected productive life are called _______________.

13.

Additions and improvements are costs incurred to increase the operating efficiency, productive capacity, or expected useful life and are referred to as _________________. .

8.60

Chapter 8: Reporting and analysing non-current assets

14.

A _____________ decline in the market value of an asset is referred to as an impairment.

15.

If disposal of a plant asset occurs at any time during the year, ___________________ for the proportion of the year to the date of disposal must be recorded.

16.

If the proceeds from the sale of a plant asset exceeds its ______________, a gain on disposal will occur.

17.

A plant asset originally cost $16,000 and was estimated to have a $1,000 residual value at the end of its 5-year useful life. If at the end of three years, the asset was sold for $4,000, and had accumulated depreciation recorded of $9,000, the company should recognise a ______________ on disposal in the amount of $____________.

18.

The average useful life of plant assets is calculated by dividing the average cost of plant assets by _______________.

19.

_______________ is calculated by dividing net sales by average total assets.

20.

The process of allocating to expense the cost of an asset over its useful life is called __________________ for tangible plant assets and __________________ for intangible assets.

21.

In recording the purchase of a business, goodwill should be recorded for the excess of ______________ over the _______________ of the net assets acquired.

22.

The management by an entity of the biological transformation of assets into produce is known as an ________________ activity.

8.61

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 8.1 – 8.14. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

cash equivalent decline Land Land Land Improvement $20,600. Depreciation accumulated depreciation, cost cost, residual value, useful life straight-line accelerated revenue expenditures

13. 14. 15. 16. 17. 18. 19. 20. 21. 22.

capital expenditures permanent depreciation Carrying amount loss, 3,000 depreciation expense Asset turnover depreciation, amortisation cost, fair market value agricultural

8.62

Chapter 8: Reporting and analysing non-current assets

Matching 114. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Plant assets Depreciation Carrying amount Residual value Straight-line method

F. G. H. I. J.

Units-of-production method Diminishing balance method Amortisation Revenue expenditures Capital expenditures

____

1. Small expenditures which primarily benefit the current period.

____

2. Cost less accumulated depreciation.

____

3. An accelerated depreciation method used for financial statement purposes.

____

4. Tangible resources that are used in operations and are not intended for resale.

____

5. Equal amount of depreciation each period.

____

6. Expected cash value of the asset at the end of its useful life.

____

7. Process of allocating the cost of equipment over its service life.

____

8. Process of allocating the cost of an intangible asset over its useful or legal life.

____

9. Useful life is expressed in terms of units of production or expected use.

____ 10. Costs associated with the purchase of plant assets.

Answers below. Learning objective 8.1 – 8.14. 1. 2. 3. 4. 5.

I C G A E

6. 7. 8. 9. 10.

D B H F J

8.63

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

115. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Gain on disposal Loss on disposal Trademark Finance lease Asset turnover

F. G. H. I. J.

Average useful life Goodwill Agricultural assets Intangible asset Research costs

____

1. Standing crops held as part of a forestry operation

____

2. Is recorded if the proceeds from the sale exceed the carrying amount of the plant asset.

____

3. Examples are franchises and licenses.

____

4. A long-term agreement allowing the lessee to use the lessor’s asset.

____

5. Can be identified only with a business as a whole.

____

6. A symbol that identifies a particular enterprise or product.

____

7. When the carrying amount of asset is greater than the proceeds received from its sale.

____

8. Must be expensed when incurred.

____

9. Calculated as the average cost of plant assets divided by depreciation expense.

____ 10. Indicates how efficiently a company is able to generate sales with a given amount of assets.

Answers below. Learning objective 8.1 – 8.14. 1. 2. 3. 4. 5.

H A I D G

6. 7. 8. 9. 10.

C B J F E

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Chapter 8: Reporting and analysing non-current assets

Short-answer/essay questions

116. The diminishing balance method is an accelerated method of depreciation. Briefly explain what is meant by an accelerated method of depreciation and justify the choosing of an accelerated method.

Answer below. Learning objective 8.1 – 8.14. An accelerated depreciation method is a method that produces higher depreciation expense in the early years than in the later years. The choice of an accelerated method can be justified if the asset being depreciated contributes more to the revenue-earning process in the earlier years and less in the later years. An accelerated method can also be justified if the asset’s value is expected to decline very quickly. In such situations, an accelerated method would properly match expense to revenue.

117. In general, how does one determine whether or not an expenditure should be included in the acquisition cost of property, plant and equipment?

Answer below. Learning objective 8.1 – 8.14. The acquisition cost of property, plant and equipment would include all expenditures deemed reasonable and necessary to prepare the asset for its intended purpose (use) and place. 118. Comment on the validity of the following statements. “As an asset loses its ability to provide services, cash needs to be set aside to replace it. Depreciation accomplishes this goal.”

Answer below. Learning objective 8.1 – 8.14. Depreciation is the process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner. Recognising depreciation for an asset does not result in the accumulation of cash for replacement of the asset. The balance in Accumulated Depreciation represents the total amount of the asset’s cost that has been charged to expense to date; it is not a cash fund.

8.65

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

119. Identify the factors that are considered in classifying an expenditure as a capital or a revenue expenditure. Are there instances where it may be difficult to classify an expenditure as one or the other (e.g., the purchase of a wastebasket that has a useful life of 5 years and cost $10)? What accounting concept would be used in the decision?

Answer below. Learning objective 8.1 – 8.14. An expenditure is classified as a revenue expenditure if it maintains the operating efficiency and expected productive life of the asset and primarily benefits the current accounting period. Revenue expenditures are usually small amounts that occur frequently throughout the life of the asset and are often called ordinary repairs. An expenditure is classified as a capital expenditure if it increases (rather than maintains) operating efficiency, productive capacity, or expected useful life, and therefore benefits more than one accounting period. Capital expenditures are usually large amounts that occur infrequently during the life of the asset. Capital expenditures can be further classified as either additions or improvements. The distinction between a capital expenditure and a revenue expenditure is not always clearcut. The purchase of an asset with a relatively insignificant cost (for example, the purchase of a $10 wastebasket with a 5-year useful life) may meet the criteria for classification as a capital expenditure, even though it is similar in many ways to a revenue expenditure (small amount, more frequent occurrence). The accounting constraint of materiality would indicate that this item could be recorded as an expense (more expedient) since it is not material enough to influence the decision of a reasonably prudent creditor or investor.

120. Goodwill is an unusual asset in that it cannot be sold individually apart from a business as a whole. If goodwill is an intangible asset, why can't it be sold like other intangible assets such as copyrights and patents? Briefly explain what makes goodwill different.

Answer below. Learning objective 8.1 – 8.14. Goodwill is the value of all favourable attributes that relate to a business enterprise. As goodwill is the product of these attributes, and would not exist apart from them, goodwill cannot be separated from the company and then sold. This is different from a copyright or patent that can exist independently of a company, and can be sold apart from any other assets.

8.66

Chapter 8: Reporting and analysing non-current assets

121. Ethics: Physician Reference Service (PRS) provides services to physicians including research assistance, diagnosis coding and medical practice software including an advanced medical record cross-referencing system. PRS is aggressive in monitoring other firms' offerings and ensuring that its services are comparable to all others. Because of its need to stay abreast of new product offerings, PRS spends a lot of money sending professionals to trade shows. In addition, PRS has agreements with several clients whereby the client requests a presentation of a competitor's services. A PRS employee poses as an employee of the client's office and attends the presentation, obtaining as much data and sample information as possible. The cost of the travel and attending presentations is charged to Product Development and expensed during the current year. In April of this year, PRS began selling a software product substitute before the competitor's software was released. The competitor, Compu-Med, sued for copyright infringement and won. PRS had to withdraw its product from the market and pay $1.5 million in damages. PRS immediately negotiated an agreement with Compu-Med to sell Compu-Med's product (since it was prohibited from offering its own version for five years). This agreement cost an additional $1.3 million, but it allowed PRS to continue to offer a full line of services. PRS' accountant, Tiana Bico, initially recorded the cash payments as "Loss from Lawsuit" and ‘Product Development’, respectively. However, H. J. ‘Taco’ Frann, the controller, instructed Tiana to create an intangible asset, named ‘Goodwill’, and charge both costs to this account. ‘We're protected from another lawsuit as long as this agreement is in effect’, he says. ‘It's about as close to goodwill as we'll ever get from our competitors. We might as well amortise the cost rather than take the full hit to income, anyway.’ Required: 1. What are the ethical issues? 2. What should Tiana do?

Answers below. Learning objective 8.1 – 8.14. 1. The following are some of the ethical issues: a. Whether PRS should continue to obtain its information by deception b. Whether PRS makes a practice of pirating software c. Whether the attempt to hide the losses from the lawsuit and software agreement is indicative of the state of the accounting system at PRS. 2. Tiana should explain to her boss that goodwill arises only when a business is purchased. It is not allowed to write off lawsuit losses or product development costs (which these clearly are) over more than one year. She cannot allow her integrity to be compromised by misrecording these economic events. She could also point out that Mr. Frann's attempt to delay recognition of the losses will undoubtedly be discovered by the auditors. All the records will then likely be subjected to much more scrutiny than would otherwise be the case.

8.67

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

122. Communication: The Old Fix-It is a company specialising in the restoration of old homes. To showcase its work, the company purchased an old Victorian home in downtown Sandy Bay, Hobart. The original home was purchased for $125,000. A new heating and airconditioning system was added for $30,000. The house was completely rewired and replumbed at a cost of $50,000. Custom cabinets were added, and the floors and trim were refurbished to their original condition, at a cost of $75,000. The project was such a success, that Old Fix-It decided to purchase another very large home, this time in Byron Bay, NSW. A Realtor offered to purchase the home in Sandy Bay for $175,000. He plans to lease it as luxury short-term apartments for visiting dignitaries. Old Fix-It decided that a modest return was all that was required, and so they agreed to sell. Only afterward did they learn that they had a $10,000 loss on the sale. The president of the company, Dale Eubanks, does not believe that a loss is possible. ‘We sold that house for more than we paid for it’, he said. ‘I know we put some money in it, but we had depreciated it for three years. How in the world can we have a loss?’ Required: Write a short memo to Mr. Eubanks explaining how it would be possible to have a loss. Do not try to use specific numbers for cost or depreciation.

8.68

Chapter 8: Reporting and analysing non-current assets

Answer below. Learning objective 8.1 – 8.14.

MEMO TO:

Dale Eubanks, President

FROM: Martha King, Accountant RE:

Loss on Sandy Bay showcase

I understand that you are concerned about the loss on the Sandy Bay showcase house. You have said that a loss is not possible, since we sold the house for more than we paid for it. Ordinarily, it would not be possible for any PPE asset to generate a loss if sold for more than the original purchase price. Accounting rules allow for writing down impaired assets, and depreciation also reduces the cost basis. In our case, however, we had added enough costs that it was almost like we purchased the house twice. Thus, we had a carrying amount of $185,000 at the time of the sale, even though we had taken three years' depreciation. All in all, I think that the Sandy Bay house was still an excellent investment — we got far more benefit from the $10,000 ‘loss’ than we would have had spending ten times that much in advertising. To prevent the problem in the future, however, you could have the Accounting Department calculate the carrying amount before you negotiate a sales contract. That way, you'll know the effect of the transaction on our profit —though you should remember that carrying amount is not a substitute for market value; we'll still have to rely on real estate agents for that. Let me know if you have further questions. (signature)

8.69

Chapter 9: Reporting and analysing liabilities

Chapter 9 True-false Statements

1. A current liability is an obligation that can reasonably be expected to be paid within the operating cycle of a business. Answer: This statement is true. Learning objective 9.1 - Explain the differences between current and non-current liabilities.

2. Notes payable, accounts payable, revenue received in advance and accrued liabilities are all examples of non-current liabilities. Answer: This statement is false. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

3. A current liability must be paid out of current earnings. Answer: This statement is false. Learning objective 9.1 - Explain the differences between current and non-current liabilities.

4. If any portion of non-current liabilities is to be paid in the next year, the entire liabilities should be classified as a current liability. Answer: This statement is false. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

5. Notes payable usually require the borrower to pay interest. Answer: This statement is true. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

6. A note payable must always be paid before an account payable. Answer: This statement is false. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

9.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

7. A $15,000, 8%, 9-month note payable requires an interest payment of $900 at maturity. Answer: This statement is true. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

8. Most notes are not interest bearing. Answer: This statement is false. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

9. Current maturities of non-current liabilities refers to the amount of interest on a note payable that must be paid in the current year. Answer: This statement is false. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

10. In Australia the taxation authority is the Australian Securities and Investments Commission (ASIC). Answer: This statement is false. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them. 11. An employer business is required by law to withhold tax from an employee’s gross pay and remit it to the taxation authority (the ATO). Answer: This statement is true. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

12. Unearned revenues should be classified as Other Revenues on the income statement. Answer: This statement is false. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

9.2

Chapter 9: Reporting and analysing liabilities

13. Sydney Symphony sells 200 season tickets for $20,000 that includes a five-concert season. The amount of Unearned Ticket Revenue after the third concert is $12,000. Answer: This statement is false. Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them.

14. Non-current liabilities are obligations of a business that it expects to pay after one year. Answer: This statement is true. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 15. Notes that are secured over some of the issuer’s assets are called debentures. Answer: This statement is true. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

16. Shareholder control is diminished by the issue of debt financing. Answer: This statement is false. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

17. Although interest expense reduces net profit, earnings per share is often higher under debt financing because no additional shares have been issued. Answer: This statement is true. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. 18. The face value of a note is also the principal amount due at maturity of the note. Answer: This statement is true. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

19. The market interest rate is the rate that investors demand for lending funds to the borrowing entity. Answer: This statement is true. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

9.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

20. If a company redeems notes and debentures, it adds debt to its statement of financial position. Answer: This statement is false. Learning objective 9.3 - Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them.

21. A mortgage is a load secured by a charge over property. Answer: This statement is true. Learning objective 9.4 - Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long-term debt.

22. If a borrower is unable to repay a mortgage, the lender has no right to recover the debt against the mortgaged property. Answer: This statement is false. Learning objective 9.4 - Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long-term debt.

23. Each time a borrower makes a mortgage repayment, the borrower must allocate the amount between unearned revenue and revenue. Answer: This statement is false. Learning objective 9.4 - Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long-term debt.

24. To the extent that long-term debt is repayable within the same period as current liabilities, it should be classified as a current liability. Answer: This statement is true. Learning objective 9.4 - Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long-term debt.

25. Provisions are liabilities for which the amount of the future sacrifice is uncertain. Answer: This statement is true. Learning objective 9.7 - Explain the differences between provisions, contingencies and other types of liabilities.

9.4

Chapter 9: Reporting and analysing liabilities

26. A warranty is an obligation of the receiver of goods and services that a future claim will not be made against the supplier of the goods if the goods prove to be unsatisfactory. Answer: This statement is false. Learning objective 9.9 - Prepare entries to record provisions for warranties.

27. If the amount of a liability cannot be exactly determined, it should never be recorded. Answer: This statement is false. Learning objective 9.8 - Explain how to report contingent liabilities.

28. A contingent liability is a liability that may materialise in the future because of something that happened in the past. Answer: This statement is true. Learning objective 9.8 - Explain how to report contingent liabilities. 29. From a manufacturer’s point of view, providing a warranty creates an obligation to repair or replace goods if certain faults arise within the warranty period. Answer: This statement is true. Learning objective 9.9 - Prepare entries to record provisions for warranties.

30. Warranties are not recognised as liabilities by manufacturers as the amount of any future claims is too uncertain and/or unlikely. Answer: This statement is false. Learning objective 9.9 - Prepare entries to record provisions for warranties.

31. Provisions for warranties may only be reported in the liabilities section of a statement of financial position as current liabilities. Answer: This statement is false. Learning objective 9.9 - Prepare entries to record provisions for warranties.

32. The acid-test ratio is computed by dividing the sum of cash, net receivables, and inventory by current liabilities. Answer: This statement is false. Learning objective 9.10 - Evaluate an entity’s liquidity and solvency.

9.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

33. The classification of a liability as current or non-current is important because it may affect the evaluation of a company’s liquidity. Answer: This statement is true. Learning objective 9.10 - Evaluate an entity’s liquidity and solvency.

34. The liabilities to total assets ratio measures the percentage of the total assets provided by creditors. Answer: This statement is true. Learning objective 9.10 - Evaluate an entity’s liquidity and solvency.

35. The times interest earned ratio is computed by dividing net profit by interest expense. Answer: This statement is false. Learning objective 9.10 - Evaluate an entity’s liquidity and solvency.

9.6

Chapter 9: Reporting and analysing liabilities

Multiple-choice questions

1. Liabilities are classified on the statement of financial position as current or: a. deferred. *b. non-current. c. unearned. d. accrued. Answer: b Learning objective 9.1 – Explain the differences between current and non-current liabilities. Feedback: Similar to assets, liabilities are classified on the statement of financial position as being either current or non-current.

2. Most companies pay current liabilities: a. by issuing shares. b. by issuing interest-bearing notes payable. *c. out of current assets. d. by creating long-term liabilities. Answer: c Learning objective 9.1 – Explain the differences between current and non-current liabilities. Feedback: Most current liabilities are settled with the payment of cash as the sacrifice of future economic benefits. Cash is a current asset.

3. A current liability is a liability that can reasonably be expected to be paid: *a. within one year or within the operating cycle (whichever is the longer). b. between 6 months and 18 months. c. out of currently recognised revenues. d. out of cash currently on hand. Answer: a Learning objective 9.1 – Explain the differences between current and non-current liabilities. Feedback: A current liability is one that can reasonably be expected to be paid within one year or within the normal operating cycle (whichever is the longer).

9.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. Which of the following most likely would be classified as a current liability? a. mortgage payable. b. bonds payable. c. three-year notes payable. *d. accounts payable. Answer: d Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: Bonds payable, three-year notes payable and mortgage payable will normally be due in more than one year’s time. Accounts payable as amounts owed to suppliers is usually paid or settled within one year or within the operating cycle.

5. Notes payable usually require the borrower to pay: a. revenue. *b. interest. c. prepayments. d. contingencies. Answer: b Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: A note payable usually requires the borrower to pay interest as well as the amount of the note.

6. Which of the following would not be classified as a current liability? a. accrued taxes payable. b. revenue received in advance. *c. mortgage. d. notes payable. Answer: c Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them.

9.8

Chapter 9: Reporting and analysing liabilities

7. The account ‘Revenue received in advance’ is properly treated as a/an: a. asset. *b. liability. c. revenue. d. payment to shareholders. Answer: b Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: The proper treatment of the account ‘Revenue received in advance’ (also known as ‘unearned revenue’) is to classify it as a liability.

8. Interest expense on an interest-bearing note is: a. always equal to zero. b. only recorded at the time the note is issued. *c. accrued over the life of the note. d. only recorded at maturity when the note is paid. Answer: c Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: On an interest-bearing note, interest expense is accrued over the life of the note.

9.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Use the following information for questions 9-11. Bondi Bank agrees to lend Tawonga Construction Company Ltd $200,000 on 1 January. Tawonga Construction Company Ltd signs a $200,000, 4%, 9-month note.

9. The entry made by Tawonga Construction Company Ltd on 1 January to record the proceeds and issue of the note is: a.

Interest Expense 6,000 Cash 194,000 Notes Payable 200,000

*b.

Cash

200,000 Notes Payable

Cash

200,000

200,000 Interest Expense Notes Payable

6,000 206,000

200,000 Interest Expense Notes Payable Interest Payable

6,000 200,000 6,000

Answer: b Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: A debit entry is made to cash to record the proceeds received from the bank and a credit entry is made to Notes Payable to record the liability to the bank. The amount is for the value of the loan. No interest is payable on the day of issue.

9.10

Chapter 9: Reporting and analysing liabilities

10. What is the adjusting entry required if Tawonga Construction Company Ltd prepares financial statements on 30 June? *a.

Interest Expense Interest Payable

4,000

Interest Expense Cash

6,000

Interest Payable Cash

6,000

Interest Payable Interest Expense

4,000

6,000

4,000

Answer: a Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: A debit to Interest expense to record the interest expense to date and a credit to interest payable to record the liability to the bank for the interest. The amount of the entry is $4,000 (($200,000 x 4%)/12) x 6.

11. What entry will Tawonga Construction Company Ltd make to pay off the note and interest at maturity? *a.

Interest Payable Notes Payable Interest Expense Cash

4,000 200,000 2,000 206,000

Notes Payable Cash

206,000

Notes Payable Interest Payable Cash

200,000

206,000

6,000 206,000

Interest Expense Notes Payable Cash

6,000 200,000 206,000

Answer: a Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: The interest to 30 June has been accrued. The correct entry will record a debit to Interest Payable to release the liability; a debit to interest expense for interest from 1 July to 30 September and lastly a credit to cash to record the payment to the Bank.

9.11

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

12. Wayfarer Ltd withheld $54 000 of ‘PAYG’. The entry to record payment of the tax to the Tax Office is: a. Cash

54 000 Tax payable

54 000

b. PAYG Tax payable Accounts payable c. Cash

54 000 54 000

54 000 Accounts payable

54 000

*d. PAYG Tax payable Cash

54 000 54 000

Answer: d Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: A debit to PAYG Tax payable will record payment of the liability and a credit to cash will record the payment to the taxation authority.

Use the following information for questions 13–14. On 1 October, Simon’s Solar Service borrows $150,000 from Statewide Bank on a 3 month, 4% note. 13. What accrual entry must Simon’s Solar Service make on 31 December before financial statements are prepared? a. Interest Payable Interest Expense

1,500

*b. Interest Expense Interest Payable

1,500

c. Interest Expense Interest Payable

6,000

d. Interest Expense Notes Payable

1,500

6,000

1,500

Answer: b Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: The interest liability to Statewide Bank must be recognised by a debit to interest expense and a credit to interest payable. The amount of the entry is $1,500 (($150,000 x 4%) x 3/12).

9.12

Chapter 9: Reporting and analysing liabilities

14. The entry by Simon’s Solar Service to record payment of the note and accrued interest on 1 January is: a. Notes Payable Cash

151,000

b. Notes Payable Interest Payable Cash

150,000 4,000

c. Notes Payable Interest Expense Cash

150,000 1,000

*d. Notes Payable Interest Payable Cash

150,000 1,500

151,000

154,000

151,000

Answer: d Learning objective 9.2 - Identify common types of current liabilities and explain how to account for them. Feedback: The correct entry is a debit to Notes Payable for the value of the note to record the release of the liability; a debit to interest payable to record the release of the interest liability and lastly a credit to cash to record the payment to the Bank.

15. Emerald Ltd has the following payroll deductions for the week ended 31 March: $20 000 medical fund deductions; $18,000 Pay-as-you-go withheld tax deductions. What is the journal entry to record the obligation for these deductions? a.

*c.

Dr Cr

Salaries expense Cash

38,000

Dr Cr

Cash

38,000 Wages payable

38,000

Dr Cr Cr

Salaries expense 38,000 Medical fund payable Pay-as-you-go tax payable

20,000 18,000

Dr Cr

Cash 38,000 Salaries payable

38,000

Answer: c Learning objective 9.2 – Identify common types of current liabilities and explain how to account for them. Feedback: A debit to salaries expense is made for the total of the deductions. An entry is then made to each payable account for the relevant amount.

9.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. On 1 January 2016 Bradley Ltd, a calendar-year company, issued $200,000 of notes payable of which $50,000 is due on 1 January for each of the next four years. The proper statement of financial position for presentation on 31 December 2016 is: a. Current Liabilities, $200,000 b. Non-current Liabilities, $200,000 *c. Current Liabilities, $50,000; Non-current liabilities, $150,000 d. Current Liabilities, $150,000; Non-current liabilities, $50,000 Answer: c Learning objective 9.4 – Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. Feedback: At the end of the year the current portion of the non-current liability is reclassified as a current liability.

17. Shareholders of a company may be reluctant to finance expansion through issuing more equity because: a. leveraging with liabilities is always a better idea. *b. their earnings per share may decrease. c. the price of the shares will automatically decrease. d. dividends must be paid on a periodic basis. Answer: b Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: Increasing the number of shares on issue may dilute the current shareholders’ earnings per share.

18. Companies may find it attractive to issue debt instead of equity because: *a. interest on debt is tax deductible. b. interest on debt has to be repaid by the shareholders, not the company. c. interest on debt is always a cheaper form of finance than dividends on shares. d. interest on debt is not locked in for repayment. Answer: a Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: Debt is sometimes preferable to equity because the interest on debt is tax deductible whereas dividends paid to equity holders are not.

9.14

Chapter 9: Reporting and analysing liabilities

19. The face value of a note is also known as the: a. market value. *b. principal. c. trading value. d. unsecured amount. Answer: b Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: The face value of a note is also known as the principal.

20. The contractual rate of interest of an unsecured note is usually stated as an: a. monthly rate. b. daily rate. c. semiannual rate. *d. annual rate. Answer: d Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: The contractual rate of interest is usually stated as an annual rate.

21. The rate used to determine the amount of interest that a borrower pays on an unsecured note and the investor receives on the unsecured note is known as the: a. market rate. b. present value rate. *c. contract interest rate. d. discounted rate. Answer: c Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: The contract interest rate is used to determine the amount of interest that a borrower pays and the investor receives.

9.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. When a company repurchases its unsecured notes, the debt has been: *a. redeemed. b. discounted. c. revalued. d. determined. Answer: a Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: When a company repurchases its unsecured notes, the debt has been redeemed.

23. A loan secured by a charge over a property is also known as a: a. contingent liability. b. warranty. *c. mortgage. d. provision. Answer: c Learning objective 9.4 – Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. Feedback: A mortgage is a loan secured by a charge over a property.

24. Century Ltd has outstanding debentures with a face value of $50,000. If Century redeems the debentures for $55,000 it must record: a. a gain of $5,000. b. a gain of $55,000. *c. a loss of $5,000. d. a loss of $50,000. Answer: c Learning objective 9.3 – Identify common types of non-current liabilities, such as debentures and unsecured notes, and explain how to account for them. Feedback: A loss of $5,000 must be recorded as the debentures were redeemed for $5,000 more than their face value.

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Chapter 9: Reporting and analysing liabilities

25. A borrower must allocate mortgage repayments between: a. interest expense and interest revenue. *b. interest expense and loan liability. c. interest revenue and loan liability. d. loan liability and shareholders’ equity. Answer: b Learning objective 9.4 – Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. Feedback: As each mortgage payment is made up of both interest and principal, a borrower must allocate mortgage repayments between interest expense and loan liability.

26. When recording a mortgage payment made by a borrower, the borrower will: a. debit cash, and credit interest expense. b. debit mortgage payable, and credit interest expense. *c. debit both interest expense and mortgage payable, and credit cash. d. debit cash, and credit both interest expense and mortgage payable. Answer: c Learning objective 9.4 – Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. Feedback: As each mortgage payment is made up of both interest and principal, when recording a mortgage payment a borrower must debit both interest expense and mortgage payable, and credit cash.

27. The current portion of non-current liabilities should: a. be paid immediately. b. be classified as a long-term liability. *c. be reclassified as a current liability. d. not be separated from the long-term portion of liabilities. Answer: c Learning objective 9.4 – Prepare journal entries for loans payable by instalment and distinguish between current and non-current components of long term debt. Feedback: The current portion of a non-current liability should be classified as a current liability.

9.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. Liabilities for which the amount of the future sacrifice is uncertain are regarded as: a. warranties b. withholdings c. redeemables *d. provisions Answer: d Learning objective 9.7 – Explain the differences between provisions, contingencies and other types of liabilities. Feedback: When the amount of the future sacrifice is uncertain, liabilities are regarded as provisions.

29. Obligations to pay for goods or services that have been provided but for which a supplier’s invoice has not yet been received are recorded as: a. debentures. *b. accounts payable. c. warranties. d. contingencies. Answer: b Learning objective 9.7 – Explain the differences between provisions, contingencies and other types of liabilities. Feedback: If goods or services have been provided but a supplier’s invoice has not yet been received then the obligation to pay for the goods or services should be recorded as an accounts payable. Accruals often involve estimation, such as the amount of the next electricity bill. The level of uncertainty associated with accruals is higher than borrowings but it is generally relatively low as the amounts can often be estimated from reoccurring changes.

30. Obligations for which the amount of the future sacrifice is so uncertain that it cannot be measured reliably are classified as: a. warranties. *b. contingent liabilities. c. provisions. d. accruals. Answer: b Learning objective 9.7 – Explain the differences between provisions, contingencies and other types of liabilities. Feedback: If the amount of the future sacrifice is so uncertain that it cannot be measured reliably then it should be classified as a contingent liability.

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Chapter 9: Reporting and analysing liabilities

31. Which of the following is not an example of a provision? a. warranty for motor vehicle repairs b. employee long service leave entitlements *c. debentures issued d. employee annual leave entitlements Answer: c Learning objective 9.7 – Explain the differences between provisions, contingencies and other types of liabilities. Feedback: The amount of the future sacrifice cannot be determined for warranties and employee leave entitlements so these should be recorded as provisions. The future sacrifice for debentures can be determined therefore it should be recorded as a liability.

32. Which of the following is an example of a contingent liability? *a. legal proceedings against the business for a damages claim. b. warranties for repairs. c. debentures payable. d. mortgage owing. Answer: a Learning objective 9.7 – Explain the differences between provisions, contingencies and other types of liabilities. Feedback: Legal proceedings against the business for damages is an example of a contingent liability as the future sacrifice cannot be measured reliably and the future sacrifice is contingent on an event – i.e. losing the court case. 33. Information about contingent liabilities may be found in a company’s financial statements in the: a. statement of financial position. b. income statement. *c. notes. d. statement of changes in equity. Answer: c Learning objective 9.8 – Explain how to report contingent liabilities. Feedback: A company’s financial statements will contain information about contingent liabilities in the notes to the financial statements.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

34. Warranty obligations are classified as provisions because the: a. amount of the future sacrifice is certain. b. future cost of repairs is known with certainty. *c. amount of future claims is uncertain. d. cost of future servicing is not able to be estimated reliably. Answer: c Learning objective 9.9 – Explain the differences between provisions, contingencies and other types of liabilities. Feedback: Warranty obligations are classified as provisions because the amount of any future claims is uncertain.

35. Timeless Ltd produces clocks and sells them with a one-year warranty. The warranty provision account currently has a debit balance of $4,000. The estimated cost of repairing clocks that have already been sold is $18,000. The adjustment needed to update the warranty provision account is: a. debit $18,000. b. credit $18,000. c. debit $22,000. *d. credit $22,000. Answer: d Learning objective 9.9 – Prepare entries to record provisions for warranties. Feedback: The warranty provision must be increased to $18,000. As provision accounts normally have a credit balance, a credit entry for $22,000 is required.

36. Vagabond Ltd manufactures handbags and provides a six-month quality warranty. The provision for warranty account has a credit balance of $50,000 and the estimated future obligations for warranty work is $190,000. The adjustment necessary to update the provision account is a: a. debit of $140,000. b. debit of $240,000. *c. credit of $140,000. d. credit of $240,000. Answer: c Learning objective 9.9 – Prepare entries to record provisions for warranties. Feedback: The warranty provision must be increased to $190,000. As provision accounts normally have a credit balance, a credit entry for $140,000 is required.

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Chapter 9: Reporting and analysing liabilities

37. Liquidity ratios measure a company's: a. operating cycle. b. revenue-producing ability. *c. short-term liabilities paying ability. d. long-range solvency. Answer: c Learning objective 9.10 – Evaluate an entity’s liquidity and solvency. Feedback: Liquidity ratios measure a company’s ability to pay its short term liabilities. 38. A quick ratio is a measure of an entity’s: a. long-term liquidity. b. medium-term liquidity. *c. short-term liquidity. d. quickness at paying creditors. Answer: c Learning objective 9.10 – Evaluate an entity’s liquidity and solvency. Feedback: The quick ratio is a stringent measure of an entity’s short term liquidity.

39. The quick ratio calculated by a business is also referred to as the: a. solvency ratio. *b. acid test. c. marketable test. d. interest coverage ratio. Answer: b Learning objective 9.10 – Evaluate an entity’s liquidity and solvency. Feedback: Another name for the quick ratio is the acid test.

9.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

40. The following information relates to Rangitata Ltd as at 30 June 2016.

Total current assets Total assets Current liabilities Total liabilities Inventories Prepayments

$000 2,200 10,000 1,100 2,400 2,000 50

The quick ratio is: a. 2 b. 9 c. 14 *d. 0.14 Answer: d Learning objective 9.10 – Evaluate an entity’s liquidity and solvency. Feedback: Inventory and prepayments are deducted from current assets as they are not highly liquid: (2,200 – 2,000 – 50)/1,100.

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Chapter 9: Reporting and analysing liabilities

Exercises

41. Identify (by letter) each of the following as being a current liability (CL), a non-current liability (NCL) or neither (NA). Items __________ 1. 3 months of revenues received in advance for an annual subscription to a magazine __________ 2. Pay-as-you-go withholding tax payable __________ 3. Unsecured notes with 9 months to maturity __________ 4. 20 year Mortgage __________ 5. 5 year debentures payable __________ 6. Interest expense __________ 7. Warranty expense

Answers below. Learning objective 9.1 – 9.10. 1. CL 2. CL 3. CL 4. NCL 5. NCL 6. NA 7. NA

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

42. The NZA Bank agrees to issue $180,000 of 3-month notes payable to Campbell Ltd on 1 March 2016. The notes are interest-bearing at the rate of 10%. Prepare the journal entries to record (a) the notes on issue date (b) the repayment of the notes including the interest, on due date

Answers below. Learning objective 9.1 – 9.10. Mar 1

Jun 1

Cash.........................................................................................180,000 Notes payable ......................................................................

180,000

Notes payable .............................................................................180,000 Interest expense ........................................................................... 4,500 Cash......................................................................................

184,500

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Chapter 9: Reporting and analysing liabilities

43. Beach Ltd’s payroll for June 2016 was $20,000. The pay week ended on 30 June and was paid on the 1 July. Payroll deductions from amounts paid during June were as follows: Medicare fund deductions ........................................................................$2,000 Pay-as-you-go tax deductions withheld ...................................................$3,500 Superannuation deductions ......................................................................$1,400 Required: (a) (b)

State the current liabilities relating to Beach Ltd’s payroll at 30 June 2016 Prepare the journal entry to record the payroll for the pay week ended 30 June

Answers below. Learning objective 9.1 – 9.10. (a)

Current liabilities for payroll at 30 June 2016 Unpaid wages ...............................................................................$20,000 Medicare fund deductions ............................................................ 2,000 Pay-as-you-go tax ........................................................................ 3,500 Superannuation deductions .......................................................... 1,400 Total ..................................................................................... 26,900

(b) Jun 30

Wages expense .......................................................................20,000 Pay-as-you-go withheld tax payable .......................... Medicare fund deductions payable ............................ Superannuation deductions payable ........................... Wages payable ...........................................................

2,000 3,500 1,400 13,100

9.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

44. The Candy Company Ltd has the following selected accounts after posting adjusting entries: Accounts Payable $ 69,000 Notes Payable, 3-month 90,000 Accumulated Depreciation — Equipment 14,000 Notes Payable, 5-year, 8% 30,000 Payroll Tax Expense 6,000 Interest Payable 3,000 Mortgage Payable 150,000 General sales tax (GST) Payable 38,000 Required: (a) Prepare the current liability section of The Candy Company's statement of financial position, assuming $25,000 of the mortgage is payable next year. (b) Comment on The Candy Company’s liquidity, assuming total current assets are $400,000.

Answers below. Learning objective 9.1 – 9.10. (a) THE CANDY COMPANY LIMITED Statement of Financial Position (partial) Current Liabilities Current portion of non-current liabilities Notes Payable, 3-month Accounts Payable General sales tax (GST) Payable Interest Payable Total Current Liabilities

$ 25,000 90,000 69,000 38,000 3,000 $225,000

(b) The liquidity position looks favourable. If all current liabilities are paid out of current assets, there would still be $175,000 of current assets (working capital). The current ratio is 1.78: 1 and it appears as though The Candy Company has sufficient current resources to meet current obligations when due.

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Chapter 9: Reporting and analysing liabilities

45. On 1 March, Marcel Ltd borrows $90,000 from the Eastward Bank by signing a 6-month, 9%, interest-bearing note. Instructions Prepare the necessary entries below associated with the note payable on the books of Marcel Ltd. (a) Prepare the entry on 1 March when the note was issued. (b) Prepare any adjusting entries necessary on 30 June in order to prepare the semiannual financial statements. Assume no other interest accrual entries have been made. (c) Prepare the entry to record payment of the note at maturity.

Answers below. Learning objective 9.1 – 9.10. (a)

(b)

(c)

March 1

June 30

Sept. 1

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

90,000

Interest Expense ........................................................... Interest Payable ................................................... ($90,000 x 9% x 4/12)

2,700

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

90,000 2,700 1,350

90,000

2,700

94,050

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

46. On May 31, Pearl Ltd borrows $20,000 from their bank by signing a 2 month, 12%, interest-bearing note. Instructions Prepare the necessary entries below associated with the note payable on the books of Pearl Ltd. (a) Prepare the entry on June 1 when the note was issued. (b) Prepare any adjusting entries necessary on 30 June in order to prepare the monthly financial statements. Assume no other interest accrual entries have been made. (c) Prepare the entry to record payment of the note at maturity.

Answers below. Learning objective 9.1 – 9.10. (a)

(b)

(c)

June

June 30

July 30

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

20,000

Interest Expense ........................................................... Interest Payable ................................................... ($20,000 x 12% / 12)

200

20,000 200 200

20,000

200

20,400

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Chapter 9: Reporting and analysing liabilities

47. The Mainland group of hotels billed its customers a total of $1,060,000 for the month of November. The total includes a 6% goods and services tax (GST). Instructions (a) Determine the proper amount of revenue to report for the month. (b) Prepare the general journal entry to record the revenue and related liabilities for the month.

Answers below. Learning objective 9.1 – 9.10. (a)

$1,060,000 / 1.06 = $1,000,000 is the total sales revenue.

(b)

$1,000,000 x .06 = $60,000 is the state general sales tax (GST) liability. Journal Entry: Accounts Receivable ...................................................................... 1,060,000 Sales Revenue ....................................................................... Goods and Services Tax (GST) Payable ...............................

1,000,000 60,000

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

48. March Ltd had cash sales of $44,000 for the month of June. Sales are subject to 10% goods and services tax (GST). Prepare the entry to record the sale.

Answer below. Learning objective 9.1 – 9.10. Cash ................................................................................................ Sales Revenue * ..................................................................... State Goods and Services Tax (GST) Payable** ................... *($44,000/1.1) **($44,000/11)

44,000 40,000 4,000

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Chapter 9: Reporting and analysing liabilities

49. Seagull Publications publishes a golf magazine for women. The magazine sells for $5.00 a copy on the news-stand. Yearly subscriptions to the magazine cost $50 per year (12 issues). During December 2016, Seagull Publications sells 5,000 copies of the golf magazine at newsstands and receives payment for 6,000 subscriptions for 2017. Financial statements are prepared monthly. Instructions (a) Prepare the December 2016 journal entries to record the news-stand sales and subscriptions received. (b) Prepare the necessary adjusting entry on 31 January, 2017. The January 2017 issue has been mailed to subscribers.

Answers below. Learning objective 9.1 – 9.10. (a)

(b)

Cash (or Accounts Receivable) ...................................................... News-stand Sales ..................................................................

25,000

Cash ................................................................................................ Revenue Received in Advance .............................................

300,000

25,000 300,000

$300,000 / 12 months = $25,000 Revenue Received in Advance ...................................................... Subscription Revenue ...........................................................

25,000 25,000

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

50. On 1 January 2016 the Guildford Group Ltd issued $800,000, 8%, 10-year unsecured notes at face value. Interest is payable semiannually on 1 July and 1 January. Guildford Group has a calendar year end. Instructions Prepare all entries related to the unsecured note issue for 2016. Answers below. Learning objective 9.1 – 9.10. 2016 Jan. 1

July

Dec. 31

Cash ....................................................................................... Unsecured Note Payable ..............................................

800,000

Note Interest Expense ........................................................... Cash .............................................................................. ($800,000 × 8% × 1/2 = $32,000)

32,000

Note Interest Expense ........................................................... Unsecured Note Interest Payable .................................

32,000

800,000

32,000

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Chapter 9: Reporting and analysing liabilities

51. The following information is available from the annual reports of 2 clothing retailers

Profit taxes Interest expense Profit Total assets Total current liabilities Total liabilities

(Amounts in millions) Cool Clothes Retro Rags $ 361 $ 766 480 1,423 594 1,048 23,628 37,675 5,970 14,109 16,469 31,906

Required: (a) Based on the preceding information, compute the following ratios for each company: 1. Liabilities to total assets 2. Times interest earned (b) What conclusion concerning the companies’ long-run solvency can be drawn from these ratios?

Answers below. Learning objective 9.1 – 9.10. (a) 1. Liabilities to total assets:

2. Times interest earned:

Cool Clothes $16,469 ÷ $23,628 = 70%

Retro Rags $31,906 ÷ $37,675 = 85%

$594 + $361 + $480 $1,048 + $766 + $1,423 $480 $1,423 = $1,435 ÷ 480 = $3,237 ÷ $1,423 = 3.0 times = 2.3 times

(b) Generally, companies prefer to maintain a lower liabilities to total assets ratio and a higher times interest earned ratio. Since CC’s liabilities ratio is 18% [(85% - 70%) ÷ 85%] lower than RR’s’ ratio and CC’s interest earned ratio is 30% [(3.0 - 2.3) ÷ 2.3] higher than RR’s, it can be concluded that Cool Clothes is in a better position regarding long-run solvency than Retro Rags.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Completion statements

52. Complete the following statements: 1.

A current liability is a liability that can be expected to be paid within ____________ year(s) or the ______________, whichever is longer.

Liabilities are classified on the statement of financial position as being _______________ liabilities or ______________ liabilities.

Obligations in written form are called ______________ payable and usually require the borrower to pay interest.

With an interest-bearing note, a borrower must pay the ________________ of the note plus _________________ at maturity.

Goods and services tax (GST) collected from customers are a ______________ of the business until they are remitted to the tax office.

The ______________ ratio is a measure of a company's immediate short-term liquidity.

If unsecured notes are issued at face value, it indicates that the ________________ rate of interest must be equal to the ________________ rate of interest.

The _________ interest _________ ratio provides an indication of a company’s ability to meet interest payments as they come due.

The ________ value of a note payable is the amount of ____________ due at maturity date.

Answers below. Learning objective 9.1 – 9.10. 1. 2. 3. 4. 5. 6. 7. 8. 9.

one, operating cycle current, non-current notes principal, interest current liability quick contractual, market times, earned face, principal

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Chapter 9: Reporting and analysing liabilities

Matching

53. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Non-current liability Present value Warranty Issue price Current liability

F. G. H. I. J.

Borrowing costs Contract interest rate Mortgage Quick ratio Provision

____

1. The amount paid by the investor on issue of a debenture or unsecured note

____

2. The value today of an amount to be paid or received at some date in the future after taking into account current interest rates

____

3. Costs of borrowing money

____

4. An obligation that is not classified as a current liability

____

5. A measure of an entity’s immediate short-term liquidity, also called the acid-test

____

6. A liability for which the amount is uncertain but able to be measured reliably by estimation

____

7. Rate used to determine the amount of interest the borrower pays and the investor receives

____

8. An obligation of the supplier of goods and services to the purchased that the product will be functional or that work performed will remain satisfactory for a period after the sale of goods

____

9. A loan that is secured by a charge over property

____ 10. An obligation than can reasonably be expected to be paid within one year or the operating cycle of a business

Answers below. Learning objective 9.1 – 9.10. 1. 2. 3. 4. 5.

D B F A I

6. 7. 8. 9. 10.

J G C H E

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions

54. Under what circumstances is a contingent liability reflected in the accounting records as though an actual liability exists.

Answer below. Learning objective 9.1 – 9.10. If the company can determine a reasonable estimate of the expected cost or loss and it is probable that it will incur the loss, then the company should accrue for the loss.

55. When an unsecured notes sells at a discount, what is probably true about the market interest rate versus the stated interest rate? Discuss.

Answer below. Learning objective 9.1 – 9.10. For someone to purchase an unsecured note at a discount, the stated interest rate normally must be below the market interest rate for similar bonds. Investors will need to make up the difference by paying less than the face value for the bonds.

56. Bonds are frequently issued at amounts greater or less than face value. Describe how the market rate of interest, relative to the contractual rate of interest, affects the selling price of bonds.

Answer below. Learning objective 9.1 – 9.10. The market rate of interest often is different from the contractual rate of interest and therefore unsecured notes are frequently issued at amounts greater or less than face value. When the market rate of interest is higher than the contractual rate, investors can find better investments elsewhere and consequently there is less demand for the notes. So to make the notes more attractive the issue price will be lowered and the notes will be issued at a discount. Conversely, if the market rate of interest is less than the contractual rate there will be greater demand for the notes because of the higher rate of interest. Thus, the issue price will be greater than face value and the notes will be issued at a premium.

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Chapter 9: Reporting and analysing liabilities

57. Ethics: Jake Granville, the president and CEO of Earth Systems Ltd, a waste management company, was recently hospitalised, suffering from exhaustion and a heart ailment. Immediately prior to his hospitalisation, Earth Systems had experienced a sharp decline in its shares price, and trading activity became almost nonexistent. The primary reason for this was concern expressed in the media over a new untested waste management system implemented by the company. Mr. Granville had been unwilling to submit the procedure to testing before implementation, but he reluctantly agreed to limited tests after the system was operational. No problems have been identified by the tests to date. The other members of management called a meeting to determine what they should do. Roger Calfrey, the marketing manager, suggested that the company buy back a large number of shares. In that way, investors might notice that activity had picked up, and might decide to buy some more shares. This plan would use up most of the company’s available cash, so that there will be no money available for a cash dividend. Earth Systems has paid cash dividends every quarter for over ten years. Required: 1. Is Mr. Calfrey’s suggestion ethical? Explain. 2. Is it ethical to discontinue the cash dividend? Explain.

Answer below. Learning objective 9.1 – 9.10. 1. There is no definite answer as to whether Mr. Calfrey’s suggestion is ethical. There are several points that might be made supporting either premise. First, it is a large transaction being made in the absence of the CEO, and made entirely to boost shares price. It is not clear what the long-term benefit to the company will be, even if it is successful. Thus, a student might argue that the large repurchase of shares, using up most of the available cash, might be unethical because of the potential damage done to the company, without a large enough potential reward. On the other hand, the company might benefit by keeping its shares price high (assuming that this purchase will enhance the shares price) by being able to issue additional shares to finance future expansion. It is to be hoped that the students can articulate the concept that legality of an action is not the only determinate of whether an action is ethical. 2. A company may discontinue its dividend at will. Ordinary shareholders should know that they are not entitled to a dividend, even when one has been declared and paid every year. There is no express or implied contract to pay a dividend to ordinary shareholders, and so the discontinuance of the dividend is ethical. However, the company may lose more in share price by discontinuing a long-standing dividend than it gains by its large repurchase of shares.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

58. Ethics: Wishbone Company maintains two separate accounts payable computer systems. One is known to all the users, and is used to process payments to vendors. Employees enter the vendor code, or the name and address of new vendors, the amount, the account, and so on. The other system is a secret one. It is used to cross-check the vendors against an approved vendor list. If a vendor is not listed as approved, the payment process is halted. Internal audit employees seek to verify the existence of a bona fide claim by the vendor. All inquiries are made at the top management level, and very discreetly. No one but top management, the internal audit staff, and the Board of Directors of the company is even aware of the second system. Required: Is it ethical for a company to have a secret system like the one described? Explain.

Answer below. Learning objective 9.1 – 9.10. Secret systems that seek to verify the integrity of the non-secret primary system are certainly ethical. In fact, nearly all fraud and theft detection systems are secret. It is only the misuse of these systems, such as to obtain unauthorised information, or to commit some other crime, that is unethical.

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Chapter 10: Reporting and analysing equity

Chapter 10: Reporting and analysing equity Multiple-choice questions

1. Under the company form of business organisation: a. a shareholder is personally liable for the debts of the company. b. shareholders can bind the company even though they have not been appointed as agents of the company. *c. the length of company’s life is continuous or perpetual. d. shareholders wishing to sell their shares must first get the approval of all other shareholders. Answer: c Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: Since a company is a legal entity, separate from its owners, the life of the company is continuous or perpetual.

2. The most common form of a corporation is a: a. trust. *b. company. c. sole proprietorship. d. partnership. Answer: b Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: A company is the most common form of corporation.

3. A public company may have a maximum of: a. 50 shareholders. b. 20 shareholders. c. 10 shareholders. *d. no maximum imposed on the number of shareholders. Answer: d Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: There is no maximum imposed on the number of shareholders a company may have.

10.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. A proprietary company may only have up to: a. 2 shareholders. b. 10 shareholders. c. 25 shareholders. *d. 50 shareholders. Answer: d Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: A proprietary company, also referred to as a private company, may have up to 50 shareholders.

5. A corporation has all of the following characteristics except: a. an existence that is separate and distinct from its owners. b. limited liability. *c. the right to hold public office. d. continuous life. Answer: c Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: A corporation cannot hold public office.

6. Shareholders of a company directly elect: a. the chairman of the company. *b. the board of directors. c. the treasurer of the company. d. all of the employees of the company. Answer: b Learning objective 10.2 - Identify and discuss the main characteristics of a corporation (company). Feedback: Although the shareholders legally own the company, they manage it indirectly through a board of directors that they elect.

10.2

Chapter 10: Reporting and analysing equity

7. The chief accounting officer in a company is known as the: *a. financial controller. b. treasurer. c. vice-president. d. president. Answer: a Learning objective 10.2 - Identify and discuss the main characteristics of a corporation (company). Feedback: The chief accounting officer of a company is known as the financial controller.

8. Which one of the following is not considered an advantage of the company form of organisation? a. limited liability of shareholders. b. separate legal existence. c. continuous life. *d. government regulation. Answer: d Learning objective 10.2 - Identify and discuss the main characteristics of a corporation (company). Feedback: Advantages of the company form of organisation include the limited liability of shareholders, transferable ownership right, separate legal existence and a continuous life.

9. Which of the following is not true of a company? a. it may buy, own, and sell property. b. it may sue and be sued. *c. the acts of its owners bind the company. d. it may enter into binding legal contracts in its own name. Answer: c Learning objective 10.2 - Identify and discuss the main characteristics of a corporation (company). Feedback: As a separate legal entity a company is not bound by the acts of its owners.

10.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. A company’s board of directors does not generally: a. select officers. b. formulate operating policies. c. declare dividends. *d. implement policy. Answer: d Learning objective 10.2 - Identify and discuss the main characteristics of a corporation (company). Feedback: A company’s Board of Directors would not normally implement policy. That function is usually the responsibility of the management of the company.

11. The officer that is generally responsible for maintaining the cash position of the company is the: a. financial controller. *b. treasurer. c. cashier. d. internal auditor. Answer: b Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: The treasurer has custody of the company’s funds and is responsible from maintaining the company’s cash position. In a small company this role may be performed by the financial controller. 12. The term residual claim refers to a shareholder’s right to: a. receive dividends. *b. share in assets upon liquidation. c. acquire additional shares when offered. d. exercise a proxy vote. Answer: b Learning objective 10.2 – Identify and discuss the main characteristics of a corporation (company). Feedback: A residual claim is a shareholder’s right to share in the assets of the company upon liquidation.

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Chapter 10: Reporting and analysing equity

13. Which of the following factors is least likely to affect the initial market price of a share? a. The company’s anticipated future earnings. *b. The length of time a company has been in existence. c. The current state of the economy. d. The expected dividend rate per share. Answer: b Learning objective 10.3 – Record the issue of ordinary shares. Feedback: The initial market price of a company share is least affected by the length of time the company has been in existence.

14. The issue of shares to identified investors is known as a: a. public issue. b. non-for-profit issue. c. debt raising. *d. private placement. Answer: d Learning objective 10.3 – Record the issue of ordinary shares. Feedback: Private placement is the issue of share to identified investors.

15. A report that contains the details of a proposed public share issue is a: *a. prospectus. b. record. c. regulation. d. constitution. Answer: a Learning objective 10.3 – Record the issue of ordinary shares. Feedback: The details of a proposed public share issue are contained in the company prospectus.

10.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. When a company issues new shares the impact on the accounting equation is to increase: a. equity and decrease assets. b. equity and increase liabilities. c. liabilities and increase assets. *d. assets and increase equity. Answer: d Learning objective 10.3 – Record the issue of ordinary shares. Feedback: When a company issues new shares, assets increase (usually cash) and equity also increases.

17. When shares are issued by private placement, the journal entry to the event is: a. b. *c. d.

Dr Cr Dr Cr Dr Cr Dr Cr

Cash Liabilities Liabilities Cash Cash Share capital Share capital Cash

Answer: c Learning objective 10.3 – Record the issue of ordinary shares. Feedback: Whenever shares are issued (private placement or public issue) the entry to record the event is a debit to an asset (usually cash) and a credit to share capital.

18. An appropriate journal entry to record the receipt of application money is: a. b. c. *d.

Dr Cr Dr Cr Cr Dr Cr Dr

Cash trust Cash at Bank Cash at Bank Cash trust Cash trust Share capital Cash trust Application

Answer: d Learning objective 10.3 – Record the issue ordinary of shares. Feedback: The receipt of application money is recorded by a debit to the Cash Trust and a credit to Application.

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Chapter 10: Reporting and analysing equity

19. When recording the application money as share capital on allotment of shares to applicants, the following journal entry is made: *a. b. c. d.

Dr Cr Dr Cr Dr Cr Dr Cr

Application Share capital Cash at Bank Share capital Cash trust Share capital Allotment Share capital

Answer: a Learning objective 10.3 – Record the issue of ordinary shares. Feedback: Recording the application money as share capital when share are allotted to applicants requires a debit to Application and a credit to Share capital. This entry removes the funds from the Application account and recognises the increase in Share capital.

20. When a company issues shares with partial payment required on application and the remainder on allotment, the journal entry to record cash received on allotment of shares is: a. *b. c. d.

Dr Cr Dr Cr Dr Cr Dr Cr

Cash trust Share capital Cash at bank Allotment Cash trust Application Cash at bank Call

Answer: b Learning objective 10.3 – Record the issue of ordinary shares. Feedback: Cash received on the allotment of shares is recorded by a debit to Cash and a credit to the Allotment account.

10.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

21. An event that involves the issue of additional shares to shareholders according to their percentage ownership and a reduction in the stated value of each share is a: a. share dividend. b. cash dividend. *c. share split. d. private placement. Answer: c Learning objective 10.4 – Describe the effect of share splits. Feedback: A share split involves the issue of additional shares to existing shareholders according to their percentage ownership and the effect is a reduction in the value of each share.

22. A share split has the following impact on total equity: a. increase. b. decrease. c. removal of equity from the statement of financial position. *d. no change in the total of equity. Answer: d Learning objective 10.4 – Describe the effect of share splits. Feedback: A share split involves the issue of additional shares to existing shareholders according to their percentage ownership and the effect is a reduction in the value of each share. A share split does not change the total amount of Equity.

23. A company with share capital comprising 15,000 $2.50 shares engages in a 5-for1 share split. After the share split the share capital of the company is: *a. $37,500. b. $5,000. c. $6,000. d. $3,000. Answer: a Learning objective 10.4 – Describe the effect of share splits. Feedback: A share split involves the issue of additional shares to existing shareholders according to their percentage ownership and the effect is a reduction in the value of each share. A share split does not change the total amount of Equity.

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Chapter 10: Reporting and analysing equity

24. The purpose of a share split is to increase the: a. market price of a company’s shares. *b. marketability of the shares by lowering the market price. c. retained earnings of the company. d. dividend payout rate of the company. Answer: b Learning objective 10.4 – Describe the effect of share splits. Feedback: The purpose of a share split is to increase the marketability of the shares by lowering the market price of each individual share.

25. A dividend is a distribution of: a. liabilities of a company to its shareholders. b. revenue by a corporation to its owners. c. accrued expenses to a corporation’s shareholders. *d. profit by a company to its shareholders. Answer: d Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: A dividend is a distribution of profit by a company to its shareholders.

26. A dividend may take any one of three forms. These are: a. cash, liabilities, or revenue. *b. cash, property, or shares. c. cash, debt or liabilities. d. cash, debentures, or debt. Answer: b Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: Dividend can take three forms: cash, property or shares. The most popular method is payment in cash.

10.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

27. A characteristic of an interim dividend is that it: *a. is paid during a year. b. may only be paid on balance date. c. is paid out after the end of the financial year. d. may only be paid in the form of cash. Answer: a Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: An interim dividend is paid at any point during the year.

28. Dividends are predominantly paid in: a. capital. b. property. *c. cash. d. shares. Answer: c Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: Whilst dividends may be paid using cash, property or shares the most popular method of payment is cash.

29. The Corporations Act states that a dividend must not be paid by a company: *a. if it would make the company insolvent. b. unless the company has first obtained the approval of all creditors. c. until it has been operating for a minimum of five years. d. before the end of a financial year. Answer: a Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: The Corporations Act states that a dividend must not be paid by a company if it materially prejudices the company’s ability to pay creditors.

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Chapter 10: Reporting and analysing equity

30. An appropriate journal entry to record a cash dividend on declaration date is: a. b. *c. d.

Dr Cr Dr Cr Dr Cr Dr Cr

Retained earnings Cash at Bank Cash at Bank Dividend payable Retained earnings Dividends payable Cash at Bank Retained earnings

Answer: c Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: If a dividend is declared before balance date the entry to record the event is a debit to retained earnings and a credit to dividends payable.

31. The date on which a cash dividend becomes a binding legal obligation is on the: a. declaration date. b. date of record. *c. payment date. d. last day of the fiscal year end. Answer: c Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: A cash dividend becomes a binding legal obligation the day it is due for payment.

32. The cumulative effect of the declaration and payment of a cash dividend on a company’s financial statements is to: a. decrease total liabilities and equity. b. increase total expenses and total liabilities. c. increase total assets and equity. *d. decrease total assets and equity. Answer: d Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: The declaration and subsequent payment of a cash dividend will decrease the total assets and decrease equity of a company.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

33. The payment of a share dividend will: *a. increase share capital. b. change the total of equity. c. increase total liabilities. d. increase total assets. Answer: a Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: The payment of a share dividend will decrease Retained Earnings and Increase Share Capital.

34. The board of directors of Westlake Ltd declared a cash dividend of $2.50 per share on 22,000 ordinary shares on 15 July 2016. The dividend is to be paid on 15 August 2016, to shareholders of record on 31 July 2016. The correct entry to be recorded on 15 July 2016 will include a: a. debit to Dividend payable. b. credit to Cash. *c. debit to Retained earnings. d. credit to Retained earnings. Answer: c Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: On the day a dividend is declared the entry to record the event is a debit to retained earnings and a credit to dividends payable.

35. The board of directors of Westlake Ltd declared a cash dividend of $2.50 per share on 22,000 ordinary shares on 15 July 2016. The dividend is to be paid on 15 August 2016, to shareholders of record on 31 July 2016. The effects of the journal entry to record the declaration of the dividend on 15 July 2016 are to: a. decrease equity and decrease assets. b. increase equity and increase liabilities. c. increase equity and decrease assets. *d. decrease equity and increase liabilities Answer: d Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: On the day a dividend is declared the entry to record the event is a debit to retained earnings and a credit to dividends payable.

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Chapter 10: Reporting and analysing equity

36. The board of directors of Westlake Ltd declared a cash dividend of $2.50 per share on 22,000 ordinary shares on 15 July 2016. The dividend is to be paid on 15 August 2016 to shareholders of record on 31 July 2016. The correct entry to be recorded on 15 August 2016 will include a: *a. debit to Dividends payable b. debit to Retained earnings. c. credit to Retained earnings. d. credit to Dividends payable. Answer: a Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: On the day a dividend is paid the entry to record the event is a debit to dividends payable and a credit to cash.

37. A company records a dividend-related liability: a. on the record date. b. on the payment date. c. when dividends are in arrears. *d. on the declaration date. Answer: d Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: On the declaration date a company will record a dividend-related liability.

38. If a company declares a 10% share dividend on its ordinary shares, the account to be debited on the date of declaration is: a. Ordinary Share Dividend Payable b. Ordinary Shares. c. Paid-up Capital. *d. Retained Earnings. Answer: d Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: On the declaration date the company will record a debit to retained earnings.

10.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

39. Indicate the respective effects of the declaration of a cash dividend on the following sections of the statement of financial position:

a. *b. c. d.

Total Assets Increase No change Decrease Decrease

Total Liabilities Decrease Increase Increase No change

Total Equity No change Decrease Decrease Increase

Answer: b Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: On the day a dividend is declared there is no change to total assets. Total liabilities increase by the amount of the dividend and total equity will decrease by the same amount.

40. The accumulated profits that have not been distributed to shareholders are classified as: *a. retained earnings. b. non-current liabilities. c. share capital. d. dividends payable Answer: a Learning objective 10.5 – Prepare the entries for cash dividends and share dividends and describe the impact on equity and assets. Feedback: Accumulated profits that have not been distributed to shareholders’ are classified as retained earnings.

41. Disclosures that aid in the determination of earning power or sustainable profit include: a. errors in prior periods. b. changes in accounting estimates. c. changes in accounting policies. *d. errors and changes in accounting estimates and policies. Answer: d Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: Certain irregular items must be identified in the income statement or notes to the accounts to assist in the assist the estimate of future cash flows. These irregularities include errors, changes in accounting estimates and policies and discontinuing operations.

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Chapter 10: Reporting and analysing equity

42. Which of the following income statement figures would probably be the best indicator of a company’s future performance? a. Total revenues. b. Profit before extraordinary items. c. Profit after income tax. *d. Profit from continuing operations. Answer: d Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: Profit from continuing operations is usually the best indicator of a company’s future performance.

43. The most likely level of profit to be obtained by a business in the future is known as its: *a. earning power. b. liquidity. c. solvency. d. profitability. Answer: a Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: Earning power is the term for the most likely profit level a business will obtain in the future.

44. Irregular items, which if they occur, are required to be disclosed in the financial statements include all of the following except: a. errors. b. changes in accounting estimates. *c. legal fees. d. discontinuing operations. Answer: c Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: Legal fees are not disclosed in the financial statements as irregular items.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

45. Prior period errors must be corrected: *a. retrospectively. b. in the next accounting period. c. in the subsequent accounting period. d. when they are detected. Answer: a Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: Prior period errors must be corrected retrospectively. Any effect on the profit or loss of a prior period is recognised as an adjustment to retained earnings in the statement of changes in equity.

46. Benjamin Limited paid legal fees amounting to $20,000 and added the cost to a non-current asset account. The error was detected in the same accounting period and corrected by: a. increasing non-current assets and decreasing current assets *b. increasing expenses and decreasing non-current assets c. decreasing expenses and decreasing equity d. decreasing revenue and increasing expenses Answer: b Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: The correction to this error requires an increase in expenses and a decrease in non-current assets. As the error was detected in the same accounting period the correction to this error requires an increase in expenses and a decrease in non-current assets.

47. The effect of changes in accounting estimates must be disclosed if they: a. affect profit b. affect assets *c. are material d. change the amount of cash held in the bank Answer: c Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: The effect of changes in accounting estimates must be disclosed if they are material.

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Chapter 10: Reporting and analysing equity

48. When a company changes from one acceptable accounting method to another the cumulative effect of the change is disclosed: a. in the statement of changes in equity *b. as a note to the financial statements c. in the income statement d. in the statement of cash flows Answer: b Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: When a company changes accounting methods the cumulative effect of the change is disclosed as a note to the financial statements.

49. A discontinuing operation is a component of an entity that is: *a. held for sale b. not profitable c. not solvent d. different to the other major operations of the entity Answer: a Learning objective 10.6 – Understand the concept of earning power and indicate how irregular items are presented. Feedback: A discontinuing operation is a component of an entity that is held for sale.

50. The equity section of the statement of financial position of a company includes: *a. Share capital, retained earnings, reserves. b. Comprehensive income and irregularities. c. Share capital and retained earnings. d. Share capital only. Answer: a Learning objective 10.7 – Identify components of comprehensive income and changes in equity. Feedback: The usual three components to the equity section of the statement of financial position are share capital, retained earnings and reserves. Share capital is often called contributed equity.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

51. When preparing the financial statements of Somersby Ltd, the accountant found the following information: Opening balance of Retained Earnings $15,000; Interim Dividends paid $2,500; Profit earned $20,000; Dividends Declared $5,000. The closing balance of Retained Earnings for Somersby Ltd is: a. $7,500. b. $30 000. *c. $27,500. d. $15 000. Answer: c Learning objective 10.8 – Identify the items that affect retained earnings. Feedback: The closing balance of retained earnings is (15,000 – 2,500 + 20,000 – 5,000) = $27,500.

52. Retained earnings of a company are classified on the statement of financial position as part of: a. Revenue. b. Assets. c. Cash at Bank. *d. Shareholders’ Equity. Answer: d Learning objective 10.8 – Identify the items that affect retained earnings. Feedback: On the statement of financial position of a company, retained earnings are classified as part of Shareholders’ Equity.

53. Which of the following items is not required to be disclosed in the notes explaining movements in the Retained Earnings account for a year? a. Dividends declared. *b. Ordinary Shares issued. c. Opening balance of Retained Earnings. d. Closing balance of Retained Earnings. Answer: b Learning objective 10.8 – Identify the items that affect retained earnings. Feedback: Ordinary Shares issued are not disclosed in the notes explaining movements in the retained Earnings account. The other three items do need to be disclosed.

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Chapter 10: Reporting and analysing equity

54. The ratio of Total Ordinary Cash Dividends Declared divided by Profit, is used to measure the: *a. dividend payout. b. return on cash. c. return on assets. d. dividend turnover rate. Answer: a Learning objective 10.9 – Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Feedback: The dividend payout is measured by the ratio of total ordinary cash dividends declared to Profit.

55. Pluto Corporation Limited declared and paid a dividend amounting to $550,000 during the year. Profit for the year was $820,000. The dividend payout rate for this company was: a. 149%. b. 214%. *c. 67%. d. 172%. Answer: c Learning objective 10.9 – Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Feedback: The dividend payout is measured by the ratio of total ordinary cash dividends declared to Profit. The dividend payout rate is ($550,000/820,000) = 0.67 or 67.07%

56. Companies that have high growth rates are often characterised by: a. high dividend payout rates. *b. low dividend payout rates. c. large dividend payouts to shareholders. d. excessive dividends to shareholders. Answer: b Learning objective 10.9 – Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Feedback: High growth rate companies are often characterised by low dividend payout rates because they reinvest most of their profits in the business.

10.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

57. Return on equity is a tool that is used to: a. gauge the risk of an investment. b. assess the creditworthiness of shareholders. c. calculate the rate of return on assets. *d. measure profitability from the shareholders’ viewpoint. Answer: d Learning objective 10.9 – Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Feedback: The tool used to measure profitability from the shareholders’ viewpoint is called Return on Equity.

58. Which of the following is not a significant advantage of debt financing over the issue of ordinary shares? a. shareholder control is not affected. b. the current owners retain control of the company. c. tax savings occur as interest on debt is deductible for tax purposes. *d. return on equity is likely to be lower. Answer: d Learning objective 10.9 – Evaluate a company’s dividend and earnings performance from a shareholder’s perspective. Feedback: Reduced return on equity is not a significant advantage of debt finance over share issues.

59. A major disadvantage for shareholders, of using debt financing, is: a. shareholder control is altered. b. interest is not deductible for tax purposes. c. debtholders assume full control of the company. *d. the company is locked in to fixed payments of interest and principal. Answer: d Learning objective 10.10 – Evaluate debt and equity as alternative sources of finance. Feedback: Debt finance locks a company into fixed payments of interest and principal regardless of how well the company is performing.

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Chapter 10: Reporting and analysing equity

Exercises

59. Identify (by letter) each of the following characteristics as being an advantage (A) or a disadvantage (D) of the company form of business organisation. A = Advantage D = Disadvantage

Characteristics _____ 1. Separate legal entity _____ 2. Taxable entity _____ 3. Continuous life _____ 4. Unlimited liability of owners _____ 5. Government regulation _____ 6. Separation of ownership and management _____ 7. Ability to acquire capital _____ 8. Ease of transfer of ownership

Answers below. Learning objective 10.1 – 10.10. 1. 2. 3. 4.

A A A N

5. 6. 7. 8.

D A A A

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

60. The Everglades Ltd has the following share transactions during 2016. Jan. 15

Issued 500,000 shares to Bombala Limited, at $7 per share.

Dec.

Declared a $0.50 per share dividend to shareholders of record on December 20, payable January 3, 2017.

Journalise the transactions for Everglades Ltd.

Answers below. Learning objective 10.1 – 10.10. Jan. 15

Dec.

Cash ...................................................................................... $3,500,000 Share Capital ................................................................

Retained earnings ................................................................. $250,000 Dividends payable ....................................................... (500,000 x $.50)

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3,500,000

250,000

Chapter 10: Reporting and analysing equity

61. Topaz Ltd has the following share transactions during March. Mar 1

Released a prospectus inviting applications for 100 000 ordinary shares of $1 each, payable in full on application

Mar 10

Received applications for 100 000 shares

Mar 15

Allotted 100 000 shares to applicants and transferred application money to bank account

Record all of these share transactions for Topaz Ltd.

Answers below. Learning objective 10.1 – 10.10.

Mar 01

No entry required

Mar 10

Dr Cash Trust Cr Application

$100 000

Dr Application Cr Share capital

$100 000

Dr Cash at Bank Cr Cash trust

$100 000

Mar 15

$100 000

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

62. The equity section of Starstruck Corporation Ltd at 31 December 2016 included the following: 200,000 ordinary shares issued and outstanding .................................

$2,000,000

On November 1 2017 the board of directors declared a $2.00 per share dividend on the ordinary shares, payable 30 November 2017 to shareholders of record on 15 November 2017. Prepare the journal entries that should be made by Starstruck Corporation Ltd on the dates indicated below: 1 November 2017 15 November 2017 30 November 2017

Answers below. Learning objective 10.1 – 10.10. 1/11/17

Retained Earnings ................................................................ 400,000 Dividends Payable — Ordinary .................................. (To record declaration of a cash dividend on ordinary shares)

400,000

15/11/17 (No entry required) 30/11/17 Dividends Payable — Ordinary ........................................... Cash ............................................................................. (To record the payment of ordinary cash dividends)

400,000 400,000

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Chapter 10: Reporting and analysing equity

63. Major’s Mining Ltd has 500,000 shares issued and outstanding at 30 June 2016. On 30 June 2016 the company’s board of directors declared a $0.40 per share cash dividend to be paid on 1 August 2016 to shareholders on record at 15 July 2016.

Instructions Prepare the necessary journal entries to be recorded on (a) the date of declaration, (b) the date of record, and (c) the date of payment.

Answers below. Learning objective 10.1 – 10.10. (a) 30 Jun 2016 Dr Retained Earnings………………………………………………200,000 Cr Dividends Payable ....................................................... (To record the declaration of a cash dividend of 500,000 x $.40) (b) 15 Jul 2016

200,000

No entry

(c) 1 Aug 2016 Dr Dividends Payable………………………………………………200,000 Cr Cash…………………………………………………………….. (To record the payment of a cash dividend)

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200,000

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

64. At 31 December 2016 Trapezium Ltd has the following components of Equity: Contributed equity

1,500,000 ordinary $1 shares

Retained Earnings

$2,000,000

Reserves

$ 600,000

On 31 December 2016, the directors of the company declared a 10% share dividend to be paid out of the balance in the Retained Earnings account on 5 January 2017. Required: (a) (b)

Prepare journal entries to record these share transactions Calculate the balance of the Retained Earnings after these share transactions have taken place

Answers below. Learning objective 10.1 – 10.10. (a) 31 Dec 2016 Dr Retained Earnings Cr Share Dividends Payable 5 Jan 2017 Dr Cr

Share Dividends Payable Share Capital

(b) $1,750,000

($2,000,000 - $150,000)

$150,000 $150,000

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Chapter 10: Reporting and analysing equity

65. Cricket Ltd has the following items in its accounting records for the current year: 1. 2. 3. 4.

200,000 $2 issued and paid up ordinary shares Opening Retained Earnings $40,000 Dividends declared and paid during the year $20,000 Transfer from Retained Earnings to General Reserve $15,000

Required: (a) (b)

Prepare journal entries to record items 3. and 4. Show the Note to the financial statements providing details of the movements in the Retained Earnings account during the year Prepare an extract from the equity section of Cricket Ltd’s statement of financial position at the end of the year.

(c)

Answers below. Learning objective 10.1 – 10.10. (a)

(b)

Dr Cr

Retained Earnings Cash

$20,000

Dr C

Retained Earnings General Reserve

$15,000

$20,000

Balance of Retained Earnings at the beginning Less: Dividends declared and paid Transfer to General Reserve Balance of Retained Earnings at the end

$15,000

$40,000 20,000 15,000 5,000

(c) CRICKET LIMITED Statement of Financial Position (extract) as at current year end Equity Contributed equity Reserves Retained Earnings Total equity

$400,000 15,000 5,000 $420,000

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

66. The following data were collected from the financial statements of Jensen Limited:

Dividends ($) Profit ($)

2016

2015

300 650

270 550

Required: (a) (b)

Calculate the dividend payout ratio for this company for both years. State whether the dividend payout rate has improved or deteriorated in 2016.

Answers below. Learning objective 10.1 – 10.10. (a)

Payout ratio

(b)

2016

2015

300/650

270/550

46.1%

49.1%

The dividend payout rate had been reduced from 49.1% to 46.1%. This means that, from the shareholders’ viewpoint, the ratio had deteriorated.

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Chapter 10: Reporting and analysing equity

Completion statements

67. Please complete the following statements: 1.

A company has a separate _________________existence distinct from its owners.

The major advantages of the company form of organisation include (1) limited _________________ of shareholders, (2) continuous ____________________ and (3) ease of transferring ___________________.

The _____________ director is the chief executive officer with direct responsibility for managing the business.

Most publicly held companies are required to make extensive disclosure of their financial affairs to the Australian _______________.

Shareholders generally have the right to share in company profits and in ______________ upon liquidation of the company.

The main difference between a public issue and a ____________ placement of shares is that in a public issue the number and identity of the _______________ is not known with certainty in advance.

Three important dates associated with dividends are the: (1)______________ date; the (2)______________ date; and the (3)__________________ date.

The entry to record the declaration of a share dividend increases _________________, and decreases ________________.

A debit balance in retained earnings account represents a ________________.

10.

The earnings performance of a company can be measured by calculating the return on ______________.

11.

Discontinued operations refers to the disposal of a _____________ segment of a business.

12.

For an item to be classified as a prior period error it must have resulted in the presentation of ______________ information in the financial statements.

13.

A change in depreciation methods during the year would be classified as a change in ____________________.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 10.1 – 10.10. 1. 2. 3. 4. 5. 6. 13.

legal liability, life, ownership managing Securities and Investments Commission assets private, applicants accounting principle

7. declaration, record, payment 8. Share capital, retained earnings 9. deficit 10. equity 11. significant 12. incorrect

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Chapter 10: Reporting and analysing equity

Matching

68. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Company Issue price Payment date Allotment Treasurer

F. G. H. I. J.

Limited liability Cash dividend Prospectus Retained Earnings Dividend

____

1. The process of issuing shares to selected applicants.

____

2. A pro rata distribution of profit paid in cash to shareholders.

____

3. A form of corporation, evidence of ownership in which is provided by shares.

____

4. A distribution by a company to its shareholders on a pro rata basis.

____

5. Amount received on issue of a share, debenture or unsecured note.

____

6. The limit of liability of owners of a company to any unpaid amount of capital.

____

7. The date dividends are paid to shareholders.

____

8. A document issued with an invitation to subscribe for shares, containing information about the offering company.

____

9. The person with custody of a company’s funds and responsibility for maintaining the company’s cash position.

____ 10. The amount of profit that has not been distributed by a company to its shareholders.

Answers below. Learning objective 10.1 – 10.10. 1. 2. 3. 4. 5.

D G A J B

6. 7. 8. 9. 10.

F C H E I

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions

69. Companies can distribute both cash dividends and share dividends. What are the major differences between these two types of dividends?

Answer below. Learning objective 10.1 – 10.10. Cash dividends entitle shareholders to a cash payout of the retained earnings of the company. A share dividend does not result in a direct cash flow to shareholders. Instead a share dividend entitles the shareholders to a distribution of profit in the form of additional shares.

70. Companies can only pay a cash dividend in Australia and New Zealand if certain criteria are met. What are the criteria?

Answers below. Learning objective 10.1 – 10.10. A company can only pay a cash dividend if its assets are greater than liabilities by an amount that exceed the dividend proposed, if it is fair and reasonable to shareholders as a whole and it does not materially prejudice the company’s ability to pay its creditors. In addition, companies are frequently constrained by agreements with their lenders on the amount of to pay dividends that can be paid to shareholders.

71. What issues must be considered when determining whether or not an item should be treated as a prior period error?

Answers below. Learning objective 10.1 – 10.10. For the item to be treated as a prior period error it must have been made in a previous period and it must have resulted in the presentation of incorrect information in the financial statements.

10.32

Chapter 11: Statement of cash flows

Chapter 11: Statement of cash flows Multiple-choice questions

1. The statement of cash flows: a. must be prepared on a daily basis. *b. summarises cash flows relating to operating, financing, and investing activities of an entity. c. is another name for the income statement. d. is a special section of the income statement. Answer: b Learning objective 11.1 – Indicate the main purpose of the statement of cash flows. Feedback: The main purpose of the statement of cash flows is to provide information about cash inflows and cash outflows and the net change in cash from operating, investing and financing activities of an entity for a period of time.

2. The primary purpose of the statement of cash flows is to: a. provide information about the investing and financing activities during a period b. prove that revenues exceed expenses if there is a profit *c. provide information about the cash receipts and cash payments during a period d. facilitate banking relationships Answer: c Learning objective 11.1 – Indicate the main purpose of the statement of cash flows. Feedback: The main purpose of the statement of cash flows is to provide information about cash inflows and cash outflows and the net change in cash from operating, investing and financing activities of an entity for a period of time.

3. In addition to the three basic financial statements, which of the following is also a required financial statement? a. Cash Budget. *b. Statement of Cash Flows. c. Statement of Cash Outstanding. d. Cash Reconciliation. Answer: b Learning objective 11.1 – Indicate the main purpose of the statement of cash flows. Feedback: The statement of cash flows is the third basic required financial statement.

11.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. The statement of cash flows will not report the: *a. amount of cheques outstanding at the end of the period b. sources of cash inflows in the current period c. uses of cash outflow in the current period d. change in the cash balance for the current period Answer: a Learning objective 11.1 – Indicate the main purpose of the statement of cash flows. Feedback: The main purpose of the statement of cash flows is to provide information about cash inflows and cash outflows and the net change in cash from operating, investing and financing activities of an entity for a period of time.

5. The acquisition of land by issuing share capital is: *a. a non-cash transaction that is not reported in a statement of cash flows. b. a cash transaction and is reported in the statement of cash flows. c. a non-cash transaction and is reported in the statement of cash flows. d. only reported if the statement of cash flows is prepared using the direct method. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The acquisition of land by issuing share capital is a non-cash transaction and will not appear in the body of a statement of cash flows but would be reported in the notes to the financial statements.

6. The order of presentation of activities on the statement of cash flows is: *a. operating, investing, financing. b. operating, financing, investing. c. financing, operating, investing. d. financing, investing, operating. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The activities on a statement of cash flows are presented in the following order: operating, investing and financing.

11.2

Chapter 11: Statement of cash flows

7. Financing activities involve: a. lending money. b. acquiring investments. *c. issuing debt. d. acquiring non-current assets. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Financing activities are those that affect the size and composition of contributed equity and borrowings. Issuing debt is a financing activity.

8. Investing activities include: *a. collecting cash from loans made. b. obtaining cash from creditors. c. obtaining capital from owners. d. repaying borrowed money. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Collecting cash from loans made is an investing activity.

9. Generally, the most important category on the statement of cash flows is cash flows from: *a. operating activities. b. investing activities. c. financing activities. d. significant non-cash activities. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Cash flows from operating activities are the most important because they provide the best measure of whether an entity can generate sufficient cash to continue as a going concern and expand its operations.

11.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

10. The category that is generally considered to be the best measure of a company's ability to continue as a going concern is: *a. cash flows from operating activities. b. cash flows from investing activities. c. cash flows from financing activities. d. it differs from year to year. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Cash flows from operating activities are the most important because they provide the best measure of whether an entity can generate sufficient cash to continue as a going concern and expand its operations.

11. Cash receipts from interest and dividends are usually classified as: a. financing activities. b. investing activities. *c. operating activities. d. either financing or investing activities. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Cash receipts from interest and dividends are usually classified as operating activities.

Use the following information for questions 12-23 Zentak Ltd engaged in the following transactions. For each transaction, indicate where, if at all, it would normally be classified on the statement of cash flows. Assume the indirect method is used.

12. Declared and issued a share dividend: a. Operating activities section. b. Investing activities section. c. Financing activities section. *d. Does not represent a cash flow. Answer: d Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: A share dividend that has been declared and issued is not a cash related activity and therefore will not appear on the statement of cash flows.

11.4

Chapter 11: Statement of cash flows

13. Collected accounts receivable: *a. Operating activities section. b. Investing activities section. c. Financing activities section. d. Does not represent a cash flow. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Accounts receivable collections would appear in the operating activities section of the statement of cash flows.

14. Purchased inventory with cash: *a. Operating activities section. b. Investing activities section. c. Financing activities section. d. Does not represent a cash flow. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Purchasing inventory with cash would appear in the operating activities section of the statement of cash flows.

15. Retired long-term debt with cash: a. Operating activities section. b. Investing activities section. *c. Financing activities section. d. Does not represent a cash flow. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Paying long-term debt with cash would appear in the financing activities section of the statement of cash flows.

11.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

16. Paid interest on note payable: *a. Operating activities section. b. Investing activities section. c. Financing activities section. d. Does not represent a cash flow. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Paying interest on a note payable would normally appear in the operating activities section of the statement of cash flows. It may also be classified as an investing or financing cash outflow. How it is classified must be applied consistently from period to period.

17. Issued shares to acquire equipment: a. Operating activities section. b. Investing activities section. c. Financing activities section. *d. Does not represent a cash flow Answer: d Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Issuing shares for equipment is not a non-cash related activity and therefore would not appear in the body of the statement of cash flows. If significant this transaction would be reported in the notes to the financial statements.

18. Received dividends on securities held: *a. Operating activities section. b. Investing activities section. c. Financing activities section. d. Does not represent a cash flow. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The receipt of dividends on securities held would normally appear in the operating activities section of the statement of cash flows but it may also be classified as a cash inflow from investing activities.

11.6

Chapter 11: Statement of cash flows

19. Paid income taxes: *a. Operating activities section. b. Investing activities section. c. Financing activities section. d. Does not represent a cash flow. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The cash payment of income taxes would appear in the operating activities section of the statement of cash flows.

20. Issued share capital for cash: a. Operating activities section. b. Investing activities section. *c. Financing activities section. d. Does not represent a cash flow. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Issuing share capital for cash would appear in the financing activities section of the statement of cash flows.

21. Purchased land for cash: a. Operating activities section. *b. Investing activities section. c. Financing activities section. d. Does not represent a cash flow. Answer: b Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The purchase of land for cash would appear in the investing activities section of the statement of cash flows.

11.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

22. Purchased land and building with a mortgage: a. Operating activities section b. Investing activities section c. Financing activities section *d. Does not represent a cash flow Answer: d Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The purchase of land and building with a mortgage is not a non-cash related activity and therefore would not appear in the body of the statement of cash flow but it would be disclosed in the notes to the financial statements.

23. Purchased notes payable and received cash: a. Operating activities section. b. Investing activities section. *c. Financing activities section. d. Does not represent a cash flow. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The purchase of notes payable and receipt of cash would appear in the financing activities section of the statement of cash flows.

24. If a company has both an inflow and outflow of cash related to property, plant, and equipment, the: a. two cash effects can be netted and presented as one investing activity. *b. cash inflow and cash outflow should be reported separately. c. two cash effects can be netted and presented as one operating activity. d. cash inflow and cash outflow should be reported in the notes. Answer: b Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Cash inflows and cash outflows relating to the same activity are reported separately on the statement of cash flows.

11.8

Chapter 11: Statement of cash flows

25. Of the items below, the one that appears first on the statement of cash flows is: a. non-cash investing and financing activities. *b. net increase or decrease in cash. c. cash at the end of the period. d. cash at the beginning of the period. Answer: b Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Non-cash items do not appear on the statement of cash flows. The net increase or decrease in cash appears before cash at either the beginning or end of the period.

26. Which of the following transactions does not affect cash during a period? *a. Write-off of an uncollectable account. b. Collection of an accounts receivable. c. Sale of debentures. d. Exercise of a call option on bonds payable. Answer: a Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Write-off of an uncollectable accounts receivable amount is a non-cash related activity.

27. Significant non-cash transactions would exclude: a. conversion of debt into share capital. b. asset acquisition through issuing debt. *c. acquisition of debentures. d. exchange of property, plant and equipment. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The acquisition or redemption by cash of debentures is a cash related transaction.

11.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

28. The statement of cash flows will not provide insight into: a. why dividends were not increased. b. whether cash flow is greater than profit. *c. the exact proceeds of a future debt issue. d. how the retirement of debt was accomplished. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The information in a statement of cash flows should help investors and creditors and others to evaluate aspects of an entity’s financial position, including: why dividends did not increase, if cash flow is greater or less than profit, and how the retirement of debt was accomplished. It cannot provide exact information about a future debt issue.

29. Ordinary shares issued in exchange for land would be reported in the statement of cash flows in: a. the cash flows from financing activities. b. the cash flows from investing activities. *c. a separate note to the financial statements. d. the cash flows from operating section. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Ordinary shares issues in exchange for land would not appear in the statement of cash flows, rather it would be reported in a separate note to the financial statements.

30. In preparing a statement of cash flows a conversion of debt into share capital will be reported in: a. the financing section. b. the "extraordinary" section. *c. a separate note to the financial statements. d. the equity section. Answer: c Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: The conversion of debt, such as convertible notes, into share capital is a non-cash transaction and would not appear on the statement of cash flows, rather it would be reported as a separate note to the financial statements.

11.10

Chapter 11: Statement of cash flows

31. On the statement of cash flows, the cash flows from operating activities would include: a. receipts from the issue of share capital. b. receipts from the sale of investments. c. payments for the acquisition of investments. *d. cash receipts from sales activities. Answer: d Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Cash flows from operating activities include cash receipts from sales activities.

32. Cash flows from operating activities as reported on the statement of cash flows would include: a. receipts from the sale of investments. *b. receipts from customers. c. payments for dividends. d. receipts from the issue of shares. Answer: b Learning objective 11.2 – Distinguish among operating, investing and financing activities. Feedback: Cash flows from operating activities include cash receipts from customers.

33. Which one of the following items is unnecessary in preparing a statement of cash flows? a. Determining the change in cash. b. Calculating the cash provided by operations. c. Determining cash from financing and investing activities. *d. Determine the cash in all bank accounts. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Determining the cash in all bank accounts is not necessary when preparing a statement of cash flows.

34. If accounts receivable have increased during the period: a. revenues on an accrual basis are less than revenues on a cash basis. *b. revenues on an accrual basis are greater than revenues on a cash basis. c. revenues on an accrual basis are the same as revenues on a cash basis. d. expenses on an accrual basis are greater than expenses on a cash basis. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: If accounts receivable have increased during the period then revenues on an accrual basis are greater than revenues on a cash basis.

11.11

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

35. Accounts receivable arising from sales to customers amounted to $35,000 and $30,000 at the beginning and end of the year respectively. Revenue reported on the income statement for the year was $130,000. Exclusive of the effect of other adjustments, the cash flows from operating activities to be reported on the statement of cash flows is: a. $100,000 b. $115,000 c. $165,000 *d. $135,000 Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The cash flows from operating activities is $135,000. That is, $130,000 plus the decrease in accounts receivable of $5,000.

36. If accounts payable have increased during a period: a. revenues on an accrual basis are less than revenues on a cash basis. b. expenses on an accrual basis are less than expenses on a cash basis. *c. expenses on an accrual basis are greater than expenses on a cash basis. d. expenses on an accrual basis are the same as expenses on a cash basis. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: If accounts payable have increased during a period then expenses on an accrual basis are greater than expenses on a cash basis.

37. Which one of the following affects cash during a period? a. Recording depreciation expense. b. Declaration of a cash dividend. c. Writing-off an uncollectable account receivable. *d. Payment of a creditor. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: During a period, the payment of a creditor will affect cash.

11.12

Chapter 11: Statement of cash flows

38. Which one of the following items is not generally used in preparing a statement of cash flows? *a. Adjusted trial balance. b. Comparative statement of financial position. c. Current income statement. d. Additional information. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The adjusted trial balance would not normally be used to prepare a statement of cash flows. Cash flow information can be determined indirectly by analysing the income statement and the statement of financial position plus additional relevant information.

39. In calculating cash flows from operating activities using the indirect method, a gain on the sale of equipment is: a. added to profit. *b. deducted from profit. c. ignored because it does not affect cash. d. not reported on a statement of cash flows. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When calculating cash flows from operating activities using the indirect method, a gain on the sale of equipment is deducted from profit as it is an investing activity.

40. In calculating cash flows from operating activities using the indirect method, a loss on the sale of equipment is: *a. added to profit. b. deducted from profit. c. ignored because it does not affect cash. d. not reported on a statement of cash flows. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When calculating cash flows from operating activities using the indirect method, a loss on the sale of equipment is deducted from profit as it is an investing activity.

11.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

41. Stella Ltd reported profit of $40,000 for the year. During the year, accounts receivable increased by $6,000, accounts payable decreased by $4,000 and depreciation expense of $7,000 was recorded. Net cash provided by operating activities for the year is: a. $31,000. b. $43,000. *c. $37,000. d. $23,000. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Net cash from operating activities is: $40,000– 6,000 – 4,000 + 7,000 = $37,000.

42. Tuncurry Ltd reported a loss of $15,000 for the year ended December 31. During the year, accounts receivable decreased $6,000, merchandise inventory increased $4,000, accounts payable increased by $5,000, and depreciation expense of $3,000 was recorded. During the year, operating activities: a. used net cash of $3,000. *b. used net cash of $5,000. c. provided net cash of $5,000. d. provided net cash of $3,000. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: During the year, operating activities provided a net cash flow of: - $15,000 + 6,000 – 4,000 + 5,000 + 3,000 = $2,000.

43. Starting with profit and adjusting it for items that affected reported profit but which did not affect cash is called the: a. direct method. *b. indirect method. c. working capital method. d. cost-benefit method. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The indirect method of calculating net cash flows from operating activities starts with profit and makes adjustments for items that affect reported profit but which do not affect cash.

11.14

Chapter 11: Statement of cash flows

44. In calculating net cash provided by operating activities using the indirect method, an increase in prepaid expenses during a period is: *a. deducted from profit. b. added to profit. c. ignored because it does not affect profit. d. ignored because it does not affect expenses. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When calculating net cash provided by operating activities using the indirect method, an increase in prepaid expenses is deducted from profit.

45. Using the indirect method, amortisation expense for the period a. is deducted from profit. b. causes cash to increase. c. causes cash to decrease. *d. is added to profit. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Using the indirect method to calculate net cash flows from operating activities, amortisation expense for the period is added to profit.

46. Which of the following would be subtracted from profit using the indirect method? a. Depreciation expense. *b. An increase in accounts receivable. c. An increase in accounts payable. d. A decrease in prepaid expenses. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Using the indirect method, an increase in accounts receivable is deducted from profit.

47. Which of the following would be added to profit using the indirect method? a. An increase in accounts receivable. b. An increase in prepaid expenses. *c. Depreciation expense. d. A decrease in accounts payable. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Using the indirect method, depreciation expense is added to profit.

11.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

48. Which of the following would not be an adjustment to profit using the indirect method to calculate net cash flows from operating activities? a. Depreciation Expense. b. An increase in Prepaid Insurance. c. Amortisation Expense. *d. An increase in Land. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Using the indirect method, an increase in land does not result in an adjustment to profit.

49. In calculating cash flows from operating activities using the indirect method, a loss on the sale of equipment will appear as an: a. subtraction from profit. *b. addition to profit. c. addition to cash flow from investing activities. d. subtraction from cash flow from investing activities. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When calculating cash flows from operating activities using the indirect method, a loss on the sale of equipment appears as an addition to profit.

50. Which of the following adjustments to convert profit to net cash provided by operating activities is correct?

a. b. *c. d.

Add to Profit Accounts Receivable Prepaid Expenses Inventory Taxes Payable

Deduct from Profit increase decrease increase decrease decrease increase decrease increase

Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When converting profit to net cash provided by operating activities, a decrease in inventory is added to profit and an increase in inventory is deducted from profit.

11.16

Chapter 11: Statement of cash flows

51. Which of the following adjustments to convert profit to net cash provided by operating activities is incorrect? Add to Profit Deduct from Profit decrease increase increase decrease decrease increase increase decrease

a. Accounts Receivable *b. Prepaid Expenses c. Inventory d. Accounts Payable

Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When converting profit to net cash provided by operating activities, an increase in prepaid expenses is deducted from profit and a decrease in prepaid expenses is added to profit.

52. Which of the following adjustments to convert profit to net cash provided by operating activities is not added to profit? *a. Gain on Sale of Equipment. b. Depreciation Expense. c. Amortisation Expense. d. Depletion Expense. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: A gain on sale of equipment is not an operating activity and therefore is not included in the adjustments to profit.

53. Using the indirect method to calculate net cash flows from operating activities, if equipment is sold at a gain, the a. sale proceeds received are deducted in the operating activities section. b. sale proceeds received are added in the operating activities section. c. amount of the gain is added in the operating activities section. *d. amount of the gain is deducted in the operating activities section. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Using the indirect method, if equipment is sold at a gain, the amount of the gain is deducted in the operating activities section.

11.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

54. A company reported profit of $175,000. Depreciation expense is $17,000. During the year Accounts Receivable increased and Inventory decreased $12,000 and $30,000, respectively. Prepaid Expenses and Accounts Payable decreased $1,500 and $5,000, respectively. There was also a loss on the sale of equipment of $6,000. The amount of cash provided by operating activities was a. $188,500. *b. $212,500. c. $206,500. d. $200,500. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Net cash from operating activities: $175,000 + 17,000 - 12,000 + 30,000 + 1,500 - 5,000 + 6,000 = $212,500.

55. The profit reported on the income statement for the current year was $200,000. Depreciation recorded on plant assets was $38,000. Accounts receivable increased and inventories decreased by $2,000 and $8,000, respectively. Prepaid Expenses decreased and Accounts Payable increased by $1,000 and $11,000, respectively. The amount of cash provided by operating activities was a. $180,000. b. $218,000. *c. $256,000. d. $238,000. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Net cash from operating activities: $200,000 + 38,000 – 2,000 + 8,000 + 1,000 + 11,000 = $256,000.

56. Profit reported on the income statement for the current year was $100,000. Depreciation was $25,000. Accounts receivable and inventories decreased by $5,000 and $15,000, respectively. Prepaid expenses and accounts payable increased, respectively, by $500 and $4,000. The cash was provided by operating activities was a. $130,500 *b. $148,500 c. $141,500 d. $98,500 Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Net cash from operating activities: $100,000 + 25,000 + 5,000 + 15,000 - $500 + $4,000 = $148,500.

11.18

Chapter 11: Statement of cash flows

57. On the statement of cash flows using the indirect method, amortisation expense will *a. be added to profit. b. be deducted from profit. c. appear as an inflow of cash in the investing section. d. appear as an outflow of cash in the investing section. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Using the indirect method, amortisation expense will be added to profit to calculate net cash from operating activities.

58. The indirect and direct methods of preparing the statement of cash flows are identical except for the a. significant non-cash activity section. *b. operating activities section. c. investing activities section. d. financing activities section. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The indirect and direct methods of preparing the statement of cash flows are identical except for the operating activities section.

59. If $200,000 of debt is issued during the year and $120,000 of old debt is retired, the statement of cash flows will show a(n) a. net increase in cash of $80,000. b. net decrease in cash of $80,000. *c. increase in cash of $200,000 and a decrease in cash of $120,000. d. net gain on retirement of debt of $80,000. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The statement of cash flows will show an increase in cash of $200,000 for the debt issue and a decrease in cash of $120,000 for the retirement of old debt.

11.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

60. Which of the following changes in retained earnings during a period will be reported in the financing activities section of the statement of cash flows? i. Declaration of a cash dividend paid during the period ii. Net profit for the period *a. i only. b. ii only. c. Neither i nor ii. d. Both i and ii. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Only the cash dividend paid will be reported in the financing activities section.

61. The statement of cash flows: a. can be prepared as an alternative to the income statement. *b. is used to assess an entity's ability to pay dividends and meet obligations. c. is prepared from comparative income statements. d. reflects earnings per share figures on a cash basis and an accrual basis. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The statement of cash flows is used to assess an entity’s ability to pay dividends and meet its obligations.

62. In preparing the statement of cash flows, determining the net increase or decrease in cash requires the use of: a. the adjusted trial balance. b. the current period's statement of changes in equity. *c. a comparative statement of financial position. d. a comparative income statement. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When preparing the statement of cash flows, the determination of the net change in cash requires the use of a comparative statement of financial position.

11.20

Chapter 11: Statement of cash flows

63. To determine the net cash provided (used) by operating activities, it is necessary to analyse: a. only the current year's income statement. b. only a comparative statement of financial position. c. additional information. *d. all of the above. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: In order to determine the net cash provided or used by operating activities it is necessary to analyse many different sources of additional information.

64. Which of the following would not be needed to determine net cash provided by operating activities? a. Receipts from customers. b. Change in accounts receivable. *c. Payment of cash dividends. d. Change in prepaid expenses. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The payment of cash dividends is a financing activity and therefore not needed to determine net cash provided by operating activities.

65. When equipment is sold for cash, the amount received is reflected in cash: a. inflows in the operating section. b. inflows in the financing section. *c. inflows in the investing section. d. outflows in the operating section. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: When equipment is sold for cash, the amount received is reported as a cash inflow in the investing section of the statement of cash flows.

11.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

66. If a gain of $25,000 is incurred in selling (for cash) office equipment with a book value of $100,000, the total amount reported as a cash flow from investing activities is a. $75,000. b. $100,000. *c. $125,000. d. $25,000. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The total reported cash inflow in the investing section is $125,000.

67. If a loss of $9,500 is incurred in selling (for cash) computer equipment with a book value of $15,500, the total amount reported as a cash flow from investing activities is: a. $9,500. b. $15,500. c. $25,000. *d. $6,000 Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The total reported cash inflow in the investing section is $6,000. (loss on sale = cash inflow – book value)

68. Land costing $78,000 was sold for $93,000 cash. The gain on the sale was reported on the income statement as other income. The amount to be reported on the statement of cash flows as an investing activity is: a. $78,000. *b. $93,000. c. $108,000. d. $15,000. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The reported cash inflow in the investing section is $93,000.

11.22

Chapter 11: Statement of cash flows

69. Gant Limited reported a $15,000 increase in inventory and a $5,000 increase in accounts payable during the year. Cost of Sales for the year was $150,000. The cash payments made to suppliers were: a. $150,000. *b. $160,000. c. $130,000. d. $145,000. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash payments made to suppliers were $150,000 +15,000 – 5,000 = $160,000.

70. The cost of sales sold during the year was $50,000. Inventory decreased by $2,000 during the year and accounts payable decreased by $1,000. Using the direct method of reporting, cash payments to suppliers total: a. $47,000. *b. $49,000. c. $51,000. d. $53,000. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash payments made to suppliers were $50,000 – 2,000 +1,000 = $49,000.

71. Rodman Limited had credit sales of $800,000. The beginning accounts receivable balance was $40,000 and the ending accounts receivable balance was $140,000. The cash collections from customers during the period were: a. $900,000. b. $800,000. *c. $700,000. d. $840,000. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash collections from customers were $800,000 – (140,000 – 40,000) = $700,000.

11.23

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

72. During 2017, Stacy Ltd had $300,000 in cash sales and $3,500,000 in credit sales. The accounts receivable balances were $450,000 and $530,000 at December 31, 2016 and 2017, respectively. The total cash collected from all customers during 2017 was: a. $3,420,000. b. $3,880,000. c. $3,800,000. *d. $3,720,000. Answer: d Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash collected from customers was $300,000 + 3,500,000 – (530,000 – 450,000) = $3,720,000.

73. Johnson Limited had the following information available: Prepaid Insurance, December 31, 2016 Prepaid Insurance, December 31, 2017 Insurance expense for 2017 500,000

$100,000 115,000

The amount of cash paid for insurance premiums by Johnson during 2017 was: a. $485,000. *b. $515,000. c. $600,000. d. $615,000. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash paid for insurance premiums for the year ended December 31, 2017 was $500,000 + (115,000 – 100,000) = $515.000.

74. Cash receipts from customers are greater than sales revenues when there is an: a. increase in accounts receivable. *b. decrease in accounts receivable. c. increase in cost of sales. d. decrease in cost of sales. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash receipts from customers exceed sales revenues when there is a decrease in accounts receivable.

11.24

Chapter 11: Statement of cash flows

75. Stapp Limited had an increase in inventory of $40,000. The cost of sales was $90,000. There was a $5,000 decrease in accounts payable from the prior period. What were Stapp's cash payments to suppliers? *a. $135,000. b. $85,000. c. $125,000. d. $95,000. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash payments to suppliers was $90,000 + 40,000 + 5,000 = $135,000.

76. Which of the following items does not appear in the statement of cash flows under the direct method? a. Cash payments to suppliers b. Cash collections from customers *c. Depreciation Expense d. Cash from the sale of equipment Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Under the direct method, depreciation expense does not appear on the statement of cash flows because it is a non-cash expense.

77. Mobile Limited has other operating expenses of $60,000. There has been a decrease in prepaid expenses of $4,000 during the year, and accrued liabilities are $6,000 larger than in the prior period. What were Mobile's cash payments for operating expenses? a. $62,000 b. $58,000 *c. $50,000 d. $70,000 Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash payments for operating expenses were $60,000 - 4,000 – 6,000 = $50,000.

11.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

78. Beech Limited shows income tax expense of $80,000. There has been a $2,000 increase in income taxes payable. What was Beech's cash payment for income taxes? a. $80,000 *b. $78,000 c. $75,000 d. $82,000 Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The cash payment for income taxes was $80,000 – 2,000 = $78,000.

79. Which of the following would not appear in the operating activities section of a statement of cash flows which is prepared under the direct method? a. Cash receipts from customers. b. Cash paid for income taxes. *c. Gain on sale of equipment. d. Cash paid to employees. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: The gain on sale of equipment would not appear in the operating activities section of a statement of cash flows. A gain is composed of two parts: the sale proceeds and the carrying amount of the equipment sold. The proceeds would be reported as a cash inflow from investing activities and the carrying amount is a non-cash expense.

80. Which of the following statements concerning the statement of cash flows is true? a. The statement of cash flows is more accurate when using the indirect method. *b. If the direct method is used a supplementary schedule reconciling the profit to net cash from operating activities must be provided. c. The statement of cash flows reflects both earnings per share and cash per share. d. The statement of cash flows is an optional financial statement for external reporting purposes. Answer: b Learning objective 11.3 – Prepare a statement of cash flows. Feedback: If the direct method is used a supplementary schedule reconciling the profit to net cash from operating activities must be provided.

11.26

Chapter 11: Statement of cash flows

81. Boone Ltd reports the following:

Inventory Accounts Payable

End of Year $25,000 $30,000

Beginning of Year $40,000 $10,000

If cost of sales for the year is $150,000, the amount of cash paid to suppliers is: a. $155,000. b. $145,000. *c. $115,000. d. $185,000. Answer: c Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash paid to suppliers is $150,000 – 15,000 – 20,000 = $115,000.

82. During the year Salaries Payable decreased by $6,000. If Salary Expense amounted to $160,000 for the year, the cash paid to employees is: *a. $166,000. b. $160,000. c. $154,000. d. $172,000. Answer: a Learning objective 11.3 – Prepare a statement of cash flows. Feedback: Cash paid to employees: $160,000 + 6,000 = $166,000.

83. A company would be expected to generate small amounts of cash from operations during the: a. introductory phase. *b. growth phase. c. maturity phase. d. decline phase. Answer: b Learning objective 11.4 – Explain the impact of the product life cycle on an entity’s cash flows. Feedback: During the growth phase, a company would usually generate small net cash from operations.

11.27

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

84. The phase in the product life cycle when a company is purchasing non-current assets and beginning to produce and sell is the: *a. introductory phase. b. growth phase. c. maturity phase. d. decline phase. Answer: a Learning objective 11.4 – Explain the impact of the product life cycle on an entity’s cash flows. Feedback: The introductory phase in the product lifecycle is when a company is purchasing non-current assets and beginning to produce and sell the product.

85. Cash from operations and profit are approximately the same during the: a. introductory phase. b. growth phase. *c. maturity phase. d. decline phase. Answer: c Learning objective 11.4 – Explain the impact of the product life cycle on an entity’s cash flows. Feedback: During the maturity phase, cash from operations and profit are approximately the same.

86. The cash-based ratio that is the counterpart of profit margin percentage is the: a. current cash debt coverage. *b. cash return on sales ratio. c. cash debt coverage. d. cash flow ratio. Answer: b Learning objective 11.5 – Use the statement of cash flows to evaluate an entity. Feedback: The cash return on sales ratio is the cash-based ratio that is the counterpart of the accrual-based profit margin percentage.

11.28

Chapter 11: Statement of cash flows

87. The current cash debt coverage ratio is used to evaluate: a. solvency. b. profitability. *c. liquidity. d. earning power. Answer: c Learning objective 11.5 – Use the statement of cash flows to evaluate an entity. Feedback: The current cash debt coverage ratio is used to evaluate liquidity.

88. The cash debt coverage ratio is computed by dividing net cash provided by operating activities by: a. average current liabilities b. net sales c. average long-term liabilities *d. average total liabilities Answer: d Learning objective 11.5 – Use the statement of cash flows to evaluate an entity. Feedback: The cash debt coverage ratio is computed by dividing net cash provided by operating activities by average total liabilities.

11.29

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises

89. Selected transactions of Daffodil Ltd are listed below: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Ordinary shares are sold for cash. Debentures are issued for cash at a discount. Interest on a short-term note receivable is collected. Merchandise is sold to customers for cash. Cash is paid to purchase inventory. Equipment is purchased by signing a 3-year, 10% note payable. Cash dividends on ordinary shares are declared and paid. One hundred shares of XYZ ordinary shares are purchased for cash. Land is sold for cash at its carrying value. Unsecured notes payable are converted into ordinary shares.

Required: Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a non-cash investing and financing activity. Answers below. Learning objective 11.2 – Distinguish among operating, investing and financing activities. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Financing activity Financing activity Operating activity Operating activity Operating activity Non-cash activity Financing activity Investing activity Investing activity Non-cash activity

11.30

Chapter 11: Statement of cash flows

90. Selected transactions for the Elder Group are listed below: Collected accounts receivable. Declared dividends on ordinary shares. Sold long-term investments for cash. Issued shares for equipment. Repaid five year note payable. Paid employee wages. Conversion of debt to ordinary shares. Acquired long-term investment with cash. Sold buildings and equipment for cash. 10. Sold merchandise to customers. 1. 2. 3. 4. 5. 6. 7. 8. 9.

Required: Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a non-cash investing and financing activity.

Answers below. Learning objective 11.2 – Distinguish among operating, investing and financing activities. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

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

Operating activity Non-cash activity Investing activity Non-cash activity Financing activity Operating activity Non-cash activity Investing activity Investing activity Operating activity

11.31

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

91. (a) Identify several alternatives for presenting significant non-cash activities in financial statements. (b) Give at least three examples of significant non-cash transactions.

Answers below. Learning objective 11.2 – Distinguish among operating, investing and financing activities. (a)

Significant non-cash transactions may appear at the bottom of the statement of cash flows as a separate schedule under the heading ‘Non-cash investing and financing activities’. They may also be presented in a separate note or supplementary schedule to the financial statements.

(b)

1. 2. 3. 4.

Issue of shares for assets Issue of shares to liquidate debt Issue of debentures or notes to acquire assets Non-cash exchange of property, plant, and equipment

11.32

Chapter 11: Statement of cash flows

92. Purple Ltd reported a profit of $260,000 for the current year. Depreciation recorded on buildings and equipment amounted to $80,000 for the year. Balances of the current asset and current liability accounts at the beginning and end of the year are as follows: End of Year $20,000 19,000 50,000 7,500 12,000 1,600

Cash Accounts receivable Inventories Prepaid expenses Accounts payable Income taxes payable

Beginning of Year $15,000 32,000 65,000 5,000 18,000 1,200

Required: Determine the cash flows from the operating activities of the company using the indirect method.

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. Profit ...................................................................................................................... Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense .................................................................................... Decrease in accounts receivable ................................................................... Decrease in inventories ................................................................................. Increase in prepaid expenses ......................................................................... Decrease in accounts payable ....................................................................... Increase in income taxes payable .................................................................. Net cash provided by operating activities .....................................................

$260,000 80,000 13,000 15,000 (2,500) (6,000) 400 $359,900

11.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

93. Assuming a statement of cash flows is prepared, indicate the reporting of the transactions and events listed below by major categories on the statement. Use the following code letters to indicate the appropriate category under which the item would appear. Code Cash Flows From Operating Activities Add to Profit Deduct from Profit

A D

Cash Flows From Investing Activities Cash Flows From Financing Activities

IA FA Category

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

Ordinary shares are issued for cash at an amount above par value. Merchandise inventory increased during the period. Depreciation expense recorded for the period. Building was purchased for cash. Notes payable were acquired and retired at their carrying value. Accounts payable decreased during the period. Prepaid expenses decreased during the period. Convertible notes were acquired for cash. Land is sold for cash at an amount equal to book value. Amortisation expense recorded for a period.

______ ______ ______ ______ ______ ______ ______ ______ ______ ______

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. 1. 2. 3. 4. 5.

Category FA D A IA FA

6. 7. 8. 9. 10.

Accounts payable decreased during the period. Prepaid expenses decreased during the period. Convertible notes were acquired for cash. Land is sold for cash at an amount equal to its carrying amount. Amortisation expense recorded for a period.

D A FA IA A

11.34

Chapter 11: Statement of cash flows

94. Assume the indirect method is used to compute cash flows from operations. For each item listed below, indicate the effect on profit in arriving at cash flows from operations by choosing one of the following code letters. Code Cash Flows From Operating Activities Add to Profit A Deduct from Profit D 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Increase in accounts receivable Increase in inventory Decrease in prepaid expenses Decrease in accounts payable Increase in accrued liabilities Increase in income taxes payable Depreciation expense Loss on sale of investment Gain on disposal of equipment Amortisation expense

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

D D A D A A A A D A

11.35

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

95. The comparative statement of financial positions for The Blue Group appear below: BLUE GROUP Comparative Statement of Financial Positions

Assets Cash Accounts receivable Prepaid expenses Inventory Long-term investments Equipment Accumulated depreciation—equipment Total assets

31 Dec 2017

31 Dec 2016

$ 23,000 18,000 6,000 27,000 -060,000 (18,000) $116,000

$15,000 14,000 9,000 15,000 18,000 30,000 (14,000) $87,000

$ 21,000 37,000 40,000 18,000 $116,000

$ 9,000 45,000 23,000 10,000 $87,000

Liabilities and Equity Accounts payable Note payable Ordinary shares Retained earnings Total liabilities and equity

Additional information: 1. Profit for the year ending 31 December 2017, was $20,000. 2. Cash dividends of $12,000 were declared and paid during the year. 3. Long-term investments that had a carrying amount of $18,000 were sold for $16,000. 4. Sales for 2017 were $120,000.

Required: 1. Prepare a statement of cash flows for the year ended 31 December 2017. 2. Compute the following cash-based ratios: a. Current cash debt coverage ratio b. Cash return on sales ratio c. Cash debt coverage ratio

11.36

Chapter 11: Statement of cash flows

Answers below. Learning objective 11.3 – Prepare a statement of cash flows.

BLUE GROUP Statement of Cash Flows for the year ended 31 December 2017

Cash flows from operating activities Profit ...................................................................................... Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................................................ $ 4,000 Loss on sale of long-term investment ................................... 2,000 Increase in accounts receivable ............................................. (4,000) Decrease in prepaid expenses ............................................... 3,000 Increase in inventories .......................................................... (12,000) Increase in accounts payable ................................................. 12,000 Net cash provided by operating activities ............................. Cash flows from investing activities Proceeds from the sale of long-term investments .......................... 16,000 Purchase of equipment ................................................................... (30,000) Net cash used by investing activities .................................... Cash flows from financing activities Issuance of ordinary shares ............................................................ 17,000 Retirement of note payable ............................................................ (8,000) Payment of cash dividends ............................................................. (12,000) Net cash used by financing activities .................................... Net increase in cash ................................................................................ Cash at beginning of period .................................................................... Cash at end of period ..............................................................................

$20,000

5,000 25,000

(14,000)

(3,000) 8,000 15,000 $23,000

11.37

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

2. a. Current cash debt coverage

b. Cash return on sales ratio

c. Cash debt coverage

Net cash provided by operating activities Average current liabilitie s

$25,000 = 1.67 times ($9,000 + $21,000 )  2

Net cashprovided by operating activities Net sales

$25,000 = 20.8% $120,000

Net cash provided by operating activities Average total liabilities

$25,000 = .45 times ($54,000 + $58,000 )  2

11.38

Chapter 11: Statement of cash flows

96. Comparative statement of financial positions for the Burgundy Corporation are presented below: BURGUNDY CORPORATION Comparative Statement of financial positions 2017

2016

Assets Cash Accounts receivable (net) Prepaid insurance Land Equipment Accumulated depreciation Total Assets

$ 39,000 80,000 22,000 18,000 70,000 (20,000) $209,000

$ 31,000 60,000 17,000 40,000 60,000 (13,000) $195,000

Liabilities and Equity Accounts payable Debentures payable Ordinary shares Retained earnings Total liabilities and equity

$ 11,000 27,000 140,000 31,000 $209,000

$ 6,000 19,000 115,000 55,000 $195,000

Additional information: 1. Net loss for 2014 is $20,000. Net sales for 2014 are $250,000. 2. Cash dividends of $4,000 were declared and paid during the year. 3. Land was sold for cash at a loss of $10,000. This was the only land transaction during the year. 4. Equipment with a cost of $15,000 and accumulated depreciation of $10,000 was sold for $5,000 cash. 5. $12,000 of debentures were retired during the year at their carrying amount. 6. Equipment was acquired for ordinary shares. The fair market value of the shares at the time of the exchange was $25,000. Required: 1. Prepare a statement of cash flows for the year ended 2017. 2. Compute the following cash based ratios: a. Current cash debt coverage b. Cash return on sales ratio c. Cash debt coverage ratio

11.39

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. 1.

BURGUNDY CORPORATION Statement of Cash Flows for the year ended 31 December 2017 _____________________________________________________________________________ Cash flows from operating activities Net loss ....................................................................................... Adjustments to reconcile profit or loss to net cash provided by operating activities: Depreciation (a) .................................................................... Loss on sale of land (b) ......................................................... Increase in accounts receivable ............................................. Increase in prepaid insurance ................................................ Increase in accounts payable ................................................. Net cash used by operating activities .................................... Cash flows from investing activities Proceeds from the sale of land (b) ................................................. Proceeds from the sale of equipment ............................................. Net cash provided by investing activities ............................. Cash flows from financing activities Retirement of debentures ............................................................... Issue of debentures ......................................................................... Payment of dividends ..................................................................... Net cash provided by financing activities ............................. Increase in cash ....................................................................................... Cash at beginning of period .................................................................... Cash at end of period ..............................................................................

$(20,000)

$17,000 10,000 (20,000) (5,000) 5,000

12,000 5,000 17,000 (12,000) 20,000 (4,000)

Non-cash investing and financing activities Purchase of equipment through issue of ordinary shares ............... (a)

Accumulated Depreciation 31/12/16 Accumulated Depreciation 31/12/17 Difference Add: Accumulated depreciation on equipment sold Depreciation expense

$13,000 20,000 7,000 10,000 17,000

(b)

Cost of land sold Less: Loss on sale of land Proceeds from sale of land

22,000 (10,000) $12,000

7,000 (13,000)

4,000 8,000 31,000 $39,000

$25,000

11.40

Chapter 11: Statement of cash flows

2. a. Current cash debt coverage

b. Cash return on sales ratio

Net cash provided by operating activities Average current liabilities ($13,000) = = (1.53) times ($6,000 + $11,000)  2

($13,000) Net cash provided by operating activities = $250,000 Net sales

= (5.2%) Net cash provided by operating activities Average total liabilities ($13,000) = = (.4) times ($25,000 + $38,000)  2

c. Cash debt coverage

11.41

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

97. The following information is available for the Bright Ltd for the year ended 31 December 2017: Collection of principal on long-term loan to a supplier Acquisition of equipment for cash Proceeds from the sale of long-term investment at their carrying amount Issue of ordinary shares for cash Depreciation expense Redemption of convertible notes at their carrying amount Payment of cash dividends Profit Purchase of land by issuing convertible notes payable

$35,000 10,000 27,000 20,000 25,000 24,000 9,000 35,000 40,000

In addition, the following information is available from the comparative statement of financial positions at the end of 2017 and 2016:

Cash Accounts receivable (net) Prepaid insurance Total current assets

2017 $107,000 20,000 17,000 $144,000

2016 $14,000 15,000 13,000 $42,000

Accounts payable Salaries payable Total current liabilities

$ 25,000 4,000 $ 29,000

$19,000 7,000 $26,000

Required: Prepare Bright’s statement of cash flows for the year ended 31 December 2017, using the indirect method.

11.42

Chapter 11: Statement of cash flows

Answers below. Learning objective 11.3 – Prepare a statement of cash flows.

BRIGHT LTD Statement of Cash Flows for the year ended 31 December 2017 _____________________________________________________________________________ Cash flows from operating activities Profit .................................................................................... Adjustments to reconcile profit to net cash provided by operating activities Depreciation .......................................................................... $25,000 Increase in accounts receivable ............................................. (5,000) Increase in prepaid insurance ................................................ (4,000) Increase in accounts payable ................................................. 6,000 Decrease in salaries payable ................................................. (3,000) Net cash provided by operating activities ............................. Cash flows from investing activities Collection of long-term loan .......................................................... 35,000 Proceeds from the sale of investments ........................................... 27,000 Purchase of equipment ................................................................... (10,000) Net cash provided by investing activities ............................. Cash flows from financing activities Issue of ordinary shares ................................................................. 20,000 Redemption of convertible notes ................................................... (24,000) Payment of dividends ..................................................................... (9,000) Net cash used by financing activities .................................... Increase in Cash .................................................................................... Cash at beginning of period .................................................................... Cash at end of period ..............................................................................

(13,000) 93,000 14,000 $107,000

Non-cash investing and financing activities Purchase of land by issuing convertible notes ...............................

$40,000

$35,000

19,000 54,000

52,000

11.43

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

98. Upshaw Company prepared the information below at 31 December. Profit .........................................................................................................................

$380,000

Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense, $35,000 ........................................................................

_______

Increase in accounts receivable, $75,000 .........................................................

_______

Decrease in inventory, $13,000 .......................................................................

_______

Amortisation of patent, $4,000 ........................................................................

_______

Increase in accounts payable, $5,600 ...............................................................

_______

Decrease in interest receivable, $4,000 ............................................................

_______

Increase in prepaid expenses, $6,000 ...............................................................

_______

Decrease in income taxes payable, $1,500 ......................................................

_______

Gain on sale of land, $5,000 ............................................................................

_______

Net cash provided (used) by operating activities .............................................

_______

Required: Show how each item should be reported in the statement of cash flows. Use parentheses for deductions.

Answers below. Learning objective 11.3 – Prepare a statement of cash flows.

Profit .........................................................................................................................

$380,000

Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ....................................................................................... Increase in accounts receivable ........................................................................ Decrease in inventory ...................................................................................... Amortisation of patent ..................................................................................... Increase in accounts payable ............................................................................ Decrease in interest receivable ......................................................................... Increase in prepaid expenses ............................................................................ Decrease in income taxes payable ................................................................... Gain on sale of land ......................................................................................... Net cash provided (used) by operating activities ....................................

35,000 (75,000) 13,000 4,000 5,600 4,000 (6,000) (1,500) (5,000) $354,100

11.44

Chapter 11: Statement of cash flows

99. Delphine Limited had total operating expenses of $140,000 in the year which included Depreciation Expense of $20,000. Also during the year, prepaid expenses increased by $5,000 and accrued expenses decreased by $6,700. Calculate the amount of cash payments for operating expenses in the year.

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. Operating expenses ............................................................... Less: Non-cash depreciation expense ................................... Add: Increase in prepaid expenses ........................................ Add: Decrease in accrued liabilities ..................................... Cash payments for operating expenses .................................

$140,000 (20,000) 5,000 6,700 $131,700

11.45

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

100. a.

Sales = $804,420; Accounts receivable increased by $49,700. Calculate cash receipts from sales.

Cost of sales = $1,520,000; inventory decreased by $78,000; accounts payable decreased by $28,500. Calculate cash payments for purchases.

The income statement shows $12,500 in income taxes. The statement of financial position shows an increase in taxes payable of $2,525. Calculate the cash paid for income taxes.

Operating expenses total $104,750; Depreciation expense = $37,200; Prepaid expenses increased by $17,400; Accrued wages decreased by $5,600. Calculate cash payments for operating expenses.

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. a. $754,720 b. $1,470,500 c. $9,975 d. $90,550

11.46

Chapter 11: Statement of cash flows

101. a.

Sales = $930,000; Accounts receivable decreased by $40,000. Calculate cash receipts from sales.

Cost of goods sold = $650,000; inventory increased by $15,000; accounts payable increased by $28,000. Calculate cash payments for purchases.

The income statement shows $25,500 in income taxes. The statement of financial position shows a decrease in taxes payable of $2,500. Calculate the cash paid for income taxes.

Operating expenses total $100,000; Depreciation expense = $4,000; Prepaid expenses decreased by $13,000; Accrued liabilities increased by $6,000. Calculate cash payments for operating expenses.

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. a. $970,000 b. $637,000 c. $28,000 d. $77,000

11.47

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

102. The general ledger of the Grey Limited provides the following information:

Accounts Receivable Inventory Accounts Payable

End of Year $ 65,000 340,000 40,000

Beginning of Year $ 94,000 210,000 65,000

The company's net sales for the year was $2,000,000 and cost of sales sold amounted to $1,700,000. Required: Compute the following: (a) Cash receipts from customers (b) Cash payments to suppliers

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. (a)

Cash receipts from customers Sales + Decrease in Accounts Receivable $2,000,000 + $29,000 = $2,029,000

(b)

Cash payments to suppliers First calculate the amount of purchases: Beginning inventory Add: Purchases Less: Ending Inventory Cost of sales Purchases

$ 210,000 ? ? 340,000 $1,700,000

= $210,000 + ? - $340,000 = $1,700,000 = $1,830,000

Amount of cash payments to suppliers: Purchases + Decrease in accounts payable $1,830,000 + $25,000 = $1,855,000

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Chapter 11: Statement of cash flows

103. The income statement of Feather Ltd for the year ended 31 December 2017, reported the following condensed information: Revenue from fees Operating expenses Income from operations Income tax expense Profit after income tax

$600,000 360,000 240,000 60,000 $180,000

The statement of financial position contained the following comparative data at December 31: 2017 $50,000 35,000 6,000

Accounts receivable Accounts payable Income taxes payable

2016 $45,000 41,000 3,000

There are no depreciable assets. Accounts payable pertains to operating expenses. Required: Prepare the operating activities section of the statement of cash flows using the direct method.

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. FEATHER LTD Statement of Cash Flows for the year ending 31 December 2017 Cash flows from operating activities Cash receipts from customers ($600,000 - $5,000) Cash payments: For operating expenses ($360,000 + $6,000) For income taxes ($60,000 - $3,000) Net cash provided by operating activities

$595,000 $366,000 57,000

423,000 $172,000

11.49

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

104. The income statement of Stalwart Ltd is shown below: STALWART LTD Income Statement for the year ended 31 December 2017 $8,200,000

Sales Cost of sales Gross profit Operating expenses Selling expenses Administrative expense Depreciation expense Amortisation expense Profit

5,400,000 2,800,000 $500,000 700,000 90,000 30,000

1,320,000 $1,480,000

Additional information: 1. Accounts receivable increased $400,000 during the year. 2. Inventory increased $250,000 during the year. 3. Prepaid expenses increased $200,000 during the year. 4. Accounts payable to merchandise suppliers increased $100,000 during the year. 5. Accrued expenses payable increased $180,000 during the year. Required: Prepare the operating activities section of the statement of cash flows for the year ended 31 December 2017, for Stalwart Ltd.

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Chapter 11: Statement of cash flows

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. STALWART LTD Statement of Cash Flows for the year ended 31 December 2017 Cash flows from operating activities Cash receipts from customers Cash payments: To suppliers For operating expenses Net cash provided by operations

$7,800,000 (1) $5,550,000 (2) 1,220,000 (3)

(1)

Sales Deduct: Increase in accounts receivable Cash receipts from customers

$8,200,000 400,000 $7,800,000

(2)

Cost of sales Add: Increase in inventory Purchases Deduct: Increase in accounts payable Cash payments to suppliers

$5,400,000 250,000 5,650,000 100,000 $5,550,000

(3)

Operating expenses exclusive of depreciation and amortisation Add: Increase in prepaid expenses Deduct: Increase in accrued expenses payable Cash payments for operating expenses

$1,200,000 200,000 (180,000) $1,220,000

6,770,000 $1,030,000

11.51

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

105. The financial statements of Lewis Limited appear below: LEWIS LIMITED Comparative Statement of financial positions 31 December Assets Cash Accounts receivable Merchandise inventory Property, plant, and equipment Accumulated depreciation Total

2017

2016

$ 44,000 26,000 20,000 50,000 (20,000) $120,000

$ 23,000 34,000 15,000 78,000 (24,000) $126,000

$ 15,000 13,000 7,000 41,000 44,000 $120,000

$ 23,000 8,000 33,000 24,000 38,000 $126,000

Liabilities and Equity Accounts payable Income taxes payable Notes payable Ordinary shares Retained earnings Total LEWIS LIMITED Income Statement for the year ended 31 December 2017 Sales Cost of sales Gross profit Selling expenses Administrative expenses Income from operations Interest expense Income before income taxes Income tax expense Profit after income tax

$350,000 280,000 70,000 $20,000 16,000

36,000 34,000 4,000 30,000 10,000 $ 20,000

The following additional data were provided: 1. Dividends declared and paid were $14,000. 2. During the year equipment was sold for $12,000 cash. This equipment cost $28,000 originally and had a carrying amount of $12,000 at the time of sale. 3. All depreciation expense is in the selling expense category. 4. All sales and purchases are on account. 5. Accounts payable pertain to merchandise suppliers. 6. All operating expenses except for depreciation were paid in cash. Required: Prepare a statement of cash flows for Lewis Limited using the direct method.

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Chapter 11: Statement of cash flows

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. LEWIS LIMITED Statement of Cash Flows for the year ended 31 December 2017 Cash flows from operating activities Cash receipts from customers ($350,000 + $8,000) Cash payments: To suppliers For operating expenses For interest expense For income taxes ($10,000 - $5,000) Net cash provided by operating activities Cash flows from investing activities Proceeds from the sale of equipment Net cash provided by investing activities Cash flows from investing activities Redemption of note payable Issue of ordinary shares Payment of cash dividend Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period

$358,000 $293,000 (1) 24,000 (2) 4,000 5,000

326,000 32,000

12,000 12,000 (26,000) 17,000 (14,000) (23,000) 21,000 23,000 $ 44,000

(1)

Cost of sales Add: Increase in inventory Purchases Add: Decrease in accounts payable Cash payments to suppliers

$280,000 5,000 285,000 8,000 $293,000

(2)

Operating expenses Less: Depreciation expense Cash payments for operating expenses

$36,000 (12,000)* $24,000

*$24,000 - $16,000 = $8,000 balance in accumulated depreciation after sale. Ending balance, $20,000 - $8,000 = $12,000 depreciation expense.

11.53

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

106. Condensed financial data of Barron Ltd appear below: BARRON LTD Comparative Statement of financial positions 31 December 2017

2016

Assets Cash Accounts receivable Inventories Prepaid expenses Investments Plant assets Accumulated depreciation Total

$ 72,000 85,000 120,000 19,000 90,000 310,000 (65,000) $631,000

$ 35,000 53,000 132,000 25,000 75,000 250,000 (60,000) $510,000

Liabilities and Equity Accounts payable Accrued expenses payable Notes payable Ordinary shares Retained earnings Total

$ 93,000 29,000 130,000 245,000 134,000 $631,000

$ 75,000 24,000 160,000 170,000 81,000 $510,000

BARRON LTD Income Statement for the year ended 31 December 2017 Sales Less:

$480,000

Cost of sales Operating expenses (excluding depreciation) Depreciation expense Income taxes Interest expense Loss on sale of plant assets Profit after income tax

$290,000 60,000 17,000 15,000 18,000 3,000

403,000 $ 77,000

Additional information: 1. New plant assets costing $85,000 were purchased for cash in 2017. 2. Old plant assets costing $25,000 were sold for $10,000 cash when their carrying amount was $13,000. 3. Notes with a face value of $30,000 were converted into $30,000 of ordinary shares. 4. A cash dividend of $24,000 was declared and paid during the year. 5. Accounts payable pertain to merchandise purchases. Required: 1. Prepare a statement of cash flows for the year. 2. Compute the following cash basis ratios: a. Current cash debt coverage b. Cash return on sales ratio c. Cash debt coverage ratio

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Chapter 11: Statement of cash flows

Answers below. Learning objective 11.3 – Prepare a statement of cash flows. 1.

BARRON LTD Statement of Cash Flows for the year ended 31 December 2017

Cash flows from operating activities Cash receipts from customers ($480,000 - $32,000) Cash payments: To suppliers For operating expenses For income taxes For interest Net cash provided by operating activities Cash flows from investing activities Purchase of investments Purchase of plant assets Proceeds from the sale of plant assets Net cash used by investing activities Cash flows from financing activities Issue of ordinary shares Payment of cash dividends Net cash provided by financing activities Net increase in cash Cash at beginning of period Cash at end of period

$448,000 $260,000 (1) 49,000 (2) 15,000 18,000

342,000 106,000

(15,000) (85,000) 10,000 (90,000) 45,000 (24,000) 21,000 37,000 35,000 $ 72,000

Non-cash investing and financing activities Conversion of notes payable into ordinary shares

$ 30,000

(1)

Cost of sales Deduct: Decrease in inventory Purchases Deduct: Increase in accounts payable Cash payments to suppliers

$290,000 (12,000) 278,000 (18,000) $260,000

(2)

Operating expenses Deduct: Decrease in prepaid expenses Deduct: Increase in accrued expenses payable Cash payments for operating expenses

$60,000 (6,000) (5,000) $49,000

2. Cash basis ratios: a. Current cash debt coverage =

b. Cash return on sales ratio

$106,000 = .96 times ($99,000 + $122,000)  2

$106,000 = 22.1% $480,000

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

c. Cash debt coverage

$106,000 = .41 times ($259,000 + $252,000)  2

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Chapter 11: Statement of cash flows

Completion statements 107. Please complete the following statements: 1.

A statement of cash flows summarises the operating, ____________, and ___________ activities of an entity.

The cash effects of selling goods and services appears in the ______________ activities section of a statement of cash flows.

Net cash provided/used by operating activities can be determined using the ____________ method or the ______________ method.

During the _________stage, cash from operations and profit are approximately the same.

During the growth phase, a company will start to generate small amounts of cash _______________.

Non-cash expense in the income statement are ___________ to profit and non-cash income is ______________ to compute cash provided by operations.

If accounts receivable increase during a period, revenues on an accrual basis are ______________ than revenues on a cash basis.

The sale of equipment at less than its carrying amount is a(an) ______________ of cash that is reported in the ______________ activities section of a statement of cash flows.

Cost of sales for the year amounted to $100,000, and during the year, accounts payable ______________ by $3,000 and inventory decreased by $7,000 resulting in cash paid to suppliers of $90,000.

10.

In computing cash payments for operating expenses, a decrease in prepaid expenses is ______________ and an increase in accrued expenses payable is ______________ to (from) operating expenses.

11.

In computing cash payments for income taxes, a decrease in income taxes payable is ______________ to (from) income tax expense. The two largest classes of items in the operating activities section for a merchandising company are cash receipts from ___________________ and cash ______________ to suppliers.

12.

13. 14.

Current cash debt coverage is computed by dividing net cash provided by operating activities by _________________ liabilities. The cash ______________ ratio indicates the company’s ability to turn sales into dollars.

11.57

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objective 11.1 – 11.5. 1. 2. 3. 4. 5. 6. 7. 8.

investing, financing operating direct, indirect maturity phase from operations added, deducted higher (greater) inflow, investing

9. increased 10. deducted, deducted 11. added 12. customers, payments 13. average, current 14. return on sales

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Chapter 11: Statement of cash flows

Matching

108. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows using the direct method. A. B. C. D. E. F. G. H. I. J.

Added in determining cash receipts from customers Deducted in determining cash receipts from customers Added in determining cash payments to suppliers Deducted in determining cash payments to suppliers Cash outflow—investing activity Cash inflow—investing activity Cash outflow—financing activity Cash inflow—financing activity Significant non-cash investing and financing activity Is not shown

____ 1. Decrease in accounts payable during a period. ____ 2. Declaration and payment of a cash dividend. ____ 3. Decrease in accounts receivable during a period. ____ 4. Depreciation expense. ____ 5. Conversion of notes payable into ordinary shares. ____ 6. Decrease in merchandise inventory during a period. ____ 7. Sale of equipment for cash at book value. ____ 8. Issue of preferred shares for cash. ____ 9. Purchase of land for cash. ____ 10. Loss on sale of a plant asset.

Answers below. Learning objective 11.1 – 11.5. 1. 2. 3. 4. 5.

C G A J I

6. 7. 8. 9. 10.

D F H E J

11.59

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions

109. The statement of cash flows is the only required financial statement that is not prepared from an adjusted trial balance. What are the sources of information for preparing a statement of cash flows? Explain how the accrual basis of accounting affects the statement of cash flows.

Answer below. Learning objective 11.1 – 11.5. The information used to prepare the statement of cash flows usually comes from three sources. These sources are (1) a comparative statement of financial position, (2) current income statement, and (3) additional information. The accrual basis of accounting requires that revenues be recorded when earned and that expenses be recorded when incurred. Thus, profit may include earned revenues for which cash has not yet been collected and include incurred expenses which have not yet been paid for in cash. These non-cash revenues and non-cash expenses do not affect the cash balance. Therefore, the non-cash revenues and non-cash expenses must be eliminated to determine the net cash provided by operating activities.

110. Cash flows from operating activities can be calculated using the indirect or direct method. Briefly describe how the two methods differ yet arrive at the same information about the net cash flows from operating activities.

Answer below. Learning objective 11.1 – 11.5. The indirect method (or reconciliation method) starts with profit and converts it to the net cash provided by operating activities. There are two types of adjustments: (1) changes in current assets and current liabilities and (2) non-cash charges and credits. For example, an increase in accounts receivable is deducted from profit and an increase in accounts payable is added to profit. Similarly, a non-cash charge for depreciation expense is added to depreciation. The adjustments are the difference between profit and the net cash provided by operating activities. Under the direct method, net cash provided by operating activities is computed by adjusting each item in the income statement from the accrual to the cash basis. Within the operating activities section, only major classes of operating cash receipts and cash payments are reported. The classes include cash receipts from customers and cash payments to suppliers. The difference between these major classes is the net cash provided by operating activities. The same adjustments are used in both methods, regardless of whether profit is adjusted or individual revenues and expenses are adjusted. Therefore, both methods arrive at the same result.

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Chapter 11: Statement of cash flows

111. When preparing a statement of cash flows using the indirect method, why is depreciation added back to profit within the operating activities section?

Answer below. Learning objective 11.1 – 11.5. The indirect method begins with profit based on accrual accounting. This includes a legitimate deduction for depreciation expense. However, depreciation expense does not represent a cash outflow and thus must be added back to profit to cancel the deduction. As a result depreciation will not be included in the calculation of net cash flows from operating activities.

112. When preparing a statement of cash flows using the direct method, why must the sales revenue figure be adjusted to arrive at cash receipts from sales?

Answer below. Learning objective 11.1 – 11.5. Sales revenue is an accrual-based figure that includes both cash and credit sales for the period. The statement of cash flows is to report the cash collections for the period, whether or not the sale arose in that period or whether the credit sale had yet to be collected. An adjustment based on the change in accounts receivable accomplishes this conversion.

113. How is it possible for a company to suffer a net loss for a given year, yet produce a positive net cash flow from operating activities?

Answer below. Learning objective 11.1 – 11.5. A net loss means that accrual-based expenses exceeded accrual-based revenues for the period. However, if you eliminate the effect of (add back) such non-cash expenses as depreciation and amortisation, it is possible to have produced a positive net cash flow from operations. Increasing payables (not paying all expenses incurred this period) and decreasing receivables (collecting more receivables than sales this period) would also cause cash flow to be higher than related net income or loss.

11.61

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

114. Ethics: Flint Hills Trading Company's most recent financial statements showed dismal performance. There was a loss of $10,000 and the statement of cash flows showed a net cash decrease in all categories. The company president called all the managers together and asked them to do all they could to make sure the next quarter's performance was better. Levi Logan, manager of the manufacturing division, sold off old manufacturing equipment. He also reclassified several workers to part time (30 hours per week) and hired additional temporary workers to take up the slack. This saved the company money, since part-time workers do not have the same insurance and other benefits as full-time workers. Gary Gilmour, financial manager, immediately suspended payments on all accounts except those on which interest would accrue. He also instituted aggressive collection procedures. Required: 1. Were Levi Logan's actions ethical? Explain. 2. Were Gary Gilmour's actions ethical? Explain. 3. Were the company president's actions ethical? Explain.

Answer below. Learning objective 11.1 – 11.5. 1. There is a valid question as to whether Levi Logan's actions are ethical or not. Either answer could be considered correct. On the one hand, he was probably within his legal rights to reclassify the workers. He also might be commended for allowing more workers to have a job than was previously the case. On the other hand, however, he has removed a very real benefit from the former full-time workers, and he has done it fairly arbitrarily. He may have harmed morale, and harmed the company if the workers quit and new workers have to be hired. 2. Gary Gilmour's actions all appear to be ethical. 3. The company president may have placed undue pressure on the employees to show better results. The managers may feel that they need to sacrifice the long-term goals of the firm for short-term benefits.

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Chapter 11: Statement of cash flows

115. Communication: You are the accountant for a small manufacturing firm. Your company is privately held, so there is no current requirement to issue financial statements using GAAP. You were hired four years ago, and at that time you instituted a cash budgeting system. Presently, you prepare a schedule of predicted cash sources and cash needs at the end of each week for the following week. Jake Griffith, the CEO, has asked whether a statement of cash flows would also be useful. Required: Prepare a short memorandum to the CEO indicating whether you believe such an addition to the financial statements to be useful. Include in your memo the benefits that might be expected from a statement of cash flows and whether those are different from the benefits of a cash sources and cash needs listing. Answer below. Learning objective 11.1 – 11.5.

TO:

Jake Griffith

FROM: RE:

Martha King

Statement of cash flows vs. Cash Sources and Needs

You asked whether a Statement of cash flows would be useful, in addition to the Cash Sources and Needs statement. In my opinion, the statement of cash flows would be extremely useful. It gives different information than the Cash Sources and Needs does. A statement of cash flows would provide historical information about where we got the funds for operating, financing, and investing activities, as well as how we used the funds. It is a summary of our performance. The Cash Sources and Needs statement, on the other hand, is a prediction of the cash we will need and the source from which it will be obtained. One is our plan, the other is our result. Please let me know if you'd like more details about the statement of cash flows. (signed)

11.63

Chapter 12: Financial statement analysis and decision making

Chapter 12: Financial statement analysis and decision making Multiple-choice questions 1. Analyses that provide information about an entity’s relative position within an industry are known as: a. company standards. b. industry boundaries. *c. industry averages. d. comparative advantages. Answer: c Learning objective 12.1 – Discuss the need for comparative analysis and identify the tools of financial statement analysis. Feedback: Industry averages provide information about an entity’s position within an industry. 2. Comparisons with other entities that provide insight into an entity’s competitive position are: a. intra-industry analyses. b. competitor data. c. industry averages. *d. inter-entity comparisons. Answer: d Learning objective 12.1 – Discuss the need for comparative analysis and identify the tools of financial statement analysis. Feedback: Inter-entity comparisons provide insight into an entity’s competitive position.

3. Which one of the following is not a tool in financial statement analysis? a. Horizontal analysis. *b. Circular analysis. c. Vertical analysis. d. Ratio analysis. Answer: b Learning objective 12.1 – Discuss the need for comparative analysis and identify the tools of financial statement analysis. Feedback: Circular analysis is not a financial statement analysis tool.

12.1

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

4. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time: a. that has been arranged from the highest number to the lowest number. b. that has been arranged from the lowest number to the highest number. c. to determine which items are in error. *d. to determine the amount and percentage increase or decrease that has taken place. Answer: d Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: Horizontal analysis determines the amount and percentage change that has taken place over time in a series of financial statement data.

5. Horizontal analysis of comparative financial statements includes the: a. development of common-size statements. b. calculation of liquidity ratios. *c. calculation of dollar amount changes and percentage changes from the previous to the current year. d. evaluation of financial statement data that expresses each item in a financial statement as a percentage of a base amount. Answer: c Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: A horizontal analysis of comparative financial statements includes the calculation of dollar amount changes and percentage changes from the previous period to the current period.

6. Horizontal analysis is a technique for evaluating financial statement data: a. within a period of time. *b. over a period of time. c. on a certain date. d. as it may appear in the future. Answer: b Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: Horizontal analysis is used to evaluate financial statement data over a period of time.

12.2

Chapter 12: Financial statement analysis and decision making

7. If year one equals $800, year two equals $840, and year three equals $896, the percentage to be assigned for year three in a trend analysis, assuming that year 1 is the base year, is: a. 100%. b. 89%. c. 105%. *d. 112%. Answer: d Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: $896/800 = 1.12 or 112%.

8. If year one equals $800, year two equals $840, and year three equals $896, the percentage to be assigned for year one in a trend analysis, assuming that year 1 is the base year, is: a. 100%. b. 89%. *c. 105%. d. 112%. Answer: c Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: $840/800 = 1.05 or 105%.

9. In horizontal analysis, each item is expressed as a percentage of the: a. retained earnings figure. b. total assets figure. c. profit figure. *d. base year figure. Answer: d Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: Horizontal analysis each item as a percentage of the base year figure.

10. Trend analysis is also known as: a. vertical analysis. b. common analysis. *c. horizontal analysis. d. intra-analysis. Answer: c Learning objective 12.2 – Explain and apply horizontal analysis. Feedback: Trend analysis is also known as horizontal analysis.

12.3

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

11. In a vertical analysis of the statement of financial position, the 100 percent figure is: a. total current assets. b. total property, plant and equipment. c. total liabilities. *d. total assets. Answer: d Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In a vertical analysis of the statement of financial position, the 100 percent figure is total assets.

12. In a vertical analysis of the income statement, the 100% figure is: a. profit. b. cost of sales. c. gross profit. *d. net sales. Answer: d Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In a vertical analysis of the income statement, the 100 percent figure is net sales.

13. Vertical analysis is a technique that expresses each item in a financial statement: a. in currency (for example, dollars). b. as a percent of the item in the previous year. *c. as a percent of a base amount. d. commencing with the highest value down to the lowest value. Answer: c Learning objective 12.3 – Explain and apply vertical analysis. Feedback: Vertical analysis is a technique that expresses each item in a financial statement as a percentage of a base amount.

14. In vertical analysis: *a. a base amount is used for comparison. b. a base amount is not needed for the analysis. c. the same base is used across all financial statements analysed. d. the results of horizontal analysis are necessary inputs for the analysis. Answer: a Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In vertical analysis a base amount is used for comparison.

12.4

Chapter 12: Financial statement analysis and decision making

15. The best way to study the relationship of the components of financial statements is to prepare: *a. vertical analysis. b. a trend analysis. c. profitability analysis. d. ratio analysis. Answer: a Learning objective 12.3 – Explain and apply vertical analysis. Feedback: Preparing vertical analysis statements is the best way to study the relationship of the components of financial statements.

16. In performing vertical analysis, the base for prepaid expenses is: a. total current assets *b. total assets c. total liabilities d. prepaid expenses in a previous year Answer: b Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In vertical analysis, the base for prepaid expenses is total assets.

17. In performing a vertical analysis, the base for sales revenues on the income statement is: *a. net sales. b. sales. c. profit. d. cost of goods available for sale. Answer: a Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In vertical analysis, the base for sales revenues on the income statement is net sales.

18. In performing vertical analysis, the appropriate base for sales returns and allowances is: a. sales. b. sales discounts. *c. net sales. d. total revenues. Answer: c Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In vertical analysis, the base for sales returns and allowances on the income statement is net sales.

12.5

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

19. In performing a vertical analysis, the base for cost of sales is: a. total selling expenses. *b. net sales. c. total revenues. d. total expenses. Answer: b Learning objective 12.3 – Explain and apply vertical analysis. Feedback: In vertical analysis, the base for cost of sales on the income statement is net sales.

20. Which one of the following is not a characteristic generally evaluated in ratio analysis? a. Liquidity. b. Profitability. *c. Marketability. d. Solvency. Answer: c Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Marketability is not a characteristic which is evaluated in ratio analysis.

21. Liquidity ratios are used to assess: *a. short-term ability of an entity to pay maturing obligations. b. long-term solvency. c. short-term sales levels. d. ability of an entity to survive over a long term. Answer: a Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Liquidity ratios are used to assess the short-term ability of an entity to pay its obligations as they mature.

12.6

Chapter 12: Financial statement analysis and decision making

22. The current ratio is calculated by dividing: a. current liabilities by current assets. b. current creditors by current accounts receivable. *c. current assets by current liabilities. d. cash by inventory. Answer: c Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: The current ratio is calculated by dividing current assets by current liabilities.

23. Radiance Limited has cash of $35,000, marketable securities totaling $15,000, net receivables amounting to $20,000, and current liabilities of $55,000. The quick ratio for this company is: a. 1.000. b. 0.780. *c. 1.273. d. 1.875. Answer: c Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: ($35,000 + 15,000 + 20,000)/55,000 = 1.273 or 1.273:1.

24. Short-term creditors are usually most interested in assessing: a. solvency. *b. liquidity. c. marketability. d. profitability. Answer: b Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Short-term creditors are usually most interested in assessing the liquidity of an entity.

12.7

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

25. A common measure of long-term solvency is: *a. cash debt coverage. b. current ratio. c. asset turnover. d. inventory turnover. Answer: a Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: The cash debt coverage ratio is a common measure of long-term solvency.

26. Return on assets is affected by two factors which are: a. profit margin and debt to total assets. *b. profit margin and asset turnover. c. times interest earned and debt to equity ratios. d. profit margin and free cash flow. Answer: b Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Return on assets is affected by profit margin and asset turnover. 27. Return on ordinary shareholders’ equity is driven by: a. gross profit rate. b. profit margin and free cash flow. c. times interest earned. *d. return on assets and leverage. Answer: d Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Return on ordinary shareholders’ equity is driven by return on assets and leverage.

12.8

Chapter 12: Financial statement analysis and decision making

28. Long-term creditors are usually most interested in evaluating: a. liquidity. b. marketability. c. profitability. *d. solvency. Answer: d Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Long-term creditors are usually most interested in evaluating solvency.

29. Which one of the following would be considered a long-term solvency ratio? a. Receivable turnover. b. Return on total assets. c. Quick ratio. *d. Debt to total asset ratio. Answer: d Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: The debt to total asset ratio is considered a measure of long-term solvency.

30. Shareholders are most interested in evaluating: a. liquidity. b. solvency. *c. profitability. d. marketability. Answer: c Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Shareholders are most interested in evaluating profitability.

12.9

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

31. The current ratio is: a. calculated by dividing current liabilities by current assets. *b. used to evaluate a company's liquidity and short-term debt paying ability. c. used to evaluate a company's solvency and long-term debt paying ability. d. calculated by subtracting current liabilities from current assets. Answer: b Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: The current ratio is a measure of a company’s liquidity and its ability to pay short-term debt as it falls due.

32. The current ratio is a: *a. liquidity ratio. b. profitability ratio. c. long-term solvency ratio. d. cash flow ratio. Answer: a Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: The current ratio is a measure of liquidity.

33. A high receivables turnover ratio indicates: *a. customers are making payments quickly. b. a large portion of the company’s sales are on credit. c. many customers are not paying their receivables. d. the company’s sales have increased. Answer: a Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: A high receivables turnover ratio indicates customers are making payments quickly.

12.10

Chapter 12: Financial statement analysis and decision making

34. Which one of the following would not be considered a liquidity ratio? a. Current ratio. b. Inventory turnover. c. Quick ratio. *d. Return on assets. Answer: d Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Return on assets is not a measure of liquidity; it is a measure of profitability.

35. Asset turnover is calculated by dividing: a. net sales by profit. b. average total assets by profit. *c. net sales by average total assets. d. average total assets by net sales. Answer: c Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Asset turnover is calculated by dividing net sales by average total assets.

36. Profit margin is calculated by dividing: a. sales by cost of sales. b. gross profit by net sales. c. profit by equity. *d. profit by net sales. Answer: d Learning objective 12.4 – Identify and calculate ratios and describe their purpose and use in analysing the liquidity, solvency and profitability of a business. Feedback: Profit margin is calculated by dividing profit by net sales.

37. Examples of estimates normally found in financial statements include all of the following except: *a. cash. b. provision for warranties. c. depreciation expense. d. allowance for doubtful debts. Answer: a Learning objective 12.5 – Discuss the limitations of financial statement analysis. Feedback: The cash figure found in financial statements is an actual figure, not an estimate.

12.11

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

38. Traditional financial statements are normally based on: a. market values. b. net present values. *c. cost. d. exit prices. Answer: c Learning objective 12.5 – Discuss the limitations of financial statement analysis. Feedback: Traditional financial statements are normally based on cost and are not adjusted for price level changes.

39. In a traditional set of financial statements, the values of items found in a statement of financial position will be: *a. lower than their current market value. b. higher than their current market value. c. the same as their current market value. d. stated at a premium to their market value. Answer: a Learning objective 12.5 – Discuss the limitations of financial statement analysis. Feedback: In a traditional set of financial statements the values of items found in a statement of financial position will usually be lower than their current market value.

12.12

Chapter 12: Financial statement analysis and decision making

Exercises 40. Comparative information taken from the Rugby Ltd’s financial statements is shown below:

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

Notes receivable Accounts receivable Retained earnings Sales Operating expenses Payables

2017 $ 20,000 182,000 30,000 930,000 170,000 45,000

2016 -0140,000 (40,000) 750,000 200,000 20,000

Required: Using horizontal analysis, show the percentage change from 2016 to 2017 with 2016 as the base year.

Answers below. Learning objectives 12.1 – 12.5. (a) (b) (c) (d) (e) (f)

Base year is zero. Not possible to compute. $42,000 ÷ $140,000 = 30% increase Base year is negative. Not possible to compute. $180,000 ÷ $750,000 = 24% increase $30,000 ÷ $200,000 = 15% decrease $25,000 ÷ $20,000 = 125% increase

12.13

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

41. Button Ltd reported profit of $4,000,000 in 2016. Using 2016 as the base year, profit decreased by 70% in 2017 and increased by 180% in 2018. Compute the profit reported by Button Ltd for 2017 and 2018.

Answers below. Learning objectives 12.1 – 12.5. 2013: X ÷ $4,000,000 = 70% X = $4,000,000 × .70 = $2,800,000 The decrease is $2,800,000; therefore profit for 2017 is $1,200,000. 2014: X ÷ $4,000,000 = 180% X = $4,000,000 × 1.8 X = $7,200,000 The profit for 2018 is $11,200,000 ($4,000,000 + $7,200,000).

12.14

Chapter 12: Financial statement analysis and decision making

42. The following items were taken from the financial statements of James Limited, over a three-year period:

Item Net Sales Cost of Sales Gross Profit

2018 $340,000 209,000 $131,000

2017 $330,000 201,000 $129,000

2016 $300,000 186,000 $114,000

Required: Using horizontal analysis and 2016 as the base year, compute the trend percentages for net sales, cost of sales and gross profit. Explain whether the trends are favourable or unfavourable for each item.

Answers below. Learning objectives 12.1 – 12.5.

Item Net Sales Cost of Sales Gross Profit

2018 113% 112% 115%

2017 110% 108% 113%

2016 100% 100% 100%

The trend in net sales is increasing and favourable. The cost of sales trend is increasing, which could be unfavourable, but the sales are increasing each year at a faster pace than cost of sales. This is apparent by examining the gross profit percentages, which show a favourable, increasing trend.

12.15

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

43. The following items were taken from the financial statements of Greenley Ltd over a three-year period: Item Net Sales Cost of Sales Gross Profit

2018 $340,000 209,000 $131,000

2017 $330,000 201,000 $129,000

2016 $300,000 186,000 $114,000

Required: Compute the following for each of the above time periods. a. b.

The amount and percentage change from 2016 to 2017. The amount and percentage change from 2017 to 2018.

Answers below. Learning objectives 12.1 – 12.5.

Item Net Sales Cost of Goods Sold Gross Profit

2018 $ $10,000 8,000 $ 2,000

Per cent 3.0 4.0 1.6

$___ 30,000 15,000 $15,000

2017 _Per cent_ 10.0 8.1 13.2

12.16

Chapter 12: Financial statement analysis and decision making

44. The comparative statement of financial position of Grange Wine Ltd appears below: GRANGE WINE LTD Comparative Statement of Financial Position 31 December 2017 _____________________________________________________________________________ Assets 2017 2016 Current assets .......................................................................................... $ 322 $280 Non-current assets ................................................................................... 678 520 Total assets ........................................................................................ $1,000 $800 Liabilities and equity Current liabilities .................................................................................... Long-term debt ........................................................................................ Ordinary shares ....................................................................................... Retained earnings .................................................................................... Total liabilities and equity ................................................................

$ 180 240 320 260 $1,000

$120 160 320 200 $800

Instructions (a) Using horizontal analysis, show the percentage change for each statement of financial position item using 2016 as a base year. (b) Using vertical analysis, prepare a common-size comparative statement of financial position.

Answers below. Learning objectives 12.1 – 12.5.

GRANGE WINE LTD Comparative Statement of Financial Position 31 December 2017

Assets Current assets Non-current assets Total assets

2014 $ 322 678 $1,000

(b) Per cent 32% 68 100%

Liabilities and equity Current liabilities Long-term debt Ordinary shares Retained earnings Total liabilities and equity

$ 180 240 320 260 $1,000

18% 24 32 26 100%

2013 $280 520 $800

(b) Per cent 35% 65 100%

(a) Per cent 15% 30% 25%

$120 160 320 200 $800

15% 20 40 25 100%

50% 50% -030% 25%

12.17

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

45. Using the following selected items from the comparative statement of financial position of ConAir Ltd, illustrate horizontal and vertical analysis.

Accounts Receivable Inventory Total Assets

31 December 2017 $ 880,000 920,000 4,000,000

31 December 2016 $ 600,000 750,000 3,000,000

31 December 2017 147% 123% 133%

31 December 2016 100% 100% 100%

31 December 2017 22% 23% 100%

31 December 2016 20% 25% 100%

Answers below. Learning objectives 12.1 – 12.5.

HORIZONTAL ANALYSIS

Accounts Receivable Inventory Total Assets

VERTICAL ANALYSIS

Accounts Receivable Inventory Total Assets

12.18

Chapter 12: Financial statement analysis and decision making

46. The following information was taken from the financial statements of Genesis Ltd:

Gross profit on sales .................................................................... Profit before income tax .............................................................. Profit after income tax ................................................................ Profit after income tax as a percentage of net sales ....................

2017 $700,000 230,000 160,000 10%

2016 $765,000 221,000 153,000 9%

Required: (a)

Compute the net sales for each year.

(b)

Compute the cost of sales in dollars and as a percentage of net sales for each year.

(c)

Compute operating expenses in dollars and as a percentage of net sales for each year. (Income taxes are not operating expenses).

Answers below. Learning objectives 12.1 – 12.5.

(a) To calculate net sales divide the net profit by the percentage of profit after income tax to net sales.

Net Sales (b)

2017 $160,000 ÷ 10% = $1,600,000

2016 $153,000 ÷ 9% = $1,700,000

Using the net sales information from (a) and the gross profits given, it is possible to calculate the cost of sales.

Net Sales Less: Gross profit Cost of sales % of net sales (c) Gross profit Less: Profit before income taxes Operating Expenses % of net sales

2017 $1,600,000 700,000 $ 900,000

2016 $1,700,000 765,000 $ 935,000

56%

55%

2017 $700,000 230,000 $470,000

2016 $765,000 221,000 $544,000

29.4%

32%

12.19

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

47. Selected information from the comparative financial statements of Dryman Ltd for the year ended 31 December appears below: 2017 2016 Accounts receivable (net) $ 180,000 $200,000 Inventory 140,000 160,000 Total assets 1,200,000 800,000 Current liabilities 140,000 110,000 Long-term debt 400,000 300,000 Net credit sales 1,500,000 700,000 Cost of sales 600,000 530,000 Interest expense 50,000 25,000 Income tax expense 60,000 29,000 Profit 150,000 85,000 Net cash provided by operating activities 240,000 135,000 Required: Answer the following questions relating to the year ended 31 December 2017. Show computations. 1. Inventory turnover for 2017 is __________. 2. The number of times interest earned ratio in 2017 is __________. 3. The debt to total assets ratio for 2017 is __________. 4. Receivables turnover for 2017 is __________. 5. Return on assets for 2017 is __________. 6. The cash return on sales ratio for 2017 is __________. 7. Current cash debt coverage for 2017 is __________.

12.20

Chapter 12: Financial statement analysis and decision making

Answers below. Learning objectives 12.1 – 12.5. 1. Inventory turnover for 2017 is 4 times.

$600,000 = 4 times ($140,000 + $160,000)  2

2. The number of times interest earned ratio in 2017 is 5.2 times.

$150,000 + $60,000 + $50,000 = 5.2 times $50,000 3. The debt to total assets ratio for 2017 is 45%.

$140,000 + $400,000 = 45% $1,200,000 4.

Receivables turnover for 2017 is 7.9 times.

$1,500,000 = 7.9 times ($180,000 + $200,000)  2 $150,000 = 15% ($1,200,000 + $800,000)  2

Return on assets for 2017 is 15%.

The cash return on sales ratio for 2017 is 16%.

Current cash debt coverage for 2017 is 1.92 times.

$240,000 = 16% $1,500,000

$240,000 = 1.92 times. ($110,000 + $140,000)  2

12.21

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

48. The financial statements of Bloggs Ltd appear below: BLOGGS LTD Comparative Statement of Financial Position 31 December 2017 _____________________________________________________________________________ Assets 2017 2016 Cash ................................................................................................... $ 25,000 $ 40,000 Marketable securities ........................................................................ 15,000 60,000 Accounts receivable (net) ................................................................. 50,000 30,000 Inventory ........................................................................................... 150,000 170,000 Property, plant and equipment (net) .................................................. 160,000 200,000 Total assets .................................................................................. $400,000 $500,000 Liabilities and equity Accounts payable .............................................................................. $ 20,000 Short-term notes payable .................................................................. 40,000 Bonds payable ................................................................................... 80,000 Ordinary shares ................................................................................. 170,000 Retained earnings .............................................................................. 90,000 Total liabilities and equity ........................................................... $400,000

$ 30,000 90,000 160,000 145,000 75,000 $500,000

BLOGGS LTD Income Statement For the Year Ended 31 December 2017 Net sales ............................................................................................ Cost of sales ...................................................................................... Gross profit ....................................................................................... Expenses Interest expense ........................................................................... Selling expenses .......................................................................... Administrative expenses ............................................................. Total expenses ....................................................................... Profit before income taxes ................................................................ Income tax expense ........................................................................... Profit .................................................................................................

$360,000 184,000 176,000 $24,000 30,000 20,000 74,000 102,000 30,000 $ 72,000

Additional information: a. Cash dividends of $57,000 were declared and paid in 2017. b. Weighted-average number of shares of ordinary shares outstanding during 2017 was 60,000 shares. c. Market value of ordinary shares on 31 December 2017 was $18 per share. d. Net cash provided by operating activities for 2017 was $63,000.

12.22

Chapter 12: Financial statement analysis and decision making

Required: Using the financial statements and additional information, compute the following ratios for the Boggs Ltd for 2017. Show all computations. Computations 1.

Current ratio _________

Return on ordinary shareholders’ equity _________

Price-earnings ratio _________

Acid-test ratio _________

Receivables turnover _________

Times interest earned _________

Profit margin _________

Average days in inventory _________

Dividend payout rate _________

10.

Return on assets _________

11.

Cash return on sales ratio _________

12.

Cash debt coverage _________

12.23

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objectives 12.1 – 12.5. 1. Current ratio 4:1.

$240,000 =4 $60,000

2. Return on ordinary shareholders equity 30%

$72,000 = .30 ($260,000 + $220,000)  2

3. Price-earnings ratio 15 times

EPS=

$72,000 = $1.20; 60,000

$18 = 15 times $1.20

4. Acid-test ratio 1.5:1

$90,000 = 1.5 : 1 $60,000

5. Receivables turnover 9 times

$360,000 =9 ($50,000 + $30,000)  2

6. Times interest earned 5.25 times

$72,000 + $30,000 + $24,000 = 5.25 $24,000

7. Profit margin 20%

$72,000 = .20 $360,000

8. Average days in inventory 317.4 days.

Inventory turnover = $184,000 = 1.15 (150,000 + $170,000)  2

365 days = 317.4 1.15 9. Dividend payout rate 79%

$57,000 = .79 $72,000

10.Return on assets 16%.

$72,000 = .16 ($400,000 + $500,000)  2

11.Cash return on sales ratio 17.5%.

12.Cash debt coverage .3 times.

$63,000 = .175 $360,000 $63,000 =.3 times ($280,000 + $140,000)  2

12.24

Chapter 12: Financial statement analysis and decision making

49. The following ratios have been computed for the Bently Bicycle Company for 2017 Profit margin 20% Times interest earned 12 times Receivable turnover 5 times Acid-test ratio 1.4:1 Current ratio 2.5:1 Debt to total assets ratio 24% The 2017 financial statements for James Ltd with missing information follows: THE BENTLY BICYCLE COMPANY Comparative Statement of Financial Position 31 December 2017 ___________________________________________________________________________________ Assets 2017 2016 Cash .................................................................................................... $ 25,000 $ 35,000 Marketable securities .......................................................................... 15,000 15,000 Accounts receivable (net) ................................................................... ? (6) 50,000 Inventory ............................................................................................. ? (8) 50,000 Property, plant, and equipment (net) ................................................... 200,000 160,000 Total assets .................................................................................. $ ? (9) $310,000 Liabilities and equity Accounts payable ................................................................................ Short-term notes payable .................................................................... Bonds payable ..................................................................................... Ordinary shares ................................................................................... Retained earnings ................................................................................ Total liabilities and equity ...........................................................

THE BENTLY BICYCLE COMPANY Income Statement for the year ended 31 December 2017 Net sales .............................................................................................. Cost of sales ........................................................................................ Gross profit .......................................................................................... Expenses: Depreciation expense (5) ............................................................... Interest expense ............................................................................ Selling expenses ........................................................................... Administrative expenses ............................................................... Total expenses (4) ................................................................... Profit before income taxes (2) .............................................................. Income tax expense (3).................................................................. Profit (1) ...............................................................................................

? (7) 35,000 ? (10) 200,000 47,000 $ ? (11)

$ 25,000 30,000 20,000 200,000 35,000 $310,000

$200,000 100,000 100,000 $

? 5,000 10,000 15,000

? ? ? ?

12.25

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Required: Use the above ratios and information from The Bently Bicycle Company financial statements to fill in the missing information on the financial statements. Follow the sequence indicated. Show computations that support your answers.

Answers below. Learning objectives 12.1 – 12.5.

THE BENTLY BICYCLE COMPANY Comparative Statement of Financial Position 31 December 2017 ___________________________________________________________________________________ Assets 2017 2016 Cash .............................................................................................. $ 25,000 $ 35,000 Marketable securities .................................................................... 15,000 15,000 Accounts receivable (net) ............................................................. 30,000 (6) 50,000 Inventory ....................................................................................... 55,000 (8) 50,000 Property, plant, and equipment (net) ............................................. 200,000 160,000 Total assets ............................................................................ $325,000 (9) $310,000 Liabilities and equity Accounts payable .......................................................................... Short-term notes payable .............................................................. Bonds payable ............................................................................... Ordinary shares ............................................................................. Retained earnings .......................................................................... Total liabilities and equity .....................................................

$ 15,000 (7) 35,000 28,000 (10) 200,000 47,000 $325,000 (11)

$ 25,000 30,000 20,000 200,000 35,000 $310,000

THE BENTLY BICYCLE COMPANY Income Statement for the year ended 31 December 2017 ___________________________________________________________________________________ Net sales ........................................................................................ $200,000 Cost of sales .................................................................................. 100,000 Gross profit .................................................................................... 100,000 Expenses Depreciation expense (5) ........................................................ $15,000 Interest expense ...................................................................... 5,000 Selling expenses ..................................................................... 10,000 Administrative expenses ......................................................... 15,000 Total expenses (4) ............................................................. 45,000 Profit before income taxes (2) ........................................................ 55,000 Income tax expense (3) .................................................................. 15,000 Profit (1) ......................................................................................... $ 40,000

12.26

Chapter 12: Financial statement analysis and decision making

(1)

Net profit = $40,000 ($200,000 × 20%).

(2)

Profit before income taxes = $55,000. Let X = Profit before income taxes and interest expense. X = 12 times; X = $60,000; $60,000 - $5,000 = $55,000. 5,000

(3)

Income tax expense = $15,000 ($55,000 - $40,000).

(4)

Total operating expenses = $45,000 ($100,000 - $55,000).

(5)

Depreciation expense = $15,000

(6)

Accounts receivable (net) = $30,000.

[$45,000 - ($5,000 + $10,000 + $15,000)].

Let X = Average receivables. $200,000 = 5 times; 5X = $200,000; X = $40,000. X

Let Y = Accounts receivable at 31/12/17. $50,000 + Y = $40,000; $50,000 + Y = $80,000; Y = $30,000. 2

(7) Accounts payable = $15,000. Let X = Current liabilities. $25,000 + $15,000 + $30,000 = 1.4; 1.4X = $70,000; X = $ 50,000; X

$50,000 - $35,000 = $15,000. (8) Inventory = $55,000 Let X = Total current assets X = 2.5; X = $125,000; $125,000 - ($25,000 + $15,000 + $30,000) = $55,000. $50,000

(9) Total assets = $325,000

($25,000 + $15,000 + $30,000 + $55,000 + $200,000)

12.27

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

(10) Bonds payable = $28,000 Let X = Total debt X ———— = 24%; X = $78,000; $78,000 - ($15,000 + $35,000) = $28,000. $325,000 (11) Total liabilities and equity = $325,000; same as total assets—see (9) above.

12.28

Chapter 12: Financial statement analysis and decision making

50. Selected data for Marcy’s Apparel appear below. Net sales Cost of sales Inventory at end of year Accounts receivable at end of year

2017 $650,000 590,000 64,000 80,000

2016 $520,000 345,000 85,000 50,000

Compute the following for 2017: (a) Gross profit percentage (b) Inventory turnover (c) Receivables turnover

Answers below. Learning objectives 12.1 – 12.5.

(a)

Gross profit = Net Sales - Cost of sales = $650,000 - $590,000 = $60,000 Gross profit percentage = Gross profit ÷ Net sales = $60,000 ÷ $650,000 = 9.2%

(b)

Inventory turnover = Cost of sales ÷ Average inventory = $590,000 ÷ [($64,000 + $85,000) ÷ 2] = 7.9 times

(c)

Receivables turnover = Net credit sales ÷ Average accounts receivables = $650,000 ÷ [($80,000 + $50,000) ÷ 2] = $650,000 ÷ $65,000 = 10 times

12.29

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

51. Willow Ltd has issued ordinary shares only. The company has been successful and has a gross profit rate of 20%. The information shown below was taken from the company's financial statements. Beginning inventory Purchases Ending inventory Average accounts receivable Average ordinary equity Sales (all on credit) Profit

$ 482,000 4,146,000 ? 700,000 3,500,000 5,110,000 420,000

Compute the following: (a)

Receivables turnover and the average number of days required to collect the accounts receivable.

(b)

The inventory turnover and the average days in inventory.

(c)

Return on ordinary shareholders’ equity.

Answers below. Learning objectives 12.1 – 12.5. (a) Receivables turnover

= = =

Credit sales Average accounts receivable $5,110,000 ÷ $700,000 7.3 times

Average collection period

= = =

(b)

365 days Receivables turnover 365 ÷ 7.3 times 50 days

Inventory turnover = Cost of sales ÷ Average inventory First calculate ending inventory. Beginning Inventory $ 482,000 + Purchases 4,146,000 - Cost of Sales (4,088,000)* Ending Inventory $ 540,000 *Since the gross profit ratio is 20%, the cost of sales ratio is 80%. 80% × $5,110,000 (net sales) = $4,088,000. Ending Inventory = $540,000 (per above) Average Inventory = ($482,000 + $540,000) ÷ 2 = $511,000 Inventory Turnover = $4,088,000 ÷ $511,000 = 8 times Days in Inventory = 365 days ÷ 8 times = 45.6 days

(c)

Return on ordinary shareholders’ equity =

Profit Average ordinary equity

$420,000 ÷ $3,500,000 = 12%

12.30

Chapter 12: Financial statement analysis and decision making

52. Birch Ltd had the following comparative current assets and current liabilities: 31 Dec 2017 31 Dec 2016 Current assets Cash $ 30,000 $ 30,000 Marketable securities 40,000 10,000 Accounts receivable 55,000 95,000 Inventory 110,000 90,000 Prepaid expenses 35,000 20,000 Total current assets $270,000 $245,000 Current liabilities Accounts payable $120,000 $110,000 Salaries payable 40,000 30,000 Current tax liabilities 20,000 15,000 Total current liabilities $180,000 $155,000 During 2017, credit sales and cost of sales were $450,000 and $250,000, respectively. Net cash provided by operating activities for 2017 was $134,000. Compute the following liquidity measures for 2017: 1. Current ratio 2. Quick ratio 3. Current cash debt coverage 4. Receivables turnover 5. Inventory turnover

12.31

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Answers below. Learning objectives 12.1 – 12.5.

1. Current Ratio = Current Assets ÷ Current Liabilities = $270,000 ÷ $180,000 = 1.5:1 2. Quick Ratio

= Cash + Marketable Securities + Accounts Receivable Current Liabilities = $30,000 + $40,000 + $55,000 $180,000 = .69:1 Cash provided by operations Average current liabilities $134,000 = $167,500

3. Current cash debt coverage

= .8 times 4. Receivables Turnover =

Net credit sales Average accounts receivable s

= $450,000 $75,000 = 6 times 5. Inventory Turnover = =

Cost of goods sold Average inventory $250,000 $100,000

= 2.5 times

12.32

Chapter 12: Financial statement analysis and decision making

53. Selected data from Oak Ltd are presented below: Total assets Average assets Profit Net sales Average ordinary equity Net cash provided by operating activities

$1,600,000 1,750,000 246,400 1,400,000 1,000,000 280,000

Calculate the profitability ratios that can be computed from the above information.

Answers below. Learning objectives 12.1 – 12.5.

With the information provided, the profitability ratios that can be calculated are as follows: 1. Profit margin = Profit ÷ Net sales = $246,400 ÷ $1,400,000 = 17.6% 2. Asset turnover = Net sales ÷ Average assets = $1,400,000 ÷ $1,750,000 = 80% 3. Return on assets = Profit ÷ Average assets = $246,400 ÷ $1,750,000 = 14.1% 4. Return on ordinary shareholders’ equity =

Net profit Average ordinary shareholde rs' equity

= $246,400 ÷ $1,000,000 = 24.6% 5. Cash return on sales =

Net cash from operations Net sales

= $280,000 ÷ $1,400,000 = 20%

12.33

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

54. The following data are taken from the financial statements of Swan Ltd:

Monthly average accounts receivable Net sales on account Terms for all sales are 2/10, n/30

2017 $ 520,000 5,720,000

2016 $ 550,000 4,950,000

Instructions (a) Compute the accounts receivable turnover and the average collection period for both years. (b) What conclusion can an analyst draw about the management of the accounts receivable?

Answers below. Learning objectives 12.1 – 12.5.

(a)

Accounts receivable turnover ratio.

Accounts receivable turnover

Average collection period

(b)

2017

2016

$5,720,000 520,000

$4,950,000 550,000

11 times

9 times

365 days 11 times

365 days 9 times

33.18 days

40.56 days

The receivables are turning faster in 2017 than they did in 2016. There is still a problem since the normal credit period is 30 days, and the average collection period for both years exceeds this target. Therefore, improvement in the management of the receivables would appear to be desirable.

12.34

Chapter 12: Financial statement analysis and decision making

55. State the effect of the following transactions on the current ratio. Use increase, decrease, or no effect for your answer. (a)

Collection of an accounts receivable

(b)

Declaration of cash dividends

(c)

Inventory is sold for cash

(d)

Accounts payable are paid

(e)

Equipment is purchased for cash

(f)

Inventory purchases are made for cash

(g)

Temporary investments are purchased for cash

Answers below. Learning objectives 12.1 – 12.5. (a) (b) (c) (d) (e) (f) (g)

no effect decrease increase increase decrease no effect no effect

12.35

Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

56. The income statement for the Yarrah Ltd for the year ended 31 December 2017 appears below. Sales Cost of sales Gross profit Expenses and income tax Profit

$610,000 380,000 230,000 180,000* $ 50,000

*Includes $30,000 of interest expense and $16,000 of income tax expense. Additional information: 1.

Ordinary shares outstanding on 1 January 2017 was 50,000 shares. On 1 July 2017 10,000 more shares were issued.

The market price of Yarrah shares was $12 at the end of 2017.

Cash dividends of $30,000 were paid, $6,000 of which were paid to preferred shareholders.

Compute the following ratios for 2017: (a) earnings per share. (b) price-earnings ratio. (c) times interest earned.

Answers below. Learning objectives 12.1 – 12.5.

(a)

Earnings per share $50,000 − $6,000 $44,000 = = $0.80 [50,000 + (10,000  2)] 55,000

(b)

Price-earnings ratio

$12.00 = 15 times 0.80 (c)

Times interest earned $50,000 + $30,000 + $16,000 = $30,000

3.2 times

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Chapter 12: Financial statement analysis and decision making

Completion statements

57. Complete the following statements: 1.

______________ analysis, also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time.

Expressing each item in a financial statement as a percentage of a base amount is called ______________ analysis.

For analysis of the financial statements, ratios can be classified into three types: (1)_____________ ratios, (2)_____________ ratios, and (3)______________ ratios.

Times interest earned is calculated by dividing ___________________ before __________________ and __________________ by interest expense.

The ratios used in evaluating a company's liquidity and short-term debt paying ability that complement each other are the ______________ ratio and the ______________ ratio.

Receivables turnover is calculated by dividing ________________ by average ___________________.

If the inventory turnover ratio is 5 times, and the average inventory was $600,000, the cost of goods sold during the year was $______________ and the average days to sell the inventory was ______________ days.

Hansen Company reported profit for the year of $300,000 and profit margin of 25%. If total average assets were $200,000, the asset turnover ratio was ____________ times.

The ______________ rate measures the percentage of earnings distributed in the form of cash dividends.

10.

The lower the _______________ to _______________ ratio, the more equity ‘buffer’ is available to the creditors if the company becomes insolvent.

Answers below. Learning objectives 12.1 – 12.5. 1. 2. 3. 4. 5. 6.

Horizontal vertical(a.k.a. common-size) liquidity, solvency, profitability profit, income tax, interest expense current, quick net credit sales, net receivables

7. 8. 9. 10.

$3,000,000, 73 6 payout Debt, total assets

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Matching

58. For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio, a profitability ratio, or a solvency ratio. Code: L = P = S =

Liquidity ratio Profitability ratio Solvency ratio

____ 1. Cash return on sales ratio ____ 2. Return on assets ____ 3. Receivables turnover ____ 4. Earnings per share ____ 5. Dividend payout rate ____ 6. Current cash debt coverage ____ 7. Acid-test ratio (Quick ratio) ____ 8. Debt to total assets ratio ____ 9. Free cash flow ____ 10. Inventory turnover

Answers below. Learning objectives 12.1 – 12.5. P P L

1. Cash return on sales ratio 2. Return on assets 3. Receivables turnover

L L S

P P

4. Earnings per share ratio 5. Dividend payout rate

S 9. Free cash flow L 10. Inventory turnover

6. Current cash debt coverage 7. Acid-test ratio (Quick ratio) 8. Debt to total assets ratio

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Chapter 12: Financial statement analysis and decision making

59. Match the ratios with the appropriate ratio computation by entering the appropriate letter in the space provided. A. Current ratio B. Acid-test ratio C. Profit margin D. Asset turnover E. Price-earnings ratio

F. Times interest earned G. Inventory turnover H. Average collection period I. Average days in inventory J. Dividend payout rate

1. Cost of sales Average inventory 2. Profit Net sales 3. Cash dividends Profit 4.

Net sales Average assets

5. Current assets Current liabilities ____ 6.

365 days Receivables turnover

____ 7. Market price per share Earnings per share ____ 8.

365 days Inventory turnover

____ 9. Profit before income taxes and interest expense Interest expense ____ 10. Cash + marketable securities + receivables (net) Current liabilities

Answers below. Learning objectives 12.1 – 12.5. 1. 2. 3. 4. 5.

G C J D A

6. 7. 8. 9. 10.

H E I F B

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions

60. Horizontal and vertical analyses are tools frequently used to analyse financial statements. What type of information or insights can be obtained by using these two techniques? Explain how the output of horizontal analysis and vertical analysis can be compared to industry averages and/or competitive companies.

Answer below. Learning objectives 12.1 – 12.5. Horizontal analysis allows an analyst to develop a picture of current trends in a company's operations. The analyst can see whether the accounts are increasing or decreasing and how large these changes actually are. Vertical analysis allows an analyst to evaluate financial statement items within a single financial statement. This technique helps the analyst to evaluate the relative size of the financial statement items and how the items relate to the financial statement as a whole. An example would be if current liabilities were a very large percentage of total liabilities and equity. Both techniques allow the company to evaluate their performance and position relative to their competitors and their industry as a whole. For example, the company could evaluate their current trend in sales and see how favourably their sales performance compared to the sales performance of other companies in the industry. Another example would be comparing the relative size of long-term liabilities or retained profit. This would show which companies have taken on a large amount of debt and which companies have reinvested earnings.

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Chapter 12: Financial statement analysis and decision making

61. The use of estimates, cost, alternative accounting methods, the presence of atypical data, and diversification of firms have been cited as factors that limit the usefulness of financial statement analysis. Identify a ratio and explain how one or more of the limiting factors can affect the usefulness of that ratio.

Answer below. Learning objectives 12.1 – 12.5. Any of the profitability ratios that involve net profit will be affected by the method of depreciation chosen. The use of an accelerated method, such as diminishing balance method will result in higher depreciation costs in the early years and lower depreciation costs in the later years. These costs will differ from the depreciation costs that would have been incurred if the straight-line method had been used. Therefore, because of the different costs, net profit will also be different. Thus, the choice of depreciation method affects net profit, which in turn affects the ratio. The acid-test ratio and receivables turnover are affected by the estimate of uncollectable accounts. The estimate will determine the amount of net receivables used to calculate the ratio. A high estimate will lower the net receivables and a low estimate will increase the net receivables. Thus, the accuracy of the estimate will have a direct effect on the accuracy of the ratio.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

62. Ethics: A trusted employee of Wilderness Tours was caught in the act of embezzling funds. He confessed to earlier embezzlements, but retracted the confession on the advice of his attorney. Over the course of the most recent quarter, it has been determined that $20,000 was embezzled. Wilderness Tours has suffered adverse publicity in the recent past because of serious injury to five tourists that occurred during a two week ‘Winter Wilds Adventure’ tour. The company has therefore decided to avoid publicity and has agreed to drop all charges against the embezzling employee. In return, the employee has agreed to a notation of ‘Terminated — Not to be Rehired’ to be appended to his personnel file. Required: 1. Who are the stakeholders in the decision not to prosecute? 2. Was it ethical for the company to decide not to prosecute? Explain.

Answer below. Learning objectives 12.1 – 12.5. 1. The stakeholders include • • • •

The embezzling employee, The other employees, Company management, and Other companies who might hire the embezzling employee.

2. The company was certainly within its legal rights not to prosecute the embezzling employee. However, the decision not to prosecute may not be ethical. First, it does not serve public justice. The embezzling employee could find a job elsewhere, and harm someone else financially. Second, to the extent that other employees know of the act and of the decision, morale may be harmed. The decision is also not the best one for the employee. Having never been forced to face the consequences of his dishonest acts, he is not deterred from (and may even feel encouraged to) commit similar acts in the future. The one argument that would support the premise that the decision was ethical is that the public disclosure would cause harm greater than that caused by keeping silent. Even this argument lacks force, because it implies a lack of moral courageousness.

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Chapter 12: Financial statement analysis and decision making

63. Communication: Fast Express specialises in the transportation of medical equipment and laboratory specimens overnight. The company has selected the following information from its most recent annual report to be the subject of an immediate press release. • The financial statements are being released. • Profit this year was $2.1 million. Last year's profit had been $1.8 million. • The current ratio has changed to 2:1 from last year's 1.5:1 . • The debt/total assets ratio has changed to 4:5 from last year's 3:5 . • The company expanded its truck fleet substantially by purchasing ten new delivery vans. • The company already had twelve delivery vans. The company is now the largest medical courier on the Eastern seaboard. Required: Prepare a brief press release incorporating the information above. Include all information. Think carefully which information (if any) is good news for the company, and which (if any) is bad news.

Answer below. Learning objectives 12.1 – 12.5. Press Release Fast Express released its financial statements today, disclosing a 17% increase in earnings, to $2.1 million from $1.8 million last year. The company also improved its short-term liquidity. Its current ratio improved to 2:1 from last year's 1.5:1. Part of the improved performance is no doubt due to the addition of ten new delivery vans to its fleet, allowing it to become the largest medical courier on the Eastern seaboard. The purchase of the vans, however, caused the debt/total asset ratio to decline. There are now $4 of debt for every $5 in assets, while last year, there were only $3 of debt to $5 in assets.

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Chapter 13: Analysing and integrating GAAP

Chapter 13: Analysing and Integrating GAAP Multiple-choice questions

1. The purpose of full disclosure principle is to report: a. timely information. b. reliable information. *c. relevant information. d. comparable information. Answer: c Learning objective 13.1 – Explain and apply the concepts and principles underlying the recording of accounting information. Feedback: The full disclosure principles requires that all circumstances and events that are relevant and could make a difference to the decisions financial statement users might make should be disclosed in the financial statements. 2. The CEO of Pure Water Ltd used the company’s money to buy a car for his wife’s personal use. The CEO has violated the: a. monetary principle. *b. accounting entity concept. c. accounting period concept. d. cost principle. Answer: b Learning objective 13.1 – Explain and apply the concepts and principles underlying the recording of accounting information. Feedback: The accounting entity concept states that every entity can be separately identified and accounted for. This means that personal transactions must be separated from the entity’s transactions.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

3. Williams Washing Machines Pty Ltd purchased second-hand equipment for its operation for $25,000. The equipment was worth $35,000. Applying the cost principle, how much should the equipment be recorded at in Williams Washing Machines’ statement of financial position? a. $30,000 (which is the average of the two prices). *b. $25,000. c. $35,000. d. The company could choose either $25,000 or $35,000. Answer: b Learning objective 13.1 – Explain and apply the concepts and principles underlying the recording of accounting information. Feedback: The cost principle states that assets are initially recorded at their purchase price or cost. In this case, the purchase price was $25,000, although the equipment was worth $35,000.

4. The cost principle states that all assets are initially recorded in the accounts at: a. present value. b. current cost. *c. historical cost. d. realisable value. Answer: c Learning objective 13.1 – Explain and apply the concepts and principles underlying the recording of accounting information. Feedback: Cost principle states that all assets are initially recorded at their purchase price or cost; that is their historical cost.

5. Lazy Company is currently in its third year of operation and has yet to issue financial statements. Which accounting concept or principle has been violated by the company? a. accounting entity concept *b. accounting period concept c. going concern principle d. cost principle Answer: b Learning objective 13.1 – Explain and apply the concepts and principles underlying the recording of accounting information. Feedback: The accounting period concept states that the life of an entity can be divided into artificial periods and financial reports covering those periods can be prepared for the entity. Lazy Company is in breach of the accounting period concept by failing to prepare financial statements for the periods that have passed.

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Chapter 13: Analysing and integrating GAAP

6. The process where standard-setters invite interested parties to contribute to the development of accounting standards is known as: a. standard-setting. b. decision-making. c. round-table discussions. *d. due process. Answer: d Learning objective 13.2 – Describe the conceptual framework, for financial reporting (the Conceptual Framework). Feedback: Due process is the process where all interested parties are consulted by standardsetters in developing standards.

7. A conceptual framework for financial reporting will not include discussion on: *a. how to prepare financial ratio analysis. b. the qualitative characteristics of financial reports. c. the elements of financial reports. d. the objective of financial reporting. Answer: a Learning objective 13.2 – Describe the conceptual framework, for financial reporting (the Conceptual Framework). Feedback: The conceptual framework will consist of a set of concepts that discuss the reporting entity, objective of general purpose financial reporting, qualitative characteristics, and definition of elements of financial statements.

8. The Financial Accounting Standards Board (FASB) is the accounting body of which country? *a. US. b. UK. c. Australia. d. New Zealand. Answer: a Learning objective 13.2 – Describe the conceptual framework, for financial reporting (the Conceptual Framework). Feedback: The FASB is the US accounting body.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

9. The Conceptual Framework adopts which of the following objective of general purpose financial reporting? a. Stewardship objective. *b. Decision-usefulness objective. c. Accounting consistency objective. d. Accountability objective. Answer: b Learning objective 13.3 – Explain the objective of general purpose financial reporting. Feedback: The Conceptual Framework is based on a decision-usefulness objective. This is consistent with SAC 2, but SAC 2 included stewardship (or accountability) as a secondary objective.

10. Which is not a quality of faithful representation in the Conceptual Framework? a. Completeness. *b. Prudence. c. Neutrality. d. Free from material error. Answer: b Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: Information is a faithful representation if it is complete, neutral and fee from material error.

11. According to the Conceptual Framework, the objective of general purpose financial reporting is to provide information that is useful to existing and potential investors, lenders and other creditors in making decision about: a. profitable investments. b. lending strategies. c. improving asset liquidity. *d. providing resources to the entity. Answer: d Learning objective 13.3 – Explain the objective of general purpose financial reporting. Feedback: The objective of general purpose financial reports is to provide information that is useful in making decisions about providing resources to the entity.

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Chapter 13: Analysing and integrating GAAP

12. The Framework issued by the AASB is equivalent to the one issued by which accounting body? a. FASB. b. AARF. c. PSASB. *d. IASB. Answer: d Learning objective 13.2 – Describe the conceptual framework, for financial reporting (the Conceptual Framework). Feedback: The Framework issued by AASB is equivalent to the one issued by the IASB. This resulted in the four SAC’s issued by the AASB prior to the decision to converge either being subsumed (SAC 3 & SAC 4) or retained (SAC 1 & SAC 2) alongside the Framework.

13. The stewardship objective of financial reporting means that: a. the objective of general purpose financial reports is to provide information to users that is useful for making decisions about allocation of scarce resources. *b. managers use general purpose financial reports to show the shareholders that they are managing resources effectively. c. the objective of general purpose financial reports is to provide information that is useful to capital providers. d. general purpose financial reports support stewardship function in entities where there is no separation of ownership from control. Answer: b Learning objective 13.3 – Explain the objective of general purpose financial reporting. Feedback: The stewardship or accountability objective of financial reporting suggest that where there is separation of ownership and control then general purpose financial reports can be used by managers to show owners they are managing resources of the entity effectively. The objective of stewardship has been de-emphasised in the Conceptual Framework.

14. Who are not the primary users of financial reports according to the Conceptual Framework? a. lenders. b. other creditors. c. equity investors. *d. government. Answer: d Learning objective 13.4 – Identify the primary and other users, and the uses of financial reports. Feedback: Primary users of general purpose financial reports are those users who provide resources to the entity and therefore require information to make decisions concerning the provision of those resources.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

15. Which of the following businesses is likely to be a reporting entity? a. An Asian grocery shop. *b. A listed company. c. A local newsagency. d. A fish & chips shop. Answer: b Learning objective 13.5 – Explain the nature of a reporting entity. Feedback: A reporting entity in an entity in which it is reasonable to expect the existence of users to depend on general purpose financial reports for information to enable them to make economic decisions. An Asian grocery, a local newsagency, and a fish chips shop are more likely to be managed by owners who can obtain the financial information they require and do not rely of general purpose financial reports.

16. Which of the following is not an indicator of a reporting entity under SAC 1? a. The entity is politically or economically important. b. The entity is considered large in terms of sales, assets, borrowings, employees and customers. *c. The entity receives government grants. d. The entity is managed by individuals who are not owners of the entity. Answer: c Learning objective 13.5 – Explain the nature of a reporting entity. Feedback: Three indicators of a reporting entity under SAC 1 are: 1) if the entity is managed by individuals who are not owners; 2) if the entity is politically or economically important; and 3) if the entity is considered large in terms of assets, sales, borrowing, employees and customers.

17. According to the Conceptual Framework what are the two fundamental qualitative characteristics of information contained in financial reports? a. reliability and relevance. *b. relevance and faithful representation. c. reliability and comparability. d. faithful representation and timeliness. Answer: b Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: The two fundamental qualitative characteristics in the proposed improved of conceptual framework are relevance and faithful representation.

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Chapter 13: Analysing and integrating GAAP

18. The following are qualities of faithful representation in the Conceptual Framework – except: *a. prudence. b. neutrality. c. completeness. d. free from material error. Answer: a Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: Information is a faithful representation of the economic phenomena it purports to represent if it is complete, neutral, and free from material error.

19. Which of the following is a constraint on financial reporting? *a. cost. b. timeliness. c. financial reports are not the only source of information. d. allocation of scarce resources. Answer: a Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: Providing financial information imposes costs, and the benefits of providing the information should outweigh the costs.

20. Timeliness refers to providing information in a timely manner such that it will not lose its: a. understandability. b. reliability. *c. relevance. d. comparability. Answer: c Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: Timeliness means preparers should not take so long to correct and prepare financial information that the information loses its relevance.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

21. The following statements are associated with the qualitative characteristics of relevance, except: *a. free from material error. b. confirms or corrects previous expectations. c. relevance is affected by materiality. d. provides a basis for predictions. Answer: a Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: Free from material error is one of the qualities of faithful representation.

22. The purpose of full disclosure principle is to report all: a. reliable information. b. comparable information. c. timely information. *d. relevant information. Answer: d Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: The full disclosure principle requires that all circumstances and events that could make a difference to the decisions that financial statement users might make (i.e. relevant) should be disclosed in the financial statements.

23. Timeliness refers to reporting information in a timely manner so that it still retains its: a. comparability. b. reliability. *c. relevance. d. materiality. Answer: c Learning objective 13.6 – Identify and apply the qualitative characteristics and constraint on financial reporting. Feedback: Timeliness is measured by whether the information is available to users before it ceases to be relevant.

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Chapter 13: Analysing and integrating GAAP

24. In AASB 118, revenue is recognised on the sale of goods when the following conditions are satisfied, except: *a. the amount of revenue can be measured with certainty. b. the entity has transferred to the buyer the significant risks and rewards of ownership of the goods. c. it is probable that the economic benefits of the revenue will flow to the entity. d. the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold. Answer: a Learning objective 13.7 – Define assets, liabilities, equity, income and expenses and apply recognition criteria. Feedback: One of the conditions to satisfy in recognising revenue on the sale goods as in the AASB 118 is that the amount of revenue can be measured reliably, not with certainty.

25. Decreases in economic benefits that arise outside the ordinary course of business are known as: a. revenues. b. expenses. c. gains. *d. losses. Answer: d Learning objective 13.7 – Define assets, liabilities, equity, income and expenses and apply recognition criteria. Feedback: Decreases in economic benefits that arise outside the ordinary course of business are called losses.

26. On 1 April 2016, Waratah Ltd paid for a yearly insurance for $24,000. How much of insurance expense should be recognised in the income statement on 31 December 2016? a. $12,000. *b. $ 18,000. c. $ 16,000. d. $10,000. Answer: b Learning objective 13.7 – Define assets, liabilities, equity, income and expenses and apply recognition criteria. Feedback: By applying expense recognition criteria, 9 month of insurance should be recognised as expense in 2016 and the remainder in 2017 (9/12 x $24,000 = $18,000).

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

27. Which of the elements of financial reports that cannot be defined independently from other elements? a. income *b. equity c. liability d. asset Answer: b Learning objective 13.7 – Define assets, liabilities, equity, income and expenses and apply recognition criteria. Feedback: Equity cannot be defined independently because it is a residual of assets after deducting liabilities.

28. For a resource to be defined as an asset: *a. the entity must have control over the resource. b. the entity must own the resource. c. the entity must be able to sell the resource for profits. d. the resource must be physically tangible. Answer: a Learning objective 13.7 – Define assets, liabilities, equity, income and expenses and apply recognition criteria. Feedback: One of the essential characteristics of an asset is that the entity must have control over the asset (ownership is the most common way of control, but not necessary).

29. The following items will be recognised as liabilities in the statement of financial position, except: a. a warranty provision. b. a bank loan. *c. a contingent liability. d. a mortgage. Answer: c Learning objective 13.7 – Define assets, liabilities, equity, income and expenses and apply recognition criteria. Feedback: A contingent liability does not satisfy the recognition criteria because it is dependent on the occurrence of certain events outside the entity’s control or the amount of future sacrifice cannot be reliably measured.

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Chapter 13: Analysing and integrating GAAP

30. Which is the correct order for preparers of financial reports in applying various aspects of GAAP? a. accounting standards, concepts and principles, conceptual framework b. conceptual framework, accounting standards, concepts and principles *c. accounting standards, conceptual framework, concepts and principles d. there is no particular order Answer: c Learning objective 13.8 – Integrate principles, concepts, standards and the Conceptual Framework. Feedback: It is important to follow the order in applying various aspects of GAAP. Accounting standards and interpretations must be followed first because they have legislative backing.

31. Which of the following statements about generally accepted accounting principles (GAAP) and conceptual framework is correct? a. Australian GAAP only consists of the developed accounting standards. *b. Conceptual framework is part of GAAP. c. GAAP is part of the conceptual framework. d. Since 2005, SAC 1 is no longer a part of Australian conceptual framework. Answer: b Learning objective 13.8 – Integrate principles, concepts, standards and the Conceptual Framework. Feedback: Australian GAAP consists of the conceptual framework, accounting standards and interpretations, as well as developed accounting concepts and principles. SAC 1 is still a part of Australian conceptual framework because the Framework developed by the IASB does not contain the definition of a reporting entity.

32. Which of the following best describes the relationships among the various aspects of GAAP? a. They operate in isolation. b. They are interrelated with no particular order of application. *c. They are interrelated and need to be applied in a particular order. d. There is no relation at all. Answer: c Learning objective 13.8 – Integrate principles, concepts, standards and the Conceptual Framework. Feedback: Various aspects of GAAP do not operate in isolation, but are interrelated. However, there is a particular order that must be followed in applying various aspects of GAAP.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Completion statements

33. Please complete the following statements. 1.

The ___________________ states that the economic life of an entity can be divided into discrete period of time.

The Conceptual Framework defines ____________ as the residual interest in the assets of the entity after deducting all its liabilities.

Under the _________________ theory, the reporting entity is viewed as separate from its owners and have substance on its own.

__________________________ are reports intended to meet the information needs of users who are unable to command reports to suit their specific needs.

_____________ serves so as not to overstate amounts when reporting the assets and income or not to understate the liabilities and expenses of a business.

A consultation process where standard-setters invite interested parties to contribute to the development of accounting standards is known as ________________ .

Accounting information is considered to be _______________ if the information makes a difference in a decision.

_________________ is the process of determining the monetary amounts at which the elements of the financial statements are to be recognised and carried in the statement of financial position and the income statement.

A liability is recognised in the statement of financial position when it is _____________ that an outflow or resources embodying economic benefits will result from the settlement of a present obligation.

10.

Increases in economic benefits that do not arise in the ordinary course of business are labelled as ______________.

11.

If the ____________________ is not assumed, then plant and equipment should be stated at their liquidation value (selling price less costs of disposal), not at their cost.

12.

The Conceptual Framework classifies relevance and faithful representation as _______________ qualitative characteristics.

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Chapter 13: Analysing and integrating GAAP

Answers below. Learning objectives 13.1 – 13.9.

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

accounting period concept equity entity theory General-purpose financial reports Prudence / Conservatism due process

7. 8. 9. 10. 11. 12.

relevant Measurement probable gains going concern principle fundamental

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Exercises

34. a. Briefly explain the essential characteristics in the definition of a liability.

What are the criteria that must be satisfied for liabilities to be recognised in the statement of financial position?

Using the definition and recognition criteria, explain why the following items are liabilities: • bank loan • revenue earned in advance (unearned revenue) • provision for employees’ annual leave

Answers below. Learning objectives 13.1 – 13.9. a.

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 resource embodying economic benefits’. There are 3 essential characteristics in the definition of a liability: • A present obligation The entity must have a present obligation, which means the entity has a duty to act or perform in a certain way in the future, such as delivering goods/service or making interest repayments. • Past transaction or event The obligation that the entity has must be as a result of a past transaction or event. This means a transaction must have occurred that results in a present obligation, and a mere intention to do something in the future does not give rise to a present obligation. • Outflow of resources or economic benefits A liability must result in an outflow of resources or economic benefits such that it can reduce the future cash flows of the entity.

b. A liability is recognised in the statement of financial position when: • it is probable that outflow of resource embodying economic benefits will result from the settlement of a present obligation; • the amount at which the settlement will take place can be measured reliably.

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Chapter 13: Analysing and integrating GAAP

c. The following items satisfy the definition and recognition criteria of a liability: • Bank loan Definition: The present obligation is the legal obligation via a debt contract between the borrower and the bank. A past transaction occurs when the borrower obtains the money from the bank as stipulated in the loan agreement. The loan will result in an outflow of economic benefits for the borrower in the form of future cash repayments for the loan and interests. Recognition: The outflow of economic benefits is probable because the borrower has to meet loan commitment to avoid defaults. The amount of loan can be reliably measured as it is stipulated in the loan agreement. •

Revenue received in advance (Unearned revenue) Definition: The present obligation is the expectation to sell goods or perform services sometimes in the future to customers. A past transaction occurs when payment was made by the customers for the goods or services. The revenue received in advance (unearned revenue) will result in an outflow of economic benefits for the seller in the form of surrendering goods or services. Recognition: The outflow of economic benefits is probable because the seller has to fulfil its obligations to deliver goods or perform services in order to avoid lawsuits or bad reputation from not honouring its obligations. The amount of the revenue received in advance (unearned revenue) can be reliably measured as the price of goods or services is known and it may be outlined in a purchase agreement.

•

Provision for employees’ annual leave Definition: The present obligation is the legal obligation entered through employee award conditions. Past transactions occur when employees accumulate annual leave entitlement each working day. The provision for annual leave will result in an outflow of economic benefits for employer in the form of cash (salaries/wages) paid to employees even though they are on leave. Recognition: The outflow of economic benefits is probable because the employees are entitled to annual leave and if they leave the place of employment, any accumulated annual leave must be paid out. The amount of provision of annual leave can be reliably measured based on the employer’s records of employees’ annual leave entitlement in the number of days, which then are converted into costs based on the expected salaries of the employees when they take leave. Obviously this calculation involves assumptions and uncertainties, which is why the account is recognised as a provision.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

35. Hello Hello Limited is a company that manufactures telephones under its own brand, as well as distributing and selling other telephone brands. Recently Hello Hello has been conducting a research project to develop a mobile phone with various functions that could be used under water. The company is hiring experts from around the world and is spending a considerable amount of money to fund this project. Required: Provide a justified opinion of whether the amount spent for the research project should be considered as an asset and recognised in the statement of financial position.

Answer below. Learning objectives 13.1 – 13.9. AASB 138 Intangible Assets defines research as ‘original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding’. The discussion as to whether the expenditure associated with researching the production of under-water mobile phones should focus on the definition and recognition criteria of assets. An asset is 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’. Thus, to satisfy the asset definition: • the entity must control the resource; • the control must be as a result of past transactions/events; • the resource must be able to provide future economic benefits or service potential to the entity. In the case of Hello Hello, the company controls the resource as the business is spending money on the research and is able to deny others the access to the information unveiled by the research. Once developed, the new mobile phones can be patented, which means Hello Hello would have complete control of the production as no one else could manufacture the same mobile phones. The company is spending money to towards the research project, and this constitutes the past transaction. The research expenditure will provide future economic benefits to the company if it assists in producing a mobile phone with various functions that can be used under water. The benefits will come in the form of mobile phone sales or the sale of the technology developed. Following these arguments, it seems that the research expenditure satisfies the definition criteria of assets. What is problematic for Hello Hello is whether the research expenditure satisfies the recognition criteria. To be recognised in the statement of financial position, the future economic benefits must be probable and capable of being measured reliably. Although it is possible to estimate the amount of future economic benefits in the form of potential sales, research expenditure spent by Hello Hello will not necessarily result in the production of mobile phones that could be used under water, especially this is only the early stage of the research. To be regarded as probable, generally it refers to the future economic benefits being more certain to flow to the entity. Furthermore, the AASB 138 distinguishes between the research phase and the development phase of a project. The standard specifically prohibits internally generated intangible assets .

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Chapter 13: Analysing and integrating GAAP

arising from research phase of an internal project (i.e. research expenditure) from being recognised on the statement of financial position. An intangible asset arising from the development phase of an internal project can only be recognised if specific conditions can be demonstrated.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Matching 36. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E. F.

Resource providers Materiality Assets SAC 2 Full disclosure principle Cost

G. H. I. J. K. L.

A conceptual framework Verifiability The Conceptual Framework The Framework Losses Contingent liabilities

____

1. 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. Liabilities that do not satisfy the recognition criteria.

____

3. A set of concepts defining the nature, purpose, and content of general purpose financial reporting to be followed by financial report preparers and standardsetters.

____

4. Outlines the objective of general purpose financial reporting.

____

5. Following consultation with the FASB, the IASB reissued this document in 2010..

____

6. The primary users of general purpose financial reports.

____

7. The extent that information presented represents the economic phenomena without bias or material error and has been prepared with appropriate recognition and measurement methods.

____

8. A resource controlled by the entity as a result of past events and from which the future economic benefits are expected to flow to the entity.

____

9. Decreases in economic benefits that do not arise in the ordinary course of business.

____ 10. Under this principle, assets are recorded in the accounts at their purchase price. ____ 11. A conceptual framework issued by the IASB and adopted by the AASB in 2005. ____ 12. The extent that omissions or misstatements of information could affect users’ decisions.

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Chapter 13: Analysing and integrating GAAP

Answers below. Learning objectives 13.1 – 13.9. 1. 2. 3. 4. 5. 6.

E L G D I A

7. 8. 9. 10. 11. 12.

H C K F I B

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

Short-answer/essay questions

37. Explain why it is necessary to develop a conceptual framework.

Answers below. Learning objectives 13.1 – 13.9. 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 and standardsetters. Without a conceptual framework, accounting standards would not be based on particular concepts, and this would result in inconsistencies between standards and accounting practices. Therefore, it is necessary to develop a conceptual framework in order to improve the standard-setting process and consistency in accounting practice.

38. Give a brief explanation of how organisations or businesses determine if they are required to prepare general purpose financial reports.

Answers below. Learning objectives 13.1 – 13.9. At this time the section on the reporting entity was not available in the Conceptual Framework, therefore SAC 1 still applies. Whether an entity is required to prepare generalpurpose financial reports depends on if there is a need to do so, and the SAC 1 determines that only a reporting entity is required to prepare general purpose financial reports. A reporting entity is defined as an entity in which it is reasonable to expect the existence of users who depend on general-purpose financial reports to make economic decisions. There are three indicators used to determine if an entity is a reporting entity: 1) if the entity is managed by individuals who are not owners of the entity; 2) if the entity is politically or economically important; and 3) if the entity is considered large in terms of assets, sales, borrowing, employees and customers.

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Chapter 13: Analysing and integrating GAAP

39. Distinguish between stewardship/accountability objectives and decision-usefulness objective of general purpose financial reporting.

Answers below. Learning objectives 13.1 – 13.9. The stewardship and accountability objectives are based on how general purpose financial reports support the stewardship/accountability function within a reporting entity. These objectives suggest that for entities where there is a separation of ownership from control (i.e. shareholders/owners versus managers), managers can use general purpose financial reports to show owners that they are fulfilling their stewardship function effectively. Owners can also use the reports to check on the managers and make them accountable. Decision-usefulness objective, on the other hand, is based on how general purpose financial reports help users in making economic decisions. According to the Conceptual Framework this perspective suggests that the objective of general purpose financial reports 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.

40. The generally accepted accounting principles (GAAP) consist of accounting standards, underlying accounting concepts and principles, and the Conceptual Framework. Explain the relationships among various components of GAAP. How do preparers of general purpose financial reports determine which component to be apply first?

Answers below. Learning objectives 13.1 – 13.9. The various components of GAAP do not operate in isolation, but are interrelated. For example, reporting entities are required to prepare general purpose financial reports (SAC 1) that are useful for decision making (SAC 2), and the usefulness is dependent upon the information’s qualitative characteristics (the Conceptual Framework) and accounting standards elaborate in detail the measurement bases to be applied in valuing certain elements of financial reports. Despite the interrelationships, it is important to determine the order in which the various components of GAAP must be applied by preparers of general purpose financial reports. Accounting standards, Corporations Acts, and authoritative interpretations of standards must be applied first because they have legislative backing. If the standards do not give explanation on certain issues, preparers can seek guidance from the Conceptual Framework. Only when there is no guidance in the Conceptual Framework would the preparers apply the underlying accounting concepts and principles.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

41. Distinguish how the Framework and the Conceptual Framework classify users of financial reports.

Answers below. Learning objectives 13.1 – 13.9. The Framework classifies users of financial reports into 3 categories based on their functions: 1) resource providers (e.g. investors, creditors, lenders, employees); 2) recipients of goods and services (e.g. customers); and parties performing oversight/review function (e.g. government, media, trade unions). The Conceptual Framework classifies users of financial reports into 2 categories, that is primary users and other users, based on whether they have a claim on the entity’s resources. The primary users are resource providers and therefore require information to make decisions concerning the provision of those resources. There are 2 types of primary resource providers: 1) equity investors who provide resources by investing cash, and 2) lenders who provide resources by lending cash. Other creditors, such as suppliers and employers may also provide resources as a result of their relationship with the entity, even though they are not primary resources providers. Other users are not resource providers. Although they may have specialised information needs they may find the financial reporting that meets the needs of resources providers to be useful. Under the Conceptual Framework financial reporting is directed to the resources providers.

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Chapter 13: Analysing and integrating GAAP

42. Ethics: Socks R Us Limited is a manufacturer of socks for various ranges of customers. Recently the company obtained a business loan from a bank with a condition that the company maintains a certain level of profitability. At the end of financial year, Socks R Us made a $15 million profit. Bob, the company’s accountant, decided to report a $20 million profit to comply with the bank’s loan requirement. In addition, Bob has changed the depreciation method of some machinery from straight-line to reducing-balance method without disclosing the changes in the notes to the financial statement because the results are similar to the previous method. Which qualitative characteristics of financial reports in the Conceptual Framework have been violated by Bob’s unethical decisions?

Answers below. Learning objectives 13.1 – 13.9. 1. In the case of overstating the company’s profit to $20 million, it seems that Bob has violated the qualitative characteristic of faithful representation. The Conceptual Framework outlines that information is a faithful representation of the economic phenomena it purports to be if it is complete, neutral and free from material error. Reporting profit to be $20 million where the actual profit is only $15 million means that the financial statement does not faithfully represent what happened. Furthermore, the financial statement is not free from material error (i.e. the $5 million difference), and is biased towards satisfying the bank’s lending requirements. 2. In the case of changing the depreciation method without disclosing it in the notes to the financial statement, it seems that Bob has violated the qualitative characteristic of comparability. Comparability is achieved when an entity uses the same or consistent accounting principles each year and different entities use the same accounting principles. The AASB 108 mandates that reporting entities must disclose the accounting methods used, including any changes made during the year. By not disclosing the change of depreciation method, users of Socks R Us’ financial reports will not be aware of the impact and lack of consistency between years.

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Testbank to accompany Financial Accounting: Reporting, Analysis and Decision Making 5e

43. Communication: Amy is a fresh accounting & finance graduate who just started working in an investment company. One of the company’s clients asked Amy to help him to decide whether he should invest in a mining company. Amy read the mining company’s financial reports and then straight away told the client that based on the financial reports, the mining company should be a good investment. As Amy’s supervisor, Helen decided to write her a memo to remind her not to rely solely on financial reports when making economic decisions.

Answers below. Learning objectives 13.1 – 13.9.

MEMO TO:

Amy

FROM: Helen RE:

Reliance on Financial Reports in Making Economic Decisions

DATE: 3rd March 2017 Although financial reports are an important source for users when making various decisions, these reports are only one source of information and it is important to incorporate other sources, such as general economic trends, political climate, industry averages and company-specific forecasts, before making decisions. The information supplied in the financial reports will be more meaningful when it is supplemented with additional information from the other sources I mentioned above. In addition, it is also important to note that most information contained in the financial reports are based on estimates and judgements. Therefore, financial reports can be seen as models of the transactions and events that have occurred rather than an exact depiction. Please do not hesitate to contact me if you have further queries to discuss in regards to this matter.

(Signature)

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