TEST BANK FOR Financial Accounting Tools for Business Decision-Making 6th Canadian Edition 6e Kimmel by StudyGuide

CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item

SO LOD

Item

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

1 1 1 1 1 1 1 1 1 1

E E E E E E E E E E

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59.

1 1 1 1 1 1 1 1 1 1 2 2 2

E E M M E E E E E E M M M

60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

111. 112. 113. 114. 115.

3 3 4 4 4

M M H M E

116. 117. 118. 119. 120.

133.

1–4 E,M

134. 135.

1 E 1,2 M

136. 137.

E = Easy

M = Medium

Note:

SO LOD Item SO LOD Item True-False Statements 2 E 21. 3 M 31. 2 E 22. 3 E 32. 2 E 23. 3 E 33. 2 E 24. 3 M 34. 2 E 25. 3 E 35. 3 E 26. 4 M 36. 3 E 27. 4 E 37. 3 M 28. 4 M 38. 3 M 29. 4 M 39. 3 E 30. 4 E 40. Multiple Choice Questions 2 E 73. 3 E 86. 2 E 74. 3 E 87. 2 E 75. 3 E 88. 2 E 76. 3 E 89. 2 M 77. 3 E 90. 2 E 78. 3 E 91. 2 M 79. 3 E 92. 3 E 80. 3 E 93. 3 E 81. 3 E 94. 3 E 82. 4 M 95. 3 E 83. 4 M 96. 3 E 84. 4 E 97. 3 M 85. 4 E 98. Exercises 4 M 121. 4 E 126. 4 E 122. 4 H 127. 4 E 123. 4 E 128. 4 M 124. 4 E 129. 4 H 125. 4 E 130. Matching

2 4

M M

Short-Answer Essay 138. 4 E 140. 139. 4 M 141. H = Hard

SO LOD

Item

SO LOD

4 4 4 4 4 4 4 4 4 4

E E E E E E E E E M

41. 42. 43. 44. 45. 46.

4 4 4 4 4 4

E M E E M E

4 4 4 4 4 4 4 4 4 4 4 4 4

M H E M E E E E H M M M M

99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110.

4 4 4 4 4 4 4 4 4 4 4 4

M M E M M M E E E E E H

4 4 4 4 4

E E E M E

131. 132.

4 4

M H

4 4

E M

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Study Objective 1 1. TF 5. TF 9. TF 49. MC 53. MC 2. TF 6. TF 10. TF 50. MC 54. MC 3. TF 7. TF 47. MC 51. MC 55. MC 4. TF 8. TF 48. MC 52. MC 56. MC Study Objective 2 11. TF 14. TF 58. MC 61. MC 64. MC 12. TF 15. TF 59. MC 62. MC 65. MC 13. TF 57. MC 60. MC 63. MC 66. MC Study Objective 3 16. TF 21. TF 67. MC 72. MC 77. MC 17. TF 22. TF 68. MC 73. MC 78. MC 18. TF 23. TF 69. MC 74. MC 79. MC 19. TF 24. TF 70. MC 75. MC 80. MC 20. TF 25. TF 71. MC 76. MC 81. MC Study Objective 4 26. TF 37. TF 83. MC 94. MC 105. MC 27. TF 38. TF 84. MC 95. MC 106. MC 28. TF 39. TF 85. MC 96. MC 107. MC 29. TF 40. TF 86. MC 97. MC 108. MC 30. TF 41. TF 87. MC 98. MC 109. MC 31. TF 42. TF 88. MC 99. MC 110. MC 32. TF 43. TF 89. MC 100. MC 113. Ex 33. TF 44. TF 90. MC 101. MC 114. Ex 34. TF 45. TF 91. MC 102. MC 115. Ex 35. TF 46. TF 92. MC 103. MC 116. Ex 36. TF 82. MC 93. MC 104. MC 117. Ex Note:

TF = True-False MC = Multiple Choice

Ma = Matching Ex = Exercise

Item

Type

Item

Type

133-1. 134. 135.

Ma SAE SAE

133-2. 133-3. 135.

Ma Ma SAE

136.

SAE

111. 112. 133-4. 133-5. 133-6.

Ex Ex Ma Ma Ma

133-7. 133-8.

Ma Ma

118. 119. 120. 121. 122. 123. 124. 125. 126. 127. 128.

Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex

129. 130. 131. 132. 133-9. 133-10. 137. 138. 139. 140. 141.

Ex Ex Ex Ex Ma Ma SAE SAE SAE SAE SAE

SAE = Short-Answer Essay

The Purpose and Use of Financial Statements

CHAPTER STUDY OBJECTIVES 1.

Identify the users and uses of accounting. The purpose of accounting is to provide useful information for decision-making. There are two types of user groups who use accounting information: internal and external users. Internal users work for the business and need accounting information to plan, organize, and run operations. The primary external users are investors, lenders and other creditors. Investors (existing and potential shareholders) use accounting information to help decide whether to buy, hold, or sell shares. Lenders (such as bankers) and other creditors (such as suppliers) use accounting information to evaluate the risk of granting credit or lending money to a business. In order for financial information to have value to its users, both internal and external, it must be prepared by individuals with high standards of ethical behaviour.

Describe the primary forms of business organizations. There are three types of organizations that use accounting information: proprietorships, partnerships, and corporations. A proprietorship is a business owned by one person. A partnership is a business owned by two or more people. A corporation is a separate legal entity whose shares provide evidence of ownership. Corporations can be public or private, which means their shares are closely held. Generally accepted accounting principles are a common set of guidelines, which can differ depending on the form of business organization, that are used to record and report economic events. Public corporations follow International Financial Reporting Standards (IFRS) and private corporations have the choice of using IFRS or Accounting Standards for Private Enterprises (ASPE). Proprietorships and partnerships generally follow ASPE.

Explain the three main types of business activity. Financing activities involve raising the necessary funds (through debt or equity) to support the business. Investing activities involve acquiring the resources (such as property, plant, and equipment) that are needed to run the business. Operating activities involve putting the resources of the business into action to generate a profit.

Describe the purpose and content of each of the financial statements. The income statement presents the revenues and expenses of a company for a specific period of time. The statement of changes in equity summarizes the changes in shareholders’ equity that have occurred for a specific period of time. The statement of financial position reports the assets, liabilities, and shareholders’ equity of a business at a specific date. The statement of cash flows summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time. Notes to the financial statements add explanatory detail where required. The financial statements are included in an annual report, along with nonfinancial and other financial information.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

TRUE-FALSE STATEMENTS 1. Accounting identifies and records economic events of a business.

2. High standards of ethics are not required for preparers of financial information.

3. Accounting information is not important to marketing managers.

4. Shareholders and creditors are the only people who need accounting information.

5. The Canada Revenue Agency is the major external user of information.

6. External users of accounting information include the managers who plan, organize, and run a business.

7. The information needs and questions of external users vary considerably.

8. Authorities, such as the Canada Revenue Agency, want to know whether a business complies with the tax laws.

9. Accounting communicates financial information about a business to both internal and external users.

10. Two internal users of accounting information are investors and managers.

11. A partnership is a business organized as a separate legal entity.

12. A proprietor has unlimited liability.

13. The liability of corporate shareholders is limited to the amount of their investment.

14. A private corporation is one whose shares are traded on an organized stock exchange, like the Toronto Stock Exchange.

15. A proprietorship is usually operated by the owner.

The Purpose and Use of Financial Statements

16. Expenses are the cost of assets consumed or services used in the process of generating revenue.

17. Financing activities for corporations include borrowing money and selling shares.

18. Investing activities involve collecting the necessary funds to operate the business.

19. The purchase of equipment is an example of a financing activity.

20. Assets are resources owned by a business that provide current services or benefits to the business. 21. Economic resources that are owned by a business are called shareholders’ equity.

22. Payments to shareholders are called dividends. 23. Revenues are increases in economic resources that result from a business’s operating activities.

24. Expenses are identified by the type of liability associated with them.

25. Depreciation is the cost of certain long-lived assets allocated to expense for each period.

26. Profit for the period is determined by subtracting total expenses and dividends from revenues.

27. Profit is another term for revenue.

28. The issue of shares and distribution of dividends are used in determining profit.

29. Financial statement users are interested in profit because it may be a predictor of future profit.

30. Shareholders’ equity is always equal to the cash on hand at any given date.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

31. The primary purpose of the statement of cash flows is to provide information about the cash receipts and cash payments of a business for a specific period of time.

32. The statement of financial position reports assets and claims to those assets at a specific point in time.

33. The statement of changes in equity covers a different time period than that covered by the income statement.

34. Creditors use the statement of financial position as another source of information to determine the likelihood they will be repaid.

35. The basic accounting equation subdivides liabilities into two categories: claims of creditors and claims of the Canada Revenue Agency.

36. The statement of cash flows shows how cash was used during the period. 37. The accounting equation can be expressed as: Assets – Shareholders’ Equity = Liabilities. 38. The accounting equation can be expressed as: Assets + Liabilities = Shareholders’ Equity. 39. If the assets owned by a business total $100,000 and liabilities total $52,000, shareholders’ equity totals $48,000.

40. Claims of creditors and shareholders on the assets of a business are called liabilities. 41. Shareholder’s equity consists of at least two parts: share capital and retained earnings.

42. Any deficiency in cash from operating activities must be made up by issuing shares.

43. The statement of changes in equity is not dependent on the results from the income statement.

44. The statement of financial position is always the first statement prepared and presented.

45. The reasons for a decrease in cash can be determined by examining the income statement.

The Purpose and Use of Financial Statements

46. A negative balance in retained earnings is called a deficit.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7. 8.

Ans. T F F F F F T T

Item 9. 10. 11. 12. 13. 14. 15. 16.

Ans. T F F T T F T T

Item 17. 18. 19. 20. 21. 22. 23. 24.

Ans. T F F F F T T F

Item 25. 26. 27. 28. 29. 30. 31. 32.

Ans. T F F F T F T T

Item 33. 34. 35. 36. 37. 38. 39. 40.

Ans. F T F T T F T F

Item 41. 42. 43. 44. 45. 46.

Ans. T F F F F T

The Purpose and Use of Financial Statements

MULTIPLE CHOICE QUESTIONS 47. The world’s economic systems depend on financial reporting that is (a) highly transparent. (b) accurate. (c) reliable. (d) all of the above.

48. Which of the following is the most appropriate definition of accounting? (a) The information system that identifies, records, and communicates the economic events of an organization to interested users. (b) a means of collecting information (c) The interconnected network of subsystems necessary to operate a business. (d) electronic collection, organization, and communication of vast amounts of information

49. Which of the following would not be considered an internal user of accounting data for XYZ Inc.? (a) the company president (b) production manager (c) merchandise inventory clerk (d) receptionist of the employees’ labour union

50. Which of the following groups uses accounting information primarily to ensure the company is operating within prescribed rules? (a) taxing authorities (b) regulatory agencies (c) labour unions (d) management

51. Which of the following uses accounting information to determine whether a company can pay its obligations? (a) shareholders (b) marketing managers (c) creditors (d) Canada Revenue Agency 52. Which of the following uses accounting information to determine whether a company’s profit will result in a share price increase? (a) shareholders (b) marketing managers (c) creditors (d) Chief Financial Officer

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

53. Which of the following uses accounting information to determine whether a marketing proposal will be cost effective? (a) shareholders (b) marketing managers (c) creditors (d) Human Resource managers

54. Which of the following would not be considered an external user of accounting data? (a) Canada Revenue Agency (b) management (c) creditors (d) customers

55. Which of the following would not be considered an internal user of accounting data? (a) the president of a company (b) the controller of a company (c) a creditor of a company (d) a salesperson of a company

56. External users want answers to all of the following questions except (a) Is the company earning satisfactory income? (b) Will the company be able to pay its debts as they come due? (c) Will the company be able to afford employee pay raises this year? (d) How does the company compare in profitability with competitors?

57. The proprietorship form of business organization (a) in most provinces, must have at least two owners. (b) is often chosen for small owner operated businesses. (c) is difficult to set up. (d) is classified as a separate legal entity.

58. A business organized as a corporation (a) is not a separate legal entity in most provinces. (b) requires that shareholders be personally liable for the debts of the business. (c) is owned by its shareholders. (d) has income tax disadvantages over a proprietorship or partnership.

59. The partnership form of business organization (a) is a separate legal entity. (b) is a common form of organization for service-type businesses. (c) enjoys an unlimited life. (d) has limited liability.

60. Which form of business would have its shares listed on a stock exchange?

The Purpose and Use of Financial Statements

(a) proprietorship (b) partnership (c) private corporation (d) public corporation

61. A business organized as a separate legal entity is a (a) corporation. (b) proprietorship. (c) government unit. (d) partnership.

62. The concept that economic activity which can be identified with a particular company must be kept separate and distinct from the owner(s) and from all other economic entities is known as (a) the separation concept. (b) the reporting entity concept. (c) the economic concept. (d) the business organization concept.

63. An advantage of the corporate form of business is that (a) it has limited life. (b) its shareholders’ personal resources are at stake. (c) its ownership is easily transferable via the sale of shares. (d) it is simple to establish.

64. A corporation has which of the following set of characteristics? (a) shareholder control, income tax disadvantages, increased skills and resources (b) simple to set up and maintains control with founder (c) harder to raise funds and gives shareholders control (d) Easier to transfer ownership and raise funds, no personal liability

65. A small neighbourhood barber shop that is operated by its owner would likely be organized as a (a) public corporation. (b) partnership. (c) private corporation. (d) proprietorship.

66. Which of the following statements is not true? (a) Public corporations must use international financial reporting standards. (b) Private corporations can choose to use either international financial reporting standards (IFRS) or accounting standards for private enterprises (ASPE). (c) Both public and private corporations issue shares. (d) All private corporations are small.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

67. The liability created by a business when it purchases coffee beans and coffee cups on credit from suppliers is called a(n) (a) account payable. (b) account receivable. (c) revenue. (d) expense.

68. The right to receive money in the future is called a(n) (a) account payable. (b) account receivable. (c) liability. (d) revenue.

69. Which of the following is not a principal type of business activity? (a) operating (b) investing (c) financing (d) marketing

70. Which of the following activities involves raising the necessary funds to support the business? (a) operating (b) investing (c) financing (d) marketing

71. Buying assets needed to operate a business is an example of a(n) (a) purchasing activity. (b) financing activity. (c) investing activity. (d) operating activity.

72. Cost of goods sold is a(n) (a) liability. (b) financing activity. (c) asset. (d) expense.

73. Allocating the cost of using long-term assets over their useful lives is called (a) allocation expense. (b) depreciation expense. (c) a general expense. (d) asset use expense.

The Purpose and Use of Financial Statements

74. Buying and selling products are examples of (a) operating activities. (b) investing activities. (c) financing activities. (d) manufacturing activities.

75. The common characteristic possessed by all assets is (a) long life. (b) great monetary value. (c) tangible nature. (d) future economic benefit.

76. Expenses are incurred (a) only on rare occasions. (b) to produce assets. (c) to produce liabilities. (d) to generate revenues.

77. The cost of assets consumed or services used is also known as a(n) (a) revenue. (b) expense. (c) liability. (d) asset.

78. Resources owned by a corporation are referred to as (a) shareholders’ equity. (b) liabilities. (c) assets. (d) revenues.

79. Debt and obligations of a business are referred to as (a) assets. (b) equities. (c) liabilities. (d) expenses.

80. Liabilities: (a) are future economic benefits. (b) are debts and obligations. (c) possess service potential. (d) are things of value owned by a business.

81. Liabilities of a company are owed to (a) debtors.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) owners. (c) creditors. (d) shareholders.

82. Dividends are reported on (a) the income statement. (b) the statement of changes in equity. (c) the statement of financial position. (d) both the income statement and statement of financial position.

83. Dividends (a) increase assets. (b) increase expenses. (c) decrease revenues. (d) decrease retained earnings.

84. The financial statement that summarizes the changes in common shares and 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.

85. Profit results when (a) Assets > Liabilities. (b) Assets < Liabilities. (c) Revenues > Expenses. (d) Revenues < Expenses.

86. 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. (c) profit for the period. (d) assets plus liabilities. 87. A company’s policy toward dividends 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.

88. An income statement (a) summarizes the changes in retained earnings for a specific period of time.

The Purpose and Use of Financial Statements

(b) reports the changes in assets, liabilities, and shareholders’ equity over a period of time. (c) reports the assets, liabilities, and shareholders’ equity at a specific date. (d) reports the revenues and expenses for a specific period of time.

89. If the retained earnings account increases from the beginning of the year to the end of the year, then (a) profit is greater than dividends. (b) a loss is less than dividends. (c) additional investments are less than reported losses. (d) dividends were received.

90. The statement of changes in equity would not show (a) the beginning retained earnings balance. (b) revenues and expenses. (c) dividends. (d) the ending retained earnings balance.

91. Which financial statement is prepared first? (a) Statement of financial position (b) Income statement (c) Statement of changes in equity (d) Statement of cash flows

92. A statement of financial position shows (a) revenues, liabilities, and shareholders’ equity. (b) expenses, dividends, and shareholders’ equity. (c) revenues, expenses, and dividends. (d) assets, liabilities, and shareholders’ equity.

93. The accounting equation may be expressed as (a) Assets = Shareholders’ Equity – Liabilities. (b) Assets = Liabilities + Shareholders’ Equity. (c) Assets + Liabilities = Shareholders’ Equity. (d) Assets + Shareholders’ Equity = Liabilities.

Use the following information for questions 94–95. Kareem’s Rental Ltd. started the year with total assets of $70,000 and total liabilities of $40,000. During the year, the business recorded $100,000 in car repair revenues, $65,000 in expenses, and paid dividends of $5,000. 94. Shareholders’ equity at the end of the year was (a) $60,000. (b) $65,000.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

95. The profit reported for the year was (a) $30,000. (b) $35,000. (c) $20,000. (d) $100,000. 96. If total liabilities increased by $15,000 and shareholders’ equity increased by $15,000 during a period of time, then total assets must change by what amount and direction (increase or decrease) during that same period? (a) $15,000 decrease (b) $15,000 increase (c) $30,000 decrease (d) $30,000 increase 97. If total liabilities decreased by $45,000 during a period of time and shareholders’ equity increased by $27,000 during the same period, then the amount and direction (increase or decrease) of the period’s change in total assets is a(n) (a) $45,000 increase. (b) $27,000 increase. (c) $18,000 decrease. (d) $18,000 increase.

98. The statement of financial position (a) summarizes the changes in shareholders’ equity for a specific period of time. (b) reports the changes in assets, liabilities, and shareholders’ equity over a period of time. (c) reports the assets, liabilities, and shareholders’ equity at a specific date. (d) presents the revenues and expenses for a specific period of time.

99. Which of the following financial statements is concerned with the company at a point in time? (a) Statement of financial position (b) Income statement (c) Statement of changes in equity (d) Statement of cash flows 100. Shareholders’ equity can be described as claims of (a) creditors on total assets. (b) owners on total assets. (c) customers on total assets. (d) debtors on total assets.

The Purpose and Use of Financial Statements

101. Payments to shareholders are called (a) expenses. (b) liabilities. (c) dividends. (d) shares.

102. Common shares are reported on (a) the statement of financial position. (b) the statement of changes in equity. (c) both the statement of financial position and the income statement. (d) both the statement of changes in equity and the statement of financial position. 103. Shareholders’ equity is usually comprised of (a) common shares and dividends. (b) common shares and retained earnings. (c) dividends and retained earnings. (d) profit and retained earnings.

104. Common shares represent (a) the creditors’ claims on the company. (b) the total profit of the company to date. (c) the amount paid by investors for ownership in the company. (d) the owners’ claims on the company.

105. Retained earnings are (a) the shareholders’ claim on total assets. (b) equal to cash. (c) equal to revenues. (d) the amount of profit kept in the corporation for future use.

106. Which financial statement would indicate whether the company relies more on debt or on shareholders’ equity to finance its assets? (a) Statement of cash flows (b) Statement of changes in equity (c) Income statement (d) Statement of financial position

107. The primary purpose of the statement of cash flows is to report (a) a company's investing transactions. (b) a company's financing transactions. (c) information about cash receipts and cash payments of a company. (d) the net increase or decrease in cash.

108. The statement of changes in equity is dependent on the results from

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) the statement of cash flows. (b) the statement of financial position. (c) the income statement. (d) a company's share capital.

109. The statement of financial position and statement of changes in equity are related because (a) the total assets on the statement of financial position is reported on the statement of changes in equity. (b) the ending amount on the statement of changes in equity is reported on the statement of financial position. (c) the ending amount on each statement is transferred to the statement of cash flows. (d) both contain information for the corporation.

110. The statement of cash flows and the statement of financial position are interrelated because (a) the ending amount of cash on the statement of cash flows must agree with the amount on the income statement. (b) the ending amount of cash on the statement of cash flows must agree with the amount in the statement of changes in equity. (c) the ending amount of cash on the statement of cash flows must agree with the amount in the statement of financial position. (d) both disclose the corporation's profit.

The Purpose and Use of Financial Statements

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58.

Ans. d a d b c a b b c c b c

Item 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70.

Ans. b d a b c d d d a b d c

Item 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82.

Ans. c d b a d d b c c b c b

Item 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94.

Ans. d d c b c d a b b d b a

Item 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106.

Ans. b d c c a b c d b c d d

Item 107. 108. 109. 110.

Ans. c c b c

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 111 Classify each of the following items as investing, financing, or operating activity: 1. Cash sale of merchandise 2. Repayment of bank loan 3. Purchase of inventory 4. Sale of equipment for cash 5. Payment of commission to a salesperson 6. Payment of dividends 7. Receipt of interest on accounts receivable 8. Payment for insurance for the current year 9. Purchase of shares in another company as a long-term investment 10. Issue of debt Solution 111 (6 min.) 1. Operating 2.

Financing

Operating

Investing

Operating

Financing

Operating

Investing

10. Financing

Ex. 112 Indicate in the space provided by each item whether it would appear on the statement of cash flows as a(n): (O) operating activity, (I) investing activity, or (F) financing activity. _____ 1. Cash receipts from customers _____ 2. Issue of common shares for cash _____ 3. Payment of cash dividends _____ 4. Cash purchase of equipment _____ 5. Cash payments to suppliers _____ 6. Sale of old machine for cash Solution 112 (5 min.) O 1.

The Purpose and Use of Financial Statements

Ex. 113 The following questions are unrelated: 1. You know that profit is $50,000, opening retained earnings $25,000, dividends $20,000, common shares $2,000, current assets $26,000 and total liabilities are $33,000. What is the amount of total assets? 2. Cash provided by operating activities is $25,000, cash used in investing activities is $20,000 and cash used in financing activities is $2,000. The ending cash balance is $10,000. What is the beginning cash balance? Solution 113 (10 min.) 1. Opening retained earnings ............................................................ Add: Profit ..................................................................................... Less: dividends ............................................................................. Ending retained earnings ..............................................................

$25,000 50,000 (20,000) $55,000

Retained earnings ......................................................................... Common shares ............................................................................ Total liabilities ............................................................................... Total liabilities and shareholders’ equity ........................................

$55,000 2,000 33,000 $90,000

Total assets...................................................................................

$90,000

Cash provided by operating activities ............................................ Cash used in investing .................................................................. Cash used in financing .................................................................. Net change in cash ....................................................................... Cash beginning ............................................................................. Cash ending ..................................................................................

$25,000 (20,000) (2,000) 3,000 X $10,000

Solving for X, cash beginning is $7,000

Ex. 114 Prepare an income statement, a statement of changes in equity, and a statement of financial position for Norman Rae Ltd., a service business, from the items listed below for the month of October, 2015: Accounts payable .......................................................................... $10,000 Accounts receivable ...................................................................... 14,000 Cash ............................................................................................. 10,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Common shares ............................................................................ Dividends paid .............................................................................. Income tax expense ...................................................................... Office equipment ........................................................................... Office supplies .............................................................................. Office supplies expense ................................................................ Rent expense ................................................................................ Retained earnings, October 1........................................................ Salaries expense........................................................................... Service revenue ............................................................................ Utilities expense ............................................................................

28,000 6,000 4,500 30,000 2,800 3,500 3,000 15,000 7,000 28,500 700

NORMAN RAE LTD. Income Statement Month Ended October 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Revenues............................................................................................. $________ Expenses ............................................................................................. $________ Total expenses..................................................................................... ________ Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

________ ________ ________

NORMAN RAE LTD. Statement of Changes in Equity Month Ended October 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Common Shares Retained Earnings Total Equity Balances, October 1 Profit Dividends Balances, October 31

$________

NORMAN RAE LTD. Statement of Financial Position October 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets $________ Assets Total assets $________ Liabilities and Shareholders’ Equity Liabilities

$________ Shareholders’ equity

The Purpose and Use of Financial Statements

Total shareholders’ equity Total liabilities and shareholders’ equity

$________ $________

Solution 114 (30 min.) NORMAN RAE LTD. Income Statement Month Ended October 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Revenues Service revenue ............................................................................ $28,500 Expenses Salaries expense........................................................................... $7,000 Office supplies expense ................................................................ 3,500 Rent expense ................................................................................ 3,000 Utilities expense ............................................................................ 700 Total expenses ....................................................................... 14,200 Profit before income tax ....................................................................... 14,300 Income tax expense ............................................................................. 4,500 Profit ............................................................................................... $ 9,800

NORMAN RAE LTD. Statement of Financial Position October 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $10,000 Accounts receivable ............................................................................. 14,000 Office supplies ..................................................................................... 2,800 Office equipment .................................................................................. 30,000 Total assets................................................................................... $56,800 Liabilities and Shareholders’ Equity Liabilities Accounts payable .......................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings .........................................................................

$10,000

$28,000 18,800

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Total shareholders’ equity......................................................... Total liabilities and shareholders’ equity ...................................

46,800 $56,800

Ex. 115 Use the following information to calculate for the year ended December 31, 2015: (a) profit, (b) ending retained earnings, and (c) total assets. Accounts payable ....................................................... Accounts receivable ................................................... Bank loan payable...................................................... Cash .......................................................................... Common shares ......................................................... Dividends ................................................................... Income tax expense ................................................... Office equipment ........................................................ Operating expenses ................................................... Retained earnings (beginning) ................................... Revenues ................................................................... Supplies .....................................................................

11,000 6,000 2,000 20,000 10,000 3,000 1,500 3,500 10,000 4,000 18,500 $ 1,500

Solution 115 (5 min.) (a) $7,000 ($18,500 – $10,000 – $1,500) (b) $8,000 ($4,000 + $7,000 – $3,000) (c) $31,000 ($1,500 + $20,000 + $6,000 + $3,500)

Ex. 116 Use the following information to prepare, in good form, an income statement, a statement of changes in equity, and a statement of financial position for Lockerby Industries Ltd. for the month ended July 31, 2015. Accounts payable ....................................................... $ 7,500 Accounts receivable ................................................... 4,400 Bank loan payable...................................................... 11,000 Cash .......................................................................... 47,000 Common shares ......................................................... 75,500 Dividends ................................................................... 5,000 Income tax expense ................................................... 13,900 Insurance expense ..................................................... 1,700 Office building ............................................................ 100,000 Retained earnings (beginning) ................................... 32,500 Revenues ................................................................... 63,000 Salaries expense........................................................ 16,500 Supplies ..................................................................... 1,000

The Purpose and Use of Financial Statements

LOCKERBY INDUSTRIES LTD. Income Statement Month Ended July 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Revenues............................................................................................. $________ Expenses ............................................................................................. $________ Total expenses..................................................................................... ________ Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

________ ________ ________

LOCKERBY INDUSTRIES LTD. Statement of Changes in Equity Month Ended July 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Common Shares Retained Earnings Total Equity Balances, July 1 Profit Dividends Balances, July 31

$________ $________ $________ $________

LOCKERBY INDUSTRIES LTD. Statement of Financial Position July 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Assets $________ Total assets $________ Liabilities and Shareholders’ Equity Liabilities

$________ Shareholders’ equity

Total shareholders’ equity Total liabilities and shareholders’ equity

$________ $________

Solution 116 (30 min.) LOCKERBY INDUSTRIES LTD. Income Statement Month Ended July 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Revenues Service revenue ............................................................................ $63,000 Expenses Salaries expense........................................................................... $16,500 Insurance expense ........................................................................ 1,700

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Total expenses ....................................................................... Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

18,200 44,800 13,900 $ 30,900

$75,500 ______ $75,500

$32,500 30,900 (5,000) $58,400

$108,000 30,900 (5,000) $133,900

LOCKERBY INDUSTRIES LTD. Statement of Financial Position July 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $ 47,000 Accounts receivable ............................................................................. 4,400 Supplies ............................................................................................... 1,000 Office building ...................................................................................... 100,000 Total assets................................................................................... $152,400 Liabilities and Shareholders’ Equity Liabilities Accounts payable .......................................................................... Bank loan payable......................................................................... Total liabilities ........................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity ...................................

$ 7,500 11,000 $ 18,500 $75,500 58,400

133,900 $152,400

Ex. 117 Listed below in alphabetical order is accounting information for Ching Corp. at December 31, 2015. Prepare a statement of financial position in good format. Accounts payable ....................................................... $ 19,000 Accounts receivable ................................................... 32,000 Building ...................................................................... 100,000 Cash .......................................................................... 42,000 Common shares ......................................................... 160,000 Land ........................................................................... 60,000 Office equipment ........................................................ 40,000 Retained earnings ...................................................... 95,000

The Purpose and Use of Financial Statements

Solution 117 (10 min.) CHING CORP Statement of Financial Position December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $ 42,000 Accounts receivable ............................................................................. 32,000 Land..................................................................................................... 60,000 Building ................................................................................................ 100,000 Office equipment .................................................................................. 40,000 Total assets .................................................................................... $274,000 Liabilities and Shareholders’ Equity Liabilities Accounts payable ........................................................................... Shareholders’ equity Common shares ............................................................................. Retained earnings .......................................................................... Total liabilities and shareholders’ equity .................................

$ 19,000

$160,000 95,000

255,000 $274,000

Ex. 118 Indicate in the space provided by each item whether it would appear on the Income statement (IS), Statement of financial position (SFP), and/or Statement of changes in equity (SCE): 1. ____

Service Revenue

____ Accounts Receivable

2. ____

Utilities Expense

____ Common Shares

3. ____

Cash

____ Equipment

4. ____

Accounts Payable

10. ____ Advertising Expense

5. ____

Office Supplies

11. ____ Dividends

6. ____

Salaries Expense

12. ____ Notes Payable

Solution 118 (5 min.) 1. IS 2.

SFP

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SFP

SCE and SFP

SFP

10. IS 11. SCE 12. SFP

Ex. 119 Grayson Inc. was reviewing its business activities at the end of its fiscal year (November 30, 2015) and decided to prepare a statement of changes in equity. At the beginning of the year, its assets were $600,000, liabilities were $150,000, and common shares were $200,000. The profit for the year was $220,000. Dividends of $120,000 were paid during the year. Instructions Prepare a statement of changes in equity for the year ended November 30, 2015. Solution 119 (10 min.) GRAYSON INC. Statement of Changes in Equity Year Ended November 30, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Common Shares Retained Earnings Total Equity Balances, Dec 1, 2014 Profit Dividends Balances, Nov 30, 2015

$200,000 _______ $200,000

$250,000 220,000 (120,000) $350,000

$450,000 220,000 (120,000) $550,000

(opening R/E = $600,000 – $150,000 – $200,000 = $250,000)

Ex. 120 At September 1, the statement of financial position accounts for GoodFood Restaurant Ltd. were as follows: Accounts payable ....................................................... $ 3,800 Accounts receivable ................................................... 1,600 Bank loan payable...................................................... 46,000 Building ...................................................................... 68,000 Cash .......................................................................... 5,000 Common shares ......................................................... ? Furniture .................................................................... 18,700 Land ........................................................................... 33,000 Retained earnings ...................................................... 43,200

The Purpose and Use of Financial Statements

Supplies .....................................................................

4,600

The following transactions occurred during the next two days: Shareholders invested an additional $32,000 cash in the business. The accounts payable were paid in full. (No payment was made on the bank loan payable.) Instructions Prepare a statement of financial position at September 3, 2015. Solution 120 (10 min.) GOODFOOD RESTAURANT LTD. Statement of Financial Position September 3, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $ 33,200 Accounts receivable ............................................................................. 1,600 Supplies ............................................................................................... 4,600 Land..................................................................................................... 33,000 Building ................................................................................................ 68,000 Furniture .............................................................................................. 18,700 Total assets................................................................................... $159,100 Liabilities and Shareholders’ Equity Liabilities Notes payable ............................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity ................................. Cash ($5,000 + $32,000 – $3,800) = $33,200 Accounts Payable ($3,800 – $3,800) = $0 Shareholders’ Equity: Beginning balance ($130,900 – $49,800) Additional investment Ending balance

$ 46,000

$69,900 43,200

113,100 $159,100

$ 81,100 32,000 $113,100

Common Shares ($113,100 – $43,200) = $69,900

Ex. 121 From the following list of selected accounts taken from the records of Smiles Unlimited Clinic Inc., identify those that would appear on the statement of financial position: (a) Common Shares (f) Accounts Payable (b) Patient Revenue (g) Cash (c) Land (h) Medical Supplies Expense (d) Wages Expense (i) Medical Supplies (e) Notes Payable (j) Utilities Expense Solution 121 (5 min.)

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(a), (c), (e), (f), (g), (i)

Ex. 122 One item is omitted in each of the following summaries of statement of financial position and income statement data for three different corporations, X, Y, and Z. Instructions Determine the amounts of the missing items, identifying each corporation by letter.

X Beginning of the Year: Assets ...................................................... Liabilities .................................................. End of the Year: Assets ...................................................... Liabilities .................................................. During the Year: Common shares issued by shareholders.. Dividends ................................................. Revenue .................................................. Expenses, including income tax expense .

Corporation Y

$400,000 250,000

$150,000 105,000

$199,000 168,000

450,000 280,000

195,000 95,000

195,000 169,000

? 70,000 195,000 155,000

79,000 83,000 ? 113,000

78,000 ? 187,000 185,000

Solution 122 (30 min.) Corporation X ($50,000) Beginning shareholders’ equity ($400,000 – $250,000) ................................... Common shares issued ($170,000 + $70,000 – $150,000 – $40,000) ............ Profit for year ($195,000 – $155,000) .............................................................. Less: dividends ............................................................................................... Ending shareholders’ equity ($450,000 – $280,000) .......................................

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

Corporation Y ($172,000) Beginning shareholders’ equity ($150,000 – $105,000) ................................... Common shares issued................................................................................... Profit for year ($183,000 – $45,000 – $79,000) .............................................. [Revenues = $172,000 ($113,000 + $59,000)] ......................................... Less: dividends ............................................................................................... Ending shareholders’ equity ($195,000 – $95,000) .........................................

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

Corporation Z ($85,000) Beginning shareholders’ equity ($199,000 – $168,000) ................................... Common shares issued................................................................................... Profit for year ($187,000 – $185,000) .............................................................. Less: dividends ($111,000 – $26,000)............................................................. Ending shareholders’ equity ($195,000 – $169,000) .......................................

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

Ex. 123

The Purpose and Use of Financial Statements

Calculate the missing items. Assets $80,000 (b) $84,000

= = = =

Liabilities $32,000 $28,000 (c)

+ + + +

Shareholders’ Equity (a) $90,000 $65,000

Solution 123 (5 min.) (a) $48,000 (b) $118,000 (c) $19,000

Ex. 124 Identify which of the following accounts appear on a statement of financial position: (a) Service revenue (b) Cash (c) Common shares (d) Accounts payable (e) Rent expense (f) Supplies (g) Land Solution 124 (5 min.) (b), (c), (d), (f), (g)

Ex. 125 For the items listed below, fill in the appropriate code letter to indicate whether the item is an asset, liability, or shareholders’ equity item. Code Asset A Liability L Shareholders’ Equity SE _____

1. Rent expense

____

7. Accounts receivable

_____

2. Office equipment

____

8. Retained earnings

_____

3. Accounts payable

____

9. Service revenue

_____

4. Common shares

____ 10. Bank loan payable

_____

5. Insurance expense

____ 11.

Dividends

_____

6. Cash

____ 12.

Unearned revenue

Solution 125 (5 min.) 1. SE

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

10. L 11. SE 12. L

Ex. 126 Classify each of these items as an asset (A), liability (L), or shareholders’ equity (SE). _____ 1. Rent receivable _____ 6. Cash _____ 2. Salaries payable _____ 7. Mortgage payable _____ 3. Preferred shares _____ 8. Land _____ 4. Office supplies _____ 9. Dividends _____ 5. Retained earnings _____ 10. Office supplies expense Solution 126 (5 min.) 1. A 2.

The Purpose and Use of Financial Statements

10. SE

Ex. 127 At the beginning of the year, Hanover Limited had total assets of $600,000 and total liabilities of $300,000. Answer the following questions, viewing each situation as being independent of the others. 1. 2. 3.

If total assets increased $225,000 during the year, and total liabilities decreased $100,000, what is the amount of shareholders’ equity at the end of the year? During the year, total liabilities increased $315,000 and shareholders’ equity decreased $130,000. What is the amount of total assets at the end of the year? If total assets decreased $60,000 and shareholders’ equity increased $180,000 during the year, what is the amount of total liabilities at the end of the year?

Solution 127 (5 min.) 1. $625,000 Total Assets Beginning $600,000 Change 225,000 Ending $825,000 2.

Shareholders’ Equity $300,000 325,000 = $625,000 (1.)

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

Shareholders’ Equity $300,000 (130,000) + $170,000

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

Shareholders’ Equity $300,000 180,000 + $480,000

$785,000

Beginning Change Ending 3.

–

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

Total Assets $600,000 185,000 $785,000 (2.)

$60,000

Beginning Change Ending

Total Assets $600,000 (60,000) $540,000

Ex. 128 Rug Repairs Ltd. has the following statement of financial position items: Accounts Payable Accounts Receivable Bank Loan Payable Cash Common Shares Equipment Retained Earnings Unearned Revenue Van Instructions Identify which items are (a) Assets (b) Liabilities

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(c) Shareholders’ Equity Solution 128 (5 min.) (a) Assets—Accounts Receivable; Cash; Equipment; Van (b) Liabilities—Accounts Payable; Bank Loan Payable; Unearned Revenue (c) Shareholders’ Equity—Common Shares; Retained Earnings

Ex. 129 On June 1, Carmelo Ltd. prepared a statement of financial position that shows the following: Assets (no cash) ........................................................................... $125,000 Liabilities ....................................................................................... 75,000 Shareholders’ Equity ..................................................................... 50,000 Shortly thereafter, all of the assets were sold for cash. Instructions How would the statement of financial position appear immediately after the sale of the assets for cash for each of the following cases?

Case A

Cash Received for the Assets Assets $135,000 $________

Balances Immediately After Sale – Liabilities = Shareholders’ Equity $________ $________

Case B

125,000

________

Case C

110,000

________

Solution 129 (5 min.) Cash Received for the Assets Case A $135,000

Balances Immediately After Sale Assets – Liabilities = Shareholders’ Equity $135,000 $75,000 $60,000

Case B

125,000

75,000

50,000

Case C

110,000

75,000

35,000

Ex. 130 Calculate the missing amount in each category of the accounting equation: Assets Liabilities Shareholders’ Equity (a) $360,000 $ ? $ 98,000 (b) $178,000 $ 73,000 $ ?___ (c) $ ? $302,000 $310,000 Solution 130 (5 min.) (a) $262,000 ($360,000 – $98,000 = $262,000). (b)

$105,000 ($178,000 – $73,000 = $105,000).

The Purpose and Use of Financial Statements

(c)

$612,000 ($302,000 + $310,000 = $612,000).

Ex. 131 Use the following information to prepare the statement of cash flows for Greece Corporation for the year ended December 31, 2015: Cash received from customers ................................... $25,000 Cash dividends paid ................................................... 3,000 Cash paid to suppliers ................................................ 10,000 Cash paid for new equipment ..................................... 30,000 Cash received from lenders ....................................... 7,000 Cash, January 1, 2015 ............................................... 25,000 Cash, December 31, 2015 ......................................... 14,000 Solution 131 (10 min.) GREECE CORPORATION Statement of Cash Flows Year Ended December 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash received from customers ...................................................... $25,000 Cash paid to suppliers ................................................................... (10,000) Net cash provided by operating activities ...................................... $15,000 Investing activities Cash paid for new equipment ........................................................ (30,000) Financing activities Cash received from lenders .......................................................... $ 7,000 Cash dividends paid ...................................................................... (3,000) Net cash provided by financing activities ....................................... 4,000 Net increase (decrease) in cash ........................................................... (11,000) Cash, January 1 ................................................................................... 25,000 Cash, December 31 ............................................................................. $14,000

Ex 132 Speedway Corporation’s shareholders’ equity equals one-fifth of the company’s total assets. The company’s liabilities are $125,000. What is the amount of the company’s shareholders’ equity? Solution 132 $31,250 (X = 1/5X + $125,000) where X = total assets Solving for X: X – 1/5X = $125,000 4/5X = $125,000 X = $125,000 × 5/4 X = $156,250 Shareholder’s equity = (1/5) × $156,250 = $31,250 Proof: $31,250 + $125,000 = $156,250

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MATCHING 133. Match the items below by entering the appropriate code letter in the space provided. (a) Internal users (b) Proprietorship (c) Expenses (d) Investing activities (e) Fiscal year

(f) (g) (h) (i) (j)

Assets Liabilities Private corporation Loss Dividends

_____ 1. Officers and others who manage the business _____ 2. Ownership is limited to one person. _____ 3. A separate legal entity that issues shares that are not publicly traded _____ 4. Consumed assets or services _____ 5. Creditor claims against the assets of the business. _____ 6. Amount by which expenses exceed revenues. _____ 7. Future economic benefits _____ 8. Involves acquiring the resources necessary to run the business _____ 9. Distributions to shareholders _____ 10. An accounting period that is one year long

The Purpose and Use of Financial Statements

ANSWERS TO MATCHING 1.

(a)

(b)

(h)

(c)

(g)

(i)

(f)

(d)

(j)

10. (e)

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SHORT-ANSWER ESSAY QUESTIONS S-A E 134 The information that a specific user of financial information needs depends upon the kinds of decisions that a user makes. Identify the major users of accounting information and discuss what questions financial information answers for each group of users. Solution 134 The major users of accounting information are internal and external users. Internal users are those who manage the business. External users are those outside the business who have either a present or potential financial interest. Financial information may answer the following questions for internal users: 1. Is cash sufficient to pay our debts? 2. Can we afford to give our employees a raise this year? 3. What is the cost of manufacturing each unit of product? 4. Which product line is the most profitable? Questions answered by financial information for external users include: 1. Is the company earning satisfactory profit? 2. How does the company compare in size and profitability with competitors? 3. Will the company be able to pay its debts as they come due?

S-A E 135 Anthony Davidson, an old friend of yours from high school, started a small business about a year ago, which is organized as a private corporation. Anthony is currently in the process of applying for a bank loan to expand his business. He shows you the most recent statement of financial position that he has prepared for the bank, which is as follows: DAVIDSON CORPORATION Statement of Financial Position September 30, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash ...................................................................................................................... $ 80,000 Accounts receivable ............................................................................................... 22,000 Equipment.............................................................................................................. 160,000 Total assets..................................................................................................... $262,000 Liabilities and Shareholders’ Equity Accounts payable................................................................................................... Shareholders’ equity .............................................................................................. Total liabilities and shareholders’ equity ..........................................................

$ 27,000 235,000 $262,000

Since Anthony knows that you are studying accounting at college, he asks your opinion. “What do you think?” he says. “Do you think the bank will be impressed and lend me the $100,000 I’m asking for?”

The Purpose and Use of Financial Statements

You study the statement for a few minutes. You are pretty sure Anthony doesn’t have anywhere near $160,000 worth of equipment belonging to the business, so you ask where all this equipment is. “Well,” explains Anthony, “in order to increase my assets, I included my personal vehicle, computer and camera equipment, and some of my furniture. They’re worth about $90,000. That should be OK, since they belong to me and I am the only shareholder anyway.” On further questioning, Anthony admits that he added his personal savings account of $45,000 in with the company cash to “make it look better.” Instructions (a) Who are the stakeholders here? (b) Is Anthony’s “creative accounting” acceptable? Why or why not? (c) What would you recommend be done here? Solution 135 (a) The stakeholders in this situation are Anthony, the bank, and any other external users who may rely on Anthony’s financial statements. (b) No, it is not acceptable. Anthony is ignoring the reporting entity concept, which requires the separation of business and personal records. It is unethical to include personal assets in with the business assets, as it distorts the overall financial picture and will mislead the bank. (c) You should recommend that Anthony revise the statement so that it correctly reflects his true financial position. It should then be as follows: DAVIDSON CORPORATION Statement of Financial Position September 30, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash ($80,000 – $45,000) ..................................................................................... $ 35,000 Accounts receivable ............................................................................................... 22,000 Equipment ($160,000 – $90,000) ........................................................................... 70,000 Total assets..................................................................................................... $127,000 Liabilities and Shareholders’ Equity Accounts payable................................................................................................... Shareholders’ equity ($235,000 – $45,000 – $90,000) ........................................... Total liabilities and shareholders’ equity .................................................................

$ 27,000 100,000 $127,000

It may be that Anthony will still be able to obtain the loan, but even if the bank turns him down, at least he can rest easy, knowing that he has acted ethically and presented a true picture of his business.

S-A E 136 Why would it be “safer” for a wealthy individual to set up his or her business as a corporation rather than as a proprietorship or partnership? Solution 136

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

With a proprietorship or partnership, the owner(s) have unlimited liability. That is, they may be required to use personal assets to satisfy business debts. The liability of a corporate shareholder, however, is limited to his or her investment in the business.

S-A E 137 Which two types of transactions affect shareholders’ equity, and how do they affect it? Solution 137 Shareholders’ equity consists generally of share capital and retained earnings. Share capital is increased by issues of common or preferred shares, for example. Retained earnings are increased by revenues, and decreased by expenses and dividends.

S-A E 138 In what order should the four financial statements be prepared? Explain why it is necessary to prepare the financial statements in the proper order. Solution 138 Order of financial statement preparation: 1. income statement; 2. statement of changes in equity; 3. statement of financial position; and 4. statement of cash flows. It is necessary to prepare the financial statements in proper order because they are interrelated. The statement of changes in equity cannot be prepared without knowing the results from the income statement. Thus the income statement must be prepared first. The statement of financial position cannot be prepared without knowing the ending balance for retained earnings, which is taken from the statement of changes in equity. Finally, the statement of cash flows shows how the cash account changed during the period. The ending cash balance shown on the statement of cash flows must agree with the cash balance shown on the statement of financial position.

S-A E 139 The framework used to record and summarize the economic activities of a company is referred to as the accounting equation. (a) State the basic accounting equation and define its major components. (b) How are business transactions and financial statements related to the accounting equation? Solution 139 (a) The basic accounting equation is expressed as follows: Assets = Liabilities + Shareholders’ Equity Assets are defined as resources owned by the business. Liabilities are creditors’ claims against the assets of the business—in other words, existing debts and obligations. Shareholders’ equity is the ownership claim on the total assets of the business; it is equal to total assets minus total liabilities. (b) Business transactions are economic events and activities that affect the elements of the basic accounting equation; that is, transactions cause increases or decreases in assets, liabilities, and shareholders’ equity. Financial statements report the results and effects of

The Purpose and Use of Financial Statements

transactions on the business' assets, liabilities, and shareholders’ equity. The statement of financial position is a summary expression of the basic accounting equation.

S-A E 140 Identify each of the four financial statements. For each statement, explain the primary purpose and identify the primary users and their uses. Answer in point form. Solution 140 Income statement • Primary purpose – report the success or failure of the company for a specific period of time • Primary users and uses 1. Shareholders/investors – to decide whether to invest or sell their investment 2. Creditors/lenders – to decide whether to loan the company money and assess whether it will be able to repay any debt. Statement of changes in equity • Primary purpose – to show the amounts and causes of changes in each component of shareholders’ equity during a specific period of time (same period as income statement) • Primary users and uses 1. Shareholders/investors – to evaluate dividend policy 2. Creditors/lenders – to monitor dividend policy as it affects the ability to repay debt Statement of financial position • Primary purpose – to report assets and claims to assets at a particular point in time • Primary users and uses 1. Creditors/lenders – to assess the likelihood that they will be repaid 2. Managers – to determine if they have the best mix of debt and equity financing Statement of cash flows • Primary purpose – to provide information about cash receipts and payments of a business for a specific period of time (same period as income statement) • Primary users and uses 1. Shareholders/investors – to decide whether to invest or sell their investment 2. Creditors/lenders – to decide whether to lend the business money and assess whether it will be able to repay its debts.

S-A E 141 Lisa Brunet is a friend of yours from high school. She decided to become a beautician after leaving high school, rather than to attend college. She recently opened her own shop on September 1, 2015 and has contracted her services to a local hospital. She is paid a fee for her services from the hospital, and receives a small gratuity (tip) from each patient. She has invested $1,000 of her own money into the company, which is a private corporation, as she plans to expand by providing services to hospitals in other nearby cities. She is the sole shareholder. She has just received her first set of financial statements from her accountant. She is quite upset. Since the income statement reports profit of $1,075 and she put $1,000 into the company, she is surprised to see her cash account only has $925 in it.

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She has written you a letter, asking you how this is possible. She does not understand why her cash balance isn’t $2,075 (her profit plus the $1,000 she invested). Along with her letter she has included her financial statements. BRUNET BEAUTICIAN LTD Income Statement Month Ended September 30, 2015 ————————————————————————————————————————— Revenues Contract revenue............................................................................................. $2,500 Gratuities………………………………………………………………... ................. 75 Total revenues…………………………………………………….. ................. 2,575 Operating expenses ............................................................................................... 1,200 Profit before income tax ......................................................................................... 1,375 Income tax expense ............................................................................................... 300 Profit ...................................................................................................................... $1,075

BRUNET BEAUTICIAN LTD. Statement of Changes in Equity Month Ended September 30, 2015 ————————————————————————————————————————— Common Shares Retained Earnings Total Equity Balances, Sep 1 $ 0 $ 0 $ 0 Issued common shares 1,000 1,000 Profit 1,075 1,075 Balances, Sep 30 $1,000 $1,075 $2,075

BRUNET BEAUTICIAN LTD. Statement of Financial Position September 30, 2015 —————————————————————————————————————————— Assets Cash .................................................................................................... $ 925 Accounts receivable ............................................................................. 1,500 Total assets................................................................................... $2,425 Liabilities and Shareholders’ Equity Liabilities Accounts payable ........................................................................... Income tax payable ........................................................................ Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................. Retained earnings .......................................................................... Total liabilities and shareholders’ equity ................................

$ 50 300 $ 350 $1,000 1,075

2,075 $2,425

Instructions Using proper form, write a short letter to Lisa, answer her question completely, but briefly.

The Purpose and Use of Financial Statements

Solution 141 Answers will vary. The instructor's requirements concerning proper form should be followed. The letter may be either business or personal. At a minimum, the letter should be in a recognizable form, and proper grammar and spelling should be used. A suggested personal letter follows:

1010 Carlsen Avenue Ottawa, Ontario K2P 1G0 (Date) Dear Lisa, The reason that your cash balance is not $2,075 is because some of the revenue you have earned has not been paid to you yet. This is the balance in the Accounts Receivable account which shows what your customer, the hospital, still owes you for the services you have provided. There are also expenses that you have incurred that you have not paid yet. The Accounts Payable account shows the money you still owe to your suppliers and the Income Tax Payable account shows the amount of money you still have to pay for income tax expense. When your customer has paid to you what they owe and when you pay off your liabilities, your cash balance will be $2,075, as the following calculation shows: Cash balance ................................................................................................ Add: Cash to be received from the hospital (Accounts Receivable)............... Less: Cash paid to your suppliers (Accounts Payable) .................................. Less: Cash paid for income tax (Income Tax Payable) .................................. Cash balance ................................................................................................

$ 925 1,500 (50) (300) $2,075

The amount of cash reported on your statement of financial position is correct. A statement of cash flows will provide information on the cash receipts and payments for your business and will help to explain the cash balance that appears on your statement of financial position.

Sincerely, (signature)

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CHAPTER 2 A FURTHER LOOK AT FINANCIAL STATEMENTS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

E E E E E E M M M M M M M M M

16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

E M E E M E M E E E E E M M M

91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105.

1 1 1 1 1 1 1 1 1 1 2 2 2 2 2

151. 152. 153. 154.

1 1 1 1

M E E E

155. 156. 157. 158.

1,2 1,2 2 2

169.

LOD

Item SO LOD Item True-False Statements E 31. 2 E 46. E 32. 2 M 47. M 33. 2 M 48. E 34. 2 M 49. 2 M 35. E 50. M 36. 2 E 51. E 37. 2 M 52. M 38. 2 M 53. M 39. 2 M 54. E 40. 3 E 55. M 41. 3 E 56. M 42. 3 M 57. M 43. 3 E 58. E 44. 3 M 59. M 45. 3 M 60. Multiple Choice Questions M 106. 2 E 121. M 107. 2 E 122. M 108. 2 M 123. H 109. 2 E 124. M 110. 2 M 125. M 111. 2 E 126. E 112. 2 M 127. H 113. 2 M 128. M 114. 2 E 129. M 115. 2 E 130. E 116. 2 M 131. M 117. 2 M 132. M 118. 2 M 133. E 119. 2 E 134. E 120. 2 M 135. Exercises M 159. 2 E 163. M 160. 2 M 164. H 161. 2 E 165. H 162. 2 H 166. Matching

LOD

Item

LOD

3 3 3 3 3 3 3 3 3 3 3 3 3 3 3

M M M M M E E E M M E M M E M

61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

3 3 3 3 3 3 3 3 3 3 3 3 3 3 3

E E E M M E E E M M H M E M E

2 2 2 2 2 2 2 2 2 3 3 3 3 3 3

E H H M M M H M M E E M M M E

136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148. 149. 150.

3 3 3 3 3 3 3 3 3 3 3 3 3 3 3

E E M H E E E E E M E H E E E

2 2 2 3

M E E E

167. 168.

3 3

M E

1–3

170. 171.

1,2 2

E M

Note:

E = Easy

172. 173.

3 3

E E

M = Medium

Short-Answer Essay 174. 3 E

H = Hard

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

Item

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

TF TF TF TF TF TF TF

8. 9. 10. 11. 12. 13. 14.

TF TF TF TF TF TF TF

15. 76. 77. 78. 79. 80. 81.

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

TF TF TF TF TF TF TF TF TF TF

26. 27. 28. 29. 30. 31. 32. 34. 34. 35.

TF TF TF TF TF TF TF TF TF TF

36. 37. 38. 39. 101. 102. 103. 104. 105. 106.

40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50.

TF TF TF TF TF TF TF TF TF TF TF

51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61.

TF TF TF TF TF TF TF TF TF TF TF

62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

Note: TF = True-False MC = Multiple Choice

Type Item Type Item Study Objective 1 TF 82. MC 89. MC 83. MC 90. MC 84. MC 91. MC 85. MC 92. MC 86. MC 93. MC 87. MC 94. MC 88. MC 95. Study Objective 2 TF 107. MC 117. TF 108. MC 118. TF 109. MC 119. TF 110. MC 120. MC 111. MC 121. MC 112. MC 122. MC 113. MC 123. MC 114. MC 124. MC 115. MC 125. MC 116. MC 126. Study Objective 3 TF 73. TF 138. TF 74. TF 139. TF 75. TF 140. TF 130. MC 141. TF 131. MC 142. TF 132. MC 143. TF 133. MC 144. TF 134. MC 145. TF 135. MC 146. TF 136. MC 147. TF 137. MC 148. Ma = Matching Ex = Exercise

Type

Item

Type

Item

Type

MC MC MC MC MC MC MC

96. 97. 98. 99. 100. 151. 152.

MC MC MC MC MC Ex Ex

153. 154. 155. 156. 169. 170.

Ex Ex Ex Ex Ma SAE

MC MC MC MC MC MC MC MC MC MC

127. 128. 129. 155. 156. 157. 158. 159. 160. 161.

MC MC MC Ex Ex Ex Ex Ex Ex Ex

162. 163. 164. 165. 169. 170. 171.

Ex Ex Ex Ex Ma SAE SAE

MC MC MC MC MC MC MC MC MC MC MC

149. 150. 166. 167. 168. 169. 172. 173. 174.

MC MC Ex Ex Ex Ma SAE SAE SAE

SAE = Short-Answer Essay

A Further Look at Financial Statements

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CHAPTER STUDY OBJECTIVES 1.

Identify the sections of a classified statement of financial position. In a classified statement of financial position, assets are classified as current or non-current assets. In the non-current asset category, they are further classified as investments; property, plant and equipment; intangible assets and goodwill; or other assets. Liabilities are classified as either current or non-current. There is also a shareholders’ equity section, which shows share capital and retained earnings, among other equity items if any exist.

Identify and calculate ratios for analyzing a company’s liquidity, solvency, and profitability. Liquidity ratios, such as working capital and the current ratio, measure a company’s short-term ability to pay its maturing obligations and meet unexpected needs for cash. Solvency ratios, such as debt to total assets, measure a company’s ability to survive over a long period by having enough assets to settle its liabilities as they fall due. Profitability ratios, such as earnings per share and the price-earnings ratio, measure a company’s operating success for a specific period of time.

Describe the framework for the preparation and presentation of financial statements. The key components of the conceptual framework are (1) the objective of financial reporting; (2) qualitative characteristics of useful financial information, which include fundamental and enhancing characteristics and the cost constraint; (3) the going concern assumption underlying the accounting process; (4) elements of the financial statements; and (5) measurement of the elements of financial statements.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

TRUE-FALSE STATEMENTS 1. Cash and office supplies are both classified as current assets.

2. Inventories and prepaid expenses are classified as long-term investments.

3. Long-term investments appear in the property, plant, and equipment section of the statement of financial position.

4. Special rights and privileges that provide a future economic benefit to the company are classified as intangible assets.

5. A liability is normally classified as a current liability if it is to be paid within the coming year. 6. Shareholders’ equity is divided into at least two parts: share capital and retained earnings.

7. All long-lived assets including land have estimated useful lives over which they are expected to generate revenue.

8. All long-lived assets are depreciated over their estimated useful lives.

9. Mortgages and pension liabilities are examples of non-current liabilities.

10. The investment classification on the statement of financial position normally includes investments that are intended to be held for a short period of time (less than one year).

11. Shareholders' equity consists of two parts: common and preferred shares.

12. The main difference between intangible assets and property, plant, and equipment is the length of the asset’s life.

13. Listing assets and liabilities in reverse order of liquidity is not permitted in Canada.

14. The statement of financial position is normally presented as follows, when ordered in order of liquidity: Current assets, current liabilities, non-current assets, non-current liabilities, and shareholders’ equity.

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15. The statement of financial position is normally presented as follows, when ordered in order of reverse liquidity: Non-current assets, current assets, shareholders’ equity, non-current liabilities, and current liabilities.

16. Intracompany comparisons are based on comparisons with competitors in the same industry.

17. Calculating financial ratios can give clues to underlying conditions that may not be noticed by examining each financial statement item separately.

18. Liquidity ratios are concerned with the frequency and amounts of dividend payments.

19. Analysis of financial statements is enhanced with the use of comparative data. 20. Solvency ratios measure the entity’s ability to survive over a long period.

21. A single ratio by itself is not very meaningful.

22. Profitability means having enough funds on hand to pay debts when they fall due.

23. Working capital is the difference between total assets and current liabilities.

24. The excess of current assets over current liabilities is called working capital.

25. The current ratio is calculated by dividing total assets by total liabilities.

26. The current ratio takes into account the composition of current assets.

27. A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current liabilities.

28. All companies, regardless of size, should have a current ratio of at least 2:1.

29. The most liquid resource is inventory.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

30. Solvency ratios measure the short-term ability of the company to pay its maturing obligations.

31. The debt to total assets ratio measures the percentage of assets financed by creditors rather than shareholders.

32. From a creditor's point of view, the higher the total debt to total assets ratio, the lower the risk that the company may be unable to pay its obligations.

33. Earnings per share is calculated by dividing profit for the period by the dollar value in the common shares account.

34. The price-earnings ratio is calculated by dividing the market price per share by the earnings per share.

35. The price-earnings ratio is a measure of liquidity.

36. Earnings per share is the only ratio that must be presented in the financial statements for publicly traded companies.

37. Earnings per share is frequently compared across companies in the same industry. 38. The higher the price-earnings ratio, the higher are investors’ expectations of the company’s future profitability.

39. Companies using Accounting Standards for Private Enterprises (ASPE) are not required to present earnings per share information in their financial statements.

40. Having a conceptual framework of accounting ensures that standards and practices are clear and consistent.

41. Canada has adopted International Financial Reporting Standards for publicly traded companies.

42. The conceptual framework is fundamentally similar for both Canadian publicly traded companies and Canadian private companies.

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43. The objective of financial reporting is to provide financial information about a company that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company.

44. The objective of financial reporting is to provide financial information that is useful to all types of internal and external users in making decisions.

45. The two fundamental qualitative characteristics are relevance and timeliness.

46. The two fundamental qualitative characteristics are faithful representation and relevance. 47. Information is relevant if it will make a difference in a user’s decision(s).

48. Faithful representation means that accounting information must be complete, neutral, and free from material error.

49. Financial reporting does not have to present the economic substance of a transaction in order to provide a faithful representation of what really happened.

50. Information has predictive value if it helps users confirm or correct their previous predictions.

51. Materiality and relevance are both defined in terms of what influences or makes a difference to a decision maker.

52. Enhancing qualitative characteristics include timeliness and comparability.

53. Accounting information does not have to be understood by the average user with a general business background in order to be useful.

54. Under the going concern assumption, reporting assets, such as land, at their cost may be more appropriate than reporting land at its fair value.

55. In order for information to be relevant, it must be reported on a timely basis.

56. Consistency aids comparability when a company uses the same accounting principles and methods from year to year or when companies with similar circumstances use the same accounting principles.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

57. Comparability in accounting means that a company uses the same generally accepted accounting principles from one accounting period to the next.

58. In order to compare the financial statements of different companies, it would be desirable to have each company develop its own set of accounting rules and practices.

59. Comparability and understandability are examples of enhancing qualitative characteristics.

60. Information has verifiability if the information is comparable.

61. The cost constraint ensures that the value of information provided is greater than the cost of providing it.

62. The cost constraint ensures that information costs less than budget.

63. The going concern assumption states that the business will continue in operation for the foreseeable future.

64. If a company is not a going concern, the classification of its assets and liabilities does not matter.

65. Using a simplified version of Canadian GAAP for small companies in order to reduce the cost of providing financial information is an example of the application of materiality.

66. Elements of financial statements include assets, equity, and expenses, but not liabilities.

67. Two measurement principles are historical cost and fair value.

68. Two recognition principles are the fair value basis of accounting and the going concern assumption.

69. In general, standard setters require that most assets be recorded using historical cost because cost is representationally faithful.

70. The fair value basis of accounting states that all assets and liabilities can be reported at fair value.

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71. Fair values may not always be representationally faithful.

72. The cost basis of accounting states that assets and liabilities should be recorded at their cost not only when originally acquired, but also during the time the entity holds them.

73. Qualitative characteristics help ensure that the information provided in financial statements is useful.

74. The going concern assumption underlies the preparation of financial statements.

75. A conceptual framework is still under development for companies using International Financial Reporting Standards (IFRS).

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO TRUE-FALSE STATEMENTS Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 1. T 14. F 27. T 40. T 53. F 66. F 2. F 15. T 28. F 41. T 54. T 67. T 3. F 16. F 29. F 42. T 55. T 68. F 4. T 17. T 30. F 43. T 56. T 69. T 5. T 18. F 31. T 44. F 57. F 70. F 6. T 19. T 32. F 45. F 58. F 71. T 7. F 20. T 33. F 46. T 59. T 72. T 8. F 21. T 34. T 47. T 60. F 73. T 9. T 22. F 35. F 48. T 61. T 74. T 10. F 23. F 36. T 49. F 62. F 75. T 11. F 24. T 37. F 50. F 63. T 12. F 25. F 38. T 51. T 64. T 13. F 26. F 39. T 52. T 65. F

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MULTIPLE CHOICE QUESTIONS 76. On a classified statement of financial position, prepaid expenses are classified as (a) a current liability. (b) property, plant, and equipment. (c) a current asset. (d) a long-term investment.

77. A current asset is (a) the last asset purchased by a business. (b) an asset which is not currently being used to produce a product or service. (c) usually found as a separate classification in the income statement. (d) expected to be converted to cash or used in the business within a relatively short period of time.

78. Which of the following is not classified as a current asset? (a) supplies (b) short-term (trading) investments (c) a fund to be used to purchase a building within the next year (d) equipment with an estimated useful life of five years

79. An intangible asset (a) derives its value from the rights and privileges it provides the company. (b) is worthless because it has no physical substance. (c) is converted into a tangible asset during the year. (d) cannot be classified on the statement of financial position because it lacks physical substance.

80. Which of the following is not considered to be an asset? (a) equipment (b) dividends (c) accounts receivable (d) inventory

81. The difference between cost and accumulated depreciation is referred to as (a) net depreciation. (b) carrying amount. (c) fair value. (d) cost value.

82. Trademarks would appear in which section of the statement of financial position? (a) Shareholders’ equity (b) Investments

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

83. Liabilities are generally classified on a statement of financial position as (a) small liabilities and large liabilities. (b) present liabilities and future liabilities. (c) tangible liabilities and intangible liabilities. (d) current liabilities and non-current liabilities.

84. Which of the following would not normally be classified as a non-current liability? (a) current maturities of non-current debt (b) bonds payable (c) mortgage payable (d) lease liabilities

85. Which of the following is not normally a current liability? (a) salaries payable (b) accounts payable (c) income tax payable (d) bonds payable

86. Office equipment is classified on the statement of financial position as (a) a current asset. (b) property, plant, and equipment. (c) shareholders’ equity. (d) a long-term investment.

87. Current liabilities are expected to be (a) converted to cash within one year. (b) paid within one year. (c) used in the business within one year. (d) acquired within one year.

88. On a classified statement of financial position, current assets are often listed (a) in alphabetical order. (b) with the largest dollar amounts first. (c) in the order in which they are expected to be converted into cash. (d) in the order of acquisition.

89. Long-lived assets without physical substance are (a) listed directly under current assets on the statement of financial position. (b) not listed on the statement of financial position because they do not have physical substance. (c) intangible assets.

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(d) listed as a long-term investment on the statement of financial position.

Use the following information to answer questions 90–94. HONEST RON'S FURNITURE OUTLET LTD. Statement of Financial Position December 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash $ 5,000 Accounts payable $ 30,000 Accounts receivable 20,000 Salaries payable 10,000 Supplies 1,000 Mortgage payable 130,000 Inventory 170,000 Total liabilities $170,000 Land 100,000 Shareholders’ equity Building $100,000 Common shares $140,000 Less: Accum. depreciation 20,000 80,000 Retained earnings 96,000 Trademark $ 40,000 Total shareholders' equity 236,000 Less:Accum. amortization 10,000 30,000 Total liabilities and Total assets $406,000 shareholders' equity $406,000

90. The dollar amount of current liabilities is (a) $196,000. (b) $170,000. (c) $ 40,000. (d) $ 30,000.

91. The dollar amount of net property, plant and equipment is (a) $ 80,000. (b) $180,000. (c) $210,000. (d) $350,000.

92. The dollar amount of current assets is (a) $ 26,000. (b) $ 40,000. (c) $ 25,000. (d) $196,000.

93. The dollar amount of share capital is (a) $406,000. (b) $236,000. (c) $140,000. (d) $ 96,000.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

94. The total obligations that have resulted from past transactions are (a) $ 20,000. (b) $ 40,000. (c) $ 96,000. (d) $170,000.

Use the following information to answer questions 95–100. MARCOTTE MASONARY LTD. Statement of Financial Position December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash $ 50,000 Accounts payable $ 40,000 Prepaid insurance 5,000 Salaries payable 5,000 Accounts receivable 75,000 Bonds payable 190,000 Inventory 110,000 Total liabilities 235,000 Land 90,000 Building $220,000 Common shares 200,000 Less: Accumulated Retained earnings 105,000 depreciation 60,000 160,000 Total shareholders’ equity 305,000 Trademark $ 75,000 Less: Accum. amort. 25,000 50,000 Total liabilities and Total assets $540,000 shareholders’ equity $540,000

95. The total dollar amount of assets to be classified as current assets is (a) $240,000. (b) $220,000. (c) $170,000. (d) $130,000.

96. The total dollar amount of assets to be classified as net property, plant, and equipment is (a) $300,000. (b) $250,000. (c) $240,000. (d) $160,000.

97. The total dollar amount of assets to be classified as investments is (a) $ 0. (b) $ 50,000. (c) $ 90,000. (d) $190,000.

98. The total amount in the contra asset accounts is (a) $ 60,000.

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(b) $ 85,000. (c) $210,000. (d) $235,000.

99. Non-current liabilities total (a) $540,000. (b) $235,000. (c) $190,000. (d) $ 45,000.

100. Profit retained for use in the business is (a) $540,000. (b) $305,000. (c) $200,000. (d) $105,000.

101. A measure of profitability is the (a) current ratio. (b) debt to total assets ratio. (c) earnings per share. (d) working capital.

102. Earnings per share is calculated by dividing (a) revenue by weighted average shareholders’ equity. (b) revenue by the weighted average number of common shares. (c) profit by weighted average shareholders’ equity. (d) profit by the weighted average number of common shares.

103. The price-earnings ratio is calculated by dividing (a) the market price per share by earnings per share. (b) earnings per share by the average number of shares. (c) profit by the market price per share. (d) earnings per share by the market price per share.

104. The relationship between current assets and current liabilities is important in evaluating a company's (a) profitability. (b) liquidity. (c) fair value. (d) solvency.

105. The most important information needed to determine if companies can pay their current obligations is the (a) profit for this year.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) projected profit for next year. (c) relationship between current assets and current liabilities. (d) relationship between current and non-current liabilities.

106. A short-term creditor is primarily interested in the ___ of the borrower. (a) liquidity (b) profitability (c) comparability (d) solvency

107. The current ratio is calculated as (a) current assets plus current liabilities. (b) current assets minus current liabilities. (c) current assets divided by current liabilities. (d) current assets times current liabilities.

108. Working capital is calculated as (a) current assets plus current liabilities. (b) current assets minus current liabilities. (c) current assets divided by current liabilities. (d) current assets times current liabilities.

109. Working capital is a measure of (a) comparability. (b) liquidity. (c) profitability. (d) solvency.

110. Long-term creditors are usually most interested in evaluating (a) liquidity and profitability. (b) comparability and profitability. (c) profitability and solvency. (d) consistency and solvency.

111. A liquidity ratio measures the (a) profit or operating success of a company over a period of time. (b) ability of a company to survive over a long period of time. (c) short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. (d) percentage of total financing provided by creditors.

112. Working capital is (a) calculated by dividing current assets by current liabilities. (b) used to evaluate a company’s liquidity and short-term debt paying ability.

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(c) used to evaluate a company’s solvency and long-term debt paying ability. (d) calculated by subtracting current liabilities from total assets.

113. The ability of a business to pay obligations that are expected to become due within the next year is called (a) leverage. (b) liquidity. (c) profitability. (d) solvency.

Use the following information to answer questions 114–118. Current assets.................... Current liabilities ................ Average assets .................. Total assets ....................... Profit ..................................

$18,000 8,000 80,000 60,000 18,000

Net sales ..................................... Total liabilities ............................. Shareholders’ equity ................... Market price of shares................. Weighted average number of common shares ......................

$40,000 10,000 50,000 $4 26,000

114. What is the total amount of working capital? (a) $4,000 (b) $8,000 (c) $10,000 (d) $14,000

115. What is the current ratio? (a) 2.3:1 (b) 2.0:1 (c) 0.6:1 (d) 0.4:1

116. What is the earnings per share? (a) $0.44 (b) $0.70 (c) $1.92 (d) $1.54

117. What is the price-earnings ratio? (a) 9.1 times (b) 5.7 times (c) 2.1 times (d) 1.7 times

118. What is the debt to total assets?

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) 12.5% (b) 20.0% (c) 75.0% (d) 16.7%

119. The debt to total assets ratio is calculated by dividing (a) non-current liabilities by total assets. (b) non-current liabilities by average assets. (c) total liabilities by total assets. (d) total liabilities by average assets.

120. A useful measure of solvency is the (a) current ratio. (b) price-earnings ratio. (c) earnings per share. (d) debt to total assets.

121. Which of the following is not considered a measure of liquidity? (a) current ratio (b) working capital (c) both current ratio and working capital (d) debt to total assets

122. Investors are usually most interested in evaluating (a) liquidity and solvency. (b) solvency and marketability. (c) liquidity and profitability. (d) profitability and solvency.

123. Shareholders are most interested in evaluating (a) liquidity and solvency. (b) profitability and solvency. (c) liquidity and profitability. (d) marketability and solvency.

124. The current assets of Mario Corporation are $420,000. The current liabilities are $300,000. The current ratio expressed as a ratio is (a) 140% (b) 1.4:1 (c) 0.7:1 (d) $420,000 ÷ $300,000

125. A weakness of the current ratio is (a) the difficulty of the calculation.

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(b) that it doesn't take into account the composition of the current assets. (c) that it is rarely used by sophisticated analysts. (d) that it can be expressed as a percentage, as a rate, or as a proportion.

126. A supplier to a company would probably be most interested in the (a) debt to total assets. (b) price-earnings ratio. (c) current ratio. (d) earnings per share.

Use the following information for questions 127–128. Cooney Corporation had $275,000 in current assets and $105,000 in current liabilities before borrowing $75,000 from the bank for a 6-month period.

127. What effect did the borrowing transaction have on the amount of Cooney's working capital? (a) No effect (b) $75,000 increase (c) $105,000 increase (d) $75,000 decrease

128. What effect did the borrowing transaction have on Cooney's current ratio? (a) The ratio remained unchanged. (b) The change in the current ratio cannot be determined. (c) The ratio decreased. (d) The ratio increased.

129. City Recycling Inc. has $120,000 in current assets and $100,000 in current liabilities. When the company pays $20,000 owed to employees (salaries payable), what effect does this have on their current ratio? (a) The ratio increases. (b) The ratio decreases. (c) The ratio stays the same. (d) Cannot be determined.

130. The conceptual framework of accounting helps to ensure that (a) users with no accounting or business knowledge will understand financial statements. (b) a rule will be in place for every possible situation. (c) there are consistent standards prescribing the nature, functions and limits of financial statements. (d) all countries have their own unique accounting standards.

131. The objective of financial reporting is to (a) provide information to the Canada Revenue Agency.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) provide financial information that is useful to existing and potential investors, lenders and other creditors. (c) comply with Accounting Standards for Private Enterprises. (d) comply with International Financial Reporting Standards.

132. The conceptual framework of accounting begins with (a) qualitative characteristics. (b) the going concern assumption. (c) the objective of financing reporting. (d) elements of financial statements.

133. Which one of the following is not a qualitative characteristic of useful accounting information? (a) relevance (b) verifiability (c) going concern (d) comparability

134. Which one of the following is a fundamental qualitative characteristic? (a) relevance (b) timeliness (c) understandability (d) comparability

135. In order for accounting information to be relevant, it must (a) have very little cost. (b) help predict future events or confirm prior expectations. (c) be verifiable. (d) be used by a lot of different organizations.

136. If accounting information has relevance, it (a) is not required to be complete. (b) will not have predictive value. (c) will only make a difference for internal stakeholders. (d) will make a difference in users’ decisions.

137. The two qualitative characteristics that are defined in terms of what influences or makes a difference to a decision maker are (a) faithful representation and materiality. (b) comparability and timeliness (c) materiality and relevance. (d) relevance and understandability

138. Which of the following is not an enhancing qualitative characteristic?

A Further Look at Financial Statements

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(a) verifiability (b) faithful representation (c) comparability (d) timeliness

139. Accounting information should be neutral in order to enhance (a) faithful representation. (b) materiality. (c) comparability. (d) understandability.

140. Which of the following is not a main section of the conceptual framework of accounting? (a) the objective of financial reporting (b) the going concern assumption (c) financial analysis (d) the elements of financial statements

141. Which of the following statements is not true? (a) Comparability means using different accounting principles from year to year within a company. (b) Faithful representation means information must be neutral, complete, and free from material error. (c) Relevant accounting information must be capable of making a difference in a user’s decision. (d) For accounting information to be relevant, it must have timeliness.

142. A company can change to a new accounting principle if management can justify that the change will result in (a) less likelihood of clerical errors. (b) higher profit. (c) lower profit for tax purposes. (d) more relevant information for decision-making.

143. If accounting information has predictive value, it will help users (a) prepare for future Canada Revenue Agency audits. (b) make predictions about future events. (c) make predictions about foreign currency exchange rates. (d) confirm or correct previous predictions or expectations.

144. The going concern assumption 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.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

145. The going concern assumption is inappropriate when (a) the business is just starting up. (b) liquidation appears likely. (c) fair values are higher than costs. (d) the business is organized as a proprietorship.

146. Which of the following is a constraint in accounting? (a) comparability (b) cost (c) faithful representation (d) timeliness

147. In general, standard setters require that most assets be recorded using historical cost because (a) fair values may overstate assets and equity. (b) fair values may not always be representationally faithful. (c) cost often cannot be verified. (d) cost values may or may not be relevant.

148. Which of the following is not a financial statement element? (a) Liabilities (b) Equity (c) Expenses (d) Fair value

149. The qualitative characteristic that says the value of information should exceed the cost of preparing it is called (a) relevance. (b) understandability. (c) cost constraint. (d) verifiability.

150. The measurement principle that says assets are reported at the price that would be received if the item were sold is called (a) fair value. (b) historical cost. (c) materiality. (d) going concern.

A Further Look at Financial Statements

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. 76. c 77. d 78. d 79. a 80. b 81. b 82. c 83. d 84. a 85. d 86. b 87. b 88. c

Item 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101.

Ans. c c b d c d a b a b c d c

Item 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114.

Ans. d a b c a c b b c c b b c

Item Ans. 115. a 116. b 117. b 118. d 119. c 120. d 121. d 122. d 123. b 124. b 125. b 126. c 127. d

Item 128. 129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139. 140.

Ans. c a c b c c a b d c b a c

Item 141. 142. 143. 144. 145. 146. 147. 148. 149. 150.

Ans. a d b d b b b d c a

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 151 Identify the errors, corrections required, and corrected subtotals required in the following classified statement of financial position. Then prepare a corrected statement of financial position. RUMPBELL INC. Statement of Financial Position Year Ended December 31, 2015 ———————————————————————————————————–––––––—— Assets Current assets Accounts receivable (net of accounts payable of $2,000)..................... $12,000 Prepaid expenses ................................................................................ 1,500 Goodwill ............................................................................................... 1,200 ............................................................................................................ 14,700 Property, plant and equipment ............................................................. $4,300 Less: Accounted depreciation .............................................................. 1,100 Other assets (non-current) ................................................................... 1,720 4,920 Total assets ......................................................................................... $19,620 Liabilities Bank loan payable (due in 6 months) ................................................... Long term debt ..................................................................................... Total liabilities ......................................................................................

$9,500 6,700

Shareholders' equity Retained earnings ................................................................................ Less: Dividends.................................................................................... Common shares................................................................................... Total.....................................................................................................

$2,460 150 1,110

16,200

3,420 $19,620

Solution 151 (15 min.) 1. The date is not properly identified in the heading—it should be December 31, 2015, not year ended. 2. The accounts payable should not be netted against the receivables—accounts receivable should be $14,000 and accounts payable shown as a current liability of $2,000. 3. Goodwill should not be a current asset. Goodwill is a type of intangible asset, shown separately. Current assets should be $15,500. 4. Other (non-current) assets should not be included with property, plant and equipment subtotal. The subtotal should be $3,200. 5. Accounted depreciation should be accumulated depreciation. 6. A heading “Liabilities and Shareholders' Equity” should replace the “Liabilities” heading. 7. Liabilities should be classified as current and non-current. 8. Current liabilities should include accounts payable of $2,000 and note payable (due in 6 months) of $9,500—for total current liabilities of $11,500. 9. Common shares should be listed first under the shareholders' equity heading. 10. Dividends should not be shown on the statement of financial position—only the ending

A Further Look at Financial Statements

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amount of retained earnings of $2,310 ($2,460 – $150) should be shown. Corrected statement of financial position: RUMPBELL INC. Statement of Financial Position December 31, 2015 ———————————————————————————————————–––––––—— Assets Current assets Accounts receivable ...................................................................... $14,000 Prepaid expenses ......................................................................... 1,500 Total current assets ............................................................................. 15,500 Property, plant and equipment ............................................................. $4,300 Less: Accumulated depreciation .......................................................... 1,100 3,200 Goodwill ............................................................................................... 1,200 Other assets (non-current) ................................................................... 1,720 Total assets ......................................................................................... $21,620 Liabilities and Shareholders’ Equity Liabilities Current liabilities Accounts payable .......................................................................... Bank loan payable (due in 6 months) ............................................ Total current liabilities .......................................................................... Non-current liabilities Long term debt .............................................................................. Total liabilities ...................................................................................... Shareholders' equity Common shares ............................................................................ Retained earnings ......................................................................... Total shareholders’ equity .................................................................... Total liabilities and shareholders’ equity ...............................................

$2,000 9,500 $11,500 6,700 18,200

$1,110 2,310 3,420 $21,620

Ex. 152 The following information is available for Jordi Ltd. at December 31, 2015: Accounts payable ....................................................... Accounts receivable ................................................... Accumulated amortization, patents ............................ Accumulated depreciation, equipment........................ Retained earnings ...................................................... Cash .......................................................................... Common shares ......................................................... Equipment .................................................................. Land ........................................................................... Long-term investments ............................................... Bank loan payable (due in 5 years) ............................ Patents.......................................................................

$14,500 2,500 3,500 3,000 6,400 41,900 40,000 3,500 15,000 500 4,200 5,500

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Short-term (trading) investments ................................

2,700

Instructions Use the above information to prepare a classified statement of financial position at December 31, 2015. Solution 152 (20 min.) JORDI LTD. Statement of Financial Position December 31, 2015 ———————————————————————————————————–––––––—— Assets Current assets Cash ............................................................................................. $41,900 Short-term (trading) investments ................................................... 2,700 Accounts receivable ...................................................................... 2,500 Total current assets ............................................................................. $47,100 Long-term Investments ........................................................................ 500 Property, plant, and equipment Land .............................................................................................. 15,000 Equipment ..................................................................................... $3,500 Less Accumulated depreciation, equipment .................................. 3,000 500 Intangible assets Patents.......................................................................................... $5,500 Less: Accumulated amortization, patents ...................................... 3,500 2,000 Total assets ......................................................................................... $65,100 Liabilities and Shareholders’ Equity Current liabilities Accounts payable ......................................................................... Total current liabilities .......................................................................... Non-current liabilities Bank loan payable......................................................................... Total liabilities ..................................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total shareholders’ equity .................................................................... Total liabilities and shareholders’ equity ...............................................

$14,500 14,500 4,200 18,700 $40,000 6,400 46,400 $65,100

Ex. 153 The following accounts were taken from a company’s statement of financial position: Account Classification Cash Inventory Trading Investments Building Accounts payable Trademarks

A Further Look at Financial Statements

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Equipment Prepaid Insurance Long term debt Unearned Revenue Mortgage Payable Accounts Receivable Accumulated Depreciation- Building Land Notes Receivable (due in 24 months)

Instructions Classify each of the above accounts as current assets (CA), non-current assets (NCA), current liabilities (CL), non- current liabilities (NCL), or shareholders’ equity (SE). Solution 153 Account Cash Inventory Trading Investments Building Accounts payable Trademarks Equipment Prepaid Insurance Long term debt Unearned Revenue Mortgage Payable Accounts Receivable Accumulated Depreciation- Building Land Notes Receivable (due in 24 months)

Classification CA CA CA NCA CL NCA NCA CA NCL CL NCL CA NCA NCA NCA

Ex. 154 Accounting standards do not prescribe the order in which items are presented in the statement of financial position. Below are various categories to the statement of financial position: Non-current assets Shareholders’ equity Current liabilities Current assets Non-current liabilities Instructions (a) Present each category in “Order of Liquidity”. (b) Present each category in “Order of Reverse Liquidity”. Solution 154 (a) Order of Liquidity Current assets

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Non-current assets Current liabilities Non-current liabilities Shareholders’ equity (b) Order of Reverse Liquidity Non-current assets Current assets Shareholders’ equity Non-current liabilities Current liabilities

Ex. 155 The following items are taken from the financial statements of La Brea Ltd. for the fiscal year ended December 31, 2015. Note they are in alphabetical order. Accounts payable ....................................................... Accounts receivable ................................................... Accumulated depreciation—video equipment............. Advertising expense ................................................... Cash .......................................................................... Common shares (10,000 shares) ............................... Depreciation expense ................................................ Dividends ................................................................... Income tax expense ................................................... Insurance expense ..................................................... Bank loan payable...................................................... Prepaid insurance ...................................................... Rent expense ............................................................. Retained earnings, January 1, 2015 .......................... Salaries expense........................................................ Salaries payable......................................................... Service revenue ......................................................... Supplies ..................................................................... Supplies expense ....................................................... Video equipment ........................................................

$ 15,500 18,000 30,500 21,000 15,000 90,000 12,000 5,000 10,000 3,000 70,000 6,000 22,000 12,000 32,000 3,000 143,000 4,000 6,000 210,000

Instructions (a) Calculate the profit for the year. (b) Calculate the balance of Retained Earnings that would appear on the statement of financial position at December 31, 2015. (c) Prepare a classified statement of financial position for La Brea Ltd. at December 31, 2015, assuming the bank loan payable is a non-current liability. (d) Calculate the current ratio, debt to total assets, and earnings per share. Assets at the beginning of 2015 totalled $183,000. No additional shares were issued or redeemed during the year. Solution 155 (20 min.) (a) Profit is $143,000 – $21,000 – $12,000 – $3,000 – $22,000 – 32,000 – $6,000 – $10,000 = $37,000

A Further Look at Financial Statements

(b)

Retained earnings, January 1 ................................... Add: Profit ................................................................ Less: Dividends ........................................................ Retained earnings, December 31 .............................

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$12,000 37,000 49,000 5,000 $44,000

(c) LA BREA LTD. Statement of Financial Position December 31, 2015 ———————————————————————————————————–––––––—— Assets Current assets Cash ............................................................................................. $ 15,000 Accounts receivable ...................................................................... 18,000 Supplies ........................................................................................ 4,000 Prepaid insurance ......................................................................... 6,000 Total current assets ................................................................ 43,000 Property, plant and equipment Video equipment ........................................................................... $210,000 Less: Accumulated depreciation—video equipment ...................... 30,500 179,500 Total assets ............................................................................ $222,500 Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................... Salaries payable............................................................................ Total current liabilities ............................................................. Non-current liabilities Bank loan payable......................................................................... Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity ................................. (d)

$ 15,500 3,000 18,500 70,000 88,500 $90,000 44,000

134,000 $222,500

Current ratio: $43,000 ÷ $18,500 = 2.3:1 Debt to total assets: $88,500 ÷ $222,500 = 39.8% Earnings per share: $37,000 ÷ 10,000 = $3.70

Ex. 156 The following items are taken from the financial statements of Columbia Ltd. for the year ended December 31, 2015: Accounts payable ....................................................... Accounts receivable ................................................... Accumulated depreciation – equipment...................... Bonds payable ........................................................... Cash ..........................................................................

$19,500 4,000 4,800 18,000 22,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Common shares (1,500 shares issued) ...................... Cost of goods sold ..................................................... Depreciation expense ................................................ Dividends ................................................................... Equipment .................................................................. Goodwill ..................................................................... Income tax expense ................................................... Interest expense......................................................... Market price per common share ................................. Retained earnings, beginning ..................................... Salaries expense........................................................ Sales revenue ............................................................ Supplies .....................................................................

25,000 12,000 4,800 300 48,000 7,500 1,000 3,500 $4.50 16,000 8,200 32,500 4,500

Instructions (a) Prepare an income statement and a classified statement of financial position for Columbia for 2015. (b) Calculate the following ratios: 1. Current ratio 2. Debt to total assets 3. Earnings per share 4. Price-earnings ratio Solution 156 (25 min.) (a) COLUMBIA LTD. Income Statement Year Ended December 31, 2015 ———————————————————————————————————–––––––—— Sales revenue ...................................................................................... $32,500 Operating expenses Cost of goods sold ........................................................................ $12,000 Salaries expense........................................................................... 8,200 Depreciation expense ................................................................... 4,800 Interest expense............................................................................ 3,500 28,500 Profit before income tax ....................................................................... 4,000 Income tax expense ............................................................................. 1,000 Profit .................................................................................................... $ 3,000 COLUMBIA LTD. Statement of Financial Position December 31, 2015 ———————————————————————————————————–––––––—— Assets Current assets Cash ............................................................................................. $22,000 Accounts receivable ...................................................................... 4,000 Supplies ........................................................................................ 4,500 Total current assets ................................................................ 30,500 Property, plant, and equipment

A Further Look at Financial Statements

Equipment ..................................................................................... Less: Accumulated depreciation—equipment................................ Goodwill ............................................................................................... Total assets ............................................................................ Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................... Non-current liabilities Bonds payable .............................................................................. Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity .................................

$48,000 4,800

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43,200 7,500 $81,200

$19,500 18,000 37,500 $25,000 18,700*

43,700 $81,200

*Retained earnings = $18,700 ($16,000 + $3,000 – $300) (b) 1. 2. 3. 4.

Current ratio: $30,500 ÷ $19,500 = 1.6:1 Debt to total assets: $37,500 ÷ $81,200 = 46.2% Earnings per share: $3,000 ÷ 1,500 = $2.00 Price-earnings ratio: $4.50 ÷ $2.00 = 2.3 times

Ex. 157 Presented below is information on XBRL Ltd.: 2015 Cash .................................................................................... $ 15,000 Cash provided by financing activities.................................... 20,000 Cash used in investing activities........................................... 18,000 Common shares ................................................................... 30,000 Current assets ...................................................................... 85,000 Current liabilities................................................................... 60,000 Dividends paid on common shares ...................................... 11,000 Long term assets.................................................................. 125,000 Price-earnings ratio .............................................................. 12 Retained earnings ................................................................ 60,000 Total liabilities ...................................................................... 110,000 Weighted average number of shares issued ........................ 1,000

2014 $ 12,000 0 7,000 30,000 75,000 45,000 15,000 110,000 14 40,000 95,000 1,000

Instructions Calculate the following for 2015: (a) Earnings per share (b) Market price per common share (c) Working capital (d) Current ratio (e) Debt to total assets Solution 157 (15–20 min.) (a) Earnings per share Calculate profit

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Retained earnings 2014 ............................................. $40,000 Less: Dividends paid on common shares ................... 11,000 Subtotal ................................................. 29,000 Profit ................................................. X Retained earnings 2015 ............................................. $60,000 Solving for X, profit = $31,000 Earnings per share = profit ÷ weighted average number of common shares = $31,000 ÷ 1,000 = $31 (b) Market price per common share Price-earnings ratio = Market price per share ÷ EPS Therefore Market price per share = Price-earnings ratio × EPS = 12 × $31 = $372 (c) Working capital = current assets – current liabilities = $85,000 – $60,000 = $25,000 (d) Current ratio = current assets ÷ current liabilities = $85,000 ÷ $60,000 = 1.4:1 (e) Debt to total assets = Total liabilities ÷ Total assets = $110,000 ÷ ($85,000 + $125,000) = 52%

Ex. 158 The following data are taken from the financial statements of Kamloops Inc.: Accounts payable ....................................................... Accounts receivable ................................................... Cash .......................................................................... Dividends ................................................................... Market price per share ............................................... Other current liabilities................................................ Profit .......................................................................... Wages payable .......................................................... Weighted average number of common shares ...........

$28,000 56,000 54,000 10,000 12.75 17,000 44,000 5,000 10,000

Instructions Calculate the following ratios: (a) Current ratio (b) Working capital (c) Earnings per share (d) Price-earnings ratio Solution 158 (10 min.) Current assets = $56,000 + $54,000 = $110,000 Current liabilities = $28,000 + $17,000 + $5,000 = $50,000 (a)

Current ratio = Current assets ÷ Current liabilities = $110,000 ÷ $50,000 = 2.2:1

(b)

Working capital = Current assets – Current liabilities = $110,000 – $50,000 = $60,000

A Further Look at Financial Statements

(c)

Earnings per share = Profit ÷ Weighted average number of common shares = $44,000 ÷ 10,000 = $4.40

(d)

Price-earnings ratio = Market price ÷ Earnings per share = $12.75 ÷ $4.40 = 2.9

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Ex. 159 The following data are taken from the financial statements of Estevan Inc.: Current assets ............................................................ Current liabilities......................................................... Dividends ................................................................... Market price per share ............................................... Net sales .................................................................... Profit .......................................................................... Total liabilities ............................................................ Total assets................................................................ Weighted average number of common shares ...........

$150,000 100,000 5,000 5 150,000 21,000 105,000 175,000 5,000

Instructions Calculate the following ratios: (a) Current ratio (b) Working capital (c) Earnings per share (d) Price-earnings ratio (e) Debt to total assets Solution 159 (15 min.) (a) Current ratio = Current assets ÷ Current liabilities = $150,000 ÷ $100,000 = 1.5:1 (b)

Working capital = Current assets – Current liabilities = $150,000 – $100,000 = $50,000

(c)

Earnings per share = Profit ÷ Weighted average number of common shares = $21,000 ÷ 5,000 = $4.20

(d)

Price-earnings ratio = Market price per share ÷ Earnings per share = $5 ÷ $4.20 = 1.2

(e)

Debt to total assets = Total debt ÷ Total assets = $105,000 ÷ $175,000 = 60%

Ex. 160 The following selected data are taken from the financial statements of Wolsco Inc. The data are in alphabetical order. Accounts payable ....................................................... Accounts receivable ................................................... Average assets .......................................................... Cash .......................................................................... Market price/share ..................................................... Net sales ....................................................................

$ 40,000 65,000 460,000 92,000 52.00 500,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Other current liabilities................................................ Profit .......................................................................... Salaries payable......................................................... Shareholders’ equity .................................................. Total assets................................................................ Weighted average number of common shares ...........

15,000 160,000 14,000 269,000 472,000 3,500

Instructions Calculate the following ratios: (a) Current ratio (b) Working capital (c) Earnings per share (d) Price-earnings ratio (e) Debt to total assets Solution 160 (10 min.) (a) Current ratio = Current assets ÷ Current liabilities = $157,000 ÷ $69,000 = 2.3:1 (b) Working capital

= Current assets – Current liabilities = $157,000 – $69,000 = $88,000

= Profit ÷ Weighted avg. number of common shares = $160,000 ÷ 3,500 = $45.71

(d) Price-earnings ratio

= Market price per share ÷ Earnings per share = $52.00 ÷ $45.71= 1.1

(e) Debt to total assets = Total liabilities ÷ Total assets = $203,000 ÷ $472,000 = 43% (Total liabilities = Total assets – Shareholders’ equity = $472,000 – $269,000 = $203,000)

Ex. 161 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 = Liquidity ratio P = Profitability ratio S = Solvency ratio ____ ____ ____ ____

1. 2. 3. 4.

Earnings per share Debt to total assets Price-earnings ratio Current ratio

Solution 161 (5 min.) P 1. Earnings per share S

2. Debt to total assets

A Further Look at Financial Statements

3. Price-earnings ratio

4. Current ratio

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Ex. 162 The following information is available from the 2015 financial statements of Hubble Corp. and Bubble Inc. (amounts in millions, except share price) Hubble Bubble Beginning total assets ................................................ $17,102 $33,130 Current assets ............................................................ 11,712 28,447 Current liabilities......................................................... 7,966 14,950 Ending total assets ..................................................... 22,088 36,167 Profit .......................................................................... 565 1,271 Sales .......................................................................... 26,510 34,512 Share price................................................................. $79 $112 Total liabilities ............................................................ 16,136 31,222 Weighted average number of common shares ........... 22 39 Instructions (a) For each company, calculate the following ratios: 1. Current ratio 2. Debt to total assets 3. Earnings per share 4. Price-earnings ratio (b) Based on your calculations, discuss the relative liquidity, solvency, and profitability of the two companies. Solution 162 (15 min.) (a) 1. Current ratio 2. Debt to total assets 3. Earnings per share 4. Price-earnings ratio

Hubble 1.5:1 ($11,712 ÷ $7,966) 73.1% ($16,136 ÷ $22,088) $25.68 ($565 ÷ 22) 3.1 ($79 ÷ $25.68)

Bubble . 1.9:1 ($28,447 ÷ $14,950) 86.3% ($31,222 ÷ $36,167) $32.59 ($1,271 ÷ 39) 3.4 ($112 ÷ $32.59)

(b) Based on the current ratio, Bubble is more liquid than Hubble since its current ratio (1.9:1) is 27% higher than Hubble’s ratio (1.5:1). However, Hubble would be considered more solvent than Bubble since its debt to total assets (73.1%) is lower than Bubble’s debt to total assets ratio (86.3%). A lower debt to total assets ratio indicates a company is more solvent and better able to survive over a long period of time. Bubble has a higher earnings per share and price-earnings ratio than Hubble. Bubble’s earnings per share ($32.59) is 26.9% higher than Hubble’s earnings per share ($25.68); as well, Bubble’s price-earnings ratio (3.4) is 9.7% higher than Hubble’s ratio (3:1).

Ex. 163 Selected information from the comparative financial statements of National Falls Inc. for the year ended December 31 appears below: 2015 2014

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Accounts receivable ................................................... $ 142,000 Bonds payable ........................................................... 490,000 Cash .......................................................................... 27,000 Cost of goods sold ..................................................... 970,000 Current liabilities......................................................... 125,000 Income tax expense ................................................... 80,000 Interest expense ........................................................ 40,000 Inventory .................................................................... 136,000 Profit .......................................................................... 220,000 Total assets................................................................ 1,350,000 Total revenues ........................................................... 2,100,000 Weighted average number of common shares ........... 15,000

$ 182,000 390,000 17,000 900,000 95,000 60,000 15,000 154,000 155,000 950,000 1,100,000 7,000

Instructions Calculate the following ratios for 2015: (a). Current ratio. (b) Working capital. (c) Debt to total assets. (d) Earnings per share. Solution 163 (12 min.) (a) Current ratio is 2.4:1. $27,000 + $142,000 + $136,000 —————————–—————– = 2.4:1 $125,000 (b) Working capital is $180,000. ($27,000 + $142,000 + $136,000) – $125,000 = $180,000 (c) Debt to total assets is 46%. $125,000 + $490,000 ———————–——– = 46% $1,350,000 (d). Earnings per share is $15. $220,000 ——–—— = $15 15,000

Ex. 164 Channing Corporation reported the following current assets and current liabilities: Dec. 31, 2015 Current assets Cash .......................................................................... $ 40,000 Short-term investments .............................................. 40,000

Dec. 31, 2014 $ 30,000 10,000

A Further Look at Financial Statements

Accounts receivable ................................................... Inventory .................................................................... Prepaid expenses ...................................................... Total current assets ............................................. Current liabilities Accounts payable ....................................................... Salaries payable......................................................... Income tax payable .................................................... Total current liabilities ..........................................

55,000 110,000 35,000 $280,000

95,000 90,000 20,000 $245,000

$120,000 40,000 20,000 $180,000

$110,000 30,000 15,000 $155,000

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Instructions (a) Calculate the following ratios for 2015: 1. Current ratio. 2. Working capital. (b) Explain the purpose of each ratio. Solution 164 (10–15 min.) (a) 1. Current ratio = Current assets ÷ Current liabilities = $280,000 ÷ $180,000 = 1.56:1 2. Working capital = $280,000 – $180,000 = $100,000 (b) The purpose of each ratio: 1. The current ratio is a measure of liquidity. For example, for every dollar of current liabilities, the corporation has $1.56 of current assets. 2. Working capital is a measure of liquidity. When working capital is positive, there is a greater likelihood that the company can pay its liabilities.

Ex. 165 Selected data from Doghouse Ltd. are presented below: Net sales .................................................................... $1,250,000 Profit .......................................................................... 195,000 Share price................................................................. 12.25 Weighted average number of common shares ........... 163,000 Instructions (a) Based on the above information, calculate two profitability ratios. (b) Explain the purpose of each ratio. Solution 165 (10–15 min.) (a) With the information provided, the profitability ratios that can be calculated are as follows: 1. Earnings per share = Profit ÷ Weighted average number of shares = $195,000 ÷ 163,000 = $1.20 2. Price-earnings = Market price per share ÷ Earnings per share = $12.25 ÷ $1.20 = 10.21 (b) The purpose of each ratio:

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1. 2.

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Earnings per share measures the profit for each common share. The price-earnings ratio measures the ratio of the market price of each common share to its earnings per share. It reflects the investors’ assessment of the company’s future profit expectations.

Ex. 166 Insert the characteristics listed below that are associated with relevance and faithful representation: Confirmatory value Completeness Neutral

1. 2. 3.

Materiality Free from material errors Predictive value

RELEVANCE _________________________ _________________________ _________________________

Solution 166 (5 min.) RELEVANCE 1. Confirmatory value

FAITHFUL REPRESENTATION 1. ______________________ 2. ______________________ 3. ______________________

FAITHFUL REPRESENTATION 1. Free from material errors

Predictive value

Completeness

Materiality

Neutral

Ex. 167 The following terms relate to the characteristics of useful information. Match the key letter of the correct term with the descriptive statement below. (a) Confirmatory value (b) Neutral (c) Predictive value (d) Relevance

(e) Faithful representation (f) Timeliness (g) Verifiability

_____ 1. Accounting information cannot be selected, prepared, or presented to favour one set of interested users over another. _____ 2. Providing information in time to make decisions _____ 3. Providing information that can be confirmed or duplicated by independent parties _____ 4. Providing information that would make a difference in a business decision _____ 5. Providing information that represents economic reality _____ 6. Helping evaluate prior decisions Solution 167 (5 min.) 1. (b) 2.

(f)

(g)

A Further Look at Financial Statements

(d)

(e)

(a)

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Ex. 168 For each of the independent situations described below, list the fundamental or enhancing qualitative characteristic that has been violated, if any. List only one term for each case. (a) Brunswick Corporation is in its third year of operations and has yet to issue financial statements. (b) Ontario Corporation has used different methods for recording the cost of inventory. In the current year, the cost of goods sold is calculated based on the average cost of inventory. Last year, the cost of inventory was calculated based on the actual cost of each item sold. Next year, the company plans to change back to average cost. (c) Manitoba Inc. is carrying inventory at its current cost of $110,000. The inventory has a fair value of $135,000. (d) Saskatchewan Corporation expenses some inexpensive office equipment even though it has a useful life of more than one year. Solution 168 (5 min.) (a) Timeliness (b) Comparability (consistency) (c) No violation (d) No violation (materiality)

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MATCHING 169. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E. F. ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

Relevance Liquidity ratios Comparability Liabilities Intangible assets Timeliness 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

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

Working capital Current ratio Earnings per share Solvency ratios Price-earnings ratio Materiality

Measures of the ability of an entity to survive over a long period of time Current assets divided by current liabilities Knowledge that will influence a user’s decision. Market price per share divided by earnings per share An omission or statement that could influence the decisions of users. Obligations that result from past transactions. Noncurrent assets that do not have physical substance. Profit divided by the weighted average number of common shares Different companies using the same accounting principles Measures of the short-term ability of the company to pay its maturing obligations. The excess of current assets over current liabilities Information is available to stakeholders before it loses its ability to influence decisions.

A Further Look at Financial Statements

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ANSWERS TO MATCHING 1.

10. B 11. G 12. F

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SHORT-ANSWER ESSAY QUESTIONS S-A E 170 Give the definition of current assets, current liabilities and the current ratio. Solution 170 Current assets are cash or other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year or the operating cycle, if longer. Current liabilities are obligations reasonably expected to be paid from the existing current assets or through the creation of other current liabilities within the next year, or the operating cycle. The current ratio is a measure used to evaluate a company’s liquidity and short-term debt paying ability, calculated by dividing current assets by current liabilities.

S-A E 171 Fast Express specializes in overnight transportation of medical equipment and laboratory specimens. 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 was $1.8 million. The current ratio has changed to 2:1 from last year's 1.5:1. The debt to 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 in the Northern Ontario region.

Instructions 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. Solution 171 Fast Express released its financial statements today, disclosing a 17% increase in profit, 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 in the Northern Ontario region. The purchase of the vans, however, caused the debt to total assets ratio to increase. There are now $4 of debt for every $5 in assets, while last year, there were only $3 of debt to $5 in assets.

SA-E 172 Comparability is an enhancing qualitative characteristic that makes accounting information useful for decision-making purposes. Briefly explain how comparability affects financial reporting. Solution 172 Comparability results when a specific company, and similar companies, use the same

A Further Look at Financial Statements

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accounting principles and methods, so that users can identify and understand similarities and differences among items on the financial reports.

S-A E 173 List four enhancing characteristics of useful decision-making information. Solution 173 To be useful for decision-making, information should have verifiability, timeliness, comparability, and understandability.

S-A E 174 Identify and describe the three characteristics information must have in order to provide a faithful representation of economic reality. Solution 174 In order to achieve faithful representation, information must be complete, neutral and free from material error. Neutral information is free of bias and does not intentionally favour one set of stakeholders over another. Completeness means that all the information that is needed to faithfully represent economic reality must be included, and nothing important is omitted. The statements should be, as far as possible, free from material error. However, this does not mean that there is necessarily 100% accuracy at all times. This is basically impossible given the fact that accounting estimates are frequently necessary.

CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVES AND LEVEL OF DIFFICULTY Item SO LOD 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

1 1 1 1 1 1 1 1 2 2 2

E E M M M M E E E E E

52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2

E M M E M E E E E E E E M M E E M E E E

149. 150. 151. 152. 153.

1 1 1 1 1,2

E E E E E

Item SO LOD Item SO LOD Item SO LOD True-False Statements 12. 2 M 23. 2 M 34. 3 E 13. 2 E 24. 2 E 35. 3 E 14. 2 E 25. 2 E 36. 3 E 15. 2 E 26. 3 E 37. 3 E 16. 2 E 27. 3 E 38. 4 E 17. 2 E 28. 3 E 39. 4 E 18. 2 E 29. 3 E 40. 4 M 2 3 4 19. E 30. E 41. E 20. 2 E 31. 3 E 42. 4 E 21. 2 E 32. 3 E 43. 4 M 22. 2 E 33. 3 E 44. 4 M Multiple Choice Questions 72. 2 E 92. 2 M 112. 3 E 73. 2 E 93. 2 E 113. 3 E 74. 2 E 94. 2 E 114. 3 M 75. 2 E 95. 2 E 115. 3 M 76. 2 E 96. 2 E 116. 3 E 77. 2 M 97. 2 E 117. 3 E 78. 2 E 98. 2 E 118. 3 M 79. 2 M 99. 2 E 119. 3 M 80. 2 M 100. 2 M 120. 3 M 81. 2 E 101. 2 M 121. 3 M 82. 2 H 102. 2 E 122. 3 M 83. 2 E 103. 2 M 123. 4 E 84. 2 M 104. 2 E 124. 4 E 85. 2 E 105. 3 E 125. 4 E 86. 2 M 106. 3 E 126. 4 E 87. 2 M 107. 3 E 127. 4 E 88. 2 M 108. 3 E 128. 4 E 89. 2 E 109. 3 E 129. 4 E 90. 2 E 110. 3 M 130. 4 E 91. 2 M 111. 3 M 131. 4 M Exercises 154. 2 E 159. 2 M 164. 3 E 155. 2 E 160. 2 M 165. 3,5 M 156. 2 E 161. 2,3 M 166. 4,5 M 157. 2 E 162. 2,4 E 167. 5 E 158. 2 E 163. 3 M 168. 5 H Matching

Item SO LOD 45. 46. 47. 48. 49. 50. 51.

4 4 5 5 5 5 5

M E M E E M M

132. 133. 134. 135. 136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148.

4 4 4 4 4 4 4 4 5 5 5 5 5 5 5 5 5

E M E E M M E E E M M M M E H M M

169. 170. 171.

5 5 5

H E E

172. 2–5 E,M 173. 174. Note:

Short-Answer Essay 2 E 175. 2 M 177. 5 M 2 E 176. 3 E 178. 5 M E = Easy M = Medium H = Hard

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item

Type

Item

1. 2. 3. 4. 5.

TF TF TF TF TF

6. 7. 8. 52. 53.

TF TF TF MC MC

54. 55. 56. 57. 58.

9. 10. 11. 12. 13. 14. 15. 16. 17. 18.

TF TF TF TF TF TF TF TF TF TF

19. 20. 21. 22. 23. 24. 25. 69. 70. 71.

TF TF TF TF TF TF TF MC MC MC

72. 73. 74. 75. 76. 77. 78. 79. 80. 81.

26. 27. 28. 29. 30. 31.

TF TF TF TF TF TF

32. 33. 34. 35. 36. 37.

TF TF TF TF TF TF

105. 106. 107. 108. 109. 110.

38. 39. 40. 41. 42.

TF TF TF TF TF

43. 44. 45. 46. 123.

TF TF TF TF MC

124. 125. 126. 127. 128.

47. 48. 49. 50.

TF TF TF TF

51. 140. 141. 142.

TF MC MC MC

143. 144. 145. 146.

Note: TF = True-False MC = Multiple Choice

Type

Item

Type

Item Type

Study Objective 1 MC 59. MC 64. MC 60. MC 65. MC 61. MC 66. MC 62. MC 67. MC 63. MC 68. Study Objective 2 MC 82. MC 92. MC 83. MC 93. MC 84. MC 94. MC 85. MC 95. MC 86. MC 96. MC 87. MC 97. MC 88. MC 98. MC 89. MC 99. MC 90. MC 100. MC 91. MC 101. Study Objective 3 MC 111. MC 117. MC 112. MC 118. MC 113. MC 119. MC 114. MC 120. MC 115. MC 121. MC 116. MC 122. Study Objective 4 MC 129. MC 134. MC 130. MC 135. MC 131. MC 136. MC 132. MC 137. MC 133. MC 138. Study Objective 5 MC 147. MC 167. MC 148. MC 168. MC 165. Ex 169. MC 166. Ex 170. Ma = Matching Ex = Exercise

Item

Type

MC MC MC MC MC

149. 150. 151. 152. 153.

Ex Ex Ex Ex Ex

MC MC MC MC MC MC MC MC MC MC

102. 103. 104. 153. 154. 155. 156. 157. 158. 159.

MC MC MC Ex Ex Ex Ex Ex Ex Ex

MC MC MC MC MC MC

161. 163. 164. 165. 172. 176.

Ex Ex Ex Ex Ma SAE

MC MC MC MC MC

139. 162. 166. 172.

MC Ex Ex Ma

Ex Ex Ex Ex

171. 172. 177. 178.

Ex Ma SAE SAE

Item

Type

160. 161. 162. 172. 173. 174. 175.

Ex Ex Ex Ma SAE SAE SAE

SAE = Short-Answer Essay

The Accounting Information System

CHAPTER STUDY OBJECTIVES 1.

Analyze the effects of transactions on the accounting equation. Each business transaction has a dual effect on the accounting equation: assets = liabilities + shareholders’ equity. For example, if an individual asset is increased, there must be a corresponding decrease in another asset, or an increase in a specific liability, or an increase in shareholders’ equity.

Define debits and credits and explain how they are used to record transactions. The terms debit and credit mean the same thing as left and right, respectively. Assets, dividends, and expenses are increased by debits and decreased by credits. The normal balance of these accounts is a debit balance (the increase side). Liabilities, common shares, retained earnings, and revenues are increased by credits and decreased by debits. The normal balance of these accounts is a credit balance (the increase side).

Journalize transactions. The initial record of a transaction is entered in a general journal. The journal discloses in one place the complete effect of a transaction, provides a chronological record of transactions, and helps prevent or locate errors because the debit and credit amounts for each entry can be readily compared.

Post transactions. Posting is the process of transferring journal entries from the general journal to the general ledger. This accumulates the effects of the journalized transactions in the individual ledger accounts.

Prepare a trial balance. A trial balance is a list of accounts and their balances at a specific time. The main purpose of the trial balance is to prove the mathematical equality of debits and credits after posting. A trial balance also can help uncover errors in journalizing and posting and is useful in preparing financial statements.

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TRUE-FALSE STATEMENTS 1. Economic events that require recording in the accounting records are called accounting transactions.

2. Revenue is only recorded when cash is received.

3. Collection of an account receivable will increase total assets.

4. Cash received from a customer in advance of work being performed or goods provided is recorded as revenue.

5. If total assets are increased, there must be a corresponding increase in liabilities or an increase in shareholders’ equity.

6. An increase in the Dividends account will result in an increase in the Retained Earnings account.

7. Prepaid expenses are recorded as liabilities.

8. The payment of an account payable decreases total assets.

9. In its simplest form, a T account consists of three parts: (1) its title, (2) a left or credit side and (3) a right or debit side.

10. An individual accounting record for a specific asset, liability or shareholders’ equity item is called an account.

11. A debit increases an account and a credit decreases an account. 12. If a revenue account is credited, this must increase shareholders’ equity.

13. The normal balance of a liability account is a debit. 14. Debit and credit can be interpreted to mean “bad” and “good,” respectively.

The Accounting Information System

16. A decrease in a liability account is recorded by a debit.

17. An increase in an asset is recorded by a debit.

18. The double-entry system of accounting refers to the placement of a double line at the end of a column of figures.

19. The double-entry accounting system records the dual effect of each transaction.

20. The normal balance of an asset is a credit.

21. The normal balance of the Dividends account is a debit.

22. Assets are decreased with a credit.

23. An expense account is a subdivision of the retained earnings account and decreases shareholders’ equity. 24. Revenues are a subdivision of shareholders’ equity.

25. Under the double-entry system, revenues must always equal expenses.

26. The first step in the recording process is entering the transaction into the general journal.

27. Source documents can provide evidence that a transaction has occurred.

28. Each transaction must be analyzed in terms of its effect on the accounts before it can be recorded in a journal.

29. A simple journal entry affects two or more accounts.

30. A journal lists all the accounts maintained by a business.

31. The journal is a chronological record of all transactions.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

32. A journal is an accounting record in which transactions are initially recorded.

33. The complete effect of a transaction on the accounts is disclosed in the journal.

34. The account titles used in journalizing transactions need not be identical to the account titles in the ledger.

35. Entering transactions into the journal is called posting.

36. The account to be credited is entered first in a journal entry.

37. A compound journal entry affects more than two accounts.

38. Transactions are entered in the general ledger and then transferred to the general journal.

39. All transactions must be entered first in the general ledger.

40. The chart of accounts is a special ledger used in accounting systems.

41. A general ledger should be arranged in financial statement order beginning with the statement of financial position accounts.

42. The chart of accounts is the framework for the accounting database.

43. Prepaid expenses are reported as assets on the statement of financial position.

44. Unearned revenues are classified as assets on the statement of financial position.

45. Posting is the process of proving the equality of debits and credits in the trial balance.

46. A list of accounts and their account numbers is called the chart of accounts.

47. A trial balance lists all the debit balances first, then all the credit balances.

48. A trial balance can still balance even if an entry is posted to the wrong account. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

49. The main purpose of the trial balance is to check that debits equal credits.

50. If a journal entry is posted twice, this will be discovered by preparing a trial balance.

51. The retained earnings on the trial balance prepared immediately after posting represents the retained earnings at the beginning of the period.

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7. 8. 9.

Ans. T F F F T F F T F

Item 10. 11. 12. 13. 14. 15. 16. 17. 18.

Ans. T F T F F F T T F

Item 19. 20. 21. 22. 23. 24. 25. 26. 27.

Ans. T F T T T T F F T

Item 28. 29. 30. 31. 32. 33. 34. 35. 36.

Ans. T F F T T T F F F

Item 37. 38. 39. 40. 41. 42. 43. 44. 45.

Ans. T F F F T T T F F

Item 46. 47. 48. 49. 50. 51.

Ans. T F T T F T

The Accounting Information System

MULTIPLE CHOICE QUESTIONS 52. Shareholders’ equity is increased by (a) dividends. (b) revenues. (c) expenses (d) liabilities.

53. If total liabilities increased by $15,000, then (a) assets must have increased by $15,000. (b) only shareholders’ equity must have increased by $15,000. (c) assets must have increased by $15,000, or shareholders’ equity must have decreased by $15,000. (d) assets and shareholders’ equity must have both decreased by $15,000.

54. Collection of a $1,500 accounts receivable (a) increases an asset $1,500; decreases a liability $1,500. (b) decreases a liability $1,500; increases shareholders’ equity $1,500. (c) decreases an asset $1,500; decreases a liability $1,500. (d) has no effect on total assets.

55. If an individual asset is increased, then (a) there could be an equal decrease in a specific liability. (b) there could be an equal decrease in shareholders’ equity. (c) there could be an equal decrease in another asset. (d) none of these is possible.

56. If services are performed on credit, then (a) assets will decrease. (b) liabilities will increase. (c) shareholders’ equity will increase. (d) liabilities will decrease.

57. If expenses are paid in cash, then (a) assets will increase. (b) liabilities will decrease. (c) shareholders’ equity will increase. (d) assets will decrease.

58. Accounting systems should record (a) all economic events. (b) events that result in a change in assets, liabilities, or shareholders’ equity items. (c) only events that involve cash. (d) only events that include revenues, expenses, and cash. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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59. An investment by the shareholders in a company increases (a) assets and shareholders’ equity. (b) assets and liabilities. (c) liabilities and shareholders’ equity. (d) assets only.

60. The purchase of an asset for cash (a) increases assets and shareholders’ equity. (b) increases assets and liabilities. (c) decreases assets and increases liabilities. (d) has no effect on total assets.

61. The purchase of an asset on credit (a) increases assets and shareholders’ equity. (b) increases assets and liabilities. (c) decreases assets and increases liabilities. (d) has no effect on total assets.

62. The payment of a liability (a) decreases assets and shareholders’ equity. (b) increases assets and decreases liabilities. (c) decreases assets and increases liabilities. (d) decreases assets and liabilities.

63. Recording revenue (a) increases assets and liabilities. (b) increases assets and shareholders’ equity. (c) increases assets and decreases shareholders’ equity. (d) has no effect on total assets.

64. A paid dividend (a) decreases assets and shareholders’ equity. (b) increases assets and shareholders’ equity. (c) increases assets and decreases shareholders’ equity. (d) decreases assets and increases shareholders’ equity.

65. An expense (a) decreases assets and liabilities. (b) decreases shareholders’ equity. (c) has no effect on shareholders’ equity. (d) increases assets and decreases shareholder’ equity.

66. Which of the following items has no effect on retained earnings? (a) expenses Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

(b) dividends (c) revenues (d) hiring a new employee

67. A paid income tax instalment (a) increases assets and shareholders’ equity. (b) decreases assets and shareholders’ equity. (c) increases assets and decreases shareholders’ equity. (d) decreases assets and increases shareholders’ equity.

68. A payment of a portion of accounts payable will (a) not affect total assets. (b) increase liabilities. (c) not affect shareholders’ equity. (d) decrease profit.

69. The left side of a T account is the (a) credit side. (b) debit side. (c) description of the account. (d) balance of the account.

70. An individual accounting record of increases and decreases in a specific asset, liability, or shareholders’ equity item is called a(n) (a) single entry accounting system. (b) accounting transaction. (c) account. (d) normal balance.

71. The equality of debits and credits is the basis for (a) the double-entry accounting system. (b) the single-entry accounting system. (c) the T account. (d) all accounting systems.

72. The right side of an account is (a) always used to record increases. (b) the credit side. (c) the debit side. (d) always used to record decreases.

73. A T 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. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) a title, a right side, and a debit balance.

74. A T account is (a) a way of illustrating the basic form of an account. (b) a special account used to record only debits. (c) a special account used to record only credits. (d) the actual account form used in real accounting systems.

75. A credit to an asset account indicates a(n) (a) error. (b) credit was made to a liability account. (c) decrease in the asset. (d) increase in the asset.

76. The normal balance of any account is the (a) left side. (b) right side. (c) side which increases the account. (d) side which decreases the account.

77. The double-entry system requires that each transaction must be recorded (a) in at least two different accounts. (b) in a T account. (c) first as a revenue and then as an expense. (d) twice.

78. A credit is not the normal balance for (a) common shares. (b) revenues. (c) liabilities. (d) cash.

79. The classification and normal balance of an expense account is (a) revenue, credit. (b) asset, debit. (c) liability, credit. (d) shareholders’ equity, debit.

80. The classification and normal balance of the retained earnings account is (a) asset, debit. (b) shareholders’ equity, credit. (c) revenues, credit. (d) liability, debit.

The Accounting Information System

81. The classification and normal balance of the unearned revenue account is (a) asset, debit. (b) liability, credit. (c) revenues, credit. (d) shareholders’ equity, credit.

82. Which one of the following represents the expanded basic accounting equation? (a) Assets = Liabilities + Common Shares + Retained Earnings + Revenues – Expenses – Dividends. (b) Assets + Liabilities = Dividends + Expenses + Common Shares + Revenues. (c) Assets – Liabilities – Dividends = Common Shares + Revenues – Expenses. (d) Assets = Revenues + Expenses – Liabilities.

83. The best interpretation of the word credit is the (a) left side of an account. (b) increase side of an account. (c) right side of an account. (d) decrease side of an account.

84. In recording an accounting transaction in a double-entry system, (a) the number of accounts to be debited must equal the number of accounts to be credited. (b) there must always be entries made on both sides of the accounting equation. (c) the amount of the debits must equal the amount of the credits. (d) there must only be two accounts affected by any transaction.

85. A debit is not the normal balance for which account listed below? (a) Dividends (b) Cash (c) Accounts Receivable (d) Service Revenue

86. Which of the following correctly identifies the normal balances of accounts? (a) Assets Debit Liabilities Credit Common Shares Credit Revenues Debit Expenses Credit (b) Assets Debit Liabilities Credit Common Shares Credit Revenues Credit Expenses Credit (c) Assets Credit Liabilities Debit Common Shares Debit Revenues Credit Expenses Debit Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) Assets Liabilities Common Shares Revenues Expenses

Debit Credit Credit Credit Debit

87. An accountant has debited an asset account for $3,000 and credited a revenue account for $6,000. What can be done to complete the recording of the transaction? (a) Nothing further can be done. (b) Credit a shareholders’ equity account for $3,000. (c) Debit another asset account for $3,000. (d) Credit another asset account for $3,000.

88. An accountant has debited an asset account for $1,000 and credited an expense account for $2,000. Which of the following would be the correct way to complete the recording of the transaction? (a) Credit an asset account for $2,000. (b) Credit a liability account for $1,000. (c) Credit a shareholders’ equity account for $1,000. (d) Debit a shareholders’ equity account for $1,000.

89. Which of the following accounts is increased with a debit? (a) Dividends (b) Legal Fees Earned (c) Rent Payable (d) Common Shares

90. Which of the following accounts is increased with a credit? (a) Supplies Expense (b) Accounts Receivable (c) Sales (d) Dividends

91. Which pair of accounts follows the rules of debit and credit in the same manner? (a) Dividends Payable and Rent Expense (b) Repair and Maintenance Expense and Bank Loan Payable (c) Prepaid Insurance and Advertising Expense (d) Service Revenue and Accounts Receivable

92. Which of the following is not true of the terms debit and credit? (a) They can be abbreviated as Dr. and Cr. (b) They can be interpreted to mean increase and decrease. (c) They can be used to describe the balance of an account. (d) They can be interpreted to mean left and right.

The Accounting Information System

93. 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.

94. For the basic accounting equation to stay in balance, each transaction recorded must (a) affect two or fewer accounts. (b) affect two or more accounts. (c) always affect exactly two accounts. (d) affect the same number of asset and liability accounts.

95. Which of the following statements is true? (a) Debits increase assets and increase liabilities. (b) Credits decrease assets and decrease liabilities. (c) Credits decrease assets and increase liabilities. (d) Debits increase liabilities and decrease assets.

96. Assets normally show (a) credit balances. (b) debit balances. (c) debit and credit balances. (d) debit or credit balances.

97. A knowledge of the normal balances of accounts would help you spot which of the following as an error in recording? (a) a debit balance in the dividends 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

98. If a company has overdrawn its bank balance, then (a) the cash account will show a debit balance. (b) the cash account will show a credit balance. (c) the cash account debits will exceed the cash account credits. (d) this cannot be detected by observing the balance of the cash account. 99. Which account below is not a subdivision of shareholders’ equity? (a) Dividends (b) Revenues (c) Expenses (d) Liabilities

100. When a corporation pays a dividend, the (a) cash account will be increased with a debit. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) dividends account will be increased with a credit. (c) retained earnings account will be directly increased with a debit. (d) dividends account will be increased with a debit.

101. The dividends account (a) appears on the income statement along with the expenses of the business. (b) must show transactions every accounting period. (c) is increased with debits and decreased with credits. (d) is not a proper subdivision of shareholders’ equity.

102. Which of the following statements is not true? (a) Expenses increase shareholders’ equity. (b) Expenses have normal debit balances. (c) Expenses decrease shareholders’ equity. (d) Expenses are a negative factor in the calculation of profit.

103. 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) will always increase shareholders’ equity. (d) must be accompanied by a debit to an asset account.

104. In the first month of operations, the total of the debit entries to the cash account amounted to $1,900 and the total of the credit entries to the cash account amounted to $1,500. Therefore, at the end of the month, the cash account has a (a) $500 credit balance. (b) $900 debit balance. (c) $400 debit balance. (d) $400 credit balance.

105. The sequence of steps in the transaction recording process is (a) journal → analyze → ledger. (b) analyze → journal → ledger. (c) journal → ledger → analyze. (d) ledger → journal → analyze.

106. In recording accounting transactions, evidence that a transaction has taken place is obtained from (a) source documents. (b) the bank. (c) the public relations department. (d) the chart of accounts.

107. The first step in the recording process is to (a) prepare financial statements. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

(b) analyze the transaction in terms of its effect on the accounts. (c) post to a journal. (d) post to the ledger.

108. Evidence that would not help with determining the effects of a transaction on the accounts would be a(n) (a) cash register sales tape. (b) invoice. (c) advertising brochure. (d) cheque.

109. The usual sequence of steps in the recording process is to (a) analyze each transaction, enter the transaction in the journal, and transfer the information to the ledger accounts. (b) analyze each transaction, enter the transaction in the ledger, and transfer the information to the journal. (c) analyze each transaction, enter the transaction in the book of accounts, and transfer the information to the journal. (d) analyze each transaction, enter the transaction in the book of original entry, and transfer the information to the journal.

110. The recording process occurs (a) once a year. (b) once a month. (c) repeatedly during the accounting period. (d) Infrequently – usually every two or three months.

111. 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.

112. The basic format of a journal would not include a(n) (a) brief explanation. (b) account title column. (c) T account. (d) date column.

113. Transactions recorded in a journal are done in (a) account number order. (b) financial statement order. (c) alphabetical order. (d) chronological order.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

114. A journal is not useful for (a) recording in one place the complete effect of a transaction. (b) finding account balances. (c) providing a record of transactions. (d) locating and preventing errors.

115. 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.

116. The name given to entering transaction data in the journal is (a) transacting. (b) listing. (c) posting. (d) journalizing.

117. Which of the following journal entries is recorded correctly in the basic format (ignoring explanations)? (a) Salaries Expense ................................................................. 550 Cash.............................................................................. 1,500 Advertising Expense ............................................................ 950 (b) Salaries Expense ................................................................. 550 Advertising Expense ............................................................ 950 Cash .................................................................................... 1,500 (c) Salaries Expense ................................................................. 550 Advertising Expense ............................................................ 950 Cash.............................................................................. 1,500 (d) Cash.............................................................................. 1,500 Salaries Expense ................................................................. 550 Advertising Expense ............................................................ 950

118. When a company has performed a service but has not yet received payment, it (a) debits Accounts Receivable and credits Service Revenue. (b) debits Service Revenue and credits Accounts Receivable. (c) debits Service Revenue and credits Accounts Payable. (d) makes no entry until the cash is received.

119. A company that receives money in advance of performing a service (a) debits Cash and credits Prepaid Fees. (b) debits Unearned Revenue and credits Accounts Payable. (c) debits Cash and credits Unearned Revenue. (d) debits Cash and credits Accounts Receivable.

The Accounting Information System

120. When a company receives a utility bill but will not pay it right away, it should (a) debit Utilities Expense and credit Accounts Receivable. (b) debit Utilities Expense and credit Accounts Payable. (c) debit Accounts Payable and credit Utilities Expense. (d) make no entry until the bill is paid.

121. 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.

122. A $30,000 machine is purchased by paying $20,000 cash and signing a bank loan payable for the balance. The journal entry should include a (a) credit to Bank Loan Payable. (b) debit to Cash. (c) credit to Notes Receivable. (d) credit to Machinery.

123. After a business transaction has been analyzed and entered in the journal, the next step in the recording process is to transfer the information to (a) the company's bank. (b) shareholders’ equity. (c) ledger accounts. (d) financial statements.

124. After transaction information has been recorded in the journal, it is transferred to the (a) chart of accounts. (b) income statement. (c) book of original entry. (d) ledger.

125. The chart of accounts begins with (a) asset accounts. (b) liability accounts. (c) revenue accounts. (d) expense accounts.

126. The purpose of the ledger is to (a) record the day’s transactions in date order. (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 liabilities have normal balances at all times.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

127. Which of the following accounts probably would be listed before the others in a chart of accounts? (a) Buildings (b) Insurance expense (c) Dividends (d) Revenue from services

128. The Unearned revenue account is classified as a(n) (a) asset. (b) revenue. (c) expense. (d) liability.

129. Which of the following is an asset? (a) Service Revenue (b) Bank Loan Payable (c) Supplies Expense (d) Prepaid Rent

130. A person who wants to determine the balance of a particular account should refer to the (a) ledger. (b) source document. (c) chart of accounts. (d) journal.

131. The usual ordering of accounts in the general ledger is (a) assets, liabilities, shareholders’ equity, revenues, and expenses. (b) assets, liabilities, shareholders’ equity, expenses, and revenues. (c) liabilities, assets, shareholders’ equity, revenues, and expenses. (d) shareholders’ equity, assets, liabilities, expenses, and revenues.

132. Management could determine the amounts due from customers by examining which ledger account? (a) Service Revenue (b) Accounts Payable (c) Accounts Receivable (d) Supplies

133. The ledger accounts should be arranged in (a) date order. (b) alphabetical order. (c) financial statement order. (d) order of appearance in the journal.

134. The procedure of transferring journal entries to the ledger accounts is called Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

(a) journalizing. (b) analyzing. (c) reporting. (d) posting.

135. A chart of accounts (a) is a chart created in Excel. (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.

136. Which of the following guidelines should be applied when choosing an account name to be included in the chart of accounts? (a) Account names should identify the nature and content of each account. (b) Account names should be used consistently. (c) Account names should use titles and not explanations. (d) All of the above are correct.

137. The principal purpose of posting is to (a) help identify errors made in the journal. (b) accumulate the effects of journalized transactions in the individual accounts. (c) enter transactions directly into the general ledger. (d) help determine if the financial statements are ready to be prepared.

138. Posting is performed by transferring information from the (a) source documents to the journal. (b) ledger to the journal. (c) source documents to the ledger. (d) journal to the ledger.

139. Josephine Debit recently started work with New Beginnings Ltd. It is her first job and she doesn’t have a lot of accounting experience. When recording the sales for the day, she debited sales and credited cash. The entry is (a) correct. (b) an error. (c) an irregularity. (d) not necessary. 140. An accounting report that lists all assets, liabilities, and shareholders’ equity accounts and their balances at a specific date is called a (a) trial balance. (b) general journal. (c) general ledger. (d) chart of accounts.

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141. 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.

142. A trial balance is a listing of the (a) transactions in a journal. (b) chart of accounts. (c) general ledger accounts and balances. (d) totals from the journal pages.

143. Usually, 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 when the business is started.

144. A trial balance would only help in detecting which one of the following errors? (a) a transaction that is not journalized (b) a journal entry that is posted twice (c) offsetting errors made in recording the transaction (d) the debit side of a transaction is posted incorrectly to the ledger

145. A trial balance proves (a) the mathematical equality of debits and credits in the ledger. (b) the ledger is posted correctly. (c) that all transactions have been recorded correctly. (d) that all transactions have been posted.

146. If the totals of a trial balance are not equal, it could be due to (a) a failure to record or post a transaction. (b) recording the same incorrect amount for both the debit and the credit parts of a transaction. (c) an error in calculating the account balances. (d) recording the transaction more than once.

147. Which of the following errors, each considered individually, 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 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. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

148. The retained earnings on the trial balance prepared immediately after posting adjusting entries represents the (a) retained earnings at the end of the period. (b) retained earnings at the beginning of the period. (c) profit for the period. (d) total shareholders’ equity at the trial balance date.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65.

Ans. b c d c c d b a d b d b a b

Item 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79.

Ans. d b c b c a b c a c c a d d

Item 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93.

Ans. b b a c c d d c d a c c b a

Item Ans. Item Ans. b 108. c 94. c 109. a 95. b 110. c 96. b 111. d 97. b 112. c 98. d 113. d 99. d 114. b 100. c 115. b 101. a 116. d 102. a 117. c 103. c 118. a 104. b 119. c 105. a 120. b 106. b 121. d 107.

Item 122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135.

Ans. a c d a c a d d a a c c d c

Item 136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148.

Ans. d b d b a d c c d a c a b

The Accounting Information System

EXERCISES Ex. 149 Selected transactions for Markley Ltd. are listed below. Describe the effect of each transaction on assets, liabilities, and shareholders’ equity for the following independent transactions: Sample: Made initial cash investment in the business. Answer: Increase in assets and increase in shareholders’ equity. 1. Paid monthly utility bill. 2. Purchased new office furniture with cash. 3. Paid cash for repair work on security system. 4. Billed customers for services performed. 5. Received cash from customers billed in transaction 4. 6. Dividends paid to shareholders. 7. Incurred advertising expenses on account. 8. Paid monthly rent. 9. Received cash from customers at the time service was provided. 10. Paid monthly tax instalment. Solution 149 (5 min.) 1. Decrease in assets and decrease in shareholders’ equity. 2. No net change in assets. 3. Decrease in assets and decrease in shareholders’ equity. 4. Increase in assets and increase in shareholders’ equity. 5. No net change in assets. 6. Decrease in assets and decrease in shareholders’ equity. 7. Increase in liabilities and decrease in shareholders’ equity. 8. Decrease in assets and decrease in shareholders’ equity. 9. Increase in assets and increase in shareholders’ equity. 10. Decrease in assets and decrease in shareholders’ equity.

Ex. 150 Analyze the transactions of a business organized as a corporation 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. Shareholders’ Assets = Liabilities + Equity 1. Received cash for services provided. _______ ______ _______ Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

2. 3. 4.

Purchased office equipment on credit. Paid employees' salaries. Received cash from customer in payment of his account receivable. 5. Paid telephone bill for the month. 6. Paid for office equipment purchased in transaction 2. 7. Received cash from a customer for work to be done later. 8. Dividends were paid. 9. Obtained a loan from the bank. 10. Billed customers for services performed.

_______ _______

______ ______

_______ _______

______ ______

_______ _______

_______

______

_______

_______ _______ _______ _______

______ ______ ______ ______

_______ _______ _______ _______

Solution 150 (10 min.)

Received cash for services provided.

Assets +

Purchased office equipment on credit.

Paid employees' salaries.

–

Received cash from customer in payment of his account receivable.

+,–

Paid telephone bill for the month.

–

Paid for office equipment purchased in transaction 2.

–

Received cash from a customer for work to be done later.

Dividends were paid.

–

Obtained a loan from the bank.

10. Billed customers for services performed.

Liabilities

Shareholders’ Equity +

+ –

–

– + +

Ex. 151 Jim Cohen decides to open a courier business near the local university campus. Analyze the following transactions for the month of November in terms of their effect on the basic accounting equation. Record each transaction by increasing (+) or decreasing (–) the dollar amount of each item affected. 1. Jim Cohen invests $25,000 cash in exchange for common shares to start a courier business on November 1. 2. Purchased bicycles for $5,000 paying $3,000 in cash and the remainder due in 30 days. 3. Purchased courier bags for $1,200 cash. 4. Received a bill from Campus News for $300 for advertising in the campus newspaper. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

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5. Cash receipts from customers for courier sales amounted to $1,600. 6. Paid salaries of $300 to student workers. 7. Billed the Maple Leaf Football Team $100 for delivering banners. 8. Paid $300 to Campus News for advertising that was previously billed in Transaction 4. 9. Jim Cohen was paid dividends of $700. 10. Received a bill from City Electric for $200 for utilities for November. TransCash

Assets Accounts + Receivable +

Courier Bicycles + Bags =

Liabilities Accounts Payable

Common Shares

Shareholders’ Equity Retained Earnings + Revenue – Expenses - Dividends

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

—————————————————————————————————————————— Solution 151 (20 min.) TransCash

Assets Accounts +Receivable +

(1)

+$25,000

(2)

–$3,000

(3)

–$1,200

Courier Bicycles +Bags =

Liabilities Accounts Payable

Common Shares

Shareholders’ Equity Retained Earnings + Revenue – Expenses- Dividends

+$25,000 +$5,000

+$2,000

+$1,200

(4)

+$300

(5)

+$1,600

(6)

–$300

(7)

+$1,600 –$300 +$100

(8)

–$300

(9)

–$700

-$300

+$100 –$300 -$700

(10) +$200 –$200 —————————————————————————————————————————————————————————— Totals $21,100 $100 $5,000 $1,200 $2,200 $25,000 $1,700 -$800 -$700 ——————————————————————————————————————————————————————————

$27,400

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 152 Analyze 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. 1. Issued shares to investors for $15,000 cash. 2. Purchased supplies on credit for $1,000. 3. Billed customers $500 for services provided. 4. Paid for supplies purchased in transaction 2. 5. Paid dividends of $200 cash to shareholders. 6. Received half of the money from customers billed in transaction 3. 7. Received and paid utility bill for $50. TransCash

Assets Accounts +Receivable +

Supplies

Liabilities Accounts Payable

Common Shares

Shareholders’ Equity Retained Earnings + Revenue - Expenses - Dividends

(1) (2) (3) (4) (5) (6) (7) —————————————————————————————————————————————————————————— Totals ——————————————————————————————————————————————————————————

Solution 152 (15 min.) TransCash (1)

Assets Accounts +Receivable +

Supplies

Liabilities Accounts Payable

+$15,000

+$1,000

+$500

(4)

–$1,000

(5)

–$200

(6)

+$250

Shareholders’ Equity Retained Earnings + Revenue – Expenses- Dividends

+$15,000

(2)

(3)

Common Shares

+$500

–$1,000

- $200

–$250

(7) –$50 -$50 —————————————————————————————————————————————————————————— Totals $14,000 $250 $1,000 $0 $15,000 $500 -$50 -$200 ——————————————————————————————————————————————————————————

The Accounting Information System

$15,250

Ex. 153 For each of the following: (a) Identify what type of account it is (Asset, Liability, Shareholders’ Equity, Revenue, or Expense); and (b) its normal balance (debit or credit). 1. 2. 3. 4. 5. 6. 7. 8. 9.

Supplies Interest Payable Service Revenue Accounts Payable Salaries Expense Common Shares Accounts Receivable Unearned Revenue Income Tax Expense

Solution 153 (10 min.)

(a) Type of Account Supplies .............................................. Asset

(b) Normal Balance Dr.

Interest Payable ..................................

Liability

Cr.

Service Revenue .................................

Revenue

Cr.

Accounts Payable................................

Liability

Cr.

Salaries Expense ................................

Expense

Dr.

Common Shares .................................

Shareholders’ Equity

Cr.

Accounts Receivable ...........................

Asset

Dr.

Unearned Revenue .............................

Liability

Cr.

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

Expense

Dr.

Ex. 154 For each item below, indicate whether the account will be debited or credited: 1. Decrease in Accounts Payable 2. Increase in Dividends 3. Increase in Common Shares 4. Increase in Unearned Revenue 5. Decrease in Interest Payable 6. Increase in Prepaid Insurance Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

7. Decrease in Salaries Expense 8. Decrease in Supplies 9. Increase in Revenues 10. Decrease in Accounts Receivable Solution 154 (5 min.) 1. Decrease in Accounts Payable

Dr.

Increase in Dividends

Dr.

Increase in Common Shares

Cr.

Increase in Unearned Revenue

Cr.

Decrease in Interest Payable

Dr.

Increase in Prepaid Insurance

Dr.

Decrease in Salaries Expense

Cr.

Decrease in Supplies

Cr.

Increase in Revenues

Cr.

10. Decrease in Accounts Receivable

Cr.

Ex. 155 For each item below, indicate whether the account will be debited or credited: 1. Decrease in Prepaid Rent 2. Decrease in Revenues 3. Decrease in Unearned Revenues 4. Decrease in Dividends 5. Decrease in Interest Receivable 6. Increase in Salaries Payable 7. Increase in Supplies 8. Increase in Salaries Expense 9. Increase in Accounts Receivable Solution 155 (5 min.) 1. Decrease in Prepaid Rent

Cr.

Decrease in Revenues

Dr.

Decrease in Unearned Revenues

Dr.

Decrease in Dividends

Cr.

Decrease in Interest Receivable

Cr.

The Accounting Information System

Increase in Salaries Payable

Cr.

Increase in Supplies

Dr.

Increase in Salaries Expense

Dr.

Increase in Accounts Receivable

Dr.

Ex. 156 For each item below, indicate whether the account will be debited or credited: 1. Increase in Salary Expense 2. Decrease in Accounts Payable 3. Increase in Prepaid Insurance 4 Increase in Common Shares 5. Decrease in Office Supplies 6. Increase in Dividends 7. Increase in Service Revenue 8. Decrease in Accounts Receivable 9. Increase in Rent Expense 10. Decrease in Store Equipment Solution 156 (5 min.) 1. Increase in Salary Expense

Dr.

Decrease in Accounts Payable

Dr.

Increase in Prepaid Insurance

Dr.

Increase in Common Shares

Cr.

Decrease in Office Supplies

Cr.

Increase in Dividends

Dr.

Increase in Service Revenue

Cr.

Decrease in Accounts Receivable

Cr.

Increase in Rent Expense

Dr.

10. Decrease in Store Equipment

Cr.

Ex. 157 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 ________________ Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

3. Accounts Receivable 4. Accounts Payable 5. Common Shares 6. Office Supplies 7. Insurance Expense 8. Dividends 9. Office Building 10. Bank Loan Payable

________________ ________________ ________________ ________________ ________________ ________________ ________________ ________________

Solution 157 (5 min.) Normal Balance Debit or Credit Credit

Accounts Service Revenue

Rent Expense

Debit

Accounts Receivable

Debit

Accounts Payable

Credit

Common Shares

Credit

Office Supplies

Debit

Insurance Expense

Debit

Dividends

Debit

Office Building

Debit

10. Bank Loan Payable

Credit

Ex. 158 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. Advertising Expense 6. Dividends 2. Service Revenue 7. Cash 3. Accounts Payable 8. Salaries Expense 4. Accounts Receivable 9. Bank Loan Payable 5. Common Shares 10. Insurance Expense Solution 158 (5 min.) 1. (a) 2.

(b)

(c)

The Accounting Information System

(c)

(b)

(a)

(c)

(a)

(c)

10. (a)

Ex. 159 Eight transactions are recorded in the following T accounts: CASH 1. 7.

35,000 22,500

2. 3. 4. 6. 8.

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

SUPPLIES 3.

COMMON SHARES

8,000

22,500

13,500 SERVICE REVENUE

35,000

ACCOUNTS PAYABLE 6.

EQUIPMENT

1,950

27,500

DIVIDENDS 10,000

4,500

SALARIES EXPENSE 4.

2,225

Indicate for each debit and each credit: (a) whether an asset, liability, common shares, 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, in which the first one has been done for you as an example: Account Debited Account Credited Transaction No. Type Effect Type Effect —————————————————————————————————————————— 1. Asset + Common Shares + —————————————————————————————————————————— 2. —————————————————————————————————————————— 3. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

—————————————————————————————————————————— 4. —————————————————————————————————————————— 5. —————————————————————————————————————————— 6. —————————————————————————————————————————— 7. —————————————————————————————————————————— 8.

Solution 159 (15 min.) Account Debited Account Credited Transaction No. Type Effect Type Effect ___________________________________________________________________________ 1. (Example) Asset + Common Shares + ___________________________________________________________________________ 2. Asset + Asset – Liability + ___________________________________________________________________________ 3. Asset + Asset – ___________________________________________________________________________ 4. Expense + Asset – ___________________________________________________________________________ 5. Asset + Revenue + ___________________________________________________________________________ 6. Liability – Asset – ___________________________________________________________________________ 7. Asset + Asset – ___________________________________________________________________________ 8. Dividends + Asset –

Ex. 160 For each of the following accounts indicate (a) the type of account (Asset, Liability, Shareholders’ 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 Common Shares Dividends

5. 6. 7. 8.

Service Revenue Insurance Expense Bank Loan Payable Equipment

The Accounting Information System

(a) Liability Account. (b) Debit decreases, credit increases. (c) Normal balance - credit.

(a) Revenue Account. (b) Debit decreases, credit increases. (c) Normal balance - credit.

(a) Asset Account. (b) Debit increases, credit decreases. (c) Normal balance - debit.

(a) Expense Account. (b) Debit increases, credit decreases. (c) Normal balance - debit.

(a) Shareholders’ Equity Account. (b) Debit decreases, credit increases. (c) Normal balance - credit.

(a) Liability Account. (b) Debit decreases, credit increases. (c) Normal balance - credit.

(a) Shareholders’ Equity Account. (b) Debit increases, credit decreases. (c) Normal balance - debit.

(a) Asset Account. (b) Debit increases, credit decreases. (c) Normal balance - debit.

Ex. 161 Now that you are taking an accounting course, your brother decided to ask you to help him with his own finances. He has kept his receipts, automated teller machine (ATM) slips, and other information for the last week and is ready for you to record the information. 1. Pay stub from his part time job showing net pay of $249.98 and ATM slip showing deposit of $249.98. 2. Receipts from grocery store for $45.89 and $15.32. 3. Receipt from video store for $3.44. 4. Notice from the bank that the $5,500 loan he applied for has been deposited to his account. 5. Receipt for the purchase of his car for $6,000. 6. Receipt from the garage for maintenance for $450.00. 7. Receipt from JapanTown Restaurant for $12.45. 8. Notice of overdue books from the library—the fine is $5.00. 9. Receipt from the coffee shop for $4.55. 10. Notice that there is a package for him at the post office. Instructions (a) Prepare a list of accounts that you will require and indicate whether each account is a(n) Asset (A), Liability (L), Revenue (R) or Expense (E). (b) Prepare journal entries to record the above transactions, identifying them by number. Use cents in your answer. You may omit explanations. Solution 161 (15 min.) (a) List of accounts: Cash (A) Food/Groceries Expense (E) Entertainment Expense (E) Car Maintenance Expense (E) Miscellaneous Expense (E) Car (A) Bank Loan Payable (L) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Account Payable (L) Employment Income (R) Note: Account names may have different titles. (b) Journal Entries 1. Cash ............................................................................................. Employment Income...............................................................

249.98

Food/Groceries Expense ($45.89 + $15.32) .................................. Cash.......................................................................................

61.21

Entertainment Expense ................................................................. Cash.......................................................................................

3.44

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

5,500.00

Car ................................................................................................ Cash.......................................................................................

6,000.00

Car Maintenance Expense ............................................................ Cash.......................................................................................

450.00

Food/Groceries (or Entertainment) Expense ................................. Cash.......................................................................................

12.45

Miscellaneous Expense................................................................. Accounts Payable...................................................................

5.00

Entertainment Expense ................................................................. Cash.......................................................................................

4.55

249.98

61.21

3.44

5,500.00

6,000.00

450.00

12.45

5.00

4.55

10.No entry.

Ex. 162 The chart of accounts used by Speedi-Copy Corporation is listed below. You are to indicate the proper accounts to be debited and credited for the following transactions by writing the account number(s) in the appropriate boxes. CHART OF ACCOUNTS 100 120 150 170 180 220 250

Cash Accounts Receivable Paper Supplies Prepaid Insurance Copy Machines Accounts Payable Bank Loan Payable

280 300 350 370 400 510 530

Unearned Revenue Common Shares Retained Earnings Dividends Photocopy Revenue Advertising Expense Rent Expense Number(s)

Number(s)

The Accounting Information System

of account(s) debited

of account(s) credited

Shareholders invested $100,000 cash to start the corporation. —————————————————————————————————————————— 2. Purchased three photocopy machines for $150,000, paying $50,000 cash and signing a 5-year, 6% bank loan for the remainder. —————————————————————————————————————————— 3. Purchased $5,000 paper supplies on credit. —————————————————————————————————————————— 4. Cash photocopy revenue received was $20,000. —————————————————————————————————————————— 5. Paid $500 cash for radio advertising. —————————————————————————————————————————— 6. Paid $1,000 on account for paper supplies purchased in transaction 3. —————————————————————————————————————————— 7. Paid a $500 cash dividend to shareholders. —————————————————————————————————————————— 8. Paid $2,500 cash for rent for the current month. —————————————————————————————————————————— 9. Received $2,000 cash advance from a customer for future copying. —————————————————————————————————————————— 10. Billed a customer for $1,000 for photocopy work done. —————————————————————————————————————————— 11. Paid $1,200 for a one year insurance policy. —————————————————————————————————————————— 12. Hired four employees to begin work in one month. Weekly salary is $500 per week. Solution 162 (15 min.) Number(s) of account(s) debited

Number(s) of account(s) credited

Shareholders invested $100,000 cash to start the corporation. 100 300 —————————————————————————————————————————— 2. Purchased three photocopy machines for $150,000, paying $50,000 cash and signing a 5-year, 6% bank loan for the remainder. 180 100, 250 —————————————————————————————————————————— 3. Purchased $5,000 paper supplies on credit. 150 220 —————————————————————————————————————————— 4. Cash photocopy revenue received was $20,000. 100 400 —————————————————————————————————————————— 5. Paid $500 cash for radio advertising. 510 100 —————————————————————————————————————————— 6. Paid $1,000 on account for paper supplies purchased in transaction 3. 220 100 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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—————————————————————————————————————————— 7. Paid a $500 cash dividend to shareholders. 370 100 —————————————————————————————————————————— 8. Paid $2,500 cash for rent for the current month. 530 100 —————————————————————————————————————————— 9. Received $2,000 cash advance from a customer for future copying. 100 280 —————————————————————————————————————————— 10. Billed a customer for $1,000 for photocopy work done. 120 400 —————————————————————————————————————————— 11. Paid $1,200 for a one year insurance policy. 170 100 —————————————————————————————————————————— 12. Hired four employees to begin work in one month. Weekly salary is $500 per week. no entry no entry

Ex. 163 Journalize the following business transactions in general journal form. Identify each transaction by number. You may omit explanations. 1. Invested $25,000 in exchange for common shares of the corporation. 2. Hired an employee to be paid $400 per week, starting tomorrow. 3. Paid six months’ rent in advance, $6,000. 4. Paid the worker’s weekly salary. 5. Recorded service revenue earned and received for the week, $1,750. Solution 163 (8 min.) 1. Cash ...................................................................................................... Common Shares ..........................................................................

25,000 25,000

No entry

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

6,000

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

400

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

1,750

6,000

400

1,750

Ex. 164 Journalize the following business transactions in general journal form. Identify each transaction by number. You may omit explanations. 1. Received $50,000 from shareholders in payment for common shares issued. 2. Purchased equipment for $90,000, paying $30,000 in cash and signing a bank loan for the balance. 3. Paid $1,200 for a one-year insurance policy. 4. Recorded $25,000 for services provided on account. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

5. 6. 7. 8.

Paid salaries of $6,500. Received $15,000 in cash for services provided. Collected $4,000 from customers on account. Received $2,000 from a new customer for services to be provided next month.

Solution 164 (8 min.) 1. Cash ..................................................................................................... Common Shares ..........................................................................

50,000

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

90,000

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

1,200

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

25,000

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

6,500

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

15,000

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

4,000

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

2,000

50,000

30,000 60,000

1,200

25,000

6,500

15,000

4,000

2,000

Ex. 165 You have been hired as the accountant for a newly formed real estate company called Antsy Real Estate Limited. The following business transactions occurred during the month of September, 2015: 1. Shareholders invested $35,000 in cash for 35,000 common shares to start the corporation. 2. Signed a lease for office space, at $9,500 per year for five years. 3. Paid $250 cash for office supplies. 4. Purchased office equipment for $12,000, paying $7,000 in cash and signing a 30-day bank loan payable for the balance. 5. Purchased $200 of office supplies on account. 6. Real estate commissions billed to clients totalled $9,700. 7. Paid $700 cash for the current month's rent. 8. Paid $100 cash on account for office supplies purchased in transaction 5. 9. Received a bill for $500 for advertising for the current month. 10. Paid $3,500 cash for office salaries. 11. Paid $1,000 cash dividends to shareholders. 12. Received a cheque for $5,000 from a client in payment on account for commissions billed in transaction 6. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Instructions (a) Record the transactions for September, 2015. You may omit explanations. (b) Prepare a trial balance. Solution 165 (15 min.) (a) 1. Cash ............................................................................................. Common Shares ....................................................................

50,000 50,000

No entry (not a transaction)

Office Supplies .............................................................................. Cash.......................................................................................

400

Office Equipment........................................................................... Cash....................................................................................... Bank Loan Payable ................................................................

12,000

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

200

Accounts Receivable ..................................................................... Real Estate Commission Revenue .........................................

9,700

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

700

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

100

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

500

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

3,500

11. Dividends ...................................................................................... Cash.......................................................................................

1,000

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

5,000

400

5,000 7,000

200

9,700

700

100

500

3,500

1,000

5,000

(b) ACTION REAL ESTATE LIMITED Trial Balance September 30, 2015 —————————————————————————————————————————— Cash Accounts Receivable

Debit $44,300 4,700

Credit

The Accounting Information System

Office Supplies Office Equipment Accounts Payable Bank Loan Payable Common Shares Dividends Real Estate Commission Revenue Rent Expense Advertising Expense Salaries Expense Totals

600 12,000 $

600 7,000 50,000

1,000 9,700 700 500 3,500 $67,300

$67,300

Ex. 166 The transactions of Emerald Delivery Limited are recorded in the general journal below. You are to post the journal entries to the accounts in the general ledger (use T accounts). After all entries have been posted, you are to prepare a trial balance at September 30, 2015. General Journal —————————————————————————————————————————— Date Account Titles and Explanation Debit Credit 2015 Sep 1 Cash ................................................................................ 15,000 Common Shares ....................................................... 15,000 (Shareholders invested cash in business) 4

Delivery Trucks ................................................................ 30,000 Cash ......................................................................... Bank Loan Payable................................................... (Paid cash and issued 2-year, 9% bank loan for balance)

10,000 20,000

Rent Expense .................................................................. Cash ......................................................................... (Paid September rent)

1,000 1,000

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

400

Cash ................................................................................ Service Revenue ...................................................... (Received cash for delivery services)

2,500

Salaries Expense............................................................. Cash ......................................................................... (Paid salaries for current period)

500

Utility Expense ................................................................. Accounts Payable ..................................................... (Received a bill for September utilities)

100

Dividends ........................................................................

750

400

2,500

500

100

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Cash ......................................................................... (Paid dividends)

750

Accounts Receivable ....................................................... 1,000 Service Revenue ...................................................... 1,000 (Billed customer for delivery service) —————————————————————————————————————————— Solution 166 (25 min.) General Ledger Cash 9/1 9/18

15,000 2,500

9/30 Bal.

4,850

Accounts Receivable 9/4 9/8 9/15 9/20 9/30

10,000 1,000 400 500 750

9/30

1,000

9/30 Bal.

1,000

Prepaid Insurance 9/15 9/30 Bal.

Delivery Trucks

400 400

9/4 9/30 Bal.

Accounts Payable 9/25 9/30 Bal.

30,000 30,000

Bank Loan Payable 100 100

9/4 9/30 Bal.

Common Shares

Dividends

9/1 9/30 Bal.

15,000 15,000

9/30 9/30 Bal.

750 750

Service Revenue

Rent Expense

9/18 9/30 9/30 Bal.

2,500 1,000 3,500

9/8

1,000

9/30 Bal.

1,000

Salaries Expense 9/20 9/30 Bal.

500 500

20,000 20,000

Utility Expense 9/25 9/30 Bal.

100 100

The Accounting Information System

—————————————————————————————————————————— Cash .................................................................................................... Accounts Receivable............................................................................ Prepaid Insurance ................................................................................ Delivery Trucks .................................................................................... Accounts Payable ................................................................................ Bank Loan Payable .............................................................................. Common Shares .................................................................................. Dividends ............................................................................................. Service Revenue.................................................................................. Rent Expense ...................................................................................... Salaries Expense ................................................................................. Utility Expense .................................................................................... Totals ..........................................................................................

Debit $ 4,850 1,000 400 30,000

Credit

100 20,000 15,000

750 3,500 1,000 500 100 $38,600

0000000 $38,600

Ex. 167 The trial balance of Winotte Limited shown below does not balance. WINOTTE LIMITED Trial Balance July 31, 2015 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 1,600 Accounts Receivable............................................................................ 6,600 Supplies ............................................................................................... 600 Equipment............................................................................................ 8,300 Accounts Payable ................................................................................ $ 9,766 Common Shares .................................................................................. 1,941 Dividends ............................................................................................. 1,500 Service Revenue.................................................................................. 15,200 Salaries Expense ................................................................................. 3,800 Repair Expense ................................................................................... 1,600 Income Tax Expense ........................................................................... 2,000 Totals .......................................................................................... $26,000 $26,907 An examination of the ledger and journal reveals the following: 1. Each of the above listed accounts has a normal balance. 2. Cash of $350 received from a customer on account was debited to Cash as $530 and credited to Accounts Receivable as $530. 3. Dividends of $300 paid to shareholders were posted as a credit to Dividends of $300 and a credit to Cash of $300. 4. Salaries Expense was posted as $3,800 rather than the correct amount of $4,100 to the general ledger. 5. The purchase of equipment on account for $700 was recorded as a debit to Repair Expense and a credit to Accounts Payable. 6. Services were performed on account for a customer for $510. Accounts Receivable was debited $510 and Service Revenue was credited $51. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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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. Solution 167 (25 min.) WINOTTE LIMITED Trial Balance July 31, 2015 —————————————————————————————————————————— Debit Credit Cash [$1,600 – $180 (2)] ..................................................................... $ 1,420 Accounts Receivable [$6,600 + $180 (2)]............................................. 6,780 Supplies ............................................................................................... 600 Equipment [$8,300 + $700 (5)] ............................................................. 9,000 Accounts Payable [$9,766 – $251– $215 (7)] ....................................... $ 9,300 Common Shares .................................................................................. 1,941 Dividends [$1,500 + $300 + $300 (3)] .................................................. 2,100 Service Revenue [$15,200 + $459 (6)] ................................................. 15,659 Salaries Expense (4) ............................................................................ 4,100 Repair Expense [$1,600 – $700 (5)]..................................................... 900 Income Tax Expense ........................................................................... 2,000 000 000 Totals............................................................................................ $26,900 $26,900

Ex. 168 Some of the following errors could 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 so, 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. 2. A $480 payment for a printer was recorded by a debit to Computer Equipment of $48 and a credit to Cash of $48. 3. An account receivable in the amount of $2,000 was collected in full. The collection was recorded by a debit to Cash of $2,000 and a debit to Accounts Payable of $2,000. 4. 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. Solution 168 (5 min.) 1. The trial balance totals will be unequal. The credit column will be $540 higher than the debit column. 2.

The trial balance totals will be misstated but not unequal.

The trial balance totals will be unequal. The debit column will be $4,000 higher than the credit column.

The trial balance totals will be misstated but not unequal.

The Accounting Information System

Ex. 169 Some of the following errors could 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 so, 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 journalized 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 $3,500 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. Solution 169 1. The trial balance totals will be misstated but not unequal. 2.

The trial balance totals will be misstated but not unequal.

The trial balance totals will be unequal. The debit column will be $90 higher than the credit column.

Ex. 170 Archer Corporation is a financial planning service. The account balances at December 31, 2015 are shown below, in alphabetical order: Accounts Payable ............................................................. $ 4,000 Accounts Receivable......................................................... 18,000 Automobiles ...................................................................... 27,500 Bank Loan Payable ........................................................... 95,000 Building ............................................................................. 120,000 Cash ................................................................................. 18,500 Common Shares ............................................................... 149,700 Computer .......................................................................... 22,000 Computer Software ........................................................... 4,200 Land.................................................................................. 42,000 Notes Receivable .............................................................. 8,100 Office Furniture ................................................................. 15,400 Office Supplies .................................................................. 800 Retained Earnings ............................................................ 30,000 Technical Library............................................................... 2,200 Instructions Prepare a trial balance with the accounts arranged in the correct financial statement order. Include the appropriate heading. Assume all accounts have a normal balance. Solution 170 (10 min.) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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ARCHER CORPORATION Trial Balance December 31, 2015 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 18,500 Accounts Receivable............................................................................ 18,000 Office Supplies ..................................................................................... 800 Notes Receivable ................................................................................. 8,100 Computer ............................................................................................. 22,000 Computer Software .............................................................................. 4,200 Technical Library.................................................................................. 2,200 Office Furniture .................................................................................... 15,400 Automobiles ......................................................................................... 27,500 Building ................................................................................................ 120,000 Land..................................................................................................... 42,000 Accounts Payable ................................................................................ $ 4,000 Bank Loan Payable .............................................................................. 95,000 Common Shares .................................................................................. 149,700 Retained Earnings .............................................................................. 30,000 Totals .......................................................................................... $278,700 $278,700

Ex. 171 The ledger accounts of the Basin Street Gym Limited at August 31, 2015 are shown below, in alphabetical order: Accounts Payable ............................................................. Accounts Receivable......................................................... Bank Loan Payable ........................................................... Building ............................................................................. Cash ................................................................................. Common Shares ............................................................... Dividends .......................................................................... Exercise Equipment .......................................................... Membership Fees Revenue .............................................. Miscellaneous Expenses................................................... Office Equipment .............................................................. Office Supplies .................................................................. Rent .................................................................................. Retained Earnings ............................................................ Weight Equipment.............................................................

$ 5,200 1,050 25,000 62,500 9,800 53,100 2,500 21,900 2,000 1,500 2,000 250 1,500 39,700 22,000

Instructions Prepare a trial balance with the ledger accounts arranged in the correct financial statement order. Include the appropriate heading. Assume all accounts have a normal balance. Solution 171 (10 min.) BASIN STREET GYM LIMITED Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

The Accounting Information System

Trial Balance August 31, 2015 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 9,800 Accounts Receivable............................................................................ 1,050 Office Supplies ..................................................................................... 250 Office Equipment ................................................................................. 2,000 Exercise Equipment ............................................................................. 21,900 Weight Equipment................................................................................ 22,000 Building ................................................................................................ 62,500 Accounts Payable ................................................................................ $ 5,200 Bank Loan Payable .............................................................................. 25,000 Common Shares .................................................................................. 53,100 Dividends ............................................................................................. 2,500 Retained Earnings ............................................................................... 39,700 Membership Fees Revenue ................................................................. 2,000 Rent ..................................................................................................... 1,500 Miscellaneous Expenses...................................................................... 1,500 0 000000 Totals .......................................................................................... $125,000 $125,000

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MATCHING 172. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

____ ____ ____ ____ ____

Account Normal balance Debit Revenue account Ledger

1. 2. 3. 4. 5.

____ 6. ____ 7. ____ 8. ____ 9. ____ 10.

F. G. H. I. J.

Journal Posting Chart of accounts Trial balance Source document

The entire group of accounts maintained by a company. Transferring journal entries to ledger accounts. The side which increases an account. A list of all the accounts used by a company. An accounting record of increases and decreases in specific assets, liabilities, and shareholders’ equity items. Left side of an account. Evidence that a transaction has taken place. Shows the debit and credit effects of specific transactions. A list of accounts and their balances at a given time. An account with a normal credit balance.

The Accounting Information System

ANSWERS TO MATCHING 1.

10. D

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SHORT-ANSWER ESSAY QUESTIONS S-A E 173 An account is an important accounting record where financial 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. Solution 173 An account is an individual accounting record of increases and decreases in specific asset, liability, and shareholders’ equity accounts. In its simplest form, an 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, shareholders’ equity, revenue, and expense. Accounts with a normal debit balance, such as assets, dividends, and expenses, are increased when debited and decreased when credited. Accounts with a normal credit balance, such as liabilities, shareholders’ equity, and revenues, are increased when credited and decreased when debited.

S-A E 174 Your friend Sheila Student is puzzled about these debits and credits you are both studying in accounting class. “I always thought that debits were bad and credits were good,” she says. “After all, if the bank debits my account, this reduces it, which to my mind is bad, but if they credit it, this increases it, which is good. But according to our accounting instructor, they just mean left and right sides of an account. Can you explain this to me?” Instructions Explain what debits and credits are to your friend. Solution 174 Sheila is correct in that, in accounting, “debit” means “left,” and “credit” means “right.” However they are merely directional signals used when recording transactions. So if you enter a number on the left side of an account, you are debiting it, and if you enter a number on the right side, you are crediting the account. This does not mean “good” or “bad,” or even that a credit increases and a debit decreases. Whether a credit increases (or decreases) the account depends on what type of account you are dealing with.

S-AE 175 The Dividends account is increased by a debit, and reduces Retained Earnings. Yet, dividends are not reported as an expense on the income statement. Explain why dividends are not reported on the income statement, and indicate where dividends are reported on the financial statements. Solution 175 Dividends are not an expense because they are not incurred for the purpose of generating revenue. Consequently, they should not be matched against revenues on the income statement. Dividends are distributions of retained earnings to shareholders. They are reported on the statement of changes in equity, separately from profit.

The Accounting Information System

Holly Hayweather started her own gardening business a year ago. She knows you are taking an accounting course so you get into a conversation about the details of accounting for transactions. She tells you that because her business is so small she doesn't use a journal but just posts directly to the general ledger. She goes on to say that she doesn't bother with revenue and expense accounts but just records these items in the retained earnings account because that is where they really belong anyway. Instructions Comment on Holly’s method of recording information. Include in your response the reasons for, and benefits of, using journals and revenue and expense accounts. Solution 176 Even though Holly’s business is small, using a journal is a good idea. It will make recording easier—both sides of a transaction will be shown together and it will be easier to find any errors. Holly needs to use revenue and expense accounts so that she will be able to prepare an income statement. She is right that the net amount (profit) will go to retained earnings, but by recording it there initially she does not capture information in a way that is useful and provides information necessary to evaluate the business. If she records everything in the retained earnings account, it will be a lot of work to go back and determine the amount of revenue and expenses. She will need the information on revenue and expenses to help manage her business.

S-A E 177 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 ensure that the ledger accounts are correct? Explain. Solution 177 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) totalling 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 in the ledger. A trial balance may also uncover errors in journalizing and posting because some errors in journalizing and posting cause a trial balance to be out of 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 journalized, (2) a correct journal entry is not posted, (3) a journal entry is posted twice, (4) incorrect accounts are used in journalizing or posting, or (5) offsetting errors are made in recording the amount of a transaction or posting to the ledger.

S-A E 178 The following trial balance was obtained from Cloverdale Ltd.'s computer system at the end of the first month of operations, November 30, 2015. RPT DPT PRIORITY RUN BY SEQUENCE ACCOUNT

TR BAL ACC MGR 2 R.HAMES 997411 BAL

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CASH SUPPLIES ACC PAY BANK LOAN PAY COMMON SHARES DIVIDENDS SERVICE REVENUE SALARIES EXP RENT EXP OTHER EXP BAL

17700 5600 7500– 1200– 5000– 500 15000– 3500 900 500 0***TR BAL IS IN BALANCE***

Instructions (a) What features make this report difficult to read? (b) Prepare a trial balance in the format shown in the chapter. Solution 178 (a) The trial balance is difficult to read because 1. The title is not explanatory, 2. Account abbreviations are used, 3. The numbers are not shown in standard currency format, 4. Debits and credits are not separately shown, but are indicated by a "–" for credits, 5. Extraneous information is provided. (b)

CLOVERDALE LTD. Trial Balance November 30, 2015 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $17,700 Supplies ............................................................................................... 5,600 Accounts Payable ................................................................................ $ 7,500 Bank Loan Payable .............................................................................. 1,200 Common Shares .................................................................................. 5,000 Dividends ............................................................................................. 500 Service Revenue.................................................................................. 15,000 Salaries Expense ................................................................................. 3,500 Rent Expense ...................................................................................... 900 Other Expenses ................................................................................... 500 _______ Totals .......................................................................................... $28,700 $28,700

CHAPTER 4 ACCRUAL ACCOUNTING CONCEPTS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item SO LOD 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

1 1 1 1 1 1 1 1 1 1 2

E E M M E E E E E M E

52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69.

1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2

E E E E E M M M M M H H H M M M M M

Note:

E = Easy

Item SO LOD Item SO LOD Item SO LOD True-False Statements 12. 2 E 23. 2 M 34. 3 E 13. 2 E 24. 2 M 35. 3 M 14. 2 M 25. 2 M 36. 3 H 15. 2 M 26. 2 E 37. 3 M 16. 2 E 27. 2 M 38. 3 M 17. 2 M 28. 2 M 39. 4 E 18. 2 M 29. 2 M 40. 4 M 19. 2 M 30. 2 M 41. 4 M 20. 2 M 31. 2 M 42. 5 M 21. 2 M 32. 2 M 43. 5 E 22. 2 E 33. 2 M 44. 5 E Multiple Choice Questions 70. 2 M 88. 2 M 106. 2 M 71. 2 H 89. 2 E 107. 2 H 72. 2 H 90. 2 E 108. 2 M 73. 2 E 91. 2 M 109. 2 M 74. 2 H 92. 2 M 110. 2 M 75. 2 M 93. 2 M 111. 2 M 76. 2 M 94. 2 E 112. 2 M 77. 2 E 95. 2 H 113. 3 H 78. 2 M 96. 2 H 114. 3 H 79. 2 H 97. 2 M 115. 3 H 80. 2 H 98. 2 M 116. 3 M 81. 2 H 99. 2 H 117. 3 M 82. 2 M 100. 2 H 118. 3 M 83. 2 M 101. 2 M 119. 3 E 84. 2 M 102. 2 M 120. 3 M 85. 2 E 103. 2 H 121. 3 M 86. 2 E 104. 2 M 122. 3 M 87. 2 M 105. 2 E 123. 3 H M = Medium

Item SO LOD 45. 46. 47. 48. 49. 50. 51.

5 5 5 5 5 5 5

E M M E E E E

124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139.

4 4 4 4 4 5 5 5 5 5 5 5 5 5 5 5

E E M M M M M E M M E M M E E E

H = Hard

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

4-2

SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED) Item SO LOD

Item SO LOD

140. 141. 142. 143. 144. 145. 146.

1 1,2 1,2 1,2 2 2 2,3

M H H H M H M

147. 148. 149. 150. 151. 152. 153.

171.

1-5

172. 173.

1 1

M M

Note:

E = Easy

174. 175.

Item SO LOD Exercises 154. 2,3 E 155. 2,3 M 156. 2,3 H 157. 2,3 E 158. 2,3 E 159. 2,3 M 160. 2,3 E Matching

Item SO LOD

Item SO LOD 168. 169. 170.

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

M M M H H E E

161. 162. 163. 164. 165. 166. 167.

2,3 2,4 2-4 2-4 3 3 4

M H M M E M E

1-5 2

Short-Answer Essay M 176. 2 E 178. E 177. 2 M 179.

2,3 2,3

E E

M = Medium

5 5 5

E E E

H = Hard

Accrual Accounting Concepts

4-3

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

Item

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

TF TF TF TF TF TF

7. 8. 9. 10. 52. 53.

TF TF TF TF MC MC

54. 55. 56. 57. 58. 59.

11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

TF TF TF TF TF TF TF TF TF TF TF TF TF TF TF TF TF

28. 29. 30. 31. 32. 33. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

TF TF TF TF TF TF MC MC MC MC MC MC MC MC MC MC MC

76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92.

34. 35. 36. 37. 38. 113. 114.

TF TF TF TF TF MC MC

115. 116. 117. 118. 119. 120. 121.

MC MC MC MC MC MC MC

122. 123. 146. 147. 148. 149. 150.

39. 40. 41.

TF TF TF

124. 125.

MC MC

126. 127. 128.

42. 43. 44. 45. 46. Note:

Type Item Type Study Objective 1 MC 60. MC MC 61. MC MC 62. MC MC 63. MC MC 64. MC MC 140. Ex Study Objective 2 MC 93. MC MC 94. MC MC 95. MC MC 96. MC MC 97. MC MC 98. MC MC 99. MC MC 100. MC MC 101. MC MC 102. MC MC 103. MC MC 104. MC MC 105. MC MC 106. MC MC 107. MC MC 108. MC MC 109. MC Study Objective 3 MC 151. Ex MC 152. Ex Ex 153. Ex Ex 154. Ex Ex 155. Ex Ex 156. Ex Ex 157. Ex Study Objective 4 MC 162. Ex MC 163. Ex MC 164. Ex Study Objective 5 MC 133. MC MC 134. MC MC 135. MC MC 136. MC

TF 48. TF 129. TF 49. TF 130. TF 50. TF 131. TF 51. TF 132. TF TF = True-False Ma = Matching MC = Multiple Choice Ex = Exercise

Item

Type

Item

Type

141. 142. 143. 171. 172. 173.

Ex Ex Ex Ma SAE SAE

174.

SAE

110. 111. 112. 141. 142. 143. 144. 145. 146. 147. 148. 149. 150. 151. 152. 153. 154.

MC MC MC Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex

155. 156. 157. 158. 159. 160. 161. 162. 163. 164. 171. 174. 175. 176. 177. 178. 179.

Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ma SAE SAE SAE SAE SAE SAE

158. 159. 160. 161. 163. 164 165

Ex Ex Ex Ex Ex Ex Ex

166. 171. 174. 178. 179.

Ex Ma SAE SAE SAE

167. 171. 174.

Ex Ma SAE

137. 138. 139. 168.

MC MC MC Ex

169. 170. 171. 174.

Ex Ex Ma SAE

SAE = Short Answer Essay

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

CHAPTER STUDY OBJECTIVES 1.

Explain when revenues and expenses are recognized and how this forms the basis for accrual accounting. Revenue is recognized (recorded) when goods or services are exchanged for cash or claims to cash, which results in an increase in future economic benefits. Expenses are recognized (recorded) when assets are consumed or services used, which results in a decrease in future economic benefits. By following revenue and expense recognition criteria, events are recorded in the period when they arise. This is known as the accrual basis of accounting.

Describe the types of adjusting entries and prepare adjusting entries for prepayments. There are two general types of adjusting entries: prepayments and accruals. Prepayments are either prepaid expenses or unearned revenues. Adjusting entries for prepayments record the portion of the prepayment that applies to the expense incurred or revenue earned in the current accounting period. The adjusting entry for prepaid expenses results in an increase (debit) to an expense account and a decrease (credit) to an asset account. The adjusting entry for unearned revenues results in a decrease (debit) to a liability account and an increase (credit) to a revenue account.

Prepare adjusting entries for accruals. Adjusting entries for accruals are required in order to record the revenues and expenses that apply to the current accounting period and that have not been recognized through daily entries. Accruals are either accrued revenues or accrued expenses. The adjusting entry for accrued revenues results in an increase (debit) to an asset account and an increase (credit) to a revenue account. The adjusting entry for accrued expenses results in an increase (debit) to an expense account and an increase (credit) to a liability account.

Prepare an adjusted trial balance. An adjusted trial balance is a trial balance that shows the balances of all accounts at the end of an accounting period, including those that have been adjusted. An adjusted trial balance facilitates the preparation of the financial statements.

Prepare closing entries and a post-closing trial balance. One purpose of closing entries is to update the Retained Earnings account to its end-of-period balance. A second purpose is to make all temporary accounts (revenue, expense and dividends accounts) begin the new period with a zero balance. To accomplish this, entries are made to close each individual revenue and expense account to a temporary summary account called Income Summary. The Income Summary account is then closed to the Retained Earnings account. The Dividends account is also closed to Retained Earnings. A post-closing trial balance lists only permanent accounts (statement of financial position accounts) and the balances that are carried forward to the next accounting period. The purpose of the post-closing trial balance is to prove the equality of total debits and total credits.

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TRUE-FALSE STATEMENTS 1. Accounting divides the economic life of a business entity into artificial time periods.

2. An accounting transaction never affects more than one accounting time period.

3. Revenue is generally recognized (recorded) when there is an increase in a liability or a decrease in an asset.

4. Revenue must be recognized once the sales or performance effort is substantially complete, regardless of whether or not collection is reasonably assured.

5. Revenue recognition follows expense recognition.

6. Expense recognition is tied to changes in assets and liabilities.

7. Expense recognition always coincides with revenue recognition.

8. Under the accrual basis of accounting, expenses are only recognized when they are paid.

9. Under the cash basis of accounting, revenue is only recognized when cash is received.

10. Under the cash basis of accounting, expense recognition generally does not follow revenue recognition.

11. Adjusting entries are needed to produce relevant financial information.

12. Adjusting entries are only required under the cash basis of accounting.

13. Since some costs are not recorded, adjusting entries are necessary.

14. For a private company reporting under ASPE, adjusting entries must be prepared at least quarterly.

15. An adjusting entry to a prepaid expense is required to recognize costs that expire with time.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

16. Prepaid expenses are costs that are paid for before they are used.

17. Accrued revenues represent money received from customers for work to be done later.

18. Expenses paid before being used or consumed are initially recorded as liabilities.

19. When money is received from a customer prior to the delivery of goods or the performance of a service, it is recorded as revenue.

20. If prepaid costs are initially recorded as an asset, no adjusting entries will be required in the future.

21. The purchase of certain types of long-lived (non-current) assets is essentially a long-term prepayment for services.

22. The cost of any depreciable asset less accumulated depreciation reflects the carrying amount of the asset.

23 The carrying amount of a depreciable asset is always equal to its actual value because depreciation is a valuation technique.

24. Accumulated Depreciation is a liability account and its normal account balance is a credit.

25. The balances of the Depreciation Expense and the Accumulated Depreciation accounts should always be the same.

26. Depreciation allocates the cost of a long-lived asset to the accounting periods over which it is used.

27. Depreciation is a valuation concept; that is, we allocate costs to reflect the actual change in the value of the asset.

28. The original cost of equipment will typically will be shown on the statement of financial position.

29. A contra asset account is subtracted from a related asset account in the statement of

Accrual Accounting Concepts

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financial position and its normal balance is a credit.

30. An asset purchased for $125,000 on the first day of the fiscal year with a useful life of 5 years has an annual depreciation expense of $25,000.

31. Expiration of one month of an insurance policy paid in advance, initially recorded by debiting Prepaid Insurance, results in an adjusting entry that reduces the company’s liabilities.

32. When a company performs a service for which payment was received in advance, a journal entry is recorded that will increase revenue and decrease unearned revenue.

33. The adjusting entry for unearned revenues results in an increase to a liability account and a decrease to a revenue account.

34. Accrued revenues are revenues that have not been earned before financial statements have been prepared.

35. Adjusting entries never affect cash.

36. If a three-month, 6% bank loan for $5,000 is signed on October 1, the interest expense for the month of October is $75.

37. The adjustment for accrued salaries results from services being paid for after the services are performed.

38. The statement of financial position and income statement can be prepared from the information provided by an adjusted trial balance.

39. An adjusted trial balance must be prepared before the adjusting entries can be recorded.

40. The purpose of an adjusted trial balance is to ensure all adjusting entries have been recorded.

41. The statement of changes in equity is prepared from the Common Shares, Retained Earnings and Dividends accounts on the adjusted trial balance.

42. When closing entries are posted, the result is a zero balance in each income statement account.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

43. The post-closing trial balance will contain only permanent accounts.

44. The Dividends account is closed to the Income Summary account at the end of each year.

45. Financial statements are generally prepared before the closing entries are posted.

46. The Income Summary account is a permanent account.

47. When preparing the statement of financial position, the balance of Retained Earnings is taken from the Adjusted Trial Balance.

48. Closing entries are prepared before adjusting entries.

49. Closing entries result in the transfer of profit or loss into the Retained Earnings account.

50. The post-closing trial balance will have fewer accounts than the adjusted trial balance.

51. The accounting cycle begins with the journalizing of the transactions.

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ANSWERS TO TRUE-FALSE STATEMENTS Item Ans. Item 1. T 9. 2. F 10. 3. F 11. 4. F 12. 5. F 13. 6. T 14. 7. F 15. 8. F 16.

Ans. T T T F T F T T

Item 17. 18. 19. 20. 21. 22. 23. 24.

Ans. F F F F T T F F

Item 25. 26. 27. 28. 29. 30. 31. 32.

Ans. F T F T T T F T

Item 33. 34. 35. 36. 37. 38. 39. 40.

Ans. F F T F T T F F

Item 41. 42. 43. 44. 45. 46. 47. 48.

Ans. F T T F T F F F

Item 49. 50. 51.

Ans. T T F

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 52. Which of the following is generally not a guideline for recognizing revenue? (a) The sale or performance effort is substantially complete. (b) Collection is reasonably assured. (c) Management declares that revenue should be recognized. (d) The amount is determinable.

53. Which of the following is not generally an accounting time period? (a) a week (b) a month (c) a quarter (d) a year

54. In general, revenue recognition occurs (a) when cash is received. (b) when it is earned. (c) when expenses are incurred. (d) in the period that income taxes are paid.

55. Revenue recognition criteria include recognized revenue when (a) cash is received. (b) goods or services are transferred to customers. (c) related expenses are recognized. (d) the revenue is recorded. 56. Recording transactions that affect a company’s financial statements in the periods in which they occur rather than when cash is received or paid is called (a) time period accounting. (b) the cash basis of accounting. (c) monetary accounting. (d) the accrual basis of accounting.

57. On February 15, a local business receives an invoice for electricity used in the month of January and pays it on March 1. In which month should the business recognize the expense? (a) February (b) January (c) March (d) No expense should be recorded.

58. A dress shop makes a dress that sells for $200 and delivers it to the customer on June 30. The customer is sent a statement on July 7 and a cheque is received by the dress shop on July 11. When should the $200 be recognized as revenue?

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(a) July 7 (b) July 11 (c) June 30 (d) July 1

59. A furniture factory's employees work overtime in February to finish an order that is sold on February 28. The office sends a statement to the customer in early March and payment is received by mid-March. The overtime salaries 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.

60. Under the accrual basis of accounting (a) cash must be received before revenue is recognized. (b) profit is calculated by matching cash outflows against cash inflows. (c) events that change a company's financial statements are recognized 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 under generally accepted accounting principles.

61. 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.

62. Mave Corp. sells $5,000 of goods on account in the current year and collects $3,000 of this. It incurs $3,500 in expenses on account during the current year and pays $2,000 of them. Mave would report what amount of profit under the cash and accrual bases of accounting, respectively? (a) $1,500 on the cash basis and $2,000 on the accrual basis (b) $1,000 on the cash basis and $1,500 on the accrual basis (c) $3,500 on the cash basis and $1,000 on the accrual basis (d) $3,000 on the cash basis and $3,500 on the accrual basis

63. Fang's Tune-Up Shop uses the accrual basis of accounting. Fang services a car on May 31. The customer picks up the vehicle on June 1 and mails payment to Fang on June 5. Fang receives the cheque in the mail on June 6. When would Fang recognize the revenue as being earned? (a) June 6 (b) June 5 (c) June 1 (d) May 31

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

64. Wong's Tune-Up Shop uses the cash basis of accounting. Wong services a car on May 31. The customer picks up the vehicle on June 1 and mails payment to Wong on June 5. Wong receives the cheque in the mail on June 6. When would Wong recognize the revenue as being earned? (a) June 6 (b) June 5 (c) June 1 (d) May 31

65. Some accounts need to be adjusted because (a) there are never enough accounts to record all the transactions. (b) they are not up-to-date at the time financial statements are prepared. (c) there are always errors made in recording transactions. (d) management can't decide what they want to report.

66. 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.

67. Adjusting entries are required (a) because some costs expire with the passage of time, but have not yet been recorded. (b) when the company’s profit is below budget. (c) when expenses are recorded in the period in which they are incurred. (d) when revenues are recorded in the period in which they are earned.

68. Which one of the following is not a justification for adjusting entries? (a) Adjusting entries are necessary to ensure that revenue recognition criteria are followed. (b) Adjusting entries are necessary to ensure that expense recognition criteria are followed. (c) Adjusting entries are necessary to enable financial statements to be in conformity with IFRS or ASPE. (d) Adjusting entries are necessary to bring the general ledger accounts in line with the budget.

69. The preparation of adjusting entries (a) is straight-forward because the accounts that need adjustment will be out of balance. (b) requires an understanding of the company’s operations and the inter-relationship of accounts. (c) is only required for accounts that do not have a normal balance. (d) is optional when financial statements are prepared.

70. Which of the following reflects the balances of prepayment accounts prior to adjustment? (a) Statement of financial position accounts are understated and income statement accounts are understated. (b) Statement of financial position accounts are overstated and income statement accounts are

Accrual Accounting Concepts

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overstated. (c) Statement of financial position accounts are overstated and income statement accounts are understated. (d) Statement of financial position accounts are understated and income statement accounts are overstated.

71. The primary difference between prepaid 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 paid and accrued expenses have not. (d) not been recorded and accrued expenses have.

72. An asset–expense relationship exists with (a) liability accounts. (b) revenue accounts. (c) prepaid expense adjusting entries. (d) accrued expense adjusting entries.

73. Unearned revenue is classified as a(n) (a) asset account. (b) revenue account. (c) equity account. (d) liability.

74. Which of the following accounts would not likely need to be adjusted at year end? (a) Office Supplies (b) Office Equipment (c) Prepaid Advertising (d) Unearned Revenue

75. An adjusting entry would not include which of the following accounts? (a) Cash (b) Interest Receivable (c) Property Tax Payable (d) Unearned Revenue

76. 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.

77. Adjusting entries can be classified as

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) postponements and advances. (b) accruals and prepayments. (c) prepayments and postponements. (d) accruals and advances.

78. The general term employed to indicate an expense that has not been paid or revenue that has not been received and has not yet been recognized in the accounts is a(n) (a) contra asset. (b) prepayment. (c) asset. (d) accrual.

79. Accrued revenues are (a) received and recorded as liabilities before they are earned. (b) earned and recorded as liabilities before they are received. (c) revenues that have not yet been received but have been earned and have been recorded for the first time by an adjusting entry. (d) earned and already received and recorded.

80. Accrued 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) expenses that have not yet been paid but have been incurred and have been recorded for the first time by an adjusting entry. (d) incurred and already paid or recorded.

81. 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.

82. Chan Inc. purchased office supplies costing $3,000 and debited Office Supplies for the full amount. At the end of the accounting period, a physical count of office supplies revealed $1,750 still on hand. The appropriate adjusting journal entry to be made at the end of the period would be (a) debit Office Supplies Expense, $1,750; credit Office Supplies, $1,750. (b) debit Office Supplies, $3,000; credit Office Supplies Expense, $3,000. (c) debit Office Supplies Expense, $1,250; credit Office Supplies, $1,250. (d) debit Office Supplies, $1,750; credit Office Supplies Expense, $1,750.

83. A legal firm received $2,000 cash for legal services to be rendered in the future. The full amount was credited to Unearned Service Revenue. 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.

Accrual Accounting Concepts

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(b) profit to be overstated. (c) liabilities to be understated. (d) revenues to be understated.

84. 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.

85. Goods purchased for future use in the business, such as supplies, are recorded as (a) assets. (b) revenues. (c) expenses. (d) liabilities.

86. The Town Laundry purchased $5,500 worth of laundry supplies on June 2 and recorded the purchase as an asset. On June 30, an inventory of the laundry supplies indicated only $3,000 on hand. The adjusting entry that should be made by the company on June 30 is (a) debit Laundry Supplies Expense, $3,000; credit Laundry Supplies, $3,000. (b) debit Laundry Supplies Expense, $2,500; credit Laundry Supplies, $2,500. (c) debit Laundry Supplies, $2,500; credit Laundry Supplies Expense, $2,500. (d) debit Laundry Supplies, $3,000; credit Laundry Supplies Expense, $3,000.

87. On July 1, Alaska Store paid $12,000 to Snow Realty for six months rent, starting July 1. Prepaid Rent was debited for the full amount. If financial statements are prepared on July 31, the adjusting entry to be made by Alaska Store is (a) debit Rent Expense, $12,000; credit Prepaid Rent, $12,000. (b) debit Prepaid Rent, $2,000; credit Rent Expense, $2,000. (c) debit Prepaid Rent, $6,000; credit Rent Expense, $6,000. (d) debit Rent Expense, $2,000; credit Prepaid Rent, $2,000.

88. The balance in the Prepaid Rent account before adjustment at the end of the year is $12,000 and represents three months rent starting on November 1. The adjusting entry required on December 31 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, $8,000; credit Prepaid Rent, $8,000.

89. If a business has received cash in advance of services being performed and credits a liability account, the adjusting entry needed after the services are performed will be (a) debit Unearned Revenue and credit Cash. (b) debit Unearned Revenue and credit Revenue. (c) credit Unearned Revenue and debit Revenue.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) debit Unearned Revenue and credit Accounts Receivable.

90. Accumulated Depreciation is a(n) (a) expense account. (b) shareholders’ equity account. (c) liability account. (d) contra asset account.

91. The Sayonara Corporation purchased a notebook computer for $3,000 on December 1. The useful life of the notebook computer is estimated to be 5 years. If financial statements are to be prepared on December 31, 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 Depreciation Expense, $2,400; credit Accumulated Depreciation, $2,400. (d) debit Office Equipment, $50; credit Accumulated Depreciation, $50.

92. Andrew Autobody purchased a car jack for $15,000 on July 1. The estimated useful life of the car jack is 5 years. If the financial statements are prepared on December 31, Andrew should make the following adjusting journal entry: (a) debit Depreciation Expense, $1,500, credit Accumulated Depreciation, $1,500. (b) debit Depreciation Expense, $15,000, credit Accumulated Depreciation, $15,000. (c) debit Depreciation Expense, $3,000, credit Accumulated Depreciation, $3,000. (d) debit Machinery, $1,500, credit Accumulated Depreciation, $1,500.

93. McCloud Realty received a cheque for $21,000 on July 1, which represents a 6-month advance payment of rent on a building it rents to a client. Unearned Rental Revenue was credited for the full $21,000. Financial statements will be prepared on July 31. McCloud Realty should make the following adjusting entry on July 31: (a) debit Unearned Rental Revenue, $3,500; credit Rental Revenue, $3,500. (b) debit Rental Revenue, $3,500; credit Unearned Rental Revenue, $3,500. (c) debit Unearned Rental Revenue, $21,000; credit Rental Revenue, $21,000. (d) debit Cash, $3,500; credit Rental Revenue, $3,500.

94. As prepaid expenses expire with the passage of time, the correct adjusting entry will be a (a) debit to an asset account and a credit to an expense account. (b) debit to an expense account and a credit to an asset account. (c) debit to an asset account and a credit to an asset account. (d) debit to an expense account and a credit to an expense account.

95. Best Value Trucks Inc. began the year with $1,200 of supplies on hand. During the year the company purchased $4,000 worth of supplies, debited to the Supplies account. At the end of the year, there was $1,000 worth of supplies left on hand. The adjusting entry for Supplies at the end of the year would be: (a) Supplies Expense ......................................................................... 4,200 Supplies ................................................................................. 4,200

Accrual Accounting Concepts

(b) Supplies Expense ......................................................................... Supplies ................................................................................. (c) Supplies ........................................................................................ Supplies Expense................................................................... (d) Supplies Expense ......................................................................... Cash.......................................................................................

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4,000 4,000 4,200 4,200 4,200 4,200

96. A company 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) totalling 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.

97. If a company fails to make an adjusting entry to record supplies expense, then (a) shareholders’ equity will be understated. (b) expenses will be understated. (c) assets will be understated. (d) profit will be understated.

98. If supplies are recorded as assets when purchased, the credit to supplies in the adjusting entry is for the amount of supplies (a) remaining. (b) purchased. (c) used. (d) purchased less the amount used.

99. If XYZ Corp. fails to adjust the Prepaid Rent account for rent that has expired, what effect will this have on that month's financial statements? (a) This will have no effect on the financial statements. (b) Expenses will be overstated and profit and shareholders’ equity will be understated. (c) Assets will be overstated and profit and shareholders’ equity will be understated. (d) Assets will be overstated and profit and shareholders’ equity will be overstated.

100. If Bee Corp. fails to adjust the Unearned Rent account for rent that has been earned, what effect will this have on that month’s 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.

101. At December 31, 2015, before any year-end adjustments, Ubanigi Corp.'s Insurance Expense account had a balance of $725 and its Prepaid Insurance account had a balance of $2,900. It was determined that $1,500 of the Prepaid Insurance had expired. The adjusted

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

balance for Insurance Expense for the year would be (a) $2,225. (b) $1,500. (c) $1,125. (d) $ 725.

102. At December 31, 2015, before any year-end adjustments, Harvest Inc.'s Prepaid Insurance account had a balance of $2,000. It was determined that $800 of the Prepaid Insurance had expired. The adjusted balance for Prepaid Insurance at year end would be (a) $ 800. (b) $1,200. (c) $2,000. (d) $2,800.

103. At the end of the current year, the required adjusting entry for depreciation on equipment was omitted. Which of the following statements is true regarding the current year’s financial statements? (a) Profit will be overstated. (b) Total assets will be understated. (c) The statement of financial position and income statement will be misstated but the statement of changes in equity will be correct. (d) Retained earnings will be understated.

104. Depreciation is the process of (a) valuing an asset at its fair value. (b) increasing the value of an asset over its useful life in a rational and systematic manner. (c) allocating the cost of a non-current asset to expense over its useful life. (d) writing down an asset to its fair value each accounting period.

105. The difference between the balance of a building account and its related accumulated depreciation account is its (a) fair value. (b) contra asset. (c) carrying amount. (d) liability.

106. A new accountant working for Malawi Limited records $800 depreciation expense on store equipment at year end as follows: Depreciation Expense ................................................................... 800 Cash....................................................................................... 800 The effect of this entry is to (a) adjust the accounts correctly at year end. (b) understate expenses on the income statement. (c) overstate the carrying amount of the depreciable assets at year end. (d) understate the carrying amount of the depreciable assets at year end.

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107. From an accounting standpoint, the acquisition of long-lived assets is essentially a(n) (a) accrual of expense. (b) accrual of revenue. (c) accrual of unearned revenue. (d) prepayment for services.

108. If a business pays rent in advance and debits the Prepaid Rent account, the company receiving the rent payment will credit (a) cash. (b) prepaid rent. (c) unearned rent revenue. (d) accrued rent revenue. 109. A common method for calculating depreciation expense is to divide the asset’s cost by (a) its fair value at date of purchase. (b) its useful life. (c) the accumulated depreciation recorded to date. (d) the actual amount paid for the asset.

110. An accumulated depreciation account (a) is a contra liability account. (b) has a normal debit balance. (c) is offset against total assets on the statement of financial position. (d) has a normal credit balance.

111. If equipment with a 5-year life was purchased on July 1, 2015 for $60,000, by December 31, 2016, (a) the accumulated depreciation would be $12,000 and the carrying amount would be $48,000. (b) the accumulated depreciation would be $40,000 and the carrying amount would be $20,000. (c) the accumulated depreciation would be $30,000 and the carrying amount would be $30,000 (d) the accumulated depreciation would be $18,000 and the carrying amount would be $42,000

112. Which of the following would not result in a credit to Unearned Revenue? (a) rent collected in advance from tenants (b) services performed on account (c) sale of season tickets to hockey games (d) sale of two-year magazine subscription

113. 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.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) an overstatement of expenses and an overstatement of liabilities.

114. Failure to prepare an adjusting entry at the end of a period to record 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.

115. On September 1, Starr Guitar Corp. borrowed $24,000 from their bank, and signed a 8%, 3-month bank loan. Principal and interest are due on December 1. If Starr prepares monthly financial statements, the adjusting entry that they should prepare for interest on September 30 would be (a) debit Interest Expense, $160; credit Interest Payable, $160. (b) debit Interest Expense, $1,920; credit Interest Payable, $1,920. (c) debit Bank Loan Payable, $480; credit Cash, $480. (d) debit Cash, $24,000; credit Bank Loan Payable, $24,000.

116. The adjusting entry to record accrued interest on a note receivable due next year consists of a (a) debit to Interest Expense and a credit to Interest Payable. (b) debit to Interest Receivable and a credit to Interest Revenue. (c) debit to Interest Expense and a credit to Note Receivable. (d) debit to Interest Receivable and a credit to Cash.

117. David Debit has performed $700 of accounting services for a client but has not yet billed the client at the end of the accounting period. What adjusting entry must David prepare? (a) Debit Cash and credit Unearned Revenue. (b) Debit Accounts Receivable and credit Unearned Revenue. (c) Debit Accounts Receivable and credit Service Revenue. (d) Debit Unearned Revenue and credit Service Revenue.

118. Clarissa Credit has billed her clients for services performed in October. In November, she receives payments from her clients. What entry will she make upon receipt of the payments? (a) Debit Unearned Revenue and credit Service Revenue. (b) Debit Cash and credit Accounts Receivable. (c) Debit Accounts Receivable and credit Service Revenue. (d) Debit Cash and credit Service Revenue.

119. On September 1, Monmouth Microwaves Ltd. signed a 9%, five-month bank loan payable for $9,000. The amount of interest to be accrued at December 31 is (a) $9,810.00. (b) $ 810.00. (c) $ 337.50. (d) $ 270.00.

Accrual Accounting Concepts

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120. On February 1, Top Shop Barbecues signed a 3%, thirteen-month bank loan payable for $120,000 to help finance increases in inventory for the spring and summer season. Assuming no entries have been made previously for the interest on this loan, what is the required adjusting entry for the interest accrued to December 31? (a) Interest Expense ........................................................................... 3,300 Interest Payable ..................................................................... 3,300 (b) Interest Expense ........................................................................... 3,600 Interest Payable ..................................................................... 3,600 (c) Interest Expense ........................................................................... 300 Cash....................................................................................... 300 (d) Interest Expense ........................................................................... 1,500 Interest Payable ..................................................................... 1,500

121. At the end of the fiscal 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) Shareholders’ equity at the end of the year is understated. 122. Sally’s Skateboard Shop has a weekly payroll of $9,000 and pays its employees every Friday. None of the staff work on weekends. This year, the last day of the company’s fiscal yearend is a Wednesday. What is the correct adjusting entry to accrue salaries expense? (a) Salaries Expense .......................................................................... 1,800 Salaries Payable .................................................................... 1,800 (b) Salaries Expense .......................................................................... 5,400 Salaries Payable .................................................................... 5,400 (c) Salaries Expense .......................................................................... 5,400 Cash....................................................................................... 5,400 (d) Salaries Expense .......................................................................... 9,000 Salaries Payable .................................................................... 9,000

123. At December 31, Witts Corp. reports Salaries Payable of $20,000 on its statement of financial position. The next payroll amounting to $50,000 is to be paid in January. What will be the journal entry to record the payment of salaries in January? (a) Salaries Expense .......................................................................... 50,000 Salaries Payable .................................................................... 20,000 Cash....................................................................................... 30,000 (b) Salaries Expense .......................................................................... 50,000 Cash....................................................................................... 50,000 (c) Salaries Expense .......................................................................... 50,000 Salaries Payable ........................................................................... 20,000 Cash....................................................................................... 70,000 (d) Salaries Expense .......................................................................... 30,000 Salaries Payable ........................................................................... 20,000 Cash....................................................................................... 50,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

124. 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.

125. Which statement below is incorrect? (a) An adjusted trial balance should show ledger account balances. (b) An adjusted trial balance can be used to prepare financial statements. (c) An adjusted trial balance proves the mathematical equality of debits and credits in the ledger. (d) An adjusted trial balance is prepared after the financial statements are completed.

126. The shareholders’ equity section of the statement of financial position uses the amount for Retained Earnings found on the (a) unadjusted trial balance. (b) adjusted trial balance. (c) statement of changes in equity. (d) the previous year’s statement of financial position.

127. An adjusted trial balance shows that (a) all journal entries have been made. (b) debits equal credits in the ledger accounts after the adjusting entries have been made. (c) all accounts have the correct balance. (d) no posting errors have been made.

128. An adjusted trial balance shows (a) all the accounts and their balances after adjusting entries have been made. (b) all the accounts and their balances before adjusting entries have been made. (c) only those accounts and their balances that need to be adjusted. (d) only those accounts and their balances that have been adjusted at the end of the accounting period.

129. 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) summarize the activity in every account.

130. Which of the following is true about closing the books of a corporation? (a) Expenses are closed to the Expense Summary account. (b) Only revenues are closed to the Income Summary account.

Accrual Accounting Concepts

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(c) Revenues and expenses are closed to the Income Summary account. (d) Revenues, expenses, and the Dividends account are closed to the Income Summary account.

131. 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.

132. A post-closing trial balance will show (a) zero balances for all accounts. (b) zero balances for statement of financial position accounts. (c) only statement of financial position accounts. (d) only income statement accounts.

133. 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.

134. Financial statements should be prepared (a) from an adjusted trial balance. (b) from a post-closing trial balance. (c) using the Income Summary account. (d) using permanent accounts only.

135. Which permanent account is affected by the closing entries? (a) Income Summary (b) Common Shares (c) Retained Earnings (d) Cash

136. Which one of the following accounts shows a balance on the post-closing trial balance? (a) Interest Expense (b) Service Revenue (c) Retained Earnings, beginning of the year (d) Common Shares

137. The process that begins with analyzing transactions and ends with the preparation of a post-closing trial balance is called

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) the fiscal period. (b) the accounting cycle. (c) the business cycle. (d) the accounting year.

138. The first required step in the accounting cycle is (a) preparing adjusting entries. (b) journalizing transactions. (c) analyzing transactions. (d) posting transactions.

139. The final step in the accounting cycle is to prepare (a) closing entries. (b) financial statements. (c) a post-closing trial balance. (d) adjusting entries.

Accrual Accounting Concepts

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64.

Ans. c a b b d b c a c a b d a

Item 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77.

Ans. b b a d b b c c d b a a b

Item Ans. 78. d 79. c 80. c 81. c 82. c 83. d 84. a 85. a 86. b 87. d 88. d 89. b 90. d

Item 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103.

Ans. b a a b a d b c d c a b a

Item 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116.

Ans. c c c d c b d c b c b a b

Item Ans. Item 117. c 130. 118. b 131. 119. d 132. 120. a 133. 121. b 134. 122. b 135. 123. d 136. 124. b 137. 125. d 138. 126. c 139. 127. b 128. a 129. c

Ans. c d c b a c d b c c

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 140 During the year ended December 31, 2016, Jones Inc. received $110,000 cash from customers. The company began the year with a balance in Accounts Receivable of $15,000, all of which was received in 2016. At the end of the year, customers owed Jones Inc. $20,000 for services provided in 2016. Instructions Calculate the revenue Jones should report in 2016 using: (a) the cash basis of accounting. (b) the accrual basis of accounting. Solution 140 (a) $110,000 (b) $115,000* *Calculation: Cash received ............................................ Less: 2015 Revenue (beginning Accounts Receivable) .......................... Add: 2016 Revenue not received ...............

$110,000 (15,000) 20,000 $115,000

Ex. 141 The statement of financial position for Tao Ltd. include the following as at December 31: 2016 2015 Interest receivable ...................................................... $2,200 $ -0Supplies ..................................................................... 4,000 2,500 Salaries payable......................................................... 2,600 2,800 Unearned revenue ..................................................... -04,000 The income statement for the year ended December 31, 2016 shows the following: Interest revenue ......................................................... Service revenue ......................................................... Supplies expense ....................................................... Salaries expense........................................................

$15,400 72,700 7,700 37,000

Instructions Calculate the following for 2016: (a) Cash received for interest. (b) Cash paid for supplies. (c) Cash paid for salaries. (d) Cash received for revenue. Solution 141 (15 min.) (a) Cash received for interest = .......................................

$ 13,200

Accrual Accounting Concepts

Interest revenue ......................................................... Less: Interest receivable ............................................ Cash received ............................................................ (b) Cash paid for supplies = ............................................. Supplies expense ....................................................... Less: Supplies (2015) ................................................ Add: Supplies (2016) .................................................. Cash paid ................................................................... (c) Cash paid for salaries = ............................................. Salaries expense........................................................ Add: Salaries payable (2015) ..................................... Less: Salaries payable (2016) .................................... Cash paid ................................................................... (d) Cash received for revenue = ...................................... Service revenue ......................................................... Less: Unearned revenue (2015) ................................. Cash received ............................................................

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$15,400 2,200 $13,200 $9,200 $7,700 2,500 5,200 4,000 $9,200 $37,200 $37,000 2,800 39,800 2,600 $37,200 $68,700 $72,700 4,000 $68,700

Ex. 142 The 2015 income statement for Taber Corporation showed rent expense of $8,000 and salary expense of $5,200. The related statement of financial position account balances at each year end were as follows: 2015 2014 Prepaid rent ............................................. $500 $300 Salaries payable....................................... 250 350 Instructions Calculate the following for 2015: (a) Cash paid for rent. (b) Cash paid for salaries. Solution 142 (10 min.) (a) Cash paid for rent =.................................................... Rent expense ............................................................. Less: Prepaid rent (2014) ........................................... Add: Prepaid rent (2015) ............................................ Cash paid ................................................................... (b) Cash paid for salaries = ............................................. Salaries expense........................................................ Add: Salaries payable (2014) ..................................... Less: Salaries payable (2015) ....................................

$8,200 $8,000 300 7,700 500 $8,200 $5,300 $5,200 350 5,550 250

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Cash paid ...................................................................

$5,300

Ex. 143 Ezra Inc. prepared the following condensed income statement using the cash basis of accounting: EZRA INC. Income Statement, Cash Basis Year Ended December 31, 2015 Service revenue ................................................................................... Expenses ............................................................................................. Profit ....................................................................................................

$820,000 640,000 $180,000

Additional data: 1. Depreciation on a company automobile for the year amounted to $9,000. This amount is not included in the expenses above. 2. On January 1, 2015, paid for a two-year insurance policy on the automobile amounting to $1,800. This amount is included in the expenses above. 3. Service revenue does not include $50,000 of services provided on account in 2015 for which payment will be received in 2016. It does, however, include $20,000 collected in 2015 for services performed in 2014. 4. Expenses do not include $50,000 of expenses that were incurred in 2015 but won’t be paid for until 2016. Instructions (a) Restate the above income statement on the accrual basis in conformity with generally accepted accounting principles. Show calculations and explain each change. (b) Explain which basis (cash or accrual) provides a better measure of profit. Solution 143 (15 min.) (a)

EZRA INC. Income Statement Year Ended December 31, 2015 —————————————————————————————————————————— Service revenue .............................................................................................. $850,000 Expenses ........................................................................................................ 698,100 Profit ............................................................................................................... $151,900 Service revenue should include the $50,000 for services performed on account, but not the $20,000 collected in 2015 for services performance in 2014. The accrual basis states that revenue is recognized in the period when the service is performed. Revenue is calculated by adjusting the cash received to reflect this ($820,000 + $50,000 – $20,000 = $850,000). Expenses should include the $50,000 for expenses incurred but not yet paid. The accrual basis states that expenses should be reflected in the period when incurred. Expenses also should only include half of the $1,800 insurance premium since only one-half of the twoyear policy applies to 2015. The other $900 is an asset and should be reflected on the statement of financial position as prepaid insurance. Since the full $1,800 is included in Expenses, $900 will have to be removed. The $9,000 of depreciation for the automobile must included as an expense in 2015. Expenses are calculated as: $640,000 + $50,000 –

Accrual Accounting Concepts

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$900 + $9,000 = $698,100. (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 recognizes revenues when earned and expenses when incurred. Revenues and expenses recognized 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 recognize revenue in the period when earned and expenses when incurred. As well, expenses are not matched with revenues when earned; therefore, expense recognition is not achieved.

Ex. 144 The Blue Canaries, a semi-professional football team, prepares financial statements on a monthly basis. Their season begins in April, but in March the team engaged in the following transactions: 1. Paid $540,000 on March 15 to Burger Queen Corp. as advance rent for use of Burger Stadium for the six-month period April 1 through September 30. 2. Collected $432,000 cash on March 20 during a sales blitz for season tickets for the team's 36 home games. This amount was credited to Unearned Revenue. During the month of April, the Blue Canaries played eight home games and five road games. Instructions Prepare the journal entries for March and the adjusting entries required at April 30 for the transactions above. Solution 144 (5 min.) Mar 15 Prepaid Rent .......................................................................... Cash ................................................................................

540,000 540,000

Mar 20 Cash....................................................................................... Unearned Revenue .........................................................

432,000

Apr 30 Rent Expense......................................................................... Prepaid Rent ................................................................... ($540,000  6 = $90,000)

90,000

Apr 30 Unearned Revenue ................................................................ Ticket Revenue ............................................................... ($432,000  36 = $12,000; $12,000  8 = $96,000)

96,000

432,000

90,000

96,000

Ex. 145 The King Street Zoo operates a drive-through tourist attraction in Toronto. The company adjusts its accounts at the end of each month. The selected accounts appearing below reflect balances after adjusting entries were prepared on April 30. The adjusted trial balance shows the following: Prepaid Rent .............................................................. $12,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Feed Shed ................................................................. Accumulated Depreciation—Feed Shed ..................... Unearned Revenue ....................................................

40,000 6,000 500

Other data: 1. Four months rent had been prepaid on April 1. 2. The feed shed is being depreciated at $7,200 per year. 3. The unearned revenue represents tickets sold for future zoo visits. The tickets were sold at $4.00 each on April 1. During April, twenty-five of the tickets were used by customers. Instructions (a) Calculate the following: 1. monthly rent expense 2. the age of the feed shed in months 3. the number of tickets sold on April 1. (b) Prepare the adjusting entries that were made by the King Street Zoo on April 30. Solution 145 (15 min.) (a) 1. $4,000. The $12,000 balance on the adjusted trial balance reflects three months remaining on the prepaid lease. This indicates that the monthly lease is $4,000. 2. The feed shed is 10 months old. By dividing annual depreciation ($7,200) by 12, the monthly depreciation expense is $600. The accumulated depreciation account shows $6,000 which means that depreciation has been taken for 10 months. 3. 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 April 1. (b) 1.

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

4,000

Depreciation Expense ............................................................ Accumulated Depreciation—FeedShed ...........................

600

Unearned Revenue ................................................................ Ticket Revenue ............................................................... (25  $4 = $100)

100

4,000

600

100

Ex. 146 Simons Equipment Ltd. purchased a delivery truck on June 1 for $42,000, paying $8,000 cash and signing a 6%, 2-month bank loan for the remaining balance. Interest is due at maturity. The estimated useful life of the truck is expected to be 5 years. Simons prepares monthly financial statements. Instructions (a) Prepare the journal entry to record the purchase of the delivery truck on June 1. (b) Prepare any adjusting journal entries that should be made on June 30.

Accrual Accounting Concepts

(c)

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Show how the delivery truck will be reflected on Simons Equipment’s statement of financial position at June 30.

Solution 146 (10 min.) (a) Jun 1 Delivery Truck ............................................................... Cash ....................................................................... Bank Loan Payable ................................................ (To record purchase of delivery truck and signing of a 2-month, 6% bank loan) (b) Jun 30

Jun 30

42,000 8,000 34,000

Depreciation Expense ................................................... Accumulated Depreciation—Vehicles ..................... (To record monthly depreciation; $42,000  5 years  12 months= $700/month)

700

Interest Expense ........................................................... Interest Payable ..................................................... (To accrue interest on bank loan payable; $34,000  6%  1  12 = $170)

170

(c) Property, Plant and Equipment: Vehicles ........................................................................ Less: Accumulated Depreciation ...................................

700

170

$42,000 700

$41,300

Ex. 147 Prepare the required year end adjusting entries for each independent case listed below. Assume no adjustments were made during the year. Case 1 Robitaille Corporation began the year with a $5,000 balance in the Office Supplies account. During the year, $2,500 worth of additional office supplies were purchased. A physical count of office supplies on hand at the end of the year revealed that $3,200 worth of office supplies had been used during the year. Case 2 Dallaire Co. Ltd. has a calendar fiscal year. On July 1, the company purchased office equipment for $30,000. The estimated useful life of the equipment is 5 years. Case 3 Fauchon Management Ltd. is in the business of renting out several apartment buildings and prepares monthly financial statements. It has been determined that 2 tenants in $750 per month apartments and one tenant in the $1,200 per month apartment had not paid their December rent as of December 31. Solution 147 (10 min.) Case 1 December 31 Supplies Expense................................................................... Supplies .......................................................................... (To record office supplies used during the year)

3,200 3,200

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Case 2 December 31 Depreciation Expense ............................................................ Accumulated Depreciation—Equipment .......................... (To record depreciation expense for six months; $30,000  5 years x 6  12 months = $3,000) Case 3 December 31 Rent Receivable ..................................................................... Rent Revenue ................................................................. (To accrue rent earned but not yet received [(2 x 750) + 1,200] = $2,700)

3,000 3,000

2,700 2,700

Ex. 148 For each of the following oversights, state whether total assets will be understated (U), overstated (O), or not affected (NA). _____ 1. Failure to record revenue earned but not yet received. _____ 2. Failure to record expired prepaid rent. _____ 3. Failure to record accrued interest on the bank savings account. _____ 4. Failure to record depreciation. _____ 5. Failure to record accrued salaries. _____ 6. Failure to recognize the earned portion of unearned revenues. Solution 148 (5 min.) 1. U 2.

Ex. 149 Before month-end adjustments are made, the February 28 trial balance of Hassan Enterprises Ltd. shows revenue of $11,000 and expenses of $6,400, excluding income tax. Adjustments are necessary for the following items: 1. Depreciation for February is $1,500. 2. Revenue earned but not yet billed is $2,800.

Accrual Accounting Concepts

3. 4. 5. 6.

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Accrued interest expense is $900. Revenue collected in advance that is now earned is $3,500. Portion of prepaid insurance expired during February is $400. Assume a 50% income tax rate, calculated on profit before income tax.

Instructions Calculate the correct profit to report on Hassan Enterprises Ltd.’s income statement for February. Solution 149 (5 min.) Profit before adjustments and income tax expense ($11,000 – $6,400) ........................................................................ Add: Unearned revenue.................................................................. Accrued revenue .................................................................... Subtract:

Depreciation expense ...................................................... Interest expense .............................................................. Insurance expense .......................................................... Profit after adjustments and before income tax expense ...................... Income tax expense ($8,100 x 50%) .................................................... Profit ....................................................................................................

$ 4,600 $3,500 2,800 $1,500 900 400

6,300 10,900

2,800 8,100 4,050 $ 4,050

Ex. 150 On December 31, 2015, Spear Limited prepared an income statement and a statement of financial position, but failed to take into account four adjusting entries. The incorrect income statement showed profit of $40,000. The statement of financial position showed total assets of $120,000; total liabilities of $50,000; and shareholders’ equity of $70,000. The data for the four adjusting entries were: 1. Depreciation on equipment of $5,000 was not recorded. 2. Salaries amounting to $8,000 for the last two days in December were not paid and not recorded. The next payroll will be in January 2016. 3. Rent of $12,000 was paid for two months in advance on December 1. The entire amount was debited to Rent Expense when paid. 4. Income tax expense was estimated to be $20,000 for the year. Instructions Complete the following tabulation to correct the financial statement amounts shown (indicate deductions with parentheses): Item Incorrect balances Effects of: Depreciation Salaries Rent Income tax

Profit $40,000

Total Assets $120,000

Total Liabilities Shareholders’ Equity $50,000 $70,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Correct balances Solution 150 (10 min.) Item Profit Incorrect balances $40,000 Effects of: Depreciation (5,000) Salaries (8,000) Rent 6,000 Income tax (20,000) Correct balances $13,000

Total Assets $120,000

Total Liabilities Shareholders’ Equity $50,000 $70,000

(5,000) 8,000 6,000 _______ $121,000

20,000 $78,000

(5,000) (8,000) 6,000 (20,000) $43,000

Ex. 151 Sheik Corporation accumulates the following adjustment data at December 31: 1. Revenue of $1,000 collected in advance has been earned. 2. Salaries of $500 are unpaid. 3. Prepaid rent of $650 has expired. 4. Supplies of $550 have been used. 5. Revenue earned but unbilled totals $850. 6. Utility expenses of $200 are unpaid. 7. Interest of $250 has accrued on a bank loan payable. Instructions (a) For each of the above items indicate: 1. The type of adjustment (prepaid expense, unearned revenue, 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 (and income tax) was $16,500. Calculate the correct profit before income tax. Codes: A = L = E =

Asset Liability Expense

R = O = U =

Revenue Overstatement Understatement

Prepare your answer in the tabular form presented below. Account Balances Before Adjustment Type of Account (Understatement Adjustment Relationship or Overstatement) Solution 151 (20 min.) (a) Type of Account Adjustment Relationship 1. Unearned revenue L/R

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

Adjusting Entry

Adjusting Entry Unearned Revenue

Income Effect Increase (Decrease)

Accrual Accounting Concepts

2. Accrued expense

3. Prepaid expense

4. Prepaid expense

5. Accrued revenue

6. Accrued expense

7. Accrued expense

E/L

E/A

A/R

E/L

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Rev. U

Service Revenue

1,000

Exp. U Liab. U

Salary Expense Salaries Payable

(500)

Exp. U Asset O

Rent Expense Prepaid Rent

(650)

Exp. U Asset O

Supplies Expense Supplies

(550)

Asset U Rev. U

Accounts Receivable Service Revenue

850

Exp. U Liab. U

Utilities Expense Accounts Payable

(200)

Exp. U Liab. U

Interest Expense Interest Payable

(250)

(b) Profit before adjustments and income tax...................................... Add: Unearned revenue (1) ..................................................... Accrued revenue (5) ........................................................ Less:

Accrued salaries (2) ......................................................... Prepaid rent expired (3) ................................................... Supplies used (4)............................................................. Accrued utilities (6) .......................................................... Accrued interest (7) ......................................................... Adjusted profit before income tax ..................................................

$16,500 $1,000 850 $500 650 550 200 250

1,850 18,350

2,150 $16,200

Ex. 152 Rodriguez Ltd.’s trial balance includes the following statement of financial position accounts that frequently require adjustment. For each account, indicate (a) the type of adjusting entry (prepaid expenses, unearned revenues, accrued revenues, or accrued expenses) and (b) the related account in the adjusting entry. (a) (b) Statement of Financial Position Acct Type of Adjusting Entry Related Account 1. Supplies 2. Accounts Receivable 3. Prepaid Insurance 4. Accumulated Depreciation 5. Interest Payable 6. Salaries Payable 7. Unearned Revenue 8. Income Tax Payable Solution 152 (15 min.)

(a)

(b)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Statement of Financial Position Acct 1. Supplies

Type of Adjusting Entry Prepaid Expense

Related Account Supplies Expense

2. Accounts Receivable

Accrued Revenue

Service Revenue

3. Prepaid Insurance

Prepaid Expense

Insurance Expense

4. Accumulated Depreciation

Prepaid Expense

Depreciation Expense

5. Interest Payable

Accrued Expense

Interest Expense

6. Salaries Payable

Accrued Expense

Salaries Expense

7. Unearned Revenue

Unearned Revenue

Service Revenue

8. Income Tax Payable

Accrued Expense

Income Tax Expense

Ex. 153 State whether each situation is a prepaid expense (PE), unearned revenue (UR), accrued revenue (AR) or an accrued expense (AE). 1. Unrecorded interest on savings account is $530. 2. Property taxes that have been incurred but that have not yet been paid or recorded are $300. 3. Legal fees of $1,000 were collected in advance. By year end, 60% are still unearned. 4. Prepaid insurance had a $500 balance prior to adjustment. By year end, 40% is still unexpired. 5. Unpaid salaries earned by year end but not yet paid or recorded are $475. Solution 153 (5 min.) 1. AR 2.

Ex. 154 Match the statements below with the appropriate terms by entering the appropriate letter code in the spaces provided. TERMS: A. Prepaid Expenses B. Unearned Revenues C. Accrued Revenues

Accrual Accounting Concepts

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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. Interest revenue collected; not yet earned. ____ 4. Rent not yet collected, but already earned. ____ 5. An expense incurred; not yet paid or recorded. ____ 6. Revenue earned; not yet collected or recorded. ____ 7. An expense not yet incurred; paid in advance. ____ 8. Interest expense incurred; not yet paid. Solution 154 (5 min.) 1. B 2.

Ex. 155 Indicate (with "Yes" or "No") whether or not each of the following accounts could be misstated if adjusting entries are not made at December 31, 2015. _____ 1. Accounts Receivable _____ 2. Prepaid Expenses _____ 3. Equipment _____ 4. Unearned Revenue _____ 5. Income Tax Payable _____ 6. Common Shares _____ 7. Retained Earnings, January 1, 2015 _____ 8. Revenue _____ 9. Utilities Expense Solution 155 (5 min.) 1. Yes 2.

Yes

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Yes

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 156 Presented below are the income statements, prepared on a cash basis, for Mingwei Ltd. for the past two years. The manager is puzzled by the fact that profit was lower in 2016 than 2015. MINGWEI LTD. Income Statement, Cash Basis Years Ended December 31 —————————————————————————————————————————— 2016 2015 Sales ........................................................................................... $350,000 $365,000 Expenses Salaries ................................................................................ 200,000 190,000 Operating expenses ............................................................. 74,000 70,000 Interest expense................................................................... 15,000 2,000 Total expenses............................................................................ 289,000 262,000 Profit before income tax .............................................................. 61,000 103,000 Income tax expense .................................................................... 24,400 41,200 Profit ........................................................................................... $ 36,600 $ 61,800 In talking with the manager, you gather the following information, which was not reflected in the above statements: 1. The company borrowed $200,000 on June 1, 2015 and repaid the amount with interest on June 1, 2016. The interest rate was 6%.The journal entry to record the repayment on June 1, 2016 was: Loan Payable ...................................................... 200,000 Interest Expense ................................................. 12,000 Cash ............................................................. 212,000 2. A customer made a deposit of $15,000 on December 1, 2015 for services to be performed in January 2016. The journal entry made on December 1, 2015 was: Cash.................................................................... 15,000 Sales ............................................................ 15,000 3. A bill for $4,000 maintenance work done in December 2015 was paid on January 15, 2016. The journal entry to record the payment in 2016 was: Operating Expenses ............................................ 4,000 Cash ............................................................. 4,000

Accrual Accounting Concepts

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Instructions Assuming that no adjusting entries were made for the above transactions, prepare revised income statements for 2015 and 2016. (Income tax is calculated at 40% of profit before income tax.) Solution 156 (15 min.) MINGWEI LTD. Income Statement Year Ended December 31 —————————————————————————————————————————— 2016 2015 Sales ........................................................................................... $365,000 $350,000 Expenses Salaries ................................................................................ 200,000 190,000 Operating expenses ............................................................. 70,000 74,000 Interest expense................................................................... 8,000 9,000 Total expenses............................................................................ 278,000 273,000 Profit before income tax .............................................................. 87,000 77,000 Income tax expense .................................................................... 34,800 30,800 Profit ........................................................................................... $ 52,200 $ 46,200 Calculations: Sales 2016: $350,000 + $15,000 = $365,000 2015: $365,000 – $15,000 = $350,000 Interest expense

2016: 2015:

$15,000 – $7,000 = $8,000 $ 2,000 + $7,000 = $9,000

Adjustment June to November 2015 = $200,000 × 6% × 7 ÷ 12 = $7,000 Operating expenses

2016: $74,000 – $4,000 = $70,000 2015: $70,000 + $4,000 = $74,000

Income tax

$87,000 × 40% = $34,800 $77,000 × 40% = $30,800

2016: 2015:

Ex. 157 Prepare adjusting entries for the following transactions. Omit explanations. 1. Depreciation on equipment is $850. 2. Interest incurred and owed on a loan but not paid or recorded is $300. 3. There was a beginning balance of supplies of $150 and the company purchased $325 of office supplies during the period. At the end of the year $85 of supplies were on hand. 4. Prepaid rent had a $2,000 normal balance prior to adjustment. By year end $600 had expired. 5. Accrued salaries at year end were $875. Solution 157 (10 min.)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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

850

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

300

Supplies Expense ......................................................................... Supplies ................................................................................. ($150 + $325 – $85)

390

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

600

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

875

850

300

390

600

875

Ex. 158 Prepare adjusting entries for the following transactions. Omit explanations. 1. Interest accrued on notes receivable is $270. 2. Property taxes owing but not paid or recorded amount to $700. 3. Legal service revenues of $3,000 were collected in advance. By year end, $600 was earned. 4. Prepaid insurance had a $400 debit balance prior to adjustment. By year end, 40% was still unexpired. 5. Salaries owing at year end but not yet paid or recorded amounted to $950. Solution 158 (10 min.) 1. Interest Receivable ....................................................................... Interest Revenue ....................................................................

270

Property Tax Expense ................................................................... Property Tax Payable .............................................................

700

Unearned Revenues ..................................................................... Legal Service Revenues.........................................................

600

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

240

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

950

270

700

600

240

950

Ex. 159 Prepare adjusting entries for the following transactions. Omit explanations. 1. Accrued interest on notes receivable is $95. 2. Unearned revenues earned totals $2,000. 3. Four months’ rent, totalling $60,000, was paid in advance one month prior to the end of the

Accrual Accounting Concepts

4. 5. 6. 7.

year. Services totalling $2,100 had been performed but not yet billed at the end of the year. Equipment purchased two years ago for $18,000 had an estimated useful life of 4 years. The balance in the Supplies account was $690 at the beginning of the year. By year end, only $100 in supplies remained. Salaries owed to employees at the end of the year total $1,000.

Solution 159 (10 min.) 1. Interest Receivable ....................................................................... Interest Revenue .................................................................... 2.

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95 95

Unearned Revenues ..................................................................... Revenues ...............................................................................

2,000

Rent Expense (60,000 ÷ 4) ........................................................... Prepaid Rent ..........................................................................

15,000

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

2,100

Depreciation Expense ($18,000 ÷ 4) ............................................. Accumulated Depreciation—Equipment .................................

4,500

Supplies Expense ......................................................................... Supplies .................................................................................

590

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

1,000

2,000

15,000

2,100

4,500

590

1,000

Ex. 160 One part of an adjusting entry is given below. Indicate the account title for the other part of the entry. 1. Unearned Revenue is debited. 2. Prepaid Rent is credited. 3. Accounts Receivable is debited. 4. Depreciation Expense is debited. 5. Utilities Expense is debited. 6. Interest Payable is credited. 7. Service Revenue is credited (give two possible debit accounts). 8. Interest Receivable is debited. Solution 160 (5 min.) 1. Service Revenue 2.

Rent Expense

Service Revenue

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Accumulated Depreciation

Utilities Payable

Interest Expense

Accounts Receivable or Unearned Revenue

Interest Revenue

Ex. 161 The following ledger accounts are used by the Clover Race Track: Accounts Receivable Prepaid Printing Prepaid Rent Unearned Revenue Printing Expense Rent Expense Admissions Revenue Concessions Revenue Instructions For each of the following transactions, prepare the journal entry (if one is required) to record the initial transaction and then prepare the adjusting entry, if any, required on September 30, the end of the fiscal year. (a) On September 1, paid rent on the track facility for three months, $240,000. (b) On September 1, sold season tickets totalling $900,000 for admission to the racetrack. The racing season is year-round with 25 racing days each month. (c) On September 1, borrowed $150,000 from First Provincial Bank by issuing a 12% bank loan payable due in three months. (d) On September 5, schedules for 20 racing days in September, 25 racing days in October, and 15 racing days in November were printed for $3,000. (e) The accountant for the company that operates the concessions (food and drink stands) reported that gross receipts for September were $140,000. Ten percent is due to Clover Race Track and will be paid by October 10. Solution 161 (15 min.) (a) Initial Journal Entry Prepaid Rent .......................................................................... Cash ................................................................................

240,000 240,000

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

80,000

(b) Initial Journal Entry Cash....................................................................................... Unearned Revenue .........................................................

900,000

80,000

900,000

Accrual Accounting Concepts

Adjusting Entry Unearned Revenue ................................................................ Admissions Revenue ....................................................... ($900,000  12 = $75,000) (c) Initial Journal Entry Cash....................................................................................... Note Payable ................................................................... Adjusting Entry Interest Expense .................................................................... Interest Payable............................................................... ($150,000  12%  1  12 = $1,500) (d) Initial Journal Entry Prepaid Printing ...................................................................... Cash ................................................................................ Adjusting Entry Printing Expense .................................................................... Prepaid Printing ............................................................... ($3,000  20  60 = $1,000)

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75,000 75,000

150,000 150,000

1,500 1,500

3,000 3,000

1,000 1,000

(e) Initial Journal Entry None Adjusting Entry Accounts Receivable ($140,000 x 10%) ................................. Concessions Revenue .....................................................

14,000 14,000

Ex. 162 Plover Corporation prepares monthly financial statements. Below are listed some selected accounts and their balances on the September 30 trial balance before any adjustments have been made for the month of September. PLOVER CORPORATION Trial Balance September 30, 2015 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $12,300 Office supplies ..................................................................................... 2,700 Prepaid insurance ................................................................................ 5,775 Equipment............................................................................................ 16,200 Accumulated depreciation—equipment ................................................ $ 540 Accounts payable................................................................................. 1,100 Unearned revenue ............................................................................... 1,200 Common shares................................................................................... 10,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Retained earnings ................................................................................ Rent revenue ....................................................................................... Salaries expense ................................................................................. Office supplies expense ....................................................................... Insurance expense............................................................................... Depreciation expense .......................................................................... Total.....................................................................................................

18,925 6,360 1,150 0 0 0 $38,125

$38,125

An analysis of the account balances provided the following additional information: 1. A physical count of office supplies revealed $1,200 on hand on September 30. 2. A two-year insurance policy was purchased on June 1 for $6,600. 3. The office equipment was purchased on July 1st for $16,200 and has an estimated useful life of five years. 4. Rent received in advance that remains unearned at September 30 is $500. Instructions (a) Using the above additional information, prepare the adjusting entries that should be made by Plover on September 30 (adjusting entries are made on a monthly basis). (b) Prepare an adjusted trial balance at September 30. Solution 162 (10 min.) (a) 1. Office Supplies Expense ($2,700 – $1,200) .................................. Office Supplies ....................................................................... (To record the amount of office supplies used) 2.

1,500 1,500

Insurance Expense ....................................................................... Prepaid Insurance .................................................................. (To record insurance expired; $6,600  24)

275

Depreciation Expense ................................................................... Accumulated Depreciation—Equipment ................................. (To record monthly depreciation; $16,200  5  12)

270

Unearned Revenue ($1,200 – $500) ............................................. Rent Revenue ........................................................................ (To record rent revenue earned)

700

275

270

700

(b) PLOVER CORPORATION Adjusted Trial Balance September 30, 2015 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $12,300 Office supplies ($2,700 - $1,500) ......................................................... 1,200 Prepaid insurance [$5,775 – ($6,600  24)] ......................................... 5,500 Equipment ........................................................................................... 16,200 Accumulated depreciation—equipment ($540 + $270) ......................... $ 810

Accrual Accounting Concepts

Accounts payable................................................................................. Unearned revenue ($1,200 - $700) ...................................................... Common shares................................................................................... Retained earnings ................................................................................ Rent revenue ($6,360 + $700) ............................................................. Salaries expense ................................................................................. Office supplies expense [$0 + ($2,700 - $1,200)] ................................. Insurance expense [$0 + ($6,600  24)] ............................................... Depreciation expense [$0 + ($16,200  5  12)] ................................... Total.....................................................................................................

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1,100 500 10,000 18,925 7,060 1,150 1,500 275 270 $38,395

$38,395

Ex. 163 Xiang Insurance Agency Ltd. prepares monthly financial statements. Presented below is an income statement prepared for the month of June 2016. XIANG INSURANCE AGENCY LTD. Income Statement Month Ended June 30, 2016 —————————————————————————————————————————— Revenues Commission revenue .................................................................... $60,000 Expenses Salary expense ............................................................................. $5,000 Advertising expense ...................................................................... 800 Rent expense ................................................................................ 4,200 Depreciation expense ................................................................... 2,800 Total expenses .............................................................................. 12,800 Profit before income tax ....................................................................... 47,200 Income tax expense ............................................................................. 0 Profit .................................................................................................... $47,200 When the income statement was prepared, the company accountant forgot to take into consideration the following information: 1. A utility bill for $800 was received on the last day of the month for electric and gas service for the month of June. 2. A company salesman sold a life insurance policy on June 20 to a client for a premium of $28,000. The agency billed the client for the policy and is entitled to a commission of 15%. 3. Supplies on hand at the beginning of the month were $700. The agency purchased additional supplies during the month for $2,500 in cash and $2,200 of supplies were on hand at June 30. 4. The agency purchased a used car at the beginning of June for $16,800 cash. The estimated useful life of the car is 4 years. 5. The agency pays its employees each Friday. Weekly payroll is $7,200. June 30 falls on a Wednesday. 6. Estimated income tax expense owing was $10,000. Instructions Prepare a corrected income statement.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Solution 163 (20 min.) XIANG INSURANCE AGENCY LTD. Income Statement For Month Ended June 30, 2016 —————————————————————————————————————————— Revenues Commission revenue [$60,000 + $4,200 ($28,000 x 15%)] ........... $64,200 Expenses Salary expense [$5,000 + $4,320 ($7,200 x 3 ÷ 5)] ....................... $9,320 Advertising expense ...................................................................... 800 Rent expense ................................................................................ 4,200 Depreciation expense ($2,800 + $350).......................................... 3,150 Utilities expense ($0 + $800) ......................................................... 800 Supplies expense ($700 + $2,500 – $2,200) ................................. 1,000 Total expenses ....................................................................... 19,270 Profit before income tax ....................................................................... 44,930 Income tax expense ($0 + $10,000) ..................................................... 10,000 Profit .................................................................................................... $34,930

Ex. 164 Presented below is the trial balance and adjusted trial balance for Sandhu Corporation on December 31, 2016. SANDHU CORPORATION Trial Balances December 31, 2016 —————————————————————————————————————————— Before Adjustments After Adjustments Dr. Cr. Dr. Cr. Cash $ 2,000 $ 2,000 Accounts receivable 2,800 3,900 Prepaid rent 2,100 1,500 Supplies 1,200 800 Vehicles 18,000 18,000 Accumulated depreciation—vehicles $ 1,300 $ 1,500 Accounts payable 2,700 3,000 Income tax payable 0 2,000 Bank loan payable 10,000 10,000 Interest payable 120 Salaries payable 600 Unearned revenue 4,460 4,360 Common shares 7,200 7,200 Dividends 3,200 3,200 Service revenue 8,000 9,200 Salaries expense 2,060 2,660 Utilities expense 1,800 2,100 Rent expense 500 1,100 Supplies expense 400 Depreciation expense—vehicles 200 Interest expense 120 Income tax expense 2,000

Accrual Accounting Concepts

Totals

$33,660

$37,980

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$37,980

Instructions Prepare in journal entry form, with explanations, the adjusting entries that explain the changes in the balances from the trial balance to the adjusted trial balance. Solution 164 (25 min.) Accounts Receivable............................................................................ Service Revenue ........................................................................... (To record revenue earned but not yet collected)

1,100 1,100

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

600

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

400

Depreciation Expense .......................................................................... Accumulated Depreciation—Vehicles............................................ (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

Unearned Revenue .............................................................................. Service Revenue ........................................................................... (To record revenue earned)

100

Utilities Expense .................................................................................. Accounts Payable ......................................................................... (To record receipt of utility bill)

300

Income Tax Expense ........................................................................... Income Tax Payable ..................................................................... (To record estimated income taxes not yet paid)

2,000

600

400

200

600

120

100

300

2,000

Ex. 165 Deng Corporation’s fiscal year ends on June 30. Deng also has a policy of paying their weekly payroll every Friday. Payroll records indicate the following salary costs were incurred late in June and early July:

Monday

Date June 28

Amount $3,000

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Tuesday Wednesday Thursday Friday

June 29 June 30 July 1 July 2

3,800 2,400 3,000 2,400

Instructions (a) Prepare any necessary adjusting journal entries that should be made at year end on June 30. (b) Prepare the journal entry to record the payment of the payroll on July 2. Solution 165 (10 min.) (a) Jun 30 Salaries Expense ($3,000 + $3,800 + $2,400)............... Salaries Payable .................................................... To accrue salaries incurred but not yet paid. (b) Jul

Salaries Payable ........................................................... Salaries Expense ($3,000 + $2,400) ............................. Cash ....................................................................... To record payment of July 2 payroll.

9,200 9,200

9,200 5,400 14,600

Ex. 166 Each Friday, Song Ltd. pays its office personnel weekly salaries of $40,000 for a five-day work week. Instructions (a) Prepare the necessary adjusting entry at March 31, assuming March 31 falls on a Thursday. (b) Prepare the journal entry for the next payday, which is Friday, April 1. Solution 166 (5 min.) (a) Mar. 31 Salaries Expense ($40,000 x 4/5) ................................ Salaries Payable .................................................. (b) Apr. 1

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

32,000 32,000 32,000 8,000 40,000

Ex. 167 The adjusted trial balance of Norfaxx Services Inc. appears below. Using the information from the adjusted trial balance, prepare, for the month ending December 31, 2016: (a) an income statement; (b) a statement of changes in equity; and (c) a statement of financial position. NORFAXX SERVICES INC. Adjusted Trial Balance December 31, 2016 ——————————————————————————————————————————

Accrual Accounting Concepts

Cash ................................................................................................... Accounts receivable ............................................................................ Office supplies .................................................................................... Equipment ........................................................................................... Accumulated depreciation—equipment ............................................... Accounts payable ................................................................................ Unearned revenue .............................................................................. Common shares................................................................................... Retained earnings ............................................................................... Dividends ............................................................................................ Service revenue .................................................................................. Office supplies expense ...................................................................... Depreciation expense ......................................................................... Rent expense ......................................................................................

Debit $ 6,000 3,000 1,500 18,000

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Credit

$ 4,800 3,400 8,000 12,100 3,300 1,600 4,000 500 3,000 2,000 $35,600

$35,600

Solution 167 (30 min.) (a) NORFAXX SERVICES INC. Income Statement Month Ended December 31, 2016 —————————————————————————————————————————— Revenues Service revenue ........................................................................... $ 4,000 Expenses Depreciation expense ................................................................... $3,000 Rent expense ............................................................................... 2,000 Office supplies expense ............................................................... 500 Total expenses ...................................................................... 5,500 Loss ..................................................................................................... $(1,500) (b) NORFAXX SERVICES INC. Statement of Changes in Equity Month Ended December 31, 2016 —————————————————————————————————————————— Common Shares Retained Earnings Total Equity Balance, December 1 $12,100 $3,300 $15,400 Loss (1,500) (1,500) Dividends ______ (1,600) (1,600) Balance, December 31 $12,100 $ 200 $12,300

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(c) NORFAXX SERVICES INC. Statement of Financial Position December 31, 2016 —————————————————————————————————————————— Assets Cash .................................................................................................... $ 6,000 Accounts receivable ............................................................................. 3,000 Office supplies ..................................................................................... 1,500 Equipment............................................................................................ $18,000 Less: accumulated depreciation—equipment ....................................... 4,800 13,200 Total assets................................................................................... $23,700 Liabilities and Shareholders’ Equity Liabilities Accounts payable .......................................................................... Unearned revenue ........................................................................ Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity .................................

$3,400 8,000 $11,400 12,100 200 $23,700

Ex. 168 The following is a list of accounts and their balances (all normal balances) as of July 31, 2016 for Ling Chan Inc. All adjusting entries have been prepared and posted. Note that the list is in random order. Cash ............................................................................................. $35,300 Utilities expense ............................................................................ 800 Accounts receivable ...................................................................... 16,000 Prepaid insurance ......................................................................... 5,000 Service revenue ............................................................................ 24,600 Supplies ........................................................................................ 1,500 Rent expense ................................................................................ 3,600 Accumulated depreciation—equipment ......................................... 3,200 Accounts payable .......................................................................... 11,000 Unearned revenue ........................................................................ 9,800 Common shares ............................................................................ 27,000 Retained earnings ......................................................................... 17,000 Dividends ...................................................................................... 1,000 Equipment ..................................................................................... 20,000 Salary expense ............................................................................ 8,200 Depreciation expense ................................................................... 1,200 Instructions Prepare the closing journal entries required. Solution 168 (10 min.) Service Revenue ...........................................................................

24,600

Accrual Accounting Concepts

Income Summary ...................................................................

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24,600

Income Summary .......................................................................... Utilities Expense ..................................................................... Rent Expense......................................................................... Salary Expense ...................................................................... Depreciation Expense ............................................................

13,800

Income Summary .......................................................................... Retained Earnings ..................................................................

10,800

Retained Earnings......................................................................... Dividends ...............................................................................

1,000

800 3,600 8,200 1,200

10,800

1,000

Ex. 169 The adjusted trial balance for Zeta-Omega Ltd. at December 31, 2016, is shown below. ZETA-OMEGA INC. Adjusted Trial Balance December 31, 2016 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 30,500 Accounts receivable ............................................................................. 23,200 Supplies ............................................................................................... 3,950 Prepaid insurance ................................................................................ 2,600 Equipment............................................................................................ 48,500 Accumulated depreciation—equipment ................................................ $ 18,800 Accounts payable................................................................................. 3,500 Unearned revenue ............................................................................... 8,700 Salaries payable .................................................................................. 1,650 Common shares .................................................................................. 24,000 Retained earnings ................................................................................ 20,000 Dividends ............................................................................................. 6,000 Service revenue ................................................................................... 70,300 Salaries expense ................................................................................. 25,850 Supplies expense................................................................................. 1,850 Insurance expense............................................................................... 700 Depreciation expense .......................................................................... 900 Utilities expense ................................................................................... 2,900 ______ Total..................................................................................................... $146,950 $146,950 Instructions Prepare the closing journal entries required. Solution 169 (10 min.) Service Revenue ........................................................................... Income Summary ...................................................................

70,300

Income Summary ..........................................................................

32,200

70,300

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Salaries Expense ................................................................... Supplies Expense................................................................... Insurance Expense................................................................. Depreciation Expense ............................................................ Utilities Expense .....................................................................

25,850 1,850 700 900 2,900

Income Summary .......................................................................... Retained earnings ..................................................................

38,100

Retained Earnings......................................................................... Dividends ...............................................................................

6,000

38,100

6,000

Ex. 170 The adjusted trial balance for Chung, Ltd. at December 31, 2016, is shown below: CHUNG LTD. Adjusted Trial Balance December 31, 2016 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 8,500 Accounts receivable ............................................................................. 3,200 Supplies ............................................................................................... 950 Prepaid insurance ................................................................................ 600 Equipment............................................................................................ 68,500 Accumulated depreciation–equipment ................................................. $ 18,500 Accounts payable................................................................................. 4,500 Salaries payable .................................................................................. 1,650 Common shares .................................................................................. 24,000 Retained earnings ................................................................................ 36,000 Revenue .............................................................................................. 28,300 Salaries expense ................................................................................. 15,850 Supplies expense................................................................................. 9,850 Insurance expense............................................................................... 700 Depreciation expense .......................................................................... 1,900 Utilities expense ................................................................................... 2,900 _______ Total..................................................................................................... $112,950 $112,950 Instructions Prepare the closing journal entries required. Solution 170 (10 min.) Revenue ....................................................................................... Income Summary ................................................................... Income Summary .......................................................................... Salary Expense ...................................................................... Supplies Expense................................................................... Insurance Expense................................................................. Depreciation Expense ............................................................

28,300 28,300 31,200 15,850 9,850 700 1,900

Accrual Accounting Concepts

Utilities Expense ..................................................................... Retained Earnings......................................................................... Income Summary ...................................................................

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2,900 2,900 2,900

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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MATCHING 171. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E. ____ cash. ____ ____ ____ ____ ____ ____ ____ ____

Unearned revenue Cash basis of accounting Temporary accounts Prepaid expenses Accrued revenues

F. G. H. I

Depreciation Post-closing trial balance Accrued expenses Carrying amount

1. Revenues and expenses are recorded only in periods the company receives or pays 2. Expenses paid before they are used, recorded as assets. 3. Cost of a depreciable asset less its accumulated depreciation. 4. Cash received before the revenue is earned, recorded as a liability. 5. Includes only permanent—statement of financial position—accounts 6. Revenue, expense and dividends accounts. 7. Revenues earned but not yet received in cash or recorded. 8. Expenses incurred but not yet paid in cash or recorded. 9. Allocation of the cost of a depreciable asset over its useful life.

Accrual Accounting Concepts

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ANSWERS TO MATCHING 1.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS S-A E 172 The income statement is an important financial statement used by individuals who are interested in the operations of a business. Explain how the criteria for revenue recognition and expense recognition provide guidance to accountants in preparing an income statement. Solution 172 In general, revenue recognition (recording) occurs when the sales or performance effort is substantially complete, the amount is reasonably measurable, and collection is reasonably assured. For a merchandising business, this would normally be when the merchandise is sold to the customer; and for a service business, at the time the service is performed. Expenses are recognized when, due to ordinary business activity, there is a decrease in future economic benefits related to a decrease in an asset or an increase in a liability, AND this change can be measured reliably. Usually, expense recognition will coincide with revenue recognition and if it does not, then it will likely be recognized due to the passage of time.

S-A E 173 What is the difference between the accrual basis of accounting and the cash basis of accounting? Which approach is preferable? Solution 173 Accrual basis accounting means that transactions and events affecting an entity’s financial statements are recorded in the period in which they occur, rather than when the entity receives or pays cash. In other words, the cash component of the transaction is secondary. Cash basis accounting records revenue only when cash is received from customers, and records expenses only when they are actually paid. The cash basis often produces misleading financial statements, since management can change the revenues and expenses reported by timing the receipt and payment of cash (“earnings management”). For example, if they wish to show a large profit, they can delay paying expenses until after year end. Cash basis accounting also does not report accounts receivable and accounts payable, which may understate current assets and/or current liabilities. Thus the accrual basis is preferable, since, because all revenues and expenses are reported each period, it produces a more meaningful picture of operations and financial position. The accrual basis also does not allow for earnings management, as the cash basis does.

S-A E 174 Ecrit Inc. is a manufacturing company that specializes 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. Ecrit 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

Accrual Accounting Concepts

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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 Anik Tibault, 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 might eventually fail. 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. Tibault then instructed you, the accountant, not to use prepaid expense accounts for insurance or 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. Instructions (a) Who are the stakeholders in this situation? (b) Describe the alternatives that you as an accountant would have in this situation. (c) Indicate which alternative you think is best. Solution 174 (a) The stakeholders in this situation include Anik Tibault, sales personnel, top management, bankers and others who might rely on the financial statements (b) The choices include: 1. Follow Ms. Tibault's instructions. 2. Explain to Ms. Tibault’s why you cannot follow her instructions. 3. Report Ms. Tibault’s actions to her superior. 4. Resign. (c) 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. On the other hand, #3 and #4 are rather drastic measures that do not seem to be justifiable given the facts, at least not yet. #2, therefore, is the best choice.

S-A E 175 Describe the requirements under IFRS and ASPE regarding the frequency required for adjusting journal entries. Solution 175 Public companies reporting under IFRS must prepare adjusting journal entries at least quarterly, as they are required to release quarterly reports to the public. In reality, many public companies prepare monthly adjusting journal entries. Private companies reporting under ASPE are only required to prepare adjusting entries annually, although many prepare them more frequently.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

S-A E 176 What is the purpose of the preparation of adjusting entries? Solution 176 Adjusting entries are needed to ensure that revenue recognition and expense recognition criteria are followed. Their purpose is to bring all accounts up to date. The use of adjusting entries makes it possible to produce relevant financial information at the end of the period.

S-A E 177 A new sales representative, Eddy Werner, has just received his copy of the latest monthly financial reports. He is puzzled by the term "unearned revenue." He has emailed you asking you to explain what this is. One of this comments in his email was “How can we have unearned revenue? Either we earned it, or we didn't!” Instructions Write a response to email to Eddy. Solution 177 A proposed email message follows: Eddy—What a pleasant surprise to hear from you! I hope you are getting along well with your new job. To your question. Your unearned revenue is the result of customers who pay in advance. When they pay before we can get their products made or shipped, we can't count the money they pay us as revenue. What we actually have is a liability—an obligation to make and ship products. So that's how we record it—as a liability. You happened to have about 25% of your sales this month that fit in that category. When production can catch up with orders, you'll get credit for the sales. You will receive your commissions the same month the company records the revenue as "earned." Thanks for asking this question. I hope I have explained “unearned revenue” to your satisfaction. If not, please contact me again any time. Best regards (Student name)

S-A E 178 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. Solution 178 Account balances must be adjusted before financial statements are prepared, even in a properly

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designed accounting system, because 1. Some events are not recorded daily, because it would not be useful or efficient to do so (for example, use of supplies), 2. Some costs are not recorded during the accounting period, because these costs expire with the passage of time (for example, rent, insurance, depreciation), and 3. Some items may not have been recorded (for example, a utility bill for the current period not received until the next period). Adjusting entries can be classified as either prepayments or accruals. Prepayments are types of adjustments of recorded transactions that must be allocated to future periods as well as the current period. Examples of prepayment adjustments include entries that reduce the balance in prepaid rent, prepaid insurance, and unearned revenue so as to recognize a portion of these accounts in the income statement. Accruals are adjustments giving rise to the initial recording of a revenue or expense that must be recognized in the current period. Examples of accrual-type adjustments are those that accrue salaries payable, interest payable, and interest receivable.

S-A E 179 Briefly distinguish between a prepayment and an accrual. Solution 179 Unlike accruals, prepayments adjust assets and liabilities that were previously recorded. They are adjusted so as to show the portion of the asset or liability that should expensed (because a portion of the benefit of that asset has expired) or recorded as revenue because of a portion of the unearned revenue liability has been earned. An accrual involves the initial recording of an expense or revenue that has arisen but that has not yet been recorded, paid, or received.

CHAPTER 5 MERCHANDISING OPERATIONS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item SO LOD 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

1 1 1 1 1 1 1 1 1 2 2 2

E E E E E E M E M M M M

58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1,6 1,6

E E E M M E M E E E M M E E E E M E E M E

Note:

E = Easy

Item SO LOD Item SO LOD Item SO LOD Item SO LOD True-False Statements 13. 2 E 25. 3 M 37. 4 M *49. 6 M 14. 2 E 26. 3 E 38. 4 M *50. 6 E 15. 2 E 27. 3 E 39. 4 E *51. 6 M 16. 2 E 28. 3 E 40. 5 E *52. 6 E 2 3 5 6 17. E 29. M 41. M *53. M 18. 2 E 30. 3 M 42. 5 M *54. 6 E 19. 2 M 31. 4 M 43. 5 E *55. 6 E 20. 2 M 32. 4 E 44. 5 E *56. 6 M 21. 3 E 33. 4 E 45. 5 E *57. 6 M 22. 3 E 34. 4 E 46. 5 E 23. 3 M 35. 4 E 47. 5 M 24. 3 M 36. 4 M *48. 6 E Multiple Choice Questions 79. 1,6 E 100. 3 E 121. 4 E 142. 5 E 80. 2 E 101. 3 E 122. 4 E 143. 5 M 81. 2 M 102. 3 M 123. 4 E 144. 5 M 82. 2 E 103. 3 E 124. 4 H *145. 6 M 83. 2 M 104. 3 M 125. 4 M *146. 6 E 84. 2 M 105. 3 E 126. 4 E *147. 6 E 85. 2 E 106. 3 E 127. 4 E *148. 6 E 86. 2 M 107. 3 M 128. 4 M *149. 6 E 87. 2 E 108. 3 E 129. 4 E *150. 6 E 88. 2 E 109. 3 M 130. 4 M *151. 6 M 89. 2 E 110. 3 M 131. 4 E *152. 6 M 90. 3 E 111. 3 E 132. 4 M *153. 6 E 91. 3 M 112. 3 E 133. 4 M *154. 6 E 92. 3 E 113. 3 E 134. 5 M *155. 6 E 93. 3 E 114. 3 E 135. 5 M *156. 6 M 94. 3 E 115. 4 E 136. 5 E *157. 6 M 95. 3 E 116. 4 E 137. 5 M *158. 6 M 96. 3 M 117. 4 E 138. 5 E *159. 6 M 97. 3 E 118. 4 E 139. 5 M *160. 6 M 98. 3 E 119. 4 E 140. 5 E *161. 6 M 99. 3 M 120. 4 M 141. 5 E M = Medium

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED) Item

LOD Item

162. 163. 164. 165. 166. 167.

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

H E M E E H

189.

1–3,5,6 E,M

190. 191. 192.

1 1,2,6 1,6

Note:

E = Easy

E M E

168. 169. 170. 171. 172. 173.

193. 194. 195.

SO LOD Item SO LOD Item SO LOD Item Exercises 2,3,6 E 174. 4,5 E *180. 6 H *186. 3 M 175. 4,5 E *181. 6 M *187. 3 E 176. 4,5 E *182. 6 E *188. 4 E 177. 4,5 E *183. 6 E 4 E 178. 5 M *184. 6 E 4 M 179. 5,6 H *185. 6 M Matching

4 4 4

M = Medium

Short-Answer Essay E 196. 4 E 199. E 197. 4 M *200. M 198. 4,5 M

5 6

SO LOD 6 6 6

E M E

E E

H = Hard

*This topic is dealt with in an appendix to the chapter.

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

Item

1. 2. 3. 4. 5.

TF TF TF TF TF

6. 7. 8. 9. 58.

TF TF TF TF MC

59. 60. 61. 62. 63.

10. 11. 12. 13. 14.

TF TF TF TF TF

15. 16. 17. 18. 19.

TF TF TF TF TF

20. 80. 81. 82. 83.

21. 22. 23. 24. 25. 26. 27.

TF TF TF TF TF TF TF

28. 29. 30. 90. 91. 92. 93.

TF TF TF MC MC MC MC

94. 95. 96. 97. 98. 99. 100.

31. 32. 33. 34. 35. 36.

TF TF TF TF TF TF

37. 38. 39. 115. 116. 117.

TF TF TF MC MC MC

118. 119. 120. 121. 122. 123.

40. 41. 42. 43.

TF TF TF TF

44. 45. 46. 47.

TF TF TF TF

134. 135. 136. 137.

*48. TF *55. TF *146. *49. TF *56. TF *147. *50. TF *57. TF *148. *51. TF *77. MC *149. *52. TF *78. MC *150. *53. TF *79. MC *151. *54. TF *145. MC *152. Note: TF = True/False MC = Multiple Choice

Type

Item

Type

Item

Type

Item

Type

Item

Study Objective 1 MC 64. MC 69. MC 74. MC 79. MC 65. MC 70. MC 75. MC 189. MC 66. MC 71. MC 76. MC 190. MC 67. MC 72. MC 77. MC 191. MC 68. MC 73. MC 78. MC 192. Study Objective 2 TF 84. MC 89. MC 166. Ex MC 85. MC 162. Ex 167. Ex MC 86. MC 163. Ex 168. Ex MC 87. MC 164. Ex 189. Ma MC 88. MC 165. Ex 191. SAE Study Objective 3 MC 101. MC 108. MC 163. Ex 170. MC 102. MC 109. MC 164. Ex 189. MC 103. MC 110. MC 165. Ex MC 104. MC 111. MC 166. Ex MC 105. MC 112. MC 167. Ex MC 106. MC 113. MC 168. Ex MC 107. MC 114. MC 169. Ex Study Objective 4 MC 124. MC 130. MC 173. Ex 194. MC 125. MC 131. MC 174. Ex 195. MC 126. MC 132. MC 175. Ex 196. MC 127. MC 133. MC 176. Ex 197. MC 128. MC 171. Ex 177. Ex 198. MC 129. MC 172. Ex 193. SAE Study Objective 5 MC 138. MC 142. MC 175. Ex 179. MC 139. MC 143. MC 176. Ex 189. MC 140. MC 144. MC 177. Ex 198. MC 141. MC 174. Ex 178. Ex 199. *Study Objective 6 MC *153. MC *160. MC *183. Ex *191. MC *154. MC *161. MC *184. Ex *192. MC *155. MC *168. Ex *185. Ex *200. MC *156. MC *179. Ex *186. Ex MC *157. MC *180. Ex *187. Ex MC *158. MC *181. Ex *188. Ex MC *159. MC *182. Ex *189. Ma Ma = Matching Ex = Exercise SAE = Short Answer Essay

Type MC Ma SAE SAE SAE

Ex Ma

SAE SAE SAE SAE SAE

Ex Ma SAE SAE SAE SAE SAE

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

CHAPTER STUDY OBJECTIVES 1.

Identify the differences between service and merchandising companies. A service company performs services. It has service or fee revenue and operating expenses. A merchandising company sells goods. It has sales revenue, cost of goods sold, and gross profit in addition to operating expenses. Both types of company may also report nonoperating items and each would report income tax expense.

Prepare entries for purchases under a perpetual inventory system. The Merchandise Inventory account is debited for all purchases of merchandise and for freight costs if those costs are paid by the buyer (shipping terms FOB shipping point). It is credited for purchase discounts, and purchase returns and allowances.

Prepare entries for sales under a perpetual inventory system. When inventory is sold, two entries are required: (1) Cash or Accounts Receivable is debited and Sales is credited for the selling price of the merchandise, and (2) Cost of Goods Sold is debited and Merchandise Inventory is credited for the cost of inventory items sold. Contra revenue accounts are used to record sales returns and allowances and sales discounts. Two journal entries are also required for sales returns so that both the selling price and the cost of the returned merchandise are recorded. Freight costs paid by the seller (shipping terms FOB destination) are recorded as an operating expense.

Prepare a single-step and a multiple-step income statement. In a single-step income statement, all data (except for income tax expense) are classified under two categories— revenues or expenses—and profit before income tax is determined in one step. Income tax expense is separated from the other expenses and reported separately after profit before income tax to determine profit (loss). A multiple-step income statement shows several steps in determining profit. Step 1 deducts sales returns and allowances and sales discounts from gross sales to determine net sales. Step 2 deducts the cost of goods sold from net sales to determine gross profit. Step 3 deducts operating expenses (which can be classified by nature or by function) from gross profit to determine profit from operations. Step 4 adds or deducts any non-operating items to determine profit before income tax. Finally, step 5 deducts income tax expense to determine profit (loss).

Calculate the gross profit margin and profit margin. The gross profit margin, calculated by dividing gross profit by net sales, measures the gross profit earned for each dollar of sales. The profit margin, calculated by dividing profit by net sales, measures the profit earned for each dollar of sales. Both are measures of profitability that are closely watched by management and other interested parties.

*6. Prepare entries for purchases and sales under a periodic inventory system and calculate cost of goods sold (Appendix 5A). The periodic inventory system differs from the perpetual inventory system in that separate temporary accounts are used in the periodic

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system to record (1) purchases, (2) purchase returns and allowances, (3) purchase discounts, and (4) freight costs that are paid by the buyer (shipping terms FOB shipping point). The formula for cost of goods purchased is as follows: Purchases – purchase returns and allowances – purchase discounts = net purchases; and net purchases + freight in = cost of goods purchased. Both systems use temporary accounts to record (1) sales, (2) sales returns and allowances, and (3) sales discounts. However, in a periodic inventory system, only one journal entry is made to record a sale of merchandise as the cost of goods sold is not recorded throughout the period. Instead, the cost of goods sold is determined at the end of the period. To determine the cost of goods sold, first calculate the cost of goods purchased, as indicated above. Then, calculate the cost of goods sold as follows: Beginning inventory + cost of goods purchased = cost of goods available for sale; and cost of goods available for sale – ending inventory = cost of goods sold. At the end of the period, the Merchandise Inventory account is adjusted to reflect its proper balance as determined from the inventory count results. The change in this account is allocated to the Cost of Goods Sold account as are the balances in the Freight In and Purchases account and any related contra accounts.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

TRUE-FALSE STATEMENTS 1. A physical inventory count should be done at least once a year regardless of whether a perpetual or periodic inventory system is being used.

2. The operating cycle of a merchandising company is generally shorter than that of a service company.

3. Sales less operating expenses equal gross profit.

4. Under a perpetual inventory system, the cost of goods sold is determined each time a sale occurs.

5. Inventory is usually the largest current asset for a merchandiser.

6. Cost of Goods Sold is considered an operating expense for a merchandising company.

7. Operating expenses are subtracted from revenue for a service company and from gross profit for a merchandising company.

8. Gross sales less cost of goods sold is called gross profit.

9. Cost of goods available for sale is considered an operating expense for a merchandising company.

10. When the terms of sale are FOB shipping point, the seller is responsible for any damages to the goods during shipping.

11. Freight terms will specify the point at which ownership of the goods is transferred from the seller to the buyer.

12. Under a perpetual inventory system, freight costs incurred by the buyer are added to the Merchandise Inventory account.

13. Under the perpetual inventory system, purchases of merchandise for sale are recorded in the Merchandise Inventory account.

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14. Freight costs incurred on incoming merchandise are an operating expense to the buyer.

15. The terms 2/10, n/30 mean that a 2% discount is allowed on payments made over 10 days but within the credit period.

16. Discounts taken for early payment of an invoice are called sales discounts by the buyer.

17. If merchandise costing $2,500, terms 2/10 n/30, is paid within 10 days, the amount of the purchase discount is $250.

18. Under the perpetual inventory system, a discount taken for early payment is credited to the Merchandise Inventory account.

19. A quantity discount is recorded separately, the same way as a purchase discount.

20. If a quantity discount of 10% is received on a purchase of $10,000, inventory would be recorded at $9,000.

21. Sales revenues are earned when the goods are transferred from buyer to seller.

22. Sales revenues are recorded by the seller when an order is placed by a buyer.

23. The Sales Returns and Allowances account and the Sales Discounts account are both classified as expense accounts.

24. When goods are shipped FOB shipping point, freight costs are an operating expense for the seller.

25. Sales Allowances and Sales Discounts are both designed to encourage customers to pay their accounts promptly.

26. Sales Discounts is a contra revenue account to Sales.

27. The normal balance of Sales Returns and Allowances is a credit.

28. When the terms of sale include a sales discount, it usually is advisable for the buyer to pay Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

within the discount period.

29. Merchandise is sold for $2,500 with terms 1/10, n/30. If $500 of the merchandise is returned prior to payment and the invoice is paid within the discount period, the amount of the sales discount is $20. 30. When returned merchandise is defective, the seller’s sales account is debited.

31. The multiple-step income statement is considered more useful than the single-step income statement for a merchandising company because it highlights the components of profit.

32. Operating expenses are similar in merchandising and service companies.

33. Gross profit appears on both the single-step and multiple-step forms of the income statement. 34. Non-operating activities include revenues and expenses that are related to the company’s main operations.

35. Corporations following IFRS must classify their expenses either by nature or by function.

36. Profit from operations appears on both the single-step and multiple-step forms of the income statement. 37. A merchandising company’s profit from operations is determined by subtracting cost of goods sold from net sales.

38. Interest revenue for a merchandising company is usually reported in the non-operating activities section of the income statement.

39. Companies following ASPE may classify their expenses by nature, but not by function.

40. Gross profit is a measure of the overall profit of a company.

41. Gross profit is expressed as a percentage of gross sales.

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43. If net sales are $1,000,000 and cost of goods sold is $800,000, the gross profit margin is 20%.

44. The gross profit amount is generally considered to be more informative than the gross profit margin.

45. Gross profit margin is calculated by dividing cost of goods sold by net sales.

46. Profit margin indicates whether a company is controlling operating expenses relative to sales.

47. Profit margin is calculated by dividing profit by net sales.

*48. Under a periodic inventory system, purchase of inventory is debited to the Purchases account.

*49. Under a periodic inventory system, freight incurred on merchandise purchases by the buyer should be debited to the Merchandise Inventory account.

*50. Under a periodic inventory system, purchases of merchandise are usually credited to the Purchases account.

*51. Under a periodic inventory system, freight incurred on merchandise sales by the seller should be debited to the Freight In account.

*52. Purchase Returns and Allowances and Purchase Discounts are contra expense accounts with normal credit balances.

*53. Freight In is subtracted from the Purchases account to arrive at cost of goods purchased.

*54. A key difference between the periodic and perpetual inventory systems is the timing of the calculation of cost of goods sold.

*55. The cost of goods sold section of an income statement prepared under a periodic inventory system will contain more detail than under a perpetual inventory system.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

*56. On the income statement for a company using the periodic inventory system, the inventory at the beginning of the period is added to the cost of merchandise purchased for the period to calculate the cost of goods available for sale during the period.

*57. Compared to a perpetual inventory system, the use of the periodic inventory system will result in a different value for inventory on the statement of financial position.

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Ans. T F F T T F T F F F T T

Item 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24.

Ans. T F F F F T F T F F F F

Item 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36.

Ans. F T F T T F T T F F T F

Item 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. *48.

Ans. F T F F F F T F F T T T

Item *49. *50. *51. *52. *53. *54. *55. *56. *57.

Ans. F F F T F T T T F

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 58. The time it takes to go from cash to cash in producing revenues is called the (a) accounting cycle. (b) purchasing cycle. (c) operating cycle. (d) merchandising cycle.

59. Gross profit equals the difference between net sales and (a) profit. (b) cost of goods sold. (c) operating expenses. (d) cost of goods sold plus operating expenses.

60. Each of the following companies is a merchandising company except a (a) wholesale parts company. (b) candy store. (c) moving company. (d) furniture store.

61. Profit will result if gross profit exceeds (a) cost of goods sold. (b) operating expenses. (c) purchases. (d) cost of goods sold plus operating expenses.

62. A merchandiser will have profit from operations of exactly $0 when (a) net sales equals cost of goods sold. (b) cost of goods sold equals gross profit. (c) operating expenses equal net sales. (d) gross profit equals operating expenses.

63. The largest current asset for a merchandiser is usually (a) inventory. (b) prepaid expenses. (c) cash. (d) accounts receivable.

64. The primary source of revenue for a wholesaler is generated by (a) investments. (b) providing services. (c) the sale of merchandise. (d) the sale of property, plant, and equipment the company owns.

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65. Generally, the revenue account for a merchandising company is called (a) Sales Revenue or Sales. (b) Investment Revenue. (c) Gross Profit. (d) Net Sales.

66. The operating cycle of a merchandising company is (a) always one year in length. (b) generally longer than that of a service company. (c) about the same as that of a service company. (d) generally shorter than that of a service company.

67. Net sales less cost of goods sold is called (a) gross profit. (b) cost of goods sold. (c) profit. (d) profit before income taxes.

68. After gross profit is calculated, operating expenses are deducted to determine (a) gross margin. (b) profit (loss) before income tax. (c) cost of goods sold. (d) profit margin. 69. Which of the following “formulas” is incorrect? (a) Gross profit – operating expenses = profit before income tax. (b) Net sales – cost of goods sold = gross profit. (c) Net sales – gross profit = cost of goods sold. (d) Operating expenses – cost of goods sold = gross profit.

70. Beginning inventory plus purchases equals (a) cost of goods available for sale. (b) cost of goods sold. (c) ending inventory. (d) total inventory on hand.

71. Which of the following is true about inventory systems? (a) Periodic inventory systems require more detailed inventory records. (b) Perpetual inventory systems require more detailed inventory records. (c) A periodic system requires cost of goods sold to be recorded after each sale. (d) A perpetual system determines cost of goods sold only at the end of the accounting period.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

72. In a perpetual inventory system, cost of goods sold is recorded (a) on a daily basis. (b) on a monthly basis. (c) on an annual basis. (d) each time a sale occurs.

73. The primary difference between a periodic and a perpetual inventory system is that a periodic system (a) keeps a detailed record showing the inventory on hand at all times. (b) provides better control over inventories. (c) records the cost of goods sold on the date the sale is made. (d) determines the cost of goods sold at the end of the accounting period.

74. The physical inventory count is used to determine (a) cost of inventory purchased during the period. (b) cost of inventory sold during the period. (c) the cost of inventory on hand. (d) the cost of goods available for sale.

75. Inventory becomes part of the cost of goods sold when a company (a) pays for the inventory. (b) purchases the inventory. (c) sells the inventory. (d) receives payment from the customer.

76. If a company determines cost of goods sold each time a sale occurs, it (a) must have a computerized accounting system. (b) uses a combination of the perpetual and periodic inventory systems. (c) uses a periodic inventory system. (d) uses a perpetual inventory system.

77. Under a perpetual inventory system (a) there is no need for a year-end physical count. (b) increases in inventory resulting from purchases are debited to Purchases. (c) accounting records continuously disclose the amount of inventory. (d) the account Purchase Returns and Allowances is credited when goods are returned to vendors.

78. Under a perpetual inventory system, the following is determined each time a sale occurs: (a) Gross Profit. (b) Cost of Goods Sold. (c) Purchases. (d) Accounts Receivable.

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79. Under the perpetual inventory system, which of the following accounts would not be used? (a) Sales (b) Purchases (c) Cost of Goods Sold (d) Merchandise Inventory

80. The abbreviation "FOB" stands for (a) free on board. (b) freight on board. (c) free only (to) buyer. (d) freight charge on buyer.

81. On July 10, Swant Inc. purchased $1,000 of inventory on terms of 2/10, n/45. The amount due on August 25 is (a) $1,020. (b) $1,000. (c) $980. (d) $990.

82. Under a perpetual inventory system, purchase of inventory is recorded as a debit to the (a) Supplies account. (b) Purchases account. (c) Merchandise Inventory account. (d) Cost of Goods Sold account.

83. The journal entry by the buyer to record a return of merchandise purchased on account under a perpetual inventory system would credit (a) Accounts Payable. (b) Purchase Returns and Allowances. (c) Sales. (d) Merchandise Inventory.

84. A company using a perpetual inventory system that returns goods purchased on credit would (a) debit Accounts Payable and credit Merchandise Inventory. (b) debit Sales and credit Accounts Payable. (c) debit Cash and credit Accounts Payable. (d) debit Accounts Payable and credit Purchases.

85. If a purchaser using a perpetual inventory system pays freight costs, then the (a) Merchandise Inventory account is increased. (b) Merchandise Inventory account is not affected. (c) Freight Out account is increased. (d) Freight In account is increased.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

86. 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 goods sold of the seller. (d) to a contra revenue account of the seller.

87. Cashmere Corporation purchased merchandise inventory with an invoice price of $16,000 and credit terms of 2/10, n/30. How much cash will Cashmere pay if they pay within the discount period? (a) $16,000 (b) $15,680 (c) $14,720 (d) $14,400

88. For a company using a perpetual inventory system, the journal entry to record the purchase of $3,500 of goods on account, with terms of 4/10, n/30, would include a (a) debit to accounts payable of $3,500. (b) credit to accounts payable of $3,360. (c) debit to merchandise inventory of $3,360. (d) debit to merchandise inventory of $3,500.

89. A purchase invoice is a document that (a) provides support for goods sold for cash. (b) provides evidence of operating expenses incurred. (c) provides evidence of credit purchases. (d) serves only as a customer receipt.

90. Under the perpetual inventory system, in addition to making the entry to record the sale, the seller would (a) debit Merchandise Inventory and credit Cost of Goods Sold. (b) debit Cost of Goods Sold and credit Purchases. (c) debit Cost of Goods Sold and credit Merchandise Inventory. (d) make no additional entry until the end of the period.

91. Sales revenues are usually considered earned when (a) cash is received from credit sales. (b) an order is received. (c) goods have been transferred from the seller to the buyer. (d) adjusting entries are made.

92. Sales Discounts is a(n) (a) contra revenue account. (b) contra asset account. (c) revenue account. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) expense account.

93. Evidence of cash sales is usually supported by (a) purchase invoices. (b) sales invoices. (c) purchase orders. (d) cash register tapes.

94. Gross sales less sales returns and allowances less sales discounts equals (a) collectible sales. (b) net sales. (c) total sales. (d) operating sales.

95. The entry to record a sale of $525 with terms of 2/10, n/30 will include a (a) debit to Sales Discounts for $10.50. (b) debit to Sales for $514.50. (c) credit to Accounts Receivable for $525. (d) credit to Sales for $525.

96. A sales invoice is prepared when goods (a) are sold for cash. (b) are sold on credit. (c) sold on credit are returned. (d) are sold on credit or for cash.

97. Sales Returns and Allowances is a(n) (a) asset account. (b) contra asset account. (c) expense account. (d) contra revenue account.

98. The entry to record the return of goods from a customer would include a (a) debit to Sales. (b) credit to Sales. (c) debit to Sales Returns and Allowances. (d) credit to Sales Returns and Allowances.

99. The collection of a $2,000 account within the 2 percent discount period will result in a (a) debit to Sales Discounts for $40. (b) debit to Accounts Receivable for $1,960. (c) credit to Cash for $1,960. (d) credit to Accounts Receivable for $1,960.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

100. Freight paid by the seller to a customer’s business is recorded as a (a) credit to Sales. (b) debit to Sales. (c) debit to an operating expense. (d) credit to Cost of Goods Sold.

101. If a customer agrees to keep defective merchandise because the seller is willing to reduce the selling price, this transaction is known as a sales (a) discount. (b) return. (c) contra asset. (d) allowance. 102. When goods from a cash sale are returned, the effect on the seller’s accounts will be (a) an increase in net sales. (b) a decrease in gross sales. (c) an increase in gross sales. (d) a decrease in net sales.

103. Management may be alerted to a quality problem with their merchandise by a sudden increase in which account? (a) Sales (b) Sales Returns and Allowances (c) Sales Discounts (d) Cost of Goods Sold

104. A Sales Returns and Allowances account is not debited if a customer (a) returns defective merchandise. (b) receives a credit for merchandise of inferior quality. (c) pays within the discount period. (d) returns goods that are not in accordance with specifications.

105. As an incentive for customers to pay their accounts promptly, a business may offer its customers (a) a sales discount. (b) free delivery. (c) a sales allowance. (d) a sales return.

106. The credit terms offered by a company are 2/10, n/30, which means that (a) the customer must pay the bill within 10 days. (b) the customer can deduct a 2% discount if the bill is paid between 10 days and 30 days from the invoice date. (c) the customer can deduct a 2% discount if the bill is paid within 10 days of the invoice date. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) two sales returns can be made within 10 days of the invoice date and no returns thereafter.

107. A sales discount does not (a) provide the purchaser with a cash saving. (b) reduce the amount of cash received from a credit sale. (c) increase a contra revenue account. (d) increase an operating expense account.

108. Company A sells $500 of merchandise on account to Company B with credit terms of 2/10, n/30. If Company B pays within the discount period, how much cash will Company A receive? (a) $400 (b) $410 (c) $490 (d) $500

109. Chocolate Corporation sells merchandise on account for $3,000 to Marshmallow Corporation with credit terms of 2/10, n/30. Marshmallow returns $600 of merchandise that was damaged, along with a cheque to settle the account within the discount period. What is the amount of the cheque? (a) $2,952 (b) $2,940 (c) $2,400 (d) $2,352

110. Mountain Corp. sells merchandise on account for $2,000 to Cliff Corp., terms 2/10, n/30. Cliff returns $800 worth of merchandise that was damaged, along with a cheque to settle the account within the discount period. What entry does Mountain make upon receipt of the cheque? (a) Cash ........................................................................................... 1,200 Accounts Receivable............................................................ 1,200 (b) Cash ........................................................................................... 1,160 Sales Returns and Allowances.................................................... 784 Sales Discounts .......................................................................... 32 Accounts Receivable............................................................ 2,000 (c) Cash ........................................................................................... 1,176 Sales Returns and Allowances.................................................... 800 Sales Discounts .......................................................................... 24 Accounts Receivable............................................................ 2,000 (d) Cash ........................................................................................... 1,160 Sales Discounts .......................................................................... 40 Sales Returns and Allowances.................................................... 800 Accounts Receivable............................................................ 2,000

111. The collection of a $1,000 account paid within the 2 percent discount period will result in a (a) credit to Cash for $980. (b) credit to Accounts Receivable for $1,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

112. Which of the following would not be classified as a contra account? (a) Sales (b) Sales Returns and Allowances (c) Accumulated Depreciation (d) Sales Discounts

113. Which of the following accounts has a normal credit balance? (a) Sales Returns and Allowances (b) Sales Discounts (c) Sales (d) Cost of Goods Sold

114. The respective normal account balances of Sales, Sales Returns and Allowances, and Sales Discounts are (a) credit, credit, credit. (b) debit, credit, debit. (c) credit, debit, debit. (d) credit, debit, credit.

115. Which one of the following would not appear on a single-step income statement? (a) gross profit (b) expenses (c) sales revenues (d) cost of goods sold

116. The form of the income statement that derives its name from the fact that the total of all expenses is deducted from the total of all revenues is called a (a) multiple-step income statement. (b) revenue income statement. (c) report-form income statement. (d) single-step income statement.

117. Gross profit does not appear (a) on a multiple-step income statement. (b) on a single-step income statement. (c) to be relevant in analyzing the operation of a merchandising company. (d) on either a multiple-step or a single-step income statement.

118. Gross profit for a merchandising company equals the difference between net sales and (a) operating expenses. (b) cost of goods sold. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Merchandising Operations

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119. A loss from operations will result if operating expenses exceed (a) cost of goods sold. (b) selling expenses. (c) cost of goods sold plus sales returns and allowances. (d) gross profit.

120. What is the term applied to the excess of net sales over the cost of goods sold? (a) gross sales (b) profit from operations (c) profit (d) gross profit

121. Which of the following is not true about a multiple-step income statement? (a) There is a section for operating expenses. (b) There may be a section for non-operating activities. (c) There may be a section for operating assets. (d) There is a section for cost of goods sold.

122. An advantage of the single-step income statement over the multiple-step form is (a) the amount of information it provides. (b) its comprehensiveness. (c) its simplicity. (d) its use in calculating ratios.

123. Profit from operations appears on (a) both a multiple-step and a single-step income statement. (b) neither a multiple-step nor a single-step income statement. (c) a single-step income statement only. (d) a multiple-step income statement only.

124. Which statement is correct about expenses on the income statement? (a) Classifying expenses by nature means that expenses are reported according to the activity for which they are incurred. (b) Examples of expenses classified by function are cost of goods sold and administrative expenses. (c) Expenses must be classified by their function. (d) Expenses must be classified in decreasing order of magnitude.

125. Which statement is not correct about expenses on the income statement? (a) Classifying expenses by function means that expenses are reported according to the activity for which they are incurred. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) Examples of expenses classified by nature are salaries and depreciation. (c) Companies following ASPE do not have to list their expenses in any particular order. (d) Expenses must be classified in decreasing order of magnitude.

126. A multiple-step income statement shows (a) gross profit but not profit from operations. (b) neither gross profit nor profit from operations. (c) both gross profit and profit from operations. (d) profit from operations but not gross profit.

127. Interest expense would be classified on a multiple-step income statement under the heading (a) Other expenses and losses. (b) Other revenues and gains. (c) Operating expenses. (d) Cost of goods sold.

128. Profit from operations for a merchandising company is net sales less (a) operating expenses. (b) cost of goods sold. (c) sales discounts and cost of goods sold. (d) operating expenses and cost of goods sold.

129. The operating expenses section of a multiple-step income statement for a merchandising company would not include (a) freight out. (b) utilities expense. (c) cost of goods sold. (d) loss on sale of equipment.

130. Which one of the following would appear on the income statement of both a merchandising company and a service company? (a) Gross profit (b) Profit (c) Sales revenues (d) Cost of goods sold

131. Gross profit does not appear (a) on a merchandising company’s multiple-step income statement. (b) on a service company’s income statement. (c) to be relevant in analyzing the operation of a merchandising company. (d) on the income statement, if the periodic inventory system is used, because it cannot be calculated.

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Use the following information to answer questions 132–135. Cost of goods sold ............................................................ $217,000 Income tax expense .......................................................... 33,600 Operating expenses .......................................................... 172,000 Sales ................................................................................. 550,000 Sales discounts ................................................................. 12,000 Sales returns and allowances ........................................... 37,000

132. The amount of net sales on the income statement would be (a) $501,000. (b) $538,000. (c) $513,000. (d) $550,000.

133. Gross profit would be (a) $112,000. (b) $284,000. (c) $378,000. (d) $501,000.

134. The gross profit margin would be (a) 56.7%. (b) 34.3%. (c) 43.3%. (d) 39.5%.

135. The profit margin would be (a) 18.5%. (b) 15.6%. (c) 60.6%. (d) 34.3%.

136. The gross profit margin is calculated by dividing gross profit by (a) sales. (b) cost of goods sold. (c) net sales. (d) operating expenses. 137. A decline in a company’s gross profit could be caused by all of the following except (a) selling products with a lower markup. (b) clearance of discontinued inventory. (c) paying lower prices to its suppliers. (d) increased competition resulting in lower selling prices.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

138. If a company has net sales of $500,000 and cost of goods sold of $350,000, the gross profit margin is (a) 15%. (b) 30%. (c) 70%. (d) 100%.

139. A company shows the following balances: Cost of goods sold ............................................................ $ 900,000 Sales ................................................................................. 2,000,000 Sales discounts ................................................................. 25,000 Sales returns and allowances ........................................... 225,000 What is the gross profit margin? (a) 42.5% (b) 48.6% (c) 49.3% (d) 55.0%

140. Profit margin is calculated by dividing (a) profit by gross profit. (b) profit by sales. (c) profit by net sales. (d) sales by profit.

141. Profit margin is a measure of (a) liquidity. (b) profitability. (c) solvency. (d) comparability.

142. Profit margin is calculated by dividing profit by (a) sales. (b) sales revenues. (c) net sales. (d) gross sales.

Use the following financial information to answer questions 143–144. Operating expenses .......................................................... $ 25,000 Sales returns and allowances ........................................... 3,000 Sales ................................................................................. 110,000 Cost of goods sold ............................................................ 55,000 Income tax expense .......................................................... 5,000

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(b) 22.7% (c) 48.6% (d) 50.0%

144. What is the profit margin? (a) 20.6% (b) 22.7% (c) 48.6% (d) 50.0%

*145. Which of the following is not true for a company using a periodic inventory system? (a) Cost of goods sold is calculated for each sale. (b) Cost of goods sold is calculated at the end of the accounting period. (c) A physical inventory count is performed at the end of the accounting period. (d) Cost of goods available for sale is calculated at the end of the accounting period.

*146. Detailed records of goods held for resale are not maintained under a (a) perpetual inventory system. (b) periodic inventory system. (c) double entry accounting system. (d) single entry accounting system.

*147. Purchases less purchase returns and allowances less purchase discounts is called (a) cost of goods purchased. (b) net purchases. (c) cost of goods sold. (d) net inventory.

*148. Under a periodic inventory system, purchase of merchandise is debited to the (a) Merchandise Inventory account. (b) Cost of Goods Sold account. (c) Purchases account. (d) Accounts Payable account.

*149. Which of the following accounts has a normal credit balance? (a) Purchases (b) Sales Returns and Allowances (c) Freight In (d) Purchase Discounts

*150. The respective normal balances of Purchases, Purchase Discounts, and Freight In are (a) credit, credit, debit. (b) debit, credit, credit. (c) debit, credit, debit. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) debit, debit, debit.

*151. The Freight In account (a) increases the cost of merchandise purchased. (b) is a contra account to the Purchases account. (c) is a permanent account. (d) has a normal credit balance.

*152. Net purchases plus freight in is called (a) cost of goods sold. (b) cost of goods available for sale. (c) cost of goods purchased. (d) total goods available for sale.

*153. Beginning inventory plus the cost of goods purchased equals (a) cost of goods sold. (b) cost of goods available for sale. (c) net purchases. (d) total goods purchased.

*154. On the income statement, purchases less purchase discounts and purchase returns and allowances, plus freight in equals (a) cost of goods purchased. (b) cost of goods available for sale. (c) net purchases. (d) gross profit.

*155. Benz Inc. shows the following account balances for last month: Freight In........................................................................... $ 1,875 Freight Out ........................................................................ 2,500 Purchases ......................................................................... 28,000 Purchase Discounts .......................................................... 2,500 Sales Returns and Allowances.......................................... 4,000 The cost of goods purchased for last month is (a) $25,875. (b) $27,375. (c) $29,875. (d) $30,500.

*156. Stylish Shoe Store reported beginning merchandise inventory of $15,000. During the period, purchases were $70,000; purchase returns, $2,000; and freight in $5,000. A physical count of inventory at the end of the period revealed that $10,000 was still on hand. The cost of goods available for sale was (a) $78,000. (b) $82,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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*157. Cost of goods sold 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.

Use the following information to answer questions *158–*160. For last month, the following data were taken from the ledger of Drillbit Inc.: Beginning Inventory .......................................................... $ 21,500 Ending Inventory ............................................................... 16,200 Freight In........................................................................... 1,150 Purchases ......................................................................... 112,000 Purchase Discounts .......................................................... 750 Purchase Returns and Allowances.................................... 1,900

*158. What was the cost of goods purchased? (a) $110,100 (b) $109,350 (c) $110,500 (d) $108,200

*159. What was the cost of goods sold? (a) $117,300 (b) $115,800 (c) $118,800 (d) $106,700

*160. What was the cost of goods available for sale? (a) $132,000 (b) $133,500 (c) $134,650 (d) $117,300

*161. On the income statement, the beginning merchandise inventory is added to the cost of goods purchased to determine the (a) cost of goods sold. (b) cost of goods available for sale. (c) profit from operations. (d) gross profit.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

Ans. c b c b d a c a b a b d a b d

Item 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87.

Ans. d c c d c b b a b c d a a b b

Item 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102.

Ans. d c c c a d b d b d c a c d d

Item 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117.

Ans. b c a c d c d c b a c c a d b

Item Ans. 118. b 119. d 120. d 121. c 122. c 123. d 124. b 125. d 126. c 127. a 128. d 129. c 130. b 131. b 132. a

Item Ans. 133. b 134. a 135. b 136. c 137. c 138. b 139. b 140. c 141. b 142. c 143. c 144. a *145. a *146. b *147. b

Item Ans. *148. c *149. d *150. c *151. a *152. c *153. b *154. a *155. b *156. c *157. d *158. c *159. b *160. a *161. b

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EXERCISES Ex. 162 Sherla Holmes is a new accountant with Moriarty Corporation. Moriarty purchased merchandise on account for $5,000. The credit terms are 2/10, n/30. Sherla has talked with the company's banker and knows that she could earn 9% on any money invested in the company's savings account. Instructions (a) Should Sherla pay the invoice within the discount period or should she keep the $5,000 in the savings account and pay at the end of the credit period (i.e., after 30 days)? Support your recommendation with a calculation showing which action would be best. (b) If Sherla forgoes the discount, it may be viewed as paying an interest rate of 2% for the use of $5,000 for 20 days. Calculate the annual rate of interest that this is equivalent to. Solution 162 (10 min.) (a) Discount of 2% on $5,000 $100.00 Interest received on $5,000 (for 20 days at 9%) $24.66 ($5,000  9%  20  365) Savings by taking the discount $75.34 Recommendation: Sherla should pay the invoice within the discount period. (b)

The equivalent annual interest rate is: 2%  365  20 = 36.5%.

Ex. 163 Jun 4 10 26

Willem Corporation purchased $4,000 worth of merchandise, terms 2/10, n/30 from Cate Corporation. The cost of the merchandise to Cate was $2,600. Willem returned $700 worth of goods to Cate for full credit. The goods had a cost of $450 to Cate and were placed back into inventory. Willem paid the account.

Instructions Prepare the journal entries to record these transactions in (a) Willem’s records and (b) Cate’s records. Both companies use the perpetual inventory system. Solution 163 (15–20 min.) (a) Willem’s records Jun 4 Merchandise Inventory....................................................... Accounts Payable ....................................................... 10

4,000 4,000

Accounts Payable .............................................................. Merchandise Inventory ................................................

700

Accounts Payable ($4,000 – $700) .................................... Cash ...........................................................................

3,300

(b) Cate’s records Jun 4 Accounts Receivable .........................................................

700

3,300

4,000

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Sales ........................................................................... 4

4,000

Cost of Goods Sold ............................................................ Merchandise Inventory ................................................

2,600

Sales Returns and Allowance ............................................ Accounts Receivable...................................................

700

Merchandise Inventory....................................................... Cost of Goods Sold .....................................................

450

Cash .................................................................................. Accounts Receivable ($4,000 – $700).........................

3,300

2,600

700

450

3,300

Ex. 164 On July 1, Ricker Cycle Shop had an inventory of 20 bicycles at a cost of $250 each. Ricker uses a perpetual inventory system. During the month of July, the following transactions occurred: Jul 4 Purchased 25 bicycles at a cost of $250 each from the Joncas Bicycle Corporation, terms 2/10, n/30. 5 Paid freight of $125 on the July 4 purchase. 6 Sold 10 bicycles from the July 1 inventory to Team Canada for $350 each, terms 2/10, n/30. 7 Received a credit from Joncas Bicycle for the return of 2 defective bicycles. 8 Sold two bicycles from the July 1 inventory for $700 cash. 13 Issued a credit memo to Team Canada for the return of a defective bicycle. 14 Paid Joncas Bicycle in full. 15 Received payment from Team Canada. Instructions Record the July transactions for Ricker Cycle Shop. Solution 164 (20 min.) Jul 4 Merchandise Inventory ($250 x 25) .................................... Accounts Payable ....................................................... 5

6,250 6,250

Merchandise Inventory....................................................... Cash ...........................................................................

125

Accounts Receivable ($350 x 10)....................................... Sales ........................................................................... Cost of Goods Sold ($250 x 10) ......................................... Merchandise Inventory ................................................

3.500

Accounts Payable .............................................................. Merchandise Inventory ................................................

500

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

700

125

3.500 2,500 2,500

500

Merchandising Operations

Sales ........................................................................... Cost of Goods Sold ($250 x 2) ........................................... Merchandise Inventory ................................................ 13

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700 500 500

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

350

Accounts Payable ($6,250 – $500) .................................... Cash ($5,750  98%) .................................................. Merchandise Inventory ($5,750  2%) .........................

5,750

Cash ($3,150 x 98%) ......................................................... Sales Discounts ($3,150 x 2%) .......................................... Accounts Receivable ($3,500 – $350).........................

3,087 63

350

5,635 115

3,150

Ex. 165 On September 1, Wilderness Inc. had an inventory of 18 backpacks at a cost of $30 each. The company uses a perpetual inventory system. During September, the following transactions occurred: Sep 4 Purchased 35 backpacks at $30 each from Back Packs Unlimited, terms 3/10, n/30. 6 Received credit of $150 for the return of 5 backpacks purchased on Sept. 4 that were defective. 9 Sold 20 backpacks for $50 each to University Supply, terms 2/10, n/30. 14 Paid Back Packs Unlimited in full. 18 Received payment from University Supply. Instructions Record the September transactions for Wilderness Inc. Solution 165 (15–20 min.) Sep 4 Merchandise Inventory ($30 x 35) ...................................... Accounts Payable ....................................................... 6

1,050 1,050

Accounts Payable .............................................................. Merchandise Inventory ................................................

150

Accounts Receivable ($50 x 20)......................................... Sales ...........................................................................

1,000

Cost of Goods Sold ($30 x 20) ........................................... Merchandise Inventory ................................................

600

Accounts Payable ($1,050 – $150) .................................... Cash ($900  97%) ..................................................... Merchandise Inventory ($900  3%)............................

900

Cash ($1,000 x 98%) ......................................................... Sales Discounts ($1,000 x 2%) .......................................... Accounts Receivable...................................................

980 20

150

1,000

600

873 27

1,000

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Ex. 166 Gia’s Gymnastics Gear uses a perpetual inventory system. The following transactions occurred in July: Jul 6 Purchased $1,800 of merchandise on credit, terms 1/10, n/30. 8 Because some of the items purchased on July 6 had a small defect, Gia’s Gymnastics Gear received a purchase allowance of $175. 9 Paid freight charges of $75 on the items purchased July 6. 19 Sold merchandise on credit for $1,800, terms 2/10, n/30. The merchandise had a cost of $900. 22 Of the merchandise sold on July 19, $200 of it was returned. The items had cost Gia’s$100 and were returned to inventory. 28 Received payment from the customer of July 19. 31 Paid for the merchandise purchased on July 6. Instructions Record the July transactions for Gia’s Gymnastics Gear. Solution 166 (15–20 min.) Jul 6 Merchandise Inventory....................................................... Accounts Payable ....................................................... 8

1,800 1,800

Accounts Payable .............................................................. Merchandise Inventory ................................................

175

Merchandise Inventory....................................................... Cash ...........................................................................

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

1,800

Cost of Goods Sold ............................................................ Merchandise Inventory ................................................

900

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

200

Merchandise Inventory....................................................... Cost of Goods Sold .....................................................

100

Cash ($1,600 x 98%) ......................................................... Sales Discount ($1,600 x 2%) ............................................ Accounts Receivable ($1,800 – $200).........................

1,568 32

Accounts Payable ($1,800 – $175) .................................... Cash ...........................................................................

1,625

175

1,800

900

200

100

1,600

1,625

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(a) Sean Corporation purchased merchandise on account from Kingston Supplies for $68,000, with terms of 2/10, n/30. During the discount period, Sean returned some merchandise and paid $56,840 as payment in full. Sean uses a perpetual inventory system. Prepare the journal entries that Sean made to record the 1. purchase of merchandise. 2. return of merchandise. 3. payment on account. (b) Willow Corporation sold merchandise to Jada Corporation on account for $84,000 with credit terms of ?/10, n/30. The cost of the merchandise sold was $42,000. During the discount period, Jada returned $14,000 worth of merchandise and paid its account in full (minus the return and the discount) by paying $67,200 in cash. The returned goods were returned to inventory. Both companies use a perpetual inventory system. Prepare the journal entries that Willow Corporation made to record the 1. sale of merchandise. 2. return of merchandise. 3. collection on account. Solution 167 (15–20 min.) (a) To calculate the amount due after returns but before the discount, divide $56,840 by 98% (100% – 2%) = $56,840  98% = $58,000 Subtract $58,000 from $68,000 to determine that $10,000 of merchandise was returned. 1.

Merchandise Inventory ........................................................... Accounts Payable ............................................................

68,000

Accounts Payable................................................................... Merchandise Inventory ....................................................

10,000

Accounts Payable................................................................... Merchandise Inventory (58,000 x 2%) ............................. Cash ................................................................................

58,000

68,000

10,000

1,160 56,840

(b) Jada returns $14,000 of merchandise and thus owes $70,000 to Willow. $67,200  $70,000 = 96%; 100% – 96% = 4% The missing discount percentage is 4%. $70,000  4% = $2,800 sales discount $70,000 – $2,800 = $67,200 cash received on account 1.

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

84,000

Cost of Goods Sold ................................................................ Merchandise Inventory ....................................................

42,000

Sales Returns and Allowances ............................................... Accounts Receivable .......................................................

14,000

Merchandise Inventory ................................................................ Cost of Goods Sold ................................................................

7,000

84,000

42,000

14,000

7,000

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Cash....................................................................................... Sales Discounts...................................................................... Accounts Receivable .......................................................

67,200 2,800 70,000

Ex. 168 Presented below are selected transactions for Scotian Corporation during July. Jul 1 Sold merchandise to Brunswick Inc. for $800, terms 3/10, n/30. The merchandise sold cost $400. 2 Purchased merchandise from Founders Corporation for $4,500, terms 4/10, n/30. 3 Paid freight charges of $100 on items purchased on July 2. 4 Purchased merchandise from Edward Company Ltd. for $5,000, n/30. 10 Received payment from Brunswick Inc. for purchase of July 1. 11 Paid Founders Corporation for July 2 purchase. Instructions (a) Record the above transactions for Scotian Corporation, assuming a perpetual inventory system is used. The cost of goods sold on July 1 was determined to be $400. (b) Record the above transactions for Scotian Corporation, assuming a periodic inventory system is used. Solution 168 (25 min.) (a) Perpetual Jul 1 Accounts Receivable ......................................................... Sales ........................................................................

800 800

Cost of Goods Sold ............................................................ Merchandise Inventory..............................................

400

Merchandise Inventory....................................................... Accounts Payable ....................................................

4,500

Merchandise Inventory....................................................... Cash .........................................................................

100

Merchandise Inventory....................................................... Accounts Payable ....................................................

5,000

Cash ($800 x 97%) ............................................................ Sales Discounts ($800 x 3%) ............................................. Accounts Receivable ................................................

776 24

Accounts Payable .............................................................. Merchandise Inventory ($4,500 x 4%)....................... Cash ($4,500 x 96%) ................................................

4,500

(b) Periodic Jul 1 Accounts Receivable ......................................................... Sales .......................................................................

400

4,500

100

5,000

800

180 4,320

800 800

Merchandising Operations

Purchases.......................................................................... Accounts Payable ....................................................

4,500

Freight-in ........................................................................... Cash .......................................................................

100

Purchases.......................................................................... Accounts Payable ....................................................

5,000

776 24

Accounts Payable .............................................................. Purchase Discounts ($4,500 x 4%) ........................... Cash ($4,500 x 96%) ................................................

4,500

5 - 35

4,500

100

5,000

800

180 4,320

Ex. 169 The following table summarizes the sales for the month of July for Perfect Platters Wholesalers Inc. The table includes the terms, sales returns and when payment was collected for each sale. Date April 3 April 5 April 11 April 18 April 22

Sale Amount $ 900 1,300 450 2,300 1,600

Terms 2/10, n/30 3/10, n/30 1/10, n/30 4/10, n/60 2/10, n/30

Returns $ 50 200 0 520 750

Date Collected April 9 April 21 April 13 April 25 May 5

Instructions Calculate the cash received from each sale. Show your calculations. Solution 169 (10 min.) Apr 3 $ 833 ($900 – $50 = $850; $850 x 2% = $17; $850 – $17 = $833) Apr

$ 1,100 ($1,300 – $200 = $1,100; discount not taken)

Apr 11

$ 445.50 ($450 x 1% = $4.50; $450 – $4.50 = $445.50)

Apr 18

$ 1,708.80 ($2,300 – $520 = $1,780; $1,780 x 4% = $71.20; $1,780 – $71.20 = $1,708.80)

Apr 22

$ 850 ($1,600 – $750 = $850; discount not taken)

Ex. 170 Storm Inc. completed the following transactions in October: Credit Sales

Sales Returns

Date of

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

5 - 36

Date Oct 3 11 17 21 23

Amount $ 800 1,200 7,000 1,700 2,500

Terms 2/10, n/30 3/10, n/30 1/10, n/30 2/10, n/60 2/10, n/30

Date

Amount

Oct 14 20 23 27

$ 500 1,200 400 500

Collection Oct 8 16 29 27 28

Storm uses a perpetual inventory system. Instructions (a) Calculate the cash received for each collection. Show your calculations. (b) Prepare the journal entry for the (1) Oct. 17 sale. The merchandise sold had a cost of $3,500. (2) Oct. 23 sales return. The merchandise returned had a cost of $200 and was returned to inventory. (3) Oct. 28 collection. Solution 170 (20 min.) (a) Oct 8 $784 [Sales $800 – Sales discount $16 ($800  2%)] $679

$5,800

[Sales $7,000 – Sales return $1,200 = $5,800; (discount not taken)]

$1,274

[Sales $1,700 – Sales return $400 = $1,300; $1,300 – Sales discount $26 ($1,300  2%)]

$1,960

[Sales $2,500 – Sales return $500 = $2,000; $2,000 – Sales discount $40 ($2,000  2%)]

(b) (1) Oct 17

(2)

(3)

[Sales $1,200 – Sales return $500 = $700; $700 – Sales discount $21 ($700  3%)]

Accounts Receivable ..................................................... Sales ...................................................................... Cost of Goods Sold ....................................................... Merchandise Inventory ...........................................

7,000

Sales Returns and Allowances ...................................... Accounts Receivable .............................................. Merchandise Inventory .................................................. Cost of Goods Sold ................................................

400

Cash ............................................................................. Sales Discounts ............................................................ Accounts Receivable ..............................................

1,960 40

7,000 3,500 3,500

400 200 200

2,000

Ex. 171

Merchandising Operations

5 - 37

Financial information is presented here for two companies. Complete the missing amounts. Empty Corporation Full Corporation Cost of goods sold $26,000 $ ? Gross profit ? 38,000 Income tax expense 6,500 9,000 Net sales 47,000 62,000 Operating expenses 8,000 ? Profit ? 9,000 Profit before income tax 13,000 18,000 Sales 50,000 ? Sales returns ? 5,000 Solution 171 (15 min.) Empty Corporation Sales returns = $3,000($50,000 – $47,000 = $3,000) Gross profit = $21,000($47,000 – $26,000 = $21,000) Profit = $6,500($21,000 – $8,000 – $6,500 = $6,500) Full Corporation Sales = $67,000($62,000 + $5,000 = $67,000) Cost of goods sold = $24,000($62,000 – $38,000 = $24,000) Operating expenses = $20,000($38,000 – $18,000 = $20,000)

Ex. 172 State the missing items identified by ?. (a) Gross profit – Operating expenses = ? (b) Sales – (? + ?) = Net sales (c) Profit from operations + ? – ? = Profit before income tax (d) Net sales – Cost of goods sold = ? (e) Cost of goods sold + Gross profit = ? Solution 172 (5 min.) (a) Profit from operations (b) Sales discounts, Sales returns and allowances (c) Other revenues and gains, Other expenses and losses (d) Gross profit (e) Net sales

Ex. 173 The following information was taken from the adjusted trial balance of Lucifer Lighting Inc. at December 31, 2015. All accounts have normal balances. Accounts payable .............................................. $ 52,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Accounts receivable .......................................... Accumulated depreciation—Building ................. Advertising expense .......................................... Building ............................................................. Cash ................................................................. Common shares ................................................ Cost of goods sold ............................................ Depreciation expense ....................................... Freight out ......................................................... Interest expense................................................ Interest revenue ................................................ Rental revenue .................................................. Retained earnings, Jan 1 .................................. Salaries expense............................................... Salaries payable................................................ Sales ................................................................ Sales discounts ................................................ Sales returns and allowances ........................... Utilities expense

18,700 44,900 38,500 600,000 85,000 417,500 410,500 12,000 22,000 5,700 2,000 6,000 154,800 279,500 5,200 798,500 8,200 29,000 9,200

Instructions Use the above information to prepare a multiple-step income statement for the year ended December 31, 2015. Solution 173 LUCIFER LIGHTING INC. Income Statement Year Ended December 31, 2015 ___________________________________________________________________________ Sales ................................................................................................. $798,500 Less: Sales returns and allowances ................................................ $ 29,000 Sales discounts ..................................................................... 8,200 37,200 Net sales ........................................................................................... 761,300 Cost of goods sold ............................................................................ 410,500 Gross profit ....................................................................................... 350,800 Operating expenses Salaries expense........................................................................ $279,500 Advertising expense ................................................................... 38,500 Freight out .................................................................................. 22,000 Depreciation expense ................................................................ 12,000 Utilities expense ......................................................................... 9,200 Total operating expenses .................................................... 361,200 Loss from operations......................................................................... (10,400) Other revenues and gains Interest revenue ......................................................................... $ 2,000 Rental revenue ........................................................................... 6,000 Other expenses and losses Interest expense......................................................................... 5,700 2,300 Loss .................................................................................................. $ (8,100)

Merchandising Operations

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Ex. 174 Financial information is presented here for two companies: Company A Company B Cost of goods sold .......................... $385,000 $ ? Gross profit ..................................... 395,000 438,000 Income tax expense ........................ 38,000 ? Net sales ......................................... 780,000 923,000 Operating expenses ........................ ? 190,000 Profit ............................................... ? 198,400 Profit before income tax .................. 190,000 248,000 Sales ............................................... ? 950,000 Sales discounts ............................... 6,000 ? Sales returns and allowances.......... 14,000 18,000 Instructions (a) Calculate the missing amounts for each company (b) For each company, calculate the gross profit margin and the profit margin. (c) Which company is more profitable? Solution 174 (20 min.) (a) Company A Sales Operating expenses Profit

$800,000 ($780,000 + $6,000 + $14,000) $205,000 ($395,000 – $190,000) $152,000 ($190,000 – $38,000)

Company B Sales discounts Cost of goods sold Income tax expense

$9,000 ($950,000 – $18,000 – $923,000) $485,000 ($923,000 – $438,000) $49,600 ($248,000 – $198,400)

(b) Company A Gross profit margin Profit margin

= 50.6% ($395,000 ÷ $780,000) = 19.5% ($152,000 ÷ $780,000)

Company B Gross profit margin Profit margin

= 47.5% ($438,000 ÷ $923,000) = 21.5% ($198,400 ÷ $923,000)

Ex. 175 The following information is available for Shawson Ltd. for calendar 2015: Cost of goods sold ..................................................... 595,000 Income tax expense ................................................... 4,500 Interest expense......................................................... 15,000 Interest revenue ......................................................... 19,000 Operating expenses ................................................... 97,000 Sales .......................................................................... $725,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Sales returns and allowances.....................................

22,000

SHAWSON LTD. Income Statement Year Ended December 31, 2015 ___________________________________________________________________________ Sales revenues Sales ............................................................................................. $725,000 Less: Sales returns and allowances ............................................. 22,000 Net sales ....................................................................................... 703,000 Cost of goods sold ........................................................................ 595,000 Gross profit ................................................................................... 108,000 Operating expenses ...................................................................... 97,000 Profit from operations .................................................................... 11,000 Other revenues and gains Interest revenue ..................................................................... $19,000 Other expenses and losses Interest expense ..................................................................... 15,000 (4,000) Profit before income tax ................................................................ 15,000 Income tax expense ...................................................................... 4,500 Profit ............................................................................................. $ 10,500 (b)

Gross profit margin: $108,000 ÷ $703,000 = 15.4% Profit margin: $10,500  $703,000 = 1.5%

Ex. 176 The adjusted trial balance of Sandhu Corporation at December 31, 2015 included the following selected accounts: Debit Credit Advertising expense .......................................... $ 15,000 Cost of goods sold ............................................ 347,000 Depreciation expense ....................................... 3,296 Freight out ......................................................... 2,000 Income tax expense .......................................... 32,000 Interest expense................................................ 19,000 Interest revenue ................................................ $ 15,000 Sales ................................................................. 575,000 Sales discounts ................................................. 10,500 Sales returns and allowances............................ 55,000 Store salaries expense ...................................... 45,000 Utilities expense ................................................ 18,000

Merchandising Operations

5 - 41

Instructions (a) Use the above information to prepare a multiple-step income statement for the year ended December 31, 2015. (b) Calculate the gross profit margin and the profit margin for 2015. Solution 176 (25 min.) (a) SANDHU CORPORATION Income Statement Year Ended December 31, 2015 ___________________________________________________________________________ Sales .................................................................................................... $575,000 Less: Sales returns and allowances ................................................... $55,000 Sales discounts ........................................................................ 10,500 65,500 Net sales .............................................................................................. 509,500 Cost of goods sold ............................................................................... 347,000 Gross profit .......................................................................................... 162,500 Operating expenses Store salaries expense .................................................................. $45,000 Utilities expense ............................................................................ 18,000 Advertising expense ...................................................................... 15,000 Depreciation expense ................................................................... 3,296 Freight out ..................................................................................... 2,000 Total operating expenses ....................................................... 83,296 Profit from operations ........................................................................... 79,204 Other revenues and gains Interest revenue ............................................................................ $15,000 Other expenses and losses Interest expense............................................................................ 19,000 4,000 Profit before income tax ....................................................................... 75,204 Income tax expense ............................................................................. 32,000 Profit .................................................................................................... $ 43,204 (b) Gross profit margin = $162,500 ÷ $509,500 = 31.9% Profit margin = $43,204 ÷ $509,500 = 8.5%

Ex. 177 The adjusted trial balance of Jayco Corporation at December 31, 2015 included the following selected accounts: Debit Credit Advertising expense .......................................... $ 45,000 Cost of goods sold ............................................ 592,000 Depreciation expense ....................................... 4,200 Freight out ......................................................... 11,200 Income tax expense .......................................... 74,280 Interest expense................................................ 12,500 Interest revenue ................................................ $ 15,000 Salaries expense............................................... 248,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Sales ................................................................. Sales discounts ................................................. Sales returns and allowances............................ Utilities expense ................................................

1,200,000 8,000 34,000 12,500

Instructions (a) Use the above information to prepare a multiple-step income statement for the year ended December 31, 2015. (b) Calculate the gross profit margin and the profit margin for 2015. Solution 177 (25 min.) (a) JAYCO CORPORATION Income Statement Year Ended December 31, 2015 ___________________________________________________________________________ Sales ................................................................................................. $1,200,000 Less: Sales returns and allowances ................................................ $ 34,000 Sales discounts ..................................................................... 8,000 42,000 Net sales ........................................................................................... 1,158,000 Cost of goods sold ............................................................................ 592,000 Gross profit ....................................................................................... 566,000 Operating expenses Salaries expense........................................................................ $248,000 Advertising expense ................................................................... 45,000 Utilities expense ......................................................................... 12,500 Freight out .................................................................................. 11,200 Depreciation expense ................................................................ 4,200 Total operating expenses .................................................... 320,900 Profit from operations ....................................................................... 245,100 Other revenues and gains Interest revenue ......................................................................... $ 15,000 Other expenses and losses Interest expense......................................................................... 12,500 2, 500 Profit before income tax .................................................................... 247,600 Income tax expense .......................................................................... 74,280 Profit ................................................................................................. $ 173,320 (b)

Gross profit margin = $566,000 ÷ $1,158,000 = 48.9% Profit margin = $173,320 ÷ $1,158,000 = 15.0%

Ex. 178 The following information is available from recent financial statements of Competitor A and Competitor B: (Amounts in millions) Competitor A Competitor B Cost of goods sold ................................... $21,761 $27,257 Income tax expense ................................. 361 766 Net sales .................................................. 29,656 36,704 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Merchandising Operations

Operating expenses ................................. Profit ........................................................ Profit before income tax ...........................

7,962 594 955

5 - 43

10,435 1,072 1,838

Instructions (a) Calculate the profit margin and gross profit margin for each company. (b) What conclusions can be drawn from the ratios calculated in part (a) about the relative profitability of the two companies? Solution 178 (15 min.) (a) Profit margin:

Gross profit margin:

Competitor A $594 ———— = 2.0% $29,656

Competitor B $1,072 ———— = 2.9% $36,704

$29,656 – $21,761 ————————– $29,656

$36,704 – $27,257 ————————– $36,704

$7,895 ———— = 26.6% $29,656

$9,447 ———— = 25.7% $36,704

(b) Competitor B’s profit margin was 45% higher [(2.9% – 2.0%) ÷ 2.0%] than Competitor A’s, but Competitor A’s gross profit margin was 3.5% higher [(26.6% – 25.7%) ÷ 25.7%] than Competitor B’s margin. It can be concluded that Competitor B was slightly more profitable than Competitor A because its profit margin was higher.

Ex. 179 Summarized below are the transactions recorded by Rummy Ltd. for calendar 2015, using a perpetual inventory system. Their Jan 1 opening balances were: accounts receivable $145,000, inventory $45,000, and accounts payable $122,000. Merchandise Inventory ......................................................................... Accounts Payable ......................................................................... (Purchase of inventory)

400,000

Merchandise Inventory ......................................................................... Cash ............................................................................................. (Payment of freight-in on inventory)

10,000

Accounts Payable ................................................................................ Merchandise Inventory .................................................................. (Returned merchandise to supplier for credit)

20,000

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

538,000 200,000

400,000

10,000

20,000

738,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(Record sales for year) Cost of Goods Sold .............................................................................. Merchandise Inventory .................................................................. (Record COGS for year)

420,000

Sales Returns and Allowances............................................................. Accounts Receivable ..................................................................... (Record goods returned from customers)

28,000

Merchandise Inventory ......................................................................... Cost of Goods Sold ....................................................................... (Record goods returned from customers)

16,800

420,000

28,000

16,800

Accounts Payable ................................................................................ 400,000 Merchandise Inventory .................................................................. Cash ............................................................................................. (Record payments to suppliers, with a $6,000 purchase discount) Cash .................................................................................................... Sales Discounts ................................................................................... Accounts Receivable ..................................................................... (Record receipts from customers)

6,000 394,000

560,000 4,000 564,000

Instructions Prepare the 2015 income statement to the gross profit line only. (a) As it would appear using the perpetual inventory system. (b) As it would appear if a periodic inventory system had been used. (c) Calculate the gross profit margin for the year. Solution 179 (20–25 min.) (a) Perpetual RUMMY LTD. Income Statement (partial) Year Ended December 31, 2015 ___________________________________________________________________________ Sales .................................................................................................... $738,000 Less: Sales returns and allowances ..................................................... $28,000 Sales discounts ............................................................................. 4,000 32,000 Net sales .............................................................................................. 706,000 Cost of goods sold* .............................................................................. 403,200 Gross profit .......................................................................................... $302,800 * $420,000 – $16,800 = $403,200 (b) Periodic RUMMY LTD. Income Statement (partial) Year Ended December 31, 2015 Sales ....................................................................................................

$738,000

Merchandising Operations

Less: Sales returns and allowances ................................................... Sales discounts ........................................................................ Net sales .............................................................................................. Cost of goods sold Inventory, January 1 ............................................................................ Purchases ............................................................................................ Less: Purchases returns and allowances ........................ $20,000 Purchase discounts ............................................... 6,000 Net purchases ...................................................................................... Add: Freight in .................................................................................. Cost of goods purchased ..................................................................... Cost of goods available for sale ........................................................... Inventory, December 31* ..................................................................... Cost of goods sold ............................................................................... Gross profit ..........................................................................................

$ 28,000 4,000

5 - 45

32,000 706,000

$ 45,000 400,000 26,000 374,000 10,000 384,000 429,000 25,800 403,200 $302,800

*Since cost of goods sold is the same as under the perpetual system, ending inventory must be $429,000 – $403,200 = $25,800. (c) Gross profit margin = $302,800 ÷ $706,000 = 42.9%

*Ex. 180 Below is a series of cost of goods sold sections for four companies that use a periodic inventory system (in thousands): Co. A Co. B Co. C Co. D Beginning inventory (a) 35 12 (m) Purchases 123 (e) 67 (n) Purchase returns and allowances (b) 9 (i) 11 Net purchases 113 205 66 178 Freight in (c) 20 (j) 12 Freight out 10 12 9 8 Cost of goods purchased 147 (f) 73 (o) Cost of goods available for sale 171 (g) (k) 190 Ending inventory (d) (h) 8 (p) Cost of goods sold 141 235 (l) 171 Instructions What are the amounts that should appear in the table where a letter in parentheses is shown? *Solution 180 (15–20 min.) ($ in thousands) Beginning inventory Purchases Purchase returns and allowances Net purchases Freight in Freight out Cost of goods purchased

Co. A $ 24 123 10 113 34 10 147

Co. B $ 35 214 9 205 20 12 225

Co. C $12 67 1 66 7 9 73

Co. D $ 0 189 11 178 12 8 190

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Cost of goods available for sale Ending inventory Cost of goods sold

171 30 141

260 25 235

85 8 77

190 19 171

*Ex. 181 On June 1, Charles Charcoal Ltd. had an inventory of 10 barbeques at a cost of $220 each. Charles uses a periodic inventory system. During the month of June the following transactions occurred: Jun 3 Purchased 25 barbeques at a cost of $220 each from Mr BBQ Ltd., terms n/30. 5 Paid $100 freight for the barbeques purchased on June 3. 6 Sold 12 barbeques to Grills Plus More for $380 each, terms 2/10, n/30. 7 Received credit from Mr BBQ for the return of two defective barbeques. 13 Issued a credit to Grills Plus More for the return of one defective barbeque. 16 Received a credit from Mr BBQ for the defective barbeque returned by Grills Plus More. 19 Purchased 10 barbeques from Holiday Barbeques at a cost of $220 each, terms 2/10, n/30. 20 Paid freight of $100 on the June 19 purchase. On June 30, Charles’ ending inventory was $3,220. Instructions (a) Prepare journal entries to record the above transactions. (b) Calculate the cost of goods sold for June. *Solution 181 (20 min.) (a) May 3 Purchases ($220 x 25) ...................................................... Accounts Payable ....................................................... 5

5,500 5,500

Freight In ........................................................................... Cash ...........................................................................

100

Accounts Receivable ($380 x 12)....................................... Sales ...........................................................................

4,560

Accounts Payable ($220 x 2) ............................................. Purchase Returns and Allowances..............................

440

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

380

Accounts Payable .............................................................. Purchase Returns and Allowances..............................

220

Purchases ($220 x 10) ....................................................... Accounts Payable .......................................................

2,200

100

4,560

440

380

220

2,200

Merchandising Operations

Freight In ........................................................................... Cash ...........................................................................

5 - 47

100 100

(b) Inventory, June 1 (10 @ $220) ...................................................... Purchases (35 @ $220) ................................................................ Less: purchase returns and allowances (3 @ $220) ...................... Net purchases ............................................................................... Add: freight in ($100 + $100) ......................................................... Cost of goods purchased .............................................................. Cost of goods available for sale .................................................... Inventory, June 30......................................................................... Cost of goods sold ........................................................................

$2,200 $7,700 660 7,040 200 7,240 9,440 3,220 $6,220

*Ex. 182 Magnesium Inc. uses a periodic inventory system. During April, the following transactions occurred: Apr 3 Purchased $2,000 of merchandise, terms 3/10, n/60. 6 Returned $300 of the merchandise purchased on April 3. 7 Paid freight charges of $150 on goods purchased on April 3. 12 Paid for the goods purchased on April 3. 13 Sold goods on credit for $1,000, terms 2/10, n/45. 14 The customer of April 13 returned $300 of the goods. 23 Received payment from the customer of April 13. Instructions Prepare journal entries to record the above transactions. *Solution 182 (20 min.) Apr 3 Purchases.......................................................................... Accounts Payable ....................................................... 6

2,000 2,000

Accounts Payable .............................................................. Purchase Returns and Allowances..............................

300

Freight In ........................................................................... Cash ...........................................................................

150

Accounts Payable ($2,000 – $300) .................................... Purchase Discounts ($1,700 x 3%) ............................. Cash ($1,700 x 97%) .................................................

1,700

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

1,000

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

300

Cash ($700 x 98%) ............................................................

686

300

150

51 1,649

1,000

300

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Sales Discounts ($700 x 2%) ............................................. Accounts Receivable ($1,000 – $300).........................

14 700

*Ex. 183 Pacific Supply Corporation uses a periodic inventory system. During September, the following transactions occurred: Sep 3 Purchased 36 backpacks at $25 each from Scott Limited, terms 2/10, n/30. 6 Received credit of $100 for the return of 4 backpacks purchased on Sept. 3 that were defective. 9 Sold 20 backpacks for $45 each to Macklin Books, terms 2/10, n/30. 13 Paid Scott account in full. Instructions Prepare journal entries to record the above transactions. *Solution 183 (15 min.) Sep 3 Purchases ($25 x 36) ......................................................... Accounts Payable ....................................................... 6

900 900

Accounts Payable .............................................................. Purchase Returns and Allowances..............................

100

Accounts Receivable ($45 x 20)......................................... Sales ...........................................................................

900

Accounts Payable ($900 – $100) ....................................... Purchase Discounts ($800 × 2%) ................................ Cash ($800 x 98%) ....................................................

800

100

900

16 784

*Ex. 184 Babylon Corporation uses a periodic inventory system. During October, the following transactions occurred: Oct 3 Purchased $16,000 of merchandise on credit, terms 4/10, n/30. 6 Returned $1,600 of the goods purchased on Oct 3. 7 Paid freight charges of $250 for goods purchased on Oct 3. 12 Paid for the goods purchased on Oct 3. Instructions Prepare journal entries to record the above transactions. *Solution 184 (15 min.) Oct 3 Purchases.......................................................................... 16,000 Accounts Payable ....................................................... 6

Accounts Payable .............................................................. Purchase Returns and Allowances..............................

16,000

1,600 1,600

Merchandising Operations

Freight In ........................................................................... Cash ...........................................................................

250

Accounts Payable ($16,000 – $1,600) ............................... Purchase Discounts ($14,400x 4%) ............................ Cash ($14,400 x 96%) ................................................

14,400

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250

576 13,824

*Ex. 185 The most recent income statement of Lawerence Limited includes the items listed below: Beginning inventory.................................................... $ 900,000 Freight in .................................................................... 20,000 Gross profit ................................................................ 1,400,000 Net sales .................................................................... 3,750,000 Operating expenses ................................................... 300,000 Purchases .................................................................. 1,520,000 Purchase discounts .................................................... 35,000 Purchase returns and allowances .............................. 12,000 Instructions Use the appropriate items listed above as a basis for calculating: (a) Cost of goods sold. (b) Cost of goods available for sale. (c) Ending inventory. *Solution 185 (15 min.) (a) Net sales – Cost of goods sold = Gross profit $3,750,000 – Cost of goods sold = $1,400,000 Cost of goods sold = $2,350,000 (b) Beginning inventory.................................................... Purchases .................................................................. Less: Purchase discounts ........................................... $35,000 Purchase returns and allowances ..................... 12,000 Net Purchases ........................................................... Add: Freight in ........................................................... Cost of goods purchased ........................................... Cost of goods available for sale .................................

$ 900,000 $1,520,000 47,000 1,473,000 20,000 1,493,000 $2,393,000

(c) Cost of goods available for sale – Ending inventory = Cost of goods sold $2,393,000 – Ending inventory = $2,350,000 Ending inventory = $43,000

*Ex. 186 Given the following information, prepare in good form the cost of goods sold section of an income statement, using the periodic inventory system. Beginning inventory.................................................... $15,000 Ending inventory ........................................................ 16,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Freight in .................................................................... Purchases .................................................................. Purchase discounts .................................................... Purchase returns and allowances .............................. *Solution 186 (15 min.) Beginning inventory .......................................................... Purchases ......................................................................... Less: Purchase returns and allowances ........................... Purchase discounts................................................. Net purchases ................................................................... Freight in ........................................................................... Cost of goods purchased .................................................. Cost of goods available for sale ........................................ Ending inventory ............................................................... Cost of goods sold ............................................................

4,000 38,000 500 1,800

$15,000 $38,000 $1,800 500

2,300 35,700 4,000 39,700 54,700 16,000 $38,700

*Ex. 187 Three items are missing in each of the following columns and are identified by a letter. Sales $ (a) $860,000 Sales returns and allowances 15,000 20,000 Sales discounts 10,000 15,000 Net sales 450,000 (d) Beginning inventory (b) 325,000 Cost of goods purchased 200,000 (e) Ending inventory 170,000 303,000 Cost of goods sold 250,000 575,000 Gross profit (c) (f) Instructions Calculate the missing amounts and identify them by letter. *Solution 187 (15 min.) (a) $475,000 (b) $220,000 (c) $200,000 (d) $825,000 (e) $553,000 (f) $250,000

*Ex. 188 Mendez Electronics Limited uses the periodic inventory system and prepares monthly financial

Merchandising Operations

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statements. All accounts have been adjusted except for merchandise inventory. A physical count of merchandise inventory on September 30, 2015 indicates that $2,000 was on hand. A partial listing of adjusted account balances follows: Accounts payable ....................................................... $ 7,250 Accounts receivable ................................................... 8,000 Cash .......................................................................... 22,000 Freight in .................................................................... 1,100 Income tax expense ................................................... 1,530 Merchandise inventory, September 1 ........................ 1,500 Operating expenses ................................................... 23,100 Purchases .................................................................. 35,000 Purchase returns and allowances .............................. 350 Sales .......................................................................... 70,000 Sales discounts .......................................................... 750 Instructions Prepare a multiple-step income statement for Hernandez Book Store for the month ended September 30, 2015. *Solution 188 (15 min.) MENDEZ ELECTRONICS LIMITED Income Statement Month Ended September 30, 2015 ___________________________________________________________________________ Sales revenues Sales .......................................................................... $70,000 Less: Sales discounts ................................................ 750 Net sales .................................................................... $69,250 Cost of goods sold Merchandise inventory, September 1 ......................... Purchases .................................................................. Less: Purchase returns and allowances ..................... Net purchases ............................................................ Add: Freight in ............................................................ Cost of goods purchased ........................................... Cost of goods available for sale ................................. Merchandise inventory, September 30 ....................... Cost of goods sold............................................... Gross profit ....................................................................... Operating expenses .......................................................... Profit before income tax .................................................... Income tax expense .......................................................... Profit .................................................................................

$ 1,500 $35,000 350 35,350 1,100 36,450 37,950 2,000 35,950 33,300 23,100 10,200 1,530 $ 8,670

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MATCHING QUESTIONS 189. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Net sales Sales discount Credit terms Periodic inventory system Gross profit margin

F. G. H. I. J.

Contra revenue Freight out Gross profit Sales invoice Purchase discount

____

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

____

2. Provides support for a credit sale

____

3. Gross profit divided by net sales

____

4. Sales less sales returns and allowances and sales discounts

____

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

____

6. Net sales less cost of goods sold

____

7. Freight cost to deliver goods to customers reported as an operating expense.

____

8. Requires a physical count of goods on hand to calculate cost of goods sold.

____

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.

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ANSWERS TO MATCHING QUESTIONS 1.

10. F

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS S-A E 190 Describe the types of inventories that organizations may report on their statements of financial position. What kind of businesses would report what type of inventory? Solution 190 Retailers and wholesalers would report merchandise inventory, which is in a form ready to sell to customers (e.g., Walmart, Loblaw, etc.). Manufacturers would report raw materials inventory (basic materials on hand ready to go into production), work in process inventory (inventory which has been started into production but is not yet complete), and finished goods inventory (manufactured items that are complete and ready for sale).

S-A E 191 The periodic and the perpetual inventory systems are two methods that companies use to account for inventories. Briefly describe the major features of each system and explain why a physical inventory is necessary under both systems. Solution 191 When a periodic inventory system is used, the Inventory account remains the same throughout the period. Separate accounts, such as Purchases, Freight In, and Purchase Discounts, are used to record the transactions. Cost of goods sold is determined by the following formula: Beginning inventory + 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 are recorded directly in the Inventory account, which eliminates the need for separate accounts. Cost of goods sold is recognized for each sale by debiting Cost of Good Sold and crediting Inventory. At the end of the period, the ending account balance should equal inventory's ending balance. However, a company should conduct a physical inventory count at least once a year, because there could be differences resulting from spoilage, theft, or errors.

S-A E 192 What is the main consideration when choosing between a periodic and a perpetual inventory system? Solution 192 When choosing between a periodic and perpetual inventory system, a company should consider the additional costs associated with keeping detailed inventory records versus the benefits of having additional information about, and control over their inventory.

S-A E 193 Distinguish between cost of goods sold, operating expenses, and non-operating expenses.

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Describe the nature of these three items and their placement on a multiple-step income statement. Solution 193 Cost of goods sold includes the cost of obtaining the goods held for resale; it is deducted directly from net sales on the income statement. Net sales less cost of goods sold results in gross profit. Operating expenses, on the other hand, appear directly below the gross profit on the income statement. Operating expenses include the costs of running the day-to-day operations of the business such as rent, salaries and insurance. Non-operating expenses are expenses unrelated to daily operations, such as interest expense.

S-A E 194 The income statement for a merchandising company presents three amounts not shown in a service company’s income statement. Identify and briefly explain the three unique amounts. Solution 194 The items reported for a merchandising company that are not reported for a service company are: sales revenues, cost of goods sold, and gross profit. Sales revenues consist of sales, sales returns and allowances, and sales discounts. Cost of goods sold represents the total cost of merchandise sold during the period. Gross profit is the excess of net sales over the cost of goods sold.

S-A E 195 Public companies in Canada must list expenses on the income statement either by nature or function. Explain what this means. Are private companies required to do the same? Solution 195 Classifying expenses by nature means that expenses are reported according to their natural classifications, e.g., salaries, depreciation, advertising, utilities. Classifying expenses by function means that expenses are reported according to the activity (business function) for which they were incurred, e.g., cost of goods sold, administration, selling expenses. An organization has the choice to classify by nature or by function – the choice should be based on whichever provides more relevant information. Note expenses may be listed in any order within the chosen classification. Note also that organizations following ASPE may list their expenses in whatever order they choose, or they may list by nature or function.

S-A E 196 In a single-step income statement, all data (except for income tax) are classified under two categories: (1) Revenues, or (2) Expenses. If the income statement is recast in a multiple-step format, what additional information or intermediate components of revenue would be presented? Solution 196 The items reported in a multiple-step income statement that are not reported in a single-step income statement are gross revenues as well as net revenues, cost of goods sold, gross profit, operating expenses, profit from operations, other revenues and gains, and other expenses and losses.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

S-A E 197 You are working for the summer at PLC Ltd., a company that operates a chain of retail stores. In past, the company has not disclosed its cost of goods sold, but now is required to do so. The company president would like to know the pros and cons of disclosing information. Prepare a memo to the president containing the information requested. Solution 197 TO: FROM: RE: DATE:

MEMO President, PLC Ltd. Accounting Student Disclosure of cost of goods sold June xx, xxxx

Disclosing the cost of goods sold enables users of the statements to better evaluate the company’s performance. They can see the relationship between the company’s sales and its cost of goods sold. The downside of disclosing the information is that competitors can also have access to this information. For example, they can use the information to estimate the company’s mark-up although its value will be limited as they can only calculate the mark-up in its aggregate (total) and not by product category.

S-A E 198 You are working as an accounting clerk for Jakubo Wholesalers for the summer. You notice that some invoices that look like inventory purchases are debited to the Operating Expenses account. When you ask your supervisor about the invoices, she says you don’t need to be concerned about it because it won’t have any effect on the profit. Instructions Does the classification of the invoices matter? Explain. Solution 198 Classifying the invoices as operating expenses rather than inventory will have the immediate effect of understating current assets on the statement of financial position and cost of goods sold on the income statement. Subsequently, when the inventory is sold in a later period, cost of goods sold will be understated and gross profit overstated. Not properly distinguishing on the income statement between cost of goods sold and operating expenses will increase the gross profit and gross profit margin. The gross margin is important in evaluating the company’s performance, so the misclassification does matter.

S-A E 199 Explain why gross profit margin is considered to be more informative than gross profit. Solution 199 Gross profit margin expresses a more meaningful relationship between gross profit and sales. Specifically, it shows how much gross profit a company earns for each $1 in net sales it generates. This puts gross profit into perspective and draws attention to a company’s

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profitability relative to its size.

*S-A E 200 A merchandising company using the periodic system frequently has the need to use contra accounts related to the purchase and sale of goods. Identify the contra accounts that have (1) normal credit balances and explain why they are not considered revenues, and (2) normal debit balances and explain why they are not considered expenses. *Solution 200 1. The contra accounts related to the purchase of goods that have normal credit balances are Purchase Discounts and Purchase Returns and Allowances. These accounts have credit balances because they are adjustments to purchases, not revenues. They are an adjustment of the outflow from the purchase of goods, rather than a revenue generating activity. 2.

The contra accounts related to the sale of goods that have normal debit balances are Sales Discounts and Sales Returns and Allowances. These accounts have debit balances but are not expenses because they are adjustments of sales, not operating, selling, or administrative expenses. They are an adjustment of the inflow from sale of goods, rather than a cost used to help earn revenue.

CHAPTER 6 REPORTING AND ANALYZING INVENTORY SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item

SO LOD

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

1 1 1 1 1 1 1 2

E E M M E E M E

39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52.

1 1 1 1 1 1 1 2 2 2 2 2 2 2

M M M E H H E E E M M M H M

109. 110. 111. 112.

1 1,4 2 2

H H H M

128.

1,2,5 E,M

129. 130. Note:

1 1,5

M E

E = Easy

Item SO LOD Item SO LOD Item SO LOD True-False Statements 9. 2 M 17. 2 E 25. 4 M 10. 2 E 18. 2 E 26. 4 E 11. 2 M 19. 2 M 27. 4 E 12. 2 E 20. 3 E 28. 5 E 13. 2 E 21. 3 M 29. 5 E 2 3 5 14. E 22. E 30. E 15. 2 E 23. 3 M 31. 5 M 16. 2 M 24. 4 M 32. 5 M Multiple Choice Questions 53. 2 M 67. 3 E 81. 3 E 54. 2 E 68. 3 E 82. 3 E 55. 2 M 69. 3 E 83. 3 M 56. 2 H 70. 3 M 84. 3 E 57. 2 M 71. 3 E 85. 3 E 58. 2 M 72. 3 E 86. 3 E 59. 2 M 73. 3 E 87. 3 M 60. 2 M 74. 3 E 88. 4 M 61. 2 H 75. 3 E 89. 4 M 62. 2 M 76. 3 M 90. 4 E 63. 2 E 77. 3 M 91. 4 E 64. 2 E 78. 3 E 92. 5 E 65. 2 E 79. 3 E 93. 5 E 66. 3 M 80. 3 M 94. 5 M Exercises 113. 2 H 117. 4 H 121. 5 M 114. 2 H 118. 4 M 122. 5 E 115. 2,3 E 119. 4 M 123. 5 M 116. 3 M 120. 5 E *124. 6 E Matching

131. 2,3 132. 2,3

Item

SO LOD

33. 34. 35. *36. *37. *38.

5 5 5 6 6 6

E E M M E E

95. 96. 97. 98. 99. 100. 101. 102. 103. *104. *105. *106. *107. *108.

5 5 5 5 5 5 5 5 5 6 6 6 6 6

M H E E E E E M H E M E E M

*125. *126. *127.

6 6 6

M M M

Short-Answer Essay H 133. 4 M M 134. 5 E

M = Medium

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Item Study Objective 1 1. TF 4. TF 7. TF 41. MC 44. MC 110. 2. TF 5. TF 39. MC 42. MC 45. MC 128. 3. TF 6. TF 40. MC 43. MC 109. Ex 129. Study Objective 2 8. TF 14. TF 46. MC 52. MC 58. MC 64. 9. TF 15. TF 47. MC 53. MC 59. MC 65. 10. TF 16. TF 48. MC 54. MC 60. MC 111. 11. TF 17. TF 49. MC 55. MC 61. MC 112. 12. TF 18. TF 50. MC 56. MC 62. MC 113. 13. TF 19. TF 51. MC 57. MC 63. MC 114. Study Objective 3 20. TF 67. MC 72. MC 77. MC 82. MC 87. 21. TF 68. MC 73. MC 78. MC 83. MC 115. 22. TF 69. MC 74. MC 79. MC 84. MC 116. 23. TF 70. MC 75. MC 80. MC 85. MC 131. 66. MC 71. MC 76. MC 81. MC 86. MC 132. Study Objective 4 24. TF 26. TF 88. MC 90. MC 110. Ex 118. 25. TF 27. TF 89. MC 91. MC 117. Ex 119. Study Objective 5 28. TF 32. TF 92. MC 96. MC 100. MC 120. 29. TF 33. TF 93. MC 97. MC 101. MC 121. 30. TF 34. TF 94. MC 98. MC 102. MC 122. 31. TF 35. TF 95. MC 99. MC 103. MC 123. *Study Objective 6 *36. TF *38. TF *105. MC *107. MC *124. Ex *126. *37. TF *104. MC *106. MC *108. MC *125. Ex *127. Note:

TF = True-False MC = Multiple Choice

Ma = Matching Ex = Exercise

Type

Item

Type

Ex Ma SAE

130.

SAE

MC MC Ex Ex Ex Ex

115. 128. 131. 132.

Ex Ma SAE SAE

Ex Ex

133.

SAE

Ex Ex Ex Ex

128. 130. 134.

Ma SAE SAE

MC Ex Ex SAE SAE

Ex Ex

SAE = Short-Answer Essay

*This topic is dealt with in an Appendix to the chapter.

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CHAPTER STUDY OBJECTIVES 1.

Describe the steps in determining inventory quantities. The steps are (1) taking a physical inventory of goods on hand and (2) determining the ownership of goods in transit, on consignment, and in similar situations.

Apply the methods of cost determination using specific identification, FIFO, and average cost under a perpetual inventory system. Costs are allocated to the cost of goods sold account each time that a sale occurs in a perpetual inventory system. The cost is determined by specific identification, or by using the first-in, first-out (FIFO) and average cost methods. Specific identification is used for goods that are not ordinarily interchangeable. This method tracks the actual physical flow of goods, allocating the exact cost of each merchandise item to cost of goods sold and ending inventory. The FIFO cost formula assumes a first-in, first-out cost flow for sales. Cost of goods sold consists of the cost of the earliest goods purchased. Ending inventory consists of the cost of the most recent goods purchased. The average cost method is used for goods that are homogenous or non-distinguishable. Under this method, a new weighted (moving) average unit cost is calculated after each purchase or purchase return and applied to the number of units sold (and as a result, to the number of units remaining in ending inventory).

Explain the effects on the financial statements of choosing each of the inventory cost determination methods. Specific identification results in an exact match of costs and revenues on the income statement. When prices are rising, the average cost formula results in a higher cost of goods sold and lower profit than FIFO. The average cost method therefore results in a better allocation on the income statement of more current (recent) costs with current revenues than does FIFO. In the statement of financial position, FIFO is considered to be better because it results in an ending inventory that is closest to current (replacement) value. All three methods result in the same cash flow before income tax.

Identify the effects of inventory errors on the financial statements. Ignoring the effects of income tax, an error made in determining the quantities and/or cost of inventory at the end of the year will also affect cost of goods sold. If ending inventory is overstated, cost of goods sold will be understated and this in turn will cause profit to be overstated. Therefore, an error that overstates inventory will also overstate profit and after recording closing entries, the overstatement in profit will be reflected as an overstatement in retained earnings. In following period, the overstatement in inventory will flow into cost of goods sold and overstate cost of goods sold and understate profit, thereby reversing the effect of the prior period error. As long as the cost of inventory at the end of this subsequent period is determined properly, the reversal of the error will mean that both inventory and retained earnings are not misstated at that time. If an error is made by recording an inventory purchase in a period preceding the actual purchase, both inventory and accounts payable will be overstated; if the purchase has actually occurred but is not recorded or counted, then both inventory and accounts payable will be understated.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Demonstrate the presentation and analysis of inventory. Inventory is valued at the lower of its cost and net realizable value, which results in the recording of an increase in cost of goods sold and a reduction in inventory when the net realizable value is less than cost. Ending inventory is reported as a current asset on the statement of financial position at the lower of cost and net realizable value. Cost of goods sold is reported as an expense on the income statement. The inventory turnover ratio is a measure of liquidity. It is calculated by dividing the cost of goods sold by average inventory. It can be converted to days in inventory by dividing 365 days by the inventory turnover ratio. In general, a higher inventory turnover and lower days in inventory ratio is desired.

*6. Apply the FIFO and average cost inventory cost determination methods under a periodic inventory system (Appendix 6A). Under the FIFO cost formula, the cost of the most recent goods purchased is allocated to ending inventory. Cost of goods sold is calculated by deducting ending inventory from the cost of goods available for sale (or proven by applying the cost of the earliest goods on hand to determine the cost of goods sold). Under the average cost method, the total cost of goods available for sale during the period is divided by the units available for sale during the same period to calculate a weighted average cost per unit. This unit cost is then applied to the number of units remaining in inventory to calculate the ending inventory. Cost of goods sold is calculated by deducting ending inventory from the cost of goods available for sale (or proven by applying the unit cost to the units sold to determine the cost of goods sold). Each of these cost methods is applied in the same cost flow order as in a perpetual inventory system. The main difference is that in a perpetual inventory system, the cost is determined at the date of each sale, while in a periodic inventory system, the cost is determined only at the end of the period.

Reporting and Analyzing Inventory

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TRUE-FALSE STATEMENTS 1. A system of internal control is not needed when a company regularly takes a physical inventory.

2. An inventory count should be done by the employees who keep track of the stock. 3. Goods in transit shipped FOB shipping point should be included in the buyer’s ending inventory.

4. Goods that have been purchased FOB destination, but are in transit, should be excluded from the buyer’s ending inventory.

5. Consigned goods are held for sale by one party although ownership of the goods is retained by another party. 6. Once goods leave the premises of the seller, they should never be added to the seller’s physical inventory count.

7. In order to remove the cost of items sold from inventory, a unit cost must be determined.

8. When using the perpetual system, the average cost method relies on a simple average calculation.

9. If prices never changed, there would be no need for alternative inventory cost methods.

10. Inventory cost methods such as FIFO and average deal more with the flow of costs than with the flow of goods.

11. The first-in, first-out (FIFO) inventory cost method results in an ending inventory valued at the most recent cost.

12. The physical inventory count determines the number of units on hand.

13. The specific identification method is desirable when a company sells a large number of lowunit-cost items.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

14. If a company has no beginning inventory and the unit cost of inventory items does not change during the year, the unit cost assigned to the cost of goods sold will be the same under FIFO and average cost formulas.

15. A company may use more than one inventory cost determination method if it has different types of inventory.

16. The cost formula a company chooses should correspond as closely as possible to the actual physical flow of goods.

17. The FIFO inventory cost formula agrees closely to the actual physical movement of goods in most businesses.

18. In periods of falling prices, FIFO will result in a higher ending inventory valuation than the average cost formula.

19. The method of inventory cost determination that best matches cost and revenues is FIFO.

20. In periods of falling prices, FIFO will result in a higher cost of goods sold than the average cost formula.

21. A change in the method of cost determination for inventory must be disclosed in the financial statements.

22. Approximating the physical flow of inventory is not important when selecting an inventory cost formula.

23. All three methods of inventory cost determination will produce the same cumulative cost of goods sold over the life cycle of the business.

24. An error in the ending inventory of the current period will have a similar but inverse effect on profit of the next accounting period.

25. An error that overstates the ending inventory will cause profit for the period to be understated.

26. An error that understates the ending inventory will cause assets to be understated.

Reporting and Analyzing Inventory

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27. An error that understates the ending inventory will cause the cost of goods sold for the period to be understated.

28. When the value of inventory is lower than its cost, the inventory is written down to its net realizable value.

29. If net realizable value of the inventory is lower than its cost, the total assets on the statement of financial position and profit on the income statement will be reduced.

30. Inventory that originally cost $100 had been written down to its net realizable value (NRV) of $75. Subsequently, the NRV of the inventory recovered to equal its cost of $100. In this situation, the amount of the $25 ($100 – $75) prior write-down in value should be reversed.

31. An inventory write down from cost to net realizable value should not be made in the period in which the price decline occurs.

32. The lower of cost and net realizable value should be applied to the total inventory, rather than to individual inventory items.

33. A low inventory turnover ratio could mean a company is at risk of experiencing inventory shortages.

34. A high inventory turnover ratio indicates that minimal funds are tied up in inventory.

35. In the average cost method used in a periodic inventory system, the same weighted average cost per unit is used to calculate all of the goods sold during the period.

*36. When the average cost method is applied in a periodic inventory system, the sale of goods during the year will change the unit cost used for calculating ending inventory.

*37. When the average cost method is applied in a periodic inventory system, a moving average cost per unit is calculated after each purchase.

*38. The results under FIFO in a perpetual inventory system are the same as in a periodic inventory system.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7.

Ans. F F T T T F F

Item 8. 9. 10. 11. 12. 13. 14.

Ans. F T F T T T T

Item 15. 16. 17. 18. 19. 20. 21.

Ans. F T T F T T F

Item 22. 23. 24. 25. 26. 27. 28.

Ans. T F F T T F T

Item 29. 30. 31. 32. 33. 34. 35.

Ans. F T T T F F F

Item *36. *37. *38.

Ans. T T F

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MULTIPLE CHOICE QUESTIONS 39. The factor which determines whether or not goods should be included in a physical count of inventory is (a) physical possession. (b) ownership. (c) management's judgement. (d) whether or not the purchase price has been paid.

40. 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 during transit. (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.

41. To ensure the accuracy of the inventory during a physical inventory count, (a) the employee is required to count all items twice for the sake of verification. (b) the items counted are compared to the inventory account balance. (c) a second employee or auditor counts the inventory and compares the result to the count made by the first employee. (d) pre-numbered inventory tags need not be used.

42. To accurately determine inventory quantities, a company must (a) use the perpetual inventory system. (b) employ an independent company to conduct inventory counts. (c) rely on the warehouse records. (d) take a physical inventory.

43. Which of the following should not be included in an inventory count? (a) goods taken home by a customer on approval (b) purchased goods shipped FOB shipping point still in transit from a supplier (c) consigned goods (d) consigned goods and goods taken home by a customer on approval

44. Westcom Corporation's goods in transit at December 31 include (1) sales made FOB destination, (2) sales made FOB shipping point, (3) purchases made FOB destination, and (4) purchases made FOB shipping point. Which items should be included in Westcom's inventory at December 31? (a) (2) and (3) (b) (1) and (4) (c) (1) and (3) (d) (2) and (4)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

45. 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 anyone’s ending inventory.

46. A company just starting in business purchased three merchandise inventory items at the following prices. March 2, $75; March 7, $80; and March 15, $90. If the company sold two units for $125 each on March 10 and March 20, and used the FIFO cost formula in a perpetual inventory system, the gross profit for March would be (a) $100. (b) $95. (c) $90. (d) $75.

47. Inventory cost methods make assumptions about the flow of (a) costs. (b) goods. (c) resale prices. (d) fair values.

48. A company just starting a business purchased three inventory items at the following prices: March 2, $75; March 7, $80; and March 15, $90. If the company sold one unit for $115 on March 10 and one unit for $125 on March 20 and uses the average cost method in a perpetual inventory system, what is the cost of ending inventory? (a) $81.67 (b) $83.75 (c) $90.00 (d) $125.00

Use the following information for questions 49–52. A company just starting business made the following four inventory purchases in June: Date Number of Units Total Cost June 1 150 $480 June 10 200 660 June 15 200 680 June 28 150 525 On June 25, the company made its first sale when a local customer purchased 500 units for $3,500. The company uses a perpetual inventory system.

49. Using the FIFO cost method, the cost of the ending inventory on June 30 is (a) $645. (b) $695. (c) $1,650.

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(d) $1,700.

50. Using the FIFO cost method, the amount of the cost of goods sold for June is (a) $645. (b) $695. (c) $1,650. (d) $1,700.

51. Using the average cost method, the cost of the ending inventory on June 30 is (a) $670.00. (b) $690.45. (c) $1,645.55. (d) $1,675.00.

52. The inventory cost formula that results in the highest gross profit for June is (a) FIFO. (b) average. (c) Gross profit is the same under both cost formulas. (d) not determinable.

53. Average Corp. purchased inventory as follows: March 3 300 units at $9 March 4 200 units at $10 March 7 100 units at $11 On March 5, Average sold 400 units for $17 each. The average unit cost to be used for the cost of goods sold on March 5, in a perpetual inventory system, is (a) $9.40. (b) $9.50. (c) $9.67. (d) $17.00.

Use the following information for the month of July for questions 54–58. ABC Inc. uses the FIFO cost method in a perpetual inventory system. Jul 1 Beginning inventory 20 units @ $19 per unit Jul 7 Purchases 70 units @ $20 per unit Jul 8 Sales 50 units Jul 9 Sales 25 units Jul 10 Purchases 50 units @ $22 per unit Jul 22 Sales 40 units

54. The cost of goods sold for the July 8 sale was (a) $950. (b) $980. (c) $989.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) $1,000.

55. The cost of goods sold for the July 9 sale was (a) $475. (b) $480. (c) $495. (d) $500.

56. Total cost of goods sold for the month of July is (a) $2,330. (b) $2,530. (c) $2,830. (d) $2,880.

57. Ending inventory at July 31 is (a) $2,330. (b) $720. (c) $680. (d) $550.

58. If ABC Inc. used the average cost method instead of FIFO, gross profit from the July 8 sale would be (a) higher. (b) lower. (c) the same. (d) cannot be determined.

Use the following information for the month of June for questions 59–62. XYZ Inc. uses the average cost formula in a perpetual inventory system. (Use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.) Jun 1 Beginning inventory 20 units @ $19.00 per unit Jun 5 Purchase 100 units @ $22.00 per unit Jun 8 Sale 70 units Jun 9 Purchase 80 units @ 22.31 per unit Jun 10 Sale 25 units Jun 22 Sale 40 units

59. The cost of goods sold for the June 8 sale is (a) $1,480.00. (b) $1,505.00. (c) $1,527.68. (d) $1,540.00.

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60. The cost of goods sold for the June 10 sale is (a) $545.60. (b) $549.96. (c) $550.00. (d) $557.75.

61. Total cost of goods sold for the month of June is (a) $2,914.65. (b) $2,934.90. (c) $2,946.24. (d) $2,994.80.

62. XYZ Inc. has an ending inventory on June 30 of (a) $1,370.00 (b) $1,418.56. (c) $1,429.90. (d) $1,450.15. 63. Gene’s Used Cars uses the specific identification method of costing inventory. During March, Gene purchased three cars for $5,000, $6,500, and $8,000, respectively. During March, two cars are sold for $7,500 each. Gene determines that at March 31, the $8,000 car is still on hand. What is Gene's cost of goods sold for March? (a) $8,000 (b) $11,500 (c) $14,500 (d) $15,000

64. Which of the following statements regarding inventories is correct? (a) FIFO 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.

65. Management may be able to manipulate profit using (a) the FIFO cost formula. (b) specific identification. (c) the average cost formula. (d) need more information to answer.

66. XYZ Inc. uses the average cost formula in a perpetual inventory system. (Use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.) Jun 1 Beginning inventory 20 units @ $19.00 per unit Jun 5 Purchase 100 units @ $22.00 per unit

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Jun 8 Sale 70 units Jun 9 Purchase 80 units @ 22.31 per unit Jun 10 Sale 25 units Jun 22 Sale 40 units If XYZ Inc. was using the FIFO cost formula instead of average, gross profit from the June 8 sale would be (a) higher. (b) lower. (c) the same. (d) cannot be determined.

67. Of the following businesses, which one would not be likely to use the specific identification method for inventory costing? (a) piano store (b) car dealership (c) antique shop (d) grocery store

68. A problem with the specific identification method is that (a) inventories can be reported at actual costs. (b) management can manipulate profit. (c) matching is not achieved. (d) lower of cost and net realizable value cannot be applied.

69. The selection of an appropriate inventory cost formula for a company is made by: (a) external auditors. (b) Canada Revenue Agency (CRA). (c) industry standards. (d) management.

70. Which of the following should a business consider when choosing between the FIFO and average cost formulas? (a) whether the method closely follows the physical flow of goods (b) whether the method reports an inventory cost that approximates recent cost (c) using the same method for inventory of similar nature and use (d) all of the above.

71. Which of the following statements regarding inventory cost determination methods is correct? (a) A company may use more than one inventory cost determination method. (b) A company should use the method that is easiest. (c) A company must use the method that allows them to manage profit. (d) A company may never change its inventory cost method once it has chosen it.

72. The specific identification method of inventory cost determination must be used

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(a) for goods that are produced and segregated for specific projects. (b) when goods are not ordinarily interchangeable. (c) when high priced goods are purchased. (d) for goods that are produced and segregated for specific projects, and/or when goods are not ordinarily interchangeable.

73. The inventory cost determination method that results in the inventory value on the statement of financial position that is closest to its actual cost is (a) FIFO. (b) specific identification. (c) average cost. (d) either FIFO or average cost.

74. In a period of declining prices, which of the following inventory cost formulas generally results in the lowest inventory figure on the statement of financial position? (a) average cost (b) FIFO (c) The figure would be the same under both FIFO and average cost. (d) Need more information to answer.

75. In a period of rising prices, which of the following inventory cost methods generally results in the lowest profit figure? (a) average cost (b) FIFO (c) The inventory cost formula only affects the statement of financial position. (d) Need more information to answer.

76. Two companies report the same cost of goods available for sale but each employs a different inventory cost formula. If the price of goods has increased during the period, then the company using (a) FIFO will report lower ending inventory. (b) Average cost will report lower ending inventory. (c) FIFO will report higher cost of goods sold. (d) Average cost will report lower cost of goods sold.

77. In a period of inflation (prices are rising), which inventory cost formula will result in higher profit? (a) FIFO (b) average cost (c) Cost of goods sold for the period will be the same under both formulas. (d) There would be no effect on profit.

78. The specific identification method of costing inventories is used when the (a) physical flow of units cannot be determined. (b) company sells large quantities of relatively homogeneous items.

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(c) company has sophisticated technology to account for its inventory. (d) company sells a small number of expensive, easily distinguishable items.

79. The specific identification method of inventory costing (a) always maximizes a company's profit. (b) always minimizes a company's profit. (c) has no effect on a company's profit. (d) may enable management to manipulate profit. 80. The managers of Winning Ways Ltd. receive performance bonuses based on the company’s profit. Which inventory cost formula are they likely to favour in periods of declining prices? (a) FIFO (b) average cost (c) They would have no preference. (d) Need more information to answer.

81. Which cost determination method smoothes the effects of price changes? (a) specific identification (b) FIFO (c) average cost (d) lower of cost and net realizable value

82. Selection of an inventory cost method by management should be influenced most by the (a) fiscal year end. (b) physical flow of goods. (c) goal of reporting inventory at its lowest cost. (d) Income tax effects.

83. Which cost method provides the better (1) income statement and (2) statement of financial position valuations, respectively? (a) (1) average and (2) FIFO (b) (1) FIFO and (2) average (c) (1) FIFO and (2) FIFO (d) (1) average and (2) average 84. During a period of inflation, using ___ will approximate a company’s current cost of ending inventory. (a) the average cost method (b) FIFO (c) the lower of cost and net realizable value (d) both FIFO and the average cost method

85. The consistent application of an inventory cost method is essential for (a) neutrality.

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(b) accuracy. (c) comparability. (d) relevance.

86. Cost of goods available for sale consists of the (a) cost of beginning inventory plus the cost of ending inventory. (b) cost of ending inventory plus the cost of goods purchased during the year. (c) cost of beginning inventory plus the cost of goods purchased during the year. (d) difference between the cost of goods purchased and the cost of goods sold during the year.

87. The cost of goods available for sale is allocated between (a) beginning inventory and ending inventory. (b) beginning inventory and cost of goods on hand. (c) beginning inventory and cost of goods purchased. (d) ending inventory and cost of goods sold.

88. An error in the physical count of goods on hand at the end of a period resulted in a $10,000 overstatement of the ending inventory. The effect of this error in the current period is Cost of Goods Sold Profit . (a) Understated Understated (b) Overstated Overstated (c) Understated Overstated (d) Overstated Understated

89. If beginning inventory is understated by $10,000, the effect of this error in the current period is Cost of Goods Sold Profit . (a) Understated Understated (b) Overstated Overstated (c) Understated Overstated (d) Overstated Understated

90. An overstatement of the beginning inventory results in (a) an overstatement of profit. (b) an understatement of profit. (c) no effect on the period’s profit. (d) a need to adjust purchases.

91. An overstatement of ending inventory in one period results in (a) no effect on profit of the next period. (b) an overstatement of profit of the next period. (c) an understatement of profit of the next period. (d) an overstatement of the ending inventory of the next period.

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92. The lower of cost and net realizable value basis of valuing inventories ensures that inventories are (a) valued at their current cost. (b) valued at their selling price. (c) not under-valued. (d) not over-valued.

93. Under the lower of cost and net realizable value basis, the adjusting entry to record a decline in net realizable value below cost includes a (a) debit to the Inventory account. (b) debit to the Cost of Goods Sold account. (c) credit to the Cost of Goods Sold account. (d) credit to the Sales account.

94. XYZ Inc. is a wholesaler of electronics. It purchased 1,000 units of Product X for $500 each during 2015. The selling price during the year was $750 per unit. At year end, it had 100 units on hand and due of changes in technology, the selling price will have to be reduced by 40% in order to sell them. The value of each unit of Product X for the year-end inventory presentation should be (a) $600. (b) $500. (c) $400. (d) $450.

95. Inventory that originally cost $10,000 was written down to its net realizable value of $8,500 at the end of 2014. At the end of 2015, the net realizable value is determined to be $10,500. At what amount should the inventory be reported on the December 31, 2015 statement of financial position? (a) $10,500 (b) $10,000 (c) $9,500 (d) $8,500

96. For 2015, Nervous Energy Inc. reported $24,000 beginning inventory and $26,000 ending inventory. Net sales were $160,000 and gross profit was $55,000 for the same period. Based on these figures, inventory turnover for 2015 was (a) 3.4 times. (b) 4.2 times. (c) 6.4 times. (d) 9.2 times.

97. An aircraft manufacturer would most likely have a (a) high inventory turnover. (b) low profit margin. (c) high volume. (d) low inventory turnover.

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98. The inventory turnover ratio is calculated by dividing cost of goods sold by (a) beginning inventory. (b) ending inventory. (c) average inventory. (d) 365 days.

99. Days in inventory is calculated by dividing 365 days by (a) average inventory. (b) beginning inventory. (c) ending inventory. (d) the inventory turnover ratio.

Use the following information for questions 100–101. The following information was available for Riley Limited at December 31, 2015: Beginning inventory ............................... $ 120,000 Ending inventory .................................... 150,000 Cost of goods sold ................................. 810,000 Net sales ................................................ 1,400,000 100. Riley’s inventory turnover was (a) 5.0 times. (b) 6.0 times. (c) 7.5 times. (d) 9.0 times. 101. Riley’s days in inventory was (a) 40.6 days. (b) 48.7 days. (c) 60.8 days. (d) 73.0 days.

102. An increase in inventory turnover means days in inventory (a) increases. (b) decreases. (c) remains the same. (d) cannot be determined.

103. NHL Canada Ltd. has a days in inventory ratio of 40 and average inventory of $254,000. What is its cost of goods sold? (a) Cannot be determined. (b) $12,700,000 (c) $2,317,750

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) $1,854,200

*104. In a periodic inventory system, the cost of goods sold is determined (a) at the beginning of the accounting period. (b) after each sale. (c) after each purchase. (d) at the end of the accounting period.

*105. In order to determine cost of goods sold in a periodic inventory system we (a) add purchases to beginning inventory. (b) subtract ending inventory from beginning inventory. (c) subtract ending inventory from cost of goods available for sale. (d) subtract purchases from ending inventory.

Use the following information to answer questions *106–*108. Abalone Corp. uses a periodic inventory system. Jul 1 Beginning inventory 20 units @ $19 7 Purchases 70 units @ $20 22 Purchases 10 units @ $22

$ 380 1,400 220 $2,000 A physical count of merchandise inventory on July 31 shows that 25 units are on hand.

*106. Under the FIFO cost method, ending inventory at July 31 was (a) $1,500. (b) $1,480. (c) $520. (d) $500.

*107. Under the average cost method, cost of goods sold for July was (a) $1,600. (b) $1,500. (c) $520. (d) $500.

*108. Which cost method will provide the highest profit? (a) average cost (b) FIFO (c) Profit is the same under both methods. (d) Cannot be determined.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 39. b 49. b 59. b 69. d 79. d 89. c 99. d 40. a 50. c 60. b 70. d 80. b 90. b 100. b 41. c 51. b 61. b 71. a 81. c 91. c 101. c 42. d 52. a 62. c 72. d 82. b 92. d 102. b 43. c 53. a 63. b 73. b 83. a 93. b 103. c 44. b 54. b 64. c 74. b 84. b 94. d *104. d 45. a 55. d 65. b 75. a 85. c 95. b *105. c 46. b 56. a 66. a 76. b 86. c 96. b *106. c 47. a 57. d 67. d 77. a 87. d 97. d *107. b 48. b 58. b 68. b 78. d 88. c 98. c *108. b

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 109 Bunkers Corporation has just completed a physical inventory count at year end, December 31, 2015. Only the items on the shelves, in storage, and in the receiving area were counted. The inventory amounted to $77,000. Bunkers uses a perpetual inventory system. During the yearend audit, the independent C.A. discovered the following additional information: 1. There were goods in transit on December 31, 2015, from a supplier with terms FOB destination, costing $8,500. Because the goods had not arrived, they were excluded from the physical inventory count. 2. On December 27, 2015, a regular customer purchased goods for cash amounting to $1,000 and left them for pickup on January 4, 2016. Bunkers had paid $1,200 for the goods and, because they were on hand, included them in the physical inventory count. 3. Bunkers Corporation, on the date of the inventory count, received notice from a supplier that goods ordered earlier, at a cost of $10,000, had been delivered to the transportation company on December 28, 2015; the terms were FOB shipping point. Because the shipment had not arrived on December 31, 2015, it was excluded from the physical inventory. 4. On December 31, 2015, there were goods in transit to customers, with terms FOB shipping point, amounting to $800 (expected delivery on January 8, 2016). Because the goods had been shipped, they were excluded from the physical inventory count. 5. On December 31, 2015, Bunkers shipped $2,500 worth of goods to a customer, FOB destination. This shipment arrived on January 5, 2016. Because the goods were not on hand, they were not included in the physical inventory count. 6. Bunkers Corporation, as the consignee, had goods on consignment that cost $5,000. Because these goods were on hand at December 31, 2015, they were included in the physical inventory count. Instructions Analyze the above information and calculate a corrected amount for the ending inventory. Explain the rationale for your treatment of each item. Solution 109 (20 min.) Start with $77,000 Item 1.

—

Item 2.

– 1,200

(Goods should be excluded. The customer owns them.)

Item 3.

+ 10,000

(Goods belong to Bunkers. Title passed when supplier delivered the goods to the transportation company.)

Item 4.

—

(Because the goods were shipped FOB shipping point, Bunkers no longer has title to these goods. Correctly excluded.)

Item 5.

+ 2,500

(Goods were shipped FOB destination. Bunkers retains title until the customer receives them.)

(Because the goods were shipped FOB destination, the title will pass to Bunkers upon arrival. Correctly excluded.)

Reporting and Analyzing Inventory

Item 6.

– 5,000

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(These goods are owned by the consignor, not the consignee, and should not be included in Bunkers' inventory.)

Corrected inventory $83,300

Ex. 110 Haddock Sales Inc. has a December 31 year end. Complete the table below to show the error (understated (U) or overstated (O)), if any, including the dollar amount. If there is no impact, state no effect (NE). Assets December 31, 2015

Profit December 31, 2015

Retained Earnings December 31, 2015

1. Inventory of $75,000 held on consignment is included in inventory at December 31, 2015. 2. $25,000 of inventory purchased was included in the inventory on December 31, 2015. It was shipped FOB shipping point on December 28, 2015, but did not arrive until January 4, 2016. 3. Merchandise costing $3,000 was returned by a customer on January 2, 2016. The merchandise was in good condition and the customer was given full credit of $5,000. $3,000 was deducted from inventory on December 31, 2015. 4. Merchandise was returned to a supplier for credit on December 28, 2015. Credit of $7,000 was received on January 2, 2016. No adjustment was made until the credit was received. 5. Merchandise shipped FOB destination was received by Haddock on December 30, 2015. It was recorded in inventory at $980—the invoice cost of $1,000 less the 2% early payment discount. The company has a policy of always taking cash discounts. Solution 110 (20–25 min.)

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Assets December 31, 2015

Profit December 31, 2015

Retained Earnings December 31, 2015

1. Inventory of $75,000 held on consignment is included in inventory at December 31, 2015.

Overstated $75,000

2. $25,000 of inventory purchased was included in the inventory on December 31, 2015. It was shipped FOB shipping point on December 28, 2015, but did not arrive until January 4, 2016.

Understated $3,000

4. Merchandise was returned to a supplier for credit on December 28, 2015. Credit of $7,000 was received on January 2, 2016. No adjustment was made until the credit was received.

Overstated $7,000

5. Merchandise shipped FOB destination was received by Haddock on December 30, 2015. It was recorded in inventory at $980—the invoice cost of $1,000 less the 2% early payment discount. The company has a policy of always taking cash discounts.

3. Goods on approval costing $3,000 were returned by a customer on January 2, 2016. The merchandise was in good condition and the customer was given full credit of $5,000. $3,000 was deducted from inventory on December 31, 2015.

Ex. 111 Hansen Corporation uses the perpetual inventory system and had the following information available: Units Unit Cost Total Cost Jan 1 Beginning inventory 15 $4.00 $ 60 20 Purchase 60 4.40 264 21 Sale 65 Jul 25 Purchase 30 4.20 126 Oct 20 Purchase 45 4.80 216 Nov 15 Sale 75 Instructions

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Answer the following independent questions and show calculations supporting your answers: (a) Assume that the company uses the FIFO cost method. The cost of goods sold for the Jan 21 sale was $__________. (b) Assume that the company uses the average cost method. The cost of goods sold for the Jan 21 sale was $__________. (Use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.) (c) Assume that the company uses the average cost method. The value of the inventory after the Nov 15 sale was $__________. (Use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer.) (d) Assume that the company uses the FIFO cost method. The value of the inventory after the Oct 20 purchase is $__________. Solution 111 (20 min.) (a) Cost of Goods Sold (FIFO):

(15 units @ $4) + (50 units @ $4.40) = $280

(b) Cost of Goods Sold (average): ($60 + $264) = $324 ÷ 75 = $4.32 per unit Sold 65 units @ $4.32 = $280.80 (c) Inventory (average): $60 + $264 – $280.80 (see (b) above) + $126 + $216 = $385.20 $385.20 ÷ (15 + 60 – 65 + 30 + 45) = $4.53 (rounded) per unit 10 units on hand (85 – 75) @ $4.53 (rounded) = $45.32 (using unrounded numbers in calculation) (d) Inventory (FIFO): $386.00 After the Jan 21 sale 10 units x $4.40 = $ 44.00 Jul 25 purchase 30 units x $4.20 = 126.00 Oct 20 purchase 45 units x $4.80 = 216.00 Value of inventory = $386.00

Ex. 112 Owl Ltd. sells many products. Hoot is one of its popular items. Below is an analysis of the inventory purchases and sales of Hoot for the month of March. Owl uses the perpetual inventory system. Purchases Sales Units Unit Cost Units Selling Price/Unit Mar 1 Beginning inventory 600 $40 3 Purchase 100 60 4 Sales 190 $80 10 Purchase 100 66 16 Sales 275 120 19 Sales 220 120 25 Sales 75 120 30 Purchase 460 75 Instructions (a) Using the FIFO cost method, calculate the cost of goods sold for March. Show calculations.

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(b) Using the average cost method, calculate the ending inventory at March 31. Show calculations and use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer. Solution 112 (20 min.) (a) FIFO Date Description Mar 1 Beginning 3 Purchase

Purchases 100

$60

COGS

$ 6,000

4 Sale

190

$40

16 Sale

275

19 Sale

135 85 15 60

40 60 60 66

10 Purchase

100

6,600

25 Sale 30 Purchase

460

34,500

30 Ending (b) Average Date Description Mar 1 Beginning 3 Purchase 4 Sale 10 Purchase

760

Purchases 100

COGS

$60

$ 6,000

6,600

190 $42.86

Ending Inventory 600 $40 $24,000 600 40 100 60 30,000 $ 7,600 410 40 100 60 22,400 410 40 100 60 100 66 29,000 11,000 135 40 100 60 100 66 18,000 15 60 10,500 100 66 7,500 4,860

40 40 460 $33,960 220

66 2,640 66 75 37,140 , $37,140

Ending Inventory 600 $42.86 $24,000 700 42.86 30,000 $ 8,143 510 42.86 21,859 610 46.65 28,459

100 16 Sale 19 Sale 25 Sale 30 Purchase 30 Ending

275 220 75 460

34,500 760

46.65 46.65 46.65

12,829 335 10,263 115 3,499 40 500 $34,734 500

46.65 46.65 46.65 72.73 ,

15,628 5,365 1,866 36,366 $36,366

Please note that discrepancies may result in the above schedule due to rounding.

Ex. 113 Nector Ltd., which uses a perpetual inventory system, recorded the following inventory transactions for this year: Purchases Sales Units Unit Cost Units Selling Price/Unit Apr 1 Beginning inventory 45 $8

Reporting and Analyzing Inventory

May Jun

25 4 16 4

Purchase Purchase Sale Purchase

150 65

9 10

120

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$16

Instructions (a) Using the FIFO cost method, calculate the cost of goods sold for the quarter ended June 30. Show calculations. (b) Using the average cost method, calculate the ending inventory at June 30. Show calculations and use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer. Solution 113 (30 min.) (a) Purchases

Cost of Goods Sold

Apr 1

Balance (45 @ $8) = $360

Apr 25

(150 @ $9) = $1,350

(45 @ $8) = $360 (150 @ $9) = 1,350 $1,710

May 4

(65 @ $10) = $650

(45 @ $8) = $360 (150 @ $9) = 1,350 (65 @ $10) = $650 $2,360

May 16

Jun 4

(b) Apr 1 Apr 25 May 4 May 16 Jun 4

(45 @ $8) = $360 (75 @ $9) = $675 $1,035 (50 @ $12) = $600

Purchases (45 @ $8) = $360.00 (150 @ $9) = $1,350.00 (65 @ $10) = $650.00 (50 @ $12) = $600.00

(75 @ $9) = $675 (65 @ $10) = $650 $1,325 (75 @ $9) = $675 (65 @ $10) = $650 (50 @ $12) = $600 $1,925

Cost of Goods Sold

Balance

(195 @ $8.77) = $1,710.00 (260 @ $9.08) = $2,360.00 (120 @ $9.08) = $1,089.23) (140 @ $9.08) = $1,270.77 (190 @ $9.85) = $1,870.77

Please note that discrepancies may result in the above schedule due to rounding.

Ex. 114 Churchill Corporation, which uses a perpetual inventory system, recorded the following inventory transactions during the last two months of 2015: Purchases Sales

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Nov

Dec

1 13 29 3 16

Beginning inventory Purchase Sale Purchase Sale

Units 105 70

Unit Cost $60 58

Units

Selling Price/Unit

$87

Instructions (a) Using the FIFO cost method, calculate the cost of goods sold for the two months of November and December. Show calculations. (b) Using the average cost method, calculate the ending inventory at December 31. Show calculations and use unrounded numbers in your calculations but round to the nearest cent for presentation purposes in your answer. Solution 114 (30 min.) (a) Purchases

Cost of Goods Sold

Nov 1 Nov 13

Balance (105 @ $60) = $6,300

(70 @ $58) = $4,060

Nov 29

(105 @ $60) = $6,300 (70 @ $58) = $4,060 $10,360 (96 @ $60) = $5,760 (9 @ $60) = $540 (70@$58)=$4,060 $4,600

Dec 3

(50 @ $56) = $2,800

Dec 16

(b) Nov 1 Nov 13 Nov 29 Dec 3 Dec 16

Purchases

(9 @ $60) = $540 (70 @ $58) = $4,060 (50 @ $56) = $2,800 $7,400 (9 @ $60) = $540 (43 @ $58)= $2494 $3,034

(27 @ $58) = $1,566 (50 @ $56) = $2,800 $4,366

Cost of Goods Sold

Balance

(105 @ $60) = $6,300.00 (175 @ $59.20) = $10,360.00 (96 @ $59.20) = $5,683.20 (79 @ $59.20) = $4,676.80 (50 @ $56) $2,800.00 (129 @ $57.96) = $7,476.80 (52 @ $57.96) = $3,013.92 (77 @ $57.96) = $4,462.88

(70 @ $58) $4,060.00

Please note that discrepancies may result in the above schedule due to rounding.

Ex. 115 Glamorous Gold Inc. opened for business on April 1, 2015 selling unique jewellery, which it

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purchases from local artisans. During April, the company made the following purchases: Date Inventory Tag Number Cost April 1 001 $2,750 April 3 002 600 April 5 003 1,150 004 2,300 April 10 005 700 April 13 006 1,200 007 3,900 April 26 008 600 009 1,700 April 31 010 2,400 On April 31, only inventory items 006, 008, and 010 remained in inventory. Instructions (a) Calculate the cost of goods sold for April using the specific identification cost determination method. (b) Discuss whether or not specific identification is an appropriate cost determination method for this company. Solution 115 (20 min.) (a) Inventory sold: Inventory Tag Number 001 002 003 004 005 007 009 Cost of goods sold:

Cost $ 2,750 600 1,150 2,300 700 3,900 1,700 $13,100

(b) Specific identification would be the preferred inventory method for this company because it provides the most accurate cost of goods sold and ending inventory values. It is appropriate because of the uniqueness of the company’s inventory items. The comparatively small volume of inventory items purchased and sold makes this method practical for either a computerized or manual inventory system.

Ex. 116 Houle Limited reported the following summarized annual data at the end of 2015: Sales revenue ............................................................ $3,500,000 Cost of goods sold* .................................................... 1,700,000 Gross profit ................................................................ 1,800,000 Operating expenses ................................................... 1,200,000 Profit before income tax ............................................. $ 600,000 *Based on an ending inventory of $420,000, using FIFO.

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The controller of the company is considering a switch from FIFO to average cost. He has determined that on an average cost basis, the ending inventory would have been $320,000. Instructions (a) Restate the summary information on an average cost basis. (b) If you were the management of this business, what would your reaction be to this proposed change? Solution 116 (25 min.) (a) Restate to average cost: Sales revenue ............................................................ $3,500,000 Cost of goods sold* .................................................... 1,800,000 Gross profit ................................................................ 1,700,000 Operating expenses ................................................... 1,200,000 Profit before income tax ............................................. $ 500,000 *Ending inventory would be $100,000 less ($420,000 – $320,000 = $100,000) under average cost, thereby increasing cost of goods by $100,000. (b) The company’s management would not likely see this change as desirable, since it results in an increase in cost of goods sold, and thus a decrease in profit before income tax. In addition, the inventory cost determination method chosen should be the one that closely corresponds with the physical flow of goods and the inventory’s recent cost reported on the statement of financial position. It should be used consistently, so unless the type of inventory or its nature and usage has changed, management should not be changing its inventory cost method.

Ex. 117 For each of the independent events listed below, analyze the impact on the indicated items at the end of the current year by placing the appropriate code letter in the box under each item. Code: O = item is overstated U = item is understated NA = item is not affected Items _ Assets Shareholders’ Cost of Profit Equity Goods Sold 1. The ending inventory in the previous period was overstated. —————————————————————————————————————————– 2. A physical count of goods on hand at the end of the current year resulted in some goods being counted twice. —————————————————————————————————————————– 3. Goods purchased on account in December of the current year and shipped FOB shipping point were recorded as purchases, but were not included in the count of goods on hand on December 31 because they had not

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arrived by December 31. —————————————————————————————————————————– 4. Goods purchased on account in December of the current year and shipped FOB destination were recorded as purchases, but were not included in the count of goods on hand on December 31 because they had not arrived by December 31. —————————————————————————————————————————– 5. The internal auditors discovered that the ending inventory in the previous period was understated $15,000 and that the ending inventory in the current period was overstated $25,000. Solution 117 (20 min.) Items Shareholders’ Cost of Equity Goods Sold NA O

Events 1.

Assets NA

Profit U

Ex. 118 Condensed income statements for Collingwood Limited are shown below for two years: 2015 2016 Sales ...................................................................... $92,000 $106,000 Cost of goods sold ................................................. 54,000 65,000 Gross profit ............................................................ 38,000 41,000 Operating expenses ............................................... 15,000 15,000 Profit before income tax ......................................... $23,000 $ 26,000 Instructions (a) Calculate the corrected profit before income tax for 2015 and 2016, assuming that the inventory as of the end of 2015 was mistakenly understated by $7,000. 2015 $____________ 2016 $____________ (b) Calculate the ending retained earnings at the end of 2016, assuming retained earnings at the end of 2015 was $195,000 and at the end of 2016, $205,000. Solution 118 (5 min.) (a) 2015 = $30,000 ($23,000 + $7,000) 2016 = $19,000 ($26,000 – $7,000)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) Retained earnings at the end of 2016 would be unchanged at $205,000 because the profit corrects itself over the two year period.

Ex. 119 Miller’s Grocery reported the following selected information: Cost of goods sold ................................................. Ending inventory ....................................................

2015 $837,000 64,000

2016 $900,000 55,000

Miller made two errors: 1. 2015 ending inventory was overstated by $5,000. 2. 2016 ending inventory was understated by $9,000. Instructions Assuming the errors have not been corrected, indicate the dollar effect that the errors had on the items listed below. Also indicate if the amounts are overstated (O) or understated (U).

Total assets

2015 Overstated/ Amount Understated $_________ _______

2016 Overstated/ Amount Understated $_________ _______

Shareholders’ equity

$_________

_______

$_________

_______

Cost of goods sold

$_________

_______

$_________

_______

Profit before income tax

$_________

_______

$_________

_______

Solution 119 (20 min.)

Total assets

2015 Overstated/ Amount Understated $5,000 O

2016 Overstated/ Amount Understated $9,000 U

Shareholders’ equity

$5,000

$9,000

Cost of goods sold

$5,000

$14,000

Profit before income tax

$5,000

$14,000

Ex. 120 Copper Mining Inc. has been stock-piling copper inventory in anticipation of better prices. Unfortunately, the market has not improved and at year end, December 31, 2014, inventory with a cost of $4.5 million would only be worth $3.5 million if it could be sold. During the next year, the prices start to recover, but the company still has not sold the inventory. At December 31, 2015, the market value of the same copper inventory has increased and would

Reporting and Analyzing Inventory

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be worth $4.6 million. Instructions (a) Prepare the adjusting entry required at December 31, 2014 to record the decline in the value of the inventory, assuming Copper Mining uses a perpetual inventory system. (b) Prepare the adjusting entry required at December 31, 2015, if any. Solution 120 (10 min.) (a) Dec 31, 2014

Cost of Goods Sold .............................................. 1,000,000 Merchandise Inventory .................................. 1,000,000 ($4,500,000 – $3,500,000 = $1,000,000)

(b) Dec 31, 2015

Merchandise Inventory ......................................... 1,000,000 Cost of Goods Sold ....................................... 1,000,000 Note that inventory cannot be written up above cost.

Ex. 121 The following information is available from recent financial statements of Competitor A and Competitor B: (Amounts in millions) Competitor A Competitor B Ending inventory ............................................... $ 7,500 $ 5,210 Beginning inventory........................................... 8,100 6,059 Cost of goods sold ............................................ 23,760 33,616 Sales ................................................................. 30,251 39,950 Instructions (a) Calculate the inventory turnover and days in inventory for both companies. (b) What conclusions concerning the management of inventory can be drawn from these data? Solution 121 (20 min.) (a)

Inventory turnover

Days in inventory

Competitor A

Competitor B

$23,760 —————————— ($7,500 + $8,100) ÷ 2

$33,616 —————————— ($5,210 + $6,059) ÷ 2

$23,760 ———— = 3.0 times $7800

$33,616 ———––– = 6.0 times $5,634.50

365 ÷ 3.0 = 122 days

365 ÷ 6.0 = 61 days

(b) Competitor B’s inventory turnover is approximately 100% [(6.0 – 3.0) ÷ 3.0)] higher than Competitor A’s. In addition, Competitor B’s days in inventory is 50% [(122– 61) ÷ 122] lower than Competitor A’s. Generally, a company prefers to maintain as high an inventory turnover as possible. We can conclude that Competitor B manages inventory more effectively than Competitor A.

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Ex. 122 The following information is available for Omari Corporation for 2015: Beginning inventory.................................................... $ 700,000 Ending inventory ........................................................ 800,000 Cost of goods sold ..................................................... 6,000,000 Sales .......................................................................... 8,000,000 Instructions Calculate the inventory turnover and days in inventory for Omari Corporation. Solution 122 (5 min.) Inventory turnover = $6,000,000 ÷ [($700,000 + $800,000) ÷ 2] = $6,000,000 ÷ $750,000 = 8 times Days in inventory

= 365 days ÷ 8 = 46 days

Ex. 123 Solve for the missing amounts: Sales .................................................. Cost of goods sold ............................. Inventory, beginning of year ............... Inventory, end of year ........................ Average inventory .............................. Gross profit ........................................ Inventory turnover .............................. Days in inventory ...............................

A $100,000 (a) 23,000 17,000 (b) 46% (c) (d)

B $239,000 122,000 45,000 39,000 (e) (f) (g) 126

C $438,000 345,000 (h) 105,000 101,500 (i) (j) (k)

A $100,000 54,000 23,000 17,000 20,000 46% 2.7 135

B $239,000 122,000 45,000 39,000 42,000 49% 2.9 126

C $438,000 345,000 98,000 105,000 101,500 21% 3.4 107

Solution 123 (20 min.) Sales .................................................. Cost of goods sold ............................. Inventory, beginning of year ............... Inventory, end of year ........................ Average inventory .............................. Gross profit ....................................... Inventory turnover .............................. Days in inventory ...............................

*Ex. 124 Quinoa Corp. uses the periodic inventory system, and has the following information about purchases and sales during the year: January 1 Beginning inventory 150 items @ $3 = $ 450 May 1 Purchases 450 items @ $5 = 2,250 Total 600 items $2,700

Reporting and Analyzing Inventory

December 31

Total sales Ending inventory

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300 items 300

Instructions Calculate the cost to be assigned to ending inventory for each of the cost methods below: (a) Average $____________ (b) FIFO $____________ *Solution 124 (10 min.) (a) $1,350 ($2,700  600 = $4.50  300) (b) $1,500 (300  $5)

*Ex. 125 Coucous Corp. uses the periodic inventory system. Information related to Coucous’ inventory for September is given below: Sep 1 Beginning inventory 200 units @ $10.00 = $ 2,000 8 Purchase 600 units @ $10.40 = 6,240 16 Purchase 400 units @ $10.80 = 4,320 24 Purchase 100 units @ $11.60 = 1,160 1,300 units $13,720 Instructions (a) Calculate the ending inventory using FIFO assuming 400 units remain on hand at September 31 (show calculations). (b) Calculate the ending inventory using average cost assuming 400 units remain on hand at September 31 (show calculations). *Solution 125 (20 min.) (a) 400 units in ending inventory Under FIFO, the units remaining in inventory are the ones purchased most recently. Sep 24 100 units @ $11.60 = $1,160 16 300 units @ 10.80 = 3,240 400 units $4,400 (b) 400 units in ending inventory Under the average cost method, the weighted-average cost per unit must be calculated: $13,720  1,300 units = $10.55 400 units  $10.55 = $4,220

*Ex. 126 Garmin Ltd. uses the periodic inventory system and had the following inventory information available: Units Unit Cost Total Cost Jan 1 Beginning inventory 100 $4 $ 400 20 Purchase 500 $5 2,500

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

25 20

Purchase Purchase

100 300 1,000

$6 $7

600 2,100 $5,600

A physical count of inventory on December 31 showed that there were 350 units on hand. Instructions Answer the following independent questions and show calculations supporting your answers. (a) Assume that the company uses FIFO. The value of the ending inventory at December 31 is $__________. (b) Assume that the company uses average cost. The value of the ending inventory on December 31 is $__________. (c) Determine the difference in the amount of profit that the company would have reported if it had used FIFO instead of average cost. Would profit have been greater or less? *Solution 126 (20 min.) (a) FIFO: Ending inventory $2,400 300 units @ $7 = $2,100 50 units @ $6 = 300 350 units $2,400 (b) Average Cost: Ending inventory $1,960 $5,600  1,000 = $5.60 per unit  350 units = $1,960 (c) FIFO: Cost of goods sold $3,200 Cost of goods available – Ending Inventory = Cost of goods sold $5,600 – $2,400 = $3,200 Proof: 100 units @ $4 = 500 units @ $5 = 50 units @ $6 = 650 units

$ 400 2,500 300 $3,200

Average: Cost of goods sold $3,640 Proof: Cost of goods available – Ending Inventory = Cost of goods sold $5,600 – $1,960 = $3,640 Profit would have been $440 ($3,640 vs. $3,200) greater if the company used FIFO instead of average.

*Ex. 127 Harmony Corporation uses the periodic inventory system and had the following inventory information available: Units Unit Cost Total Cost Jan 1 Beginning inventory 15 $4.00 $ 60 20 Purchase 60 4.40 264 Jul 25 Purchase 30 4.20 126

Reporting and Analyzing Inventory

Oct 20

Purchase

45 150

4.80

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216 $666

A physical inventory count on December 31 showed that there were 50 units on hand. Instructions Answer the following independent questions and show calculations supporting your answers: (a) Assume that the company uses FIFO. The value of the ending inventory at December 31 is $__________. (b) Assume that the company uses average cost. The value of the ending inventory on December 31 is $__________. (c) Assume that the company uses average cost. The value of cost of goods sold for the year ended December 31 is $__________. (d) Assume that the company uses FIFO. The value of the cost of goods sold for the year ended December 31 is $__________. *Solution 127 (20 min.) (a) FIFO: Ending inventory $237 45 units @ $4.80 = $216 5 units @ $4.20 = 21 50 units $237 (b) Average Cost: Ending inventory $222 $666  150 = $4.44 per unit  50 units = $222 (c) Average Cost: Cost of Goods Sold Cost of goods available – Ending Inventory = Cost of goods sold $666 – $222 = $444 (d) FIFO: Cost of goods sold $429 Cost of goods available – Ending Inventory = Cost of goods sold $666 – $237 = $429

Proof: 15 units 60 units 25 units 100 units

@ $4.00 = $ 60 @ $4.40 = 264 @ $4.20 = 105 $429

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MATCHING 128. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Merchandise inventory Cost FOB shipping point FOB destination Specific identification method

F. G. H. I. J.

First-in, first-out (FIFO) Periodic Average cost Perpetual Inventory turnover

Cost of goods sold is determined at the time of each sale in a ___ inventory system.

___ consists of goods ready for sale to customers by retailers and wholesalers.

If goods are sold ___ and are in transit at the end of the period, they should be included in the buyer’s inventory.

If goods are sold ___ and are in transit at the end of the period, they should be included in the seller’s inventory.

Each of the inventory cost methods used in a perpetual inventory system may be used in a(n) ___ inventory system.

The ___ method tracks the actual physical flow for each inventory item available for sale.

Ending inventory consists of the most recent inventory purchases in the ___ cost method.

The same unit cost is used to determine the cost of inventory and cost of goods sold in the ___ cost method.

Inventory is valued on the statement of financial position at the lower of ___ and net realizable value.

10. The ___ measures the number of times the inventory sold during the period.

Reporting and Analyzing Inventory

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ANSWERS TO MATCHING 1.

10. J

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SHORT-ANSWER ESSAY QUESTIONS S-A E 129 Lucia Kraus and Tren Lee are department managers in the housewares and shoe departments, respectively, for Beatons, a large department store. Tren 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 “goody-goody” image. This week, Lucia tried on several pairs of expensive running shoes in her department before finding a pair that suited her. She did not, however, buy them. That very pair was missing this morning. Beatons recently replaced its old periodic inventory system with a perpetual inventory system using scanners and bar codes. In addition, the annual physical inventory count is to be replaced by a monthly inventory conducted by an independent firm. On hearing the news of the changes, Tren relaxes. "The system will catch Lucia now," he says to himself. Instructions (a) Who are the stakeholders in this situation? (b) Is Tren's attitude justified? Why or why not? (c) What, if any, action should Tren take now? Solution 129 (a) The stakeholders in this situation include Lucia Kraus Tren Lee Company management Bankers and other parties who might rely on the financial statements (b) Tren's attitude is not justified. The system will only be able to detect that merchandise is missing, but will not be able to determine who took it. (c) Tren should notify his superiors at once. He has knowledge of what may be criminal acts, and by concealing them, he is very close to becoming a party to the acts. Tren's apparent fear of not being promoted because of a “goody-goody” image seems unjustified. It would seem more likely that Tren's refusal to accept unethical (and illegal) acts by others would make him a more valuable manager. He may even be jeopardizing his career with Beatons if someone else reports Lucia's actions. The resulting investigation may implicate Tren because of his failure to notify the proper authorities in a timely manner.

S-A E 130 Why do you think a business will take goods on consignment, rather than purchasing them outright? Solution 130 Two common reasons for taking goods on consignment are to keep inventory costs down and to avoid buying inventory that the business may not be able to sell. Consignments will also keep the inventory turnover ratio higher. Consignments are commonly entered into by used clothing and sporting goods stores, art galleries, and antique dealers.

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S-A E 131 FIFO and average cost are the two most commonly used cost methods in Canada. The amounts assigned to the same inventory items on hand may be different under each cost method. Assuming a perpetual inventory system, explain the difference in the cost of the ending inventory under FIFO and average cost when prices of inventory items purchased during the period have (1) been increasing, (2) been decreasing, and (3) remained constant. Solution 131 The FIFO cost formula method determines cost of goods sold using the earliest purchase cost. The amount left in inventory represents the cost of the most recent purchase(s). The average cost method determines the cost of goods sold using an average cost calculated at the date of each purchase. The amount left in inventory represents the same (moving) average cost. If the FIFO cost method is used and prices during the period are increasing, the ending inventory value under FIFO will be greater than under average cost. Likewise, if the FIFO cost method is used and prices during the period are decreasing, the ending inventory under FIFO will be less than under average. If prices remain constant, then there will be no difference in the ending inventory values.

S-A E 132 The general manager of Winnipeg Manufacturing Corp. wants to use the specific identification method for the machinery the company manufactures (all of which have a unique serial number), and average cost for the parts inventory. The controller, on the other hand, insists that Winnipeg must use the same cost determination method for all the company’s inventory, “otherwise, we won’t be following the principle of consistency.” Who do you think is right here? Give your rationale. Solution 132 They are both right. It is acceptable to use two different inventory cost determination methods for different types of inventory, as long as the company is consistent. Specific identification is normally used for items that are not interchangeable and can be easily tracked (such as the machinery which can be identified by serial number). Since parts can be interchanged easily and it would be prohibitively expensive to track each one separately, average cost would be an acceptable method to use.

S-A E 133 Vu Mobutu, a new employee of Crafter's Paradise, recorded $3,000 in consigned goods received as part of the company's January 2015 inventory. The goods were received one day after the end of the month, 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. Instructions

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You are Vu's supervisor. Write a memo to Vu explaining why the error should have been corrected. Solution 133 MEMO

TO:

Vu Mobutu, Accounting Department

FROM: Supervisor DATE:

March 12, 2015

It has come to my attention that $3,000 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 $3,000 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)

S-A E 134 Winter Wonderland Ltd. is a private company that sells winter sports equipment. Its year end is June 30, which is the off-season for its products. Matilda Eisenberg, the company's new controller, has decided to mark all inventory down by 20% for the current year end. Her theory is that sales are slow at this time of year and, therefore, inventory should be less. There is no indication based on prior years that inventory will be sold at less than cost. Matilda says the write-down is necessary and justifies it based on the rule of reporting inventory at lower of cost and net realizable value. She also points out that it will produce the added benefit of paying less income tax. Instructions Is the controller's treatment appropriate? Why or why not?

Reporting and Analyzing Inventory

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Solution 134 The controller's treatment is not appropriate. Sales are slow because it is the off-season. It doesn't mean there is a decline in the net realizable value or that net realizable value will fall below cost. It is appropriate to use the lower of cost and net realizable value rule only when there is evidence that the net realizable value has declined below cost. The facts in this case, including information from previous years, do not support a write-down. The fact that Winter Wonderland is a private company or that the write-down will reduce income tax is not relevant. In any case, even if the inventory were written down and the value recovered the following year (assuming the inventory was still on hand), the write-down would have to be reversed.

CHAPTER 7 INTERNAL CONTROL AND CASH SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item

SO LOD

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

1 1 1 1 1 1 1 1 1 1

E E E E E M M E M M

47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

1 1 1 1 1 1 1 1 1 1 1 1 1 1

H E E M M E M M M M M E M E

114. 115. 116. 117.

1 1 1 1,2

E E M M

133.

1–4 E,M

134. 135.

1 1

E M

Note:

E = Easy

Item SO LOD Item SO LOD Item SO LOD True-False Statements 11. 1 M 21. 1 M 31. 3 M 12. 1 M 22. 1 E 32. 3 M 13. 1 E 23. 2 E 33. 3 E 14. 1 M 24. 2 E 34. 3 M 1 2 3 15. M 25. E 35. E 16. 1 M 26. 2 M 36. 3 M 17. 1 E 27. 2 E 37. 4 E 18. 1 E 28. 2 E 38. 4 M 19. 1 M 29. 3 E 39. 4 M 20. 1 M 30. 3 E 40. 4 E Multiple Choice Questions 61. 1 M 75. 2 E 89. 3 M 62. 1 E 76. 2 M 90. 3 E 63. 1 E 77. 2 E 91. 3 E 64. 1 M 78. 2 E 92. 3 E 65. 1 M 79. 2 M 93. 3 M 66. 1 H 80. 2 M 94. 3 E 67. 1 M 81. 2 E 95. 3 E 68. 1 M 82. 2 E 96. 3 E 69. 1 H 83. 3 M 97. 3 M 70. 1 M 84. 3 M 98. 3 M 71. 1 E 85. 3 E 99. 3 M 72. 2 E 86. 3 M 100. 3 M 73. 2 E 87. 3 M 101. 3 M 74. 2 M 88. 3 M 102. 3 E Exercises 118. 1,2 M 122. 3 M 126. 3 H 119. 3 E 123. 3 M 127. 3 M 120. 3 E 124. 3 M 128. 3 E 121. 3 E 125. 3 M 129. 3 M Matching

136. 137.

1 2

Short-Answer Essay M 138. 3 M 140. M 139. 3 M 141.

M = Medium

4 4

Item SO LOD 41. 42. 43. 44. 45. 46.

4 4 4 4 4 4

E E M M E E

103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113.

3 3 3 3 3 3 4 4 4 4 4

E H M M H M E M M E E

130. 131. 132.

3 3 4

E H H

E M

H = Hard

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Study Objective 1 1. TF 9. TF 17. TF 49. MC 57. MC 2. TF 10. TF 18. TF 50. MC 58. MC 3. TF 11. TF 19. TF 51. MC 59. MC 4. TF 12. TF 20. TF 52. MC 60. MC 5. TF 13. TF 21. TF 53. MC 61. MC 6. TF 14. TF 22. TF 54. MC 62. MC 7. TF 15. TF 47. MC 55. MC 63. MC 8. TF 16. TF 48. MC 56. MC 64. MC Study Objective 2 23. TF 26. TF 72. MC 75. MC 78. MC 24. TF 27. TF 73. MC 76. MC 79. MC 25. TF 28. TF 74. MC 77. MC 80. MC Study Objective 3 29. TF 83. MC 91. MC 99. MC 107. MC 30. TF 84. MC 92. MC 100. MC 108. MC 31. TF 85. MC 93. MC 101. MC 119. Ex 32. TF 86. MC 94. MC 102. MC 120. Ex 33. TF 87. MC 95. MC 103. MC 121. Ex 34. TF 88. MC 96. MC 104. MC 122. Ex 35. TF 89. MC 97. MC 105. MC 123. Ex 36. TF 90. MC 98. MC 106. MC 124. Ex Study Objective 4 37. TF 40. TF 43. TF 46. TF 111. MC 38. TF 41. TF 44. TF 109. MC 112. MC 39. TF 42. TF 45. TF 110. MC 113. MC Note:

TF = True-False MC = Multiple Choice

Ma = Matching Ex = Exercise

Item

Type

Item

Type

65. 66. 67. 68. 69. 70. 71. 114.

MC MC MC MC MC MC MC Ex

115. 116. 117. 118. 133. 134. 135. 136.

Ex Ex Ex Ex Ma SAE SAE SAE

81. 82. 117.

MC MC Ex

118. 133. 137.

Ex Ma SAE

125. 126. 127. 128. 129. 130. 131. 133.

Ex Ex Ex Ex Ex Ex Ex Ma

138. 139.

SAE SAE

132. 133. 140.

Ex Ma SAE

141.

SAE

SAE = Short-Answer Essay

Internal Control and Cash

CHAPTER STUDY OBJECTIVES 1.

Describe the primary components of an internal control system. Internal control systems have the following components: the control environment, risk assessment, control activities, information and communication and monitoring. Control activities include the authorization of transactions and activities, segregation of duties, documentation, physical controls, independent performance checks, and human resource controls.

Apply the key control activities to cash receipts and payments. Control activities over cash receipts include (a) designating only personnel such as cashiers to handle cash; (b) assigning the duties of receiving cash, recording cash, and having custody of cash to different individuals; (c) obtaining remittance advices for mail receipts, cash register tapes for over-the-counter receipts, and deposit slips or confirmations for bank deposits; (d) using company safes and bank vaults to store cash, with access limited to authorized personnel, and using cash registers in executing over-the-counter receipts; (e) depositing all cash intact daily in the bank account or using EFT; (f) making independent daily counts of register receipts and daily comparisons of total receipts with total deposits; and (g) conducting background checks, bonding personnel who handle cash, and requiring employees to take vacations. Control activities over cash payments include (a) making all payments by cheque or by EFT; (b) having only specified individuals authorized to sign cheques; (c) assigning to different individuals the duties of approving items for payment, paying the items, and recording the payments; (d) using prenumbered cheques and accounting for all cheques; (e) storing each cheque in a safe or vault with access restricted to authorized personnel, and using electronic methods to print amounts on cheques; (f) comparing each cheque or EFT with the approved invoice before initiating payment, and making monthly reconciliations of bank and book balances; and (g) conducting background checks, bonding personnel who handle cash, and requiring employees to take vacations.

Prepare a bank reconciliation. In reconciling the bank account, it is customary to reconcile the balance per books and the balance per bank to their adjusted balances. Reconciling items for the bank include deposits in transit, outstanding cheques, and any errors made by the bank. Reconciling items for the books include unrecorded amounts added to or deducted from the bank account and any errors made by the company. Adjusting entries must be made for all items required to reconcile the balance per books to the adjusted cash balance.

Explain the reporting and management of cash. Cash is usually listed first in the current assets section of the statement of financial position. Cash restricted for a special purpose is reported separately as a current asset or as a non-current asset, depending on when the cash is expected to be used. Compensating balances are a form of restriction on the use of cash and are reported as a current or non-current asset depending on the term of the restriction. The six principles of cash management are to (a) accelerate the collection of receivables,

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) keep inventory levels low, (c) delay the payment of liabilities, (d) plan the timing of major expenditures, (e) invest idle cash, and (f) prepare a cash budget.

Internal Control and Cash

TRUE-FALSE STATEMENTS 1. Fraud is an unintentional act to misappropriate (steal) assets or misstate financial statements.

2. A good system of internal control does not require monitoring.

3. Errors give rise to unintentional misstatements in the financial statements.

4. Risk assessment is one component of a good system of internal control.

5. When one individual is responsible for all related activities, the potential for errors and irregularities is decreased.

6. Control activities are most effective when several people are responsible for a given task.

7. The responsibility for keeping the records for an asset should be separate from the physical custody of that asset.

8. Requiring employees to take vacations is a weakness in a control activity because it does not promote operational efficiency.

9. The person responsible for making credit sales should be the vice-president of finance. 10. External auditors report on whether or not the company’s financial statements fairly present its financial position and results of operations.

11. External auditors are usually employees of the company.

12. Bonding means insuring a company against misappropriation of assets by employees.

13. It is unlikely that a company would want to bond its employees who handle cash or inventory.

14. An effective control activity results when at least two individuals are assigned to one cash drawer so that each can serve as check on the other.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

15. A good internal control system will help a company achieve reliable financial reporting, effective and efficient operations, and compliance with laws and regulations.

16. An internal control system cannot be considered effective until the possibility of human error has been completely eliminated.

17. Only large companies need to be concerned with a system of internal control.

18. The responsibility for ordering, receiving, and paying for merchandise should be assigned to different individuals.

19. Background checks of prospective employees are not necessary when a company has an effective system of internal control.

20. The extent of internal control activities adopted by a company must be evaluated in terms of cost-benefit.

21. Segregation of duties among employees eliminates the possibility of collusion.

22. All documents should be prenumbered.

23. Debit card and bank credit card transactions are considered cash.

24. The use of a bank account makes internal control over cash more difficult.

25. The use of electronic funds transfers normally results in better control over cash.

26. Control over cash disbursements is improved if all expenditures are paid by cheque or through use of electronic funds transfers.

27. An example of segregation of duties is having a cheque signer record cash disbursements.

28. An authorized signing officer should sign a cheque only after reviewing the appropriate supporting documentation.

29. To obtain maximum benefit from a bank reconciliation, the reconciliation should be prepared

Internal Control and Cash

by the person authorized to sign cheques.

30. Electronic funds transfers never have to be recorded.

31. All reconciling items in determining the adjusted cash balance per books require the depositor to make adjusting journal entries to the Cash account. 32. NSF cheques received from customers are debited by the bank to the depositor’s account.

33. A bank reconciliation is generally prepared by the bank and sent to the depositor along with cancelled cheques.

34. An NSF cheque that was received is recorded as an account receivable.

35. NSF cheques received are accounted for by adding them to the cash balance per books.

36. Deposits in transit require an adjustment to the cash balance per books.

37. Management only needs to know how much cash is available at the end of the month (when the bank reconciliation is prepared).

38. Debt investments due within three months are normally classified as cash equivalents.

39. A compensating balance is always reported as a non-current asset.

40. Cash restricted in use should be reported separately on the statement of financial position.

41. When the cash account has a credit balance in the general ledger, it is reported as a noncurrent liability.

42. A basic principle of cash management is to increase the speed of paying liabilities.

43. A company should plan the timing of major expenditures in light of its operating cycle.

44. A cash budget will help determine if additional financing will be necessary.

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45. Idle cash should be reported as restricted cash.

46. A key principle of cash management is to increase the speed of collection on receivables.

Internal Control and Cash

ANSWERS TO TRUE-FALSE STATEMENTS Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 1. F 9. F 17. F 25. T 33. F 41. F 2. F 10. T 18. T 26. T 34. T 42. F 3. T 11. F 19. F 27. F 35. F 43. T 4. T 12. T 20. T 28. T 36. F 44. T 5. F 13. F 21. F 29. F 37. F 45. F 6. F 14. F 22. T 30. F 38. T 46. T 7. T 15. T 23. T 31, T 39. F 8. F 16. F 24. F 32. T 40. T

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MULTIPLE CHOICE QUESTIONS 47. Internal controls may be limited by each of the following except (a) the size of the business. (b) the human element. (c) bonding of employees. (d) collusion.

48. Which one of the following is not a primary component of an internal control system? (a) control activities (b) delay payment of liabilities (c) risk assessment (d) control environment

49. Independent internal reviews should be done (a) at the end of each accounting period. (b) at the end of each month. (c) periodically on a surprise basis. (d) by the external auditor.

50. All of the following are examples of a control activity except (a) using prenumbered documents. (b) reconciling the bank statement. (c) insistence that employees work overtime. (d) insistence that employees take vacations.

51. All of the following are examples of a control activity except (a) an extensive marketing plan. (b) bonding of employees. (c) segregation of duties. (d) recording of all transactions.

52. All of the following are examples of a control activity except (a) limit access to assets. (b) independent internal reviews. (c) authorization of transactions. (d) increasing the speed of collection on receivables.

53. Which of the following is not a limitation of internal control? (a) cost of establishing control procedures (b) the human element (c) use of a bank account (d) the size of the company

Internal Control and Cash

54. Internal controls are concerned with all of the following except (a) computerized systems of accounting. (b) effective and efficient operations. (c) ensuring reliable financial reporting. (d) compliance with relevant laws and regulations.

55. An employee who makes a sale, ships the goods, and bills the customer violates which control activity? (a) authorization of transactions and activities (b) documentation (c) segregation of duties (d) human resource controls

56. Physical controls are not designed to safeguard assets from (a) natural disasters. (b) employee theft. (c) robbery. (d) unauthorized use.

57. Having one person responsible for the related activities of ordering merchandise, receiving goods, and paying for them (a) increases the potential for errors and fraud. (b) decreases the potential for errors and fraud. (c) is an example of a control activity. (d) reduces cost and maximizes benefit.

58. The custodian of a company asset should (a) not be bonded. (b) be someone outside the company. (c) not have access to the accounting records for that asset. (d) be an accountant.

59. Internal auditors (a) are hired by independent accounting firms to audit companies. (b) are employees of the government 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 companies that employ them because they are not independent.

60. When two or more people get together for the purpose of circumventing prescribed controls, it is called (a) fraud prevention.

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(b) collusion. (c) a division of duties. (d) bonding of employees.

61. From an internal control standpoint, what type of controls are thorough background checks and bonding of employees? (a) physical controls (b) human resource controls (c) independent checks of performance (d) documentation

62. The control activity related to not having the same person authorize and pay for goods is known as (a) authorization of transactions and activities. (b) independent checks of performance. (c) segregation of duties. (d) human resource controls.

63. Joe is warehouse custodian and also maintains the accounting records of the inventory held at the warehouse. Which control activity is violated? (a) documentation (b) independent checks of performance (c) segregation of duties (d) authorization of transactions and activities

64. Physical controls to safeguard assets do not include (a) cashier department supervisors. (b) vaults. (c) safety deposit boxes. (d) locked warehouses.

65. In large companies, independent checks of performance are often assigned to (a) shift supervisors. (b) management. (c) internal auditors. (d) external auditors.

66. Maximum benefit from independent checks of performance is obtained when (a) it is made on a pre-announced basis. (b) it is done by the employee possessing custody of the asset. (c) discrepancies are reported to management. (d) it is done at the time of the external audit.

67. If employees are bonded, it means that

Internal Control and Cash

(a) they are not allowed to handle cash. (b) they have worked for the company for at least 10 years. (c) they have been insured against misappropriation of assets. (d) they are not allowed to take vacations.

68. Ms. Greene has worked for Ambleside Inc. for 20 years without taking a vacation. An internal control activity that would address this situation would be (a) human resource controls. (b) authorization of transactions and activities. (c) physical controls. (d) documentation.

69. A system of internal control can only provide reasonable assurance, which is based on the belief that (a) the system is infallible. (b) the system can always detect errors and irregularities. (c) the costs of establishing control activities should not be greater than their expected benefit. (d) the human element is not important.

70. Two employees at a retail store work the same cash register. You evaluate this situation as (a) a violation of authorization of transactions and activities. (b) a violation of segregation of duties. (c) supporting the authorization of transactions and activities. (d) supporting independent checks of performance.

71. An accounts payable clerk also has cheque signing authority. Which control procedure is violated? (a) authorization of transactions and activities (b) independent checks of performance (c) documentation (d) segregation of duties

72. The use of electronic funds transfers (a) normally results in better internal controls. (b) does not require segregation of duties. (c) eliminates opportunities for fraud. (d) does not require proper authorization.

73. Which one of the following items would not be considered cash? (a) debit cards (b) money orders (c) coins (d) post-dated cheques

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74. Which of the following is(are) considered cash? (a) debit cards only (b) debit cards and bank credit cards (c) bank credit cards only (d) debit cards and all types of credit cards

75. Which of the following is not a good control activity over cash? (a) Payments to creditors should be made in cash. (b) There should be limited access to cash. (c) The amount of cash on hand should be kept at a minimum. (d) Cash should be deposited daily.

76. 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) payments are made by cheque or electronic funds transfer. (d) all purchases are made on credit.

77. Which of the following is not a suggested procedure to establish a good control activity over cash disbursements? (a) pre-signed blank cheques (b) Different individuals approve and make payments. (c) Blank cheques are stored with limited access. (d) The bank statement is reconciled monthly.

78. Which of the following is not a control activity over cash? (a) Only designated personnel are authorized 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.

79. The use of prenumbered cheques is an example of (a) documentation. (b) independent checks of performance. (c) authorization of transactions and activities. (d) segregation of duties.

80. Allowing only the treasurer to sign cheques is an example of which control activity? (a) documentation (b) segregation of duties (c) human resource controls (d) authorization of transactions and activities

81. Blank cheques

Internal Control and Cash

(a) should be safeguarded. (b) should be pre-signed. (c) do not need to be safeguarded since they must be signed to be valid. (d) should not be prenumbered.

82. An employee authorized to sign cheques should not record (a) shipping documents. (b) mail receipts. (c) cash disbursement transactions. (d) sales transactions.

83. A bank statement (a) lets 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 provided. (d) shows the activity that increased or decreased the depositor's account balance.

84. 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) payment of a note payable (d) cheques marked NSF

85. A company maintains the asset account, Cash in Bank, on its books, while the bank maintains a reciprocal account that is recorded, on the bank’s books, as (a) a contra-asset account. (b) a liability account. (c) an asset account. (d) a shareholders’ equity account.

86. On the April 30 bank reconciliation, a deposit made by a company to its bank account on April 18 will likely appear as a(n) (a) addition to the balance per books. (b) deduction from the balance per books. (c) deduction from the balance per bank. (d) This will not affect the current period’s bank reconciliation.

87. An NSF cheque received from a customer should appear in which section of the bank reconciliation? (a) addition to the balance per books (b) deduction from the balance per books (c) addition to the balance per bank (d) deduction from the balance per bank

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88. On a bank reconciliation, which of the following would be deducted from the balance per books? (a) outstanding cheques (b) deposits in transit (c) electronic payment by a customer on account (d) bank service charges

89. On a bank reconciliation, which of the following would be added to the balance per books? (a) outstanding cheques (b) deposits in transit (c) electronic payment by a customer on account (d) bank service charges

90. On a bank reconciliation, which of the following would be deducted from the balance per bank? (a) outstanding cheques (b) deposits in transit (c) electronic payment by a customer on account (d) bank service charges

91. On a bank reconciliation, which of the following would be added to the balance per bank? (a) outstanding cheques (b) deposits in transit (c) electronic payment by a customer on account (d) bank service charges

92. A cheque returned by the bank marked "NSF" means (a) no service fee. (b) no signature found. (c) not satisfactorily filled out. (d) not sufficient funds.

93. Outstanding cheques from the prior period which clear the bank in the current period (a) should be added to the balance per books. (b) should be deducted from the balance per books. (c) should be deducted from the balance per bank. (d) do not affect the current period’s bank reconciliation.

94. A bank reconciliation should be prepared (a) whenever the bank refuses to lend the depositor money. (b) when an employee is suspected of fraud. (c) to explain any difference between the depositor's balance per books and the balance per bank. (d) by the person who is authorized to sign cheques.

Internal Control and Cash

95. Deposits in transit (a) have been recorded on the depositor's books but not yet by the bank. (b) have been recorded by the bank but not yet by the depositor. (c) have not been recorded by either the bank or the depositor. (d) are customers’ cheques that are in the mail but have not yet been received by the depositor.

96. 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.

97. If a cheque correctly written and paid by the bank for $521 is incorrectly recorded on the company's books for $251, the appropriate treatment on the bank reconciliation would be to (a) add $270 to the balance per bank. (b) add $270 to the balance per books. (c) deduct $270 from the balance per books. (d) deduct $270 from the balance per bank.

98. A cheque written by the company for $157 is incorrectly recorded 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.

99. For which of the following errors should the appropriate amount be added to the balance per bank on a bank reconciliation? (a) cheque for $43 recorded as $34 by the depositor (b) deposit of $500 recorded by the bank as $50 (c) a paid cheque for $200 recorded by the bank as $20 (d) cheque for $35 recorded as $53 by the depositor

100. Which of the following bank reconciliation items would not require an adjusting entry on the depositor’s books? (a) bank service charge (b) outstanding cheques (c) a customer’s NSF cheque (d) electronic payment on account

101. Which of the following bank reconciliation items would require an adjusting entry on the depositor’s books? (a) error by the bank (b) outstanding cheques

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102. All of the following bank reconciliation items would require an adjusting entry on the depositor’s books except (a) interest earned. (b) deposits in transit. (c) a bank service charge. (d) a customer’s NSF cheque. 103. Notification by the bank that a customer’s deposited cheque was returned NSF requires that the depositor make the following adjusting entry: (a) Accounts Receivable Cash (b) Cash Accounts Receivable (c) Bank Charges Expense Accounts Receivable (d) No adjusting entry is necessary.

104. On Druskus Corp.’s April bank reconciliation, cheques outstanding totalled $7,200. In May, the corporation issued cheques totalling $43,300. The May bank statement shows that $32,900 in cheques cleared the bank in May. A cheque from one of Druskus Corp.'s customers in the amount of $290 was also returned marked "NSF." The amount of outstanding cheques on Druskus' May bank reconciliation should be (a) $10,400. (b) $17,310. (c) $17,890. (d) $17,600.

105. Great Scott Corporation gathered the following reconciling information in preparing its August bank reconciliation: Cash balance per books, August 31 ........................... $3,500 Deposits in transit....................................................... 150 Electronic collection of account receivable ................. 850 Bank charge for cheque printing................................. 20 Outstanding cheques ................................................. 2,000 NSF cheque ............................................................... 170 The adjusted cash balance per books at August 31 is (a) $4,160. (b) $4,010. (c) $2,460. (d) $2,310.

106. Driftech Limited gathered the following reconciling information in preparing its October bank reconciliation:

Internal Control and Cash

Cash balance per books, October 31 ......................... Electronic collection of account .................................. Outstanding cheques ................................................. Deposits in transit....................................................... Bank service charge................................................... NSF cheque ............................................................... The adjusted cash balance per books at October 31 is (a) $14,380. (b) $19,500. (c) $18,490. (d) $17,290.

$15,500 4,000 11,000 13,200 1,010 1,200

107. Island Corporation gathered the following reconciling information in preparing its September bank reconciliation: Cash balance per bank, September 30 ...................... $11,000 Note receivable collected by bank .............................. 6,000 Outstanding cheques ................................................. 9,000 Deposit in transit ........................................................ 4,500 Bank service charge................................................... 75 NSF cheque ............................................................... 1,200 The adjusted cash balance per bank at September 30 is (a) $ 1,775. (b) $ 6,500. (c) $ 9,725. (d) $15,725.

108. Bank errors (a) occur because of time lags. (b) must be corrected by debits. (c) are infrequent in occurrence. (d) are corrected by making an adjusting entry on the depositor's books.

109. Cash equivalents are (a) often combined with cash and reported as a current asset. (b) usually reported as a non-current asset. (c) reported as a current liability. (d) included as a compensating balance.

110. Which of the following is not true with respect to the reporting of cash? (a) Cash equivalents are normally combined with cash and reported as a current asset. (b) Compensating balances are minimum cash balances required by the bank. (c) Restricted cash can be either a current or a non-current asset, depending on when it is expected to be used. (d) Cash overdrafts are reported as contra-assets.

111. Cash equivalents

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(a) include all investments in shares. (b) include short-term, highly liquid trading investments plus accounts receivable less any bank overdrafts. (c) include short-term, highly liquid trading investments less any bank overdrafts. (d) are reported as non-current assets.

112. Which of the following is not a basic principle of cash management? (a) Increase collection of receivables. (b) Keep inventory levels high. (c) Delay payment of liabilities. (d) Invest idle cash.

113. It is a good idea to invest idle cash because (a) it will increase the speed of collection on receivables. (b) it will keep inventory levels low. (c) cash on hand earns nothing. (d) it will delay the payment of liabilities.

Internal Control and Cash

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 47. c 59. c 71. d 83. d 95. a 48. b 60. b 72. a 84. b 96. d 49. c 61. b 73. d 85. b 97. c 50. c 62. c 74. b 86. d 98. a 51. a 63. c 75. a 87. b 99. b 52. d 64. a 76. c 88. d 100. b 53. c 65. c 77. a 89. c 101. c 54. a 66. c 78. b 90. a 102. b 55. c 67. c 79. a 91. b 103. a 56. a 68. a 80. d 92. d 104. d 57. a 69. c 81. a 93. d 105. a 58. c 70. a 82. c 94. c 106. d

Item 107. 108. 109. 110. 111. 112. 113.

Ans. b c a d c b c

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EXERCISES Ex. 114 Below are descriptions of internal control problems. In the space to the left of each item, enter the code letter of the one best control activity that is related to the problem described. Control Activity A. Authorization of transactions and activities B. Segregation of duties C. Physical controls D. Documentation E. Independent internal reviews F. Independent external reviews G. Human resource 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 authorized 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 vacation for over 5 years. 8. The external audit firm reports on the financial statements each year.

Solution 114 (5 min.) 1. B 2.

Ex. 115 Indicate whether each of the business practices listed below strengthens (S) or weakens (W) a

Internal Control and Cash

company’s system of control activities. ____ (a) Cashiers are not bonded. ____ (b) All payments are made with cheques instead of cash. ____ (c) Employees are encouraged to take paid vacations. ____ (d) Two people handle cash sales from the same cash register drawer. ____ (e) The company uses prenumbered sales invoices. ____ (f) Audited financial statements are provided to the creditors each fiscal year. Solution 115 (5 min.) (a) W (b) S (c) S (d) W (e) S (f) S

Ex. 116 Craig Thompson has worked for Dr. Hung Pow, a dentist, for several years. Craig demonstrates a loyalty that is rare among employees. He hasn't taken a vacation in the last three years. One of Craig's primary duties is to open the mail and list the cheques received. He also takes cash from patients as they leave. At times it is so hectic that Craig 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 and a receipt later. When it is slow in the office, Craig offers to help Julia post payments to the patients' accounts receivable. She is always happy to receive his help, because Craig is such a conscientious worker. Instructions Identify any internal control activities that may be violated in this situation. Solution 116 (10 min.) Violations: 1. It is Julia's responsibility to post payments to patient accounts. In allowing Craig to assist her, the control activity of authorization of transactions and activities is violated. 2. Although it appears to be a small office, it is not appropriate that Craig both opens the mail and receives and records cash receipts from patients. He also appears to have custody of cash. This situation violates the segregation of duties control activity. By posting to patients' accounts, it would be possible to post credits to patient accounts and pocket the cash. 3. The documentation control is violated when patients are not given cash receipts. Although many professional offices do not have cash registers, computerized or manual receipts are customary and necessary. 4. Independent internal review (independent checks of performance) is also being violated.

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There is no independent counting of the cash and comparison to total receipts. 5. Human resource controls are being violated. Is Craig bonded? As well, he should be required to take regular vacations.

Ex. 117 Sally Small is the sole shareholder of a corner store, The Small Store Inc. She hasn't taken a vacation in two years and is planning to take one next month. She would like to know things are being properly handled in the store before she leaves. She has asked you to observe her operations for a day and tell her if there are any problems you see or improvements you can suggest to the way the company operates with respect to internal controls. She would also like to know if there are things she is doing correctly so that she can continue to do them. You note the following activities during the day. Sally opens the store at 9 a.m. She balances the cash from the previous day before opening. Sarah, a long time employee, starts work at 10 a.m. and works until 5 p.m. Peter, another part time employee, works from 4 p.m. until 11 p.m. and closes the store. He locks the cash register when he leaves. Sally, Sarah and Peter all serve customers during the day. There is only one cash register. Sally leaves the store for lunch and finishes for the day around 6 p.m. She tells you she sometimes drops back in at night to see how things are going. Bread and milk are delivered to the store during the day and whoever is at the cash register at the time takes money from the register to pay for the products. There is a camera that records customers at the cash register and a mirror so the person serving at the cash register can see most of the store. Instructions a) Prepare a list of control activity weaknesses over cash, explaining why each is a weakness and a suggestion as to how to improve. Use point form. b) Prepare a list of items that are being done correctly and why they provide good control. Use point form. Solution 117 (10 min.) a) Weaknesses • The cash is left in the store in the cash register overnight. This increases the risk of it being stolen. It should be locked in the safe or taken to the night deposit. • There is only one cash register but three people work the cash. This means it is not possible to establish who is responsible for any shortages. Each person should have his or her own cash drawer and user numbers for the cash register. • Cash is not deposited intact—payments are made in cash for purchases. This may result in inadequate documentation and will make errors harder to find. Purchases should be paid for with a cheque. • The fact that Sally has not taken a vacation in two years is not a concern, as she is the owner. But normally, employees not taking a vacation may indicate they are concerned with covering something up. Everyone should be encouraged/required to take vacation on a regular basis. b) Strengths

Internal Control and Cash

• •

The camera is a good control because it records events. Sally dropping in unexpectedly at night is a good control as she can do spot checks.

Ex. 118 Listed below are seven errors or problems that might occur in the processing of cash transactions. Also shown is a list of control activities. Evaluate each possible error and cite a control activity given that would reduce the probability of the error occurring. If none of the control activities given will correct the problem, write "None." If you think more than one control is appropriate, list all 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 to herself without fear of detection. ____ 4. A salesclerk in 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. ____ 6. Each cashier counts his/her own register drawer each day and verbally reports the results to the supervisor. ____ 7. Cashiers with over 5 years’ experience are not bonded. Internal Control Activities (a) Authorization of transactions and activities (b) Segregation of duties (c) Physical controls (d) Documentation (e) Independent checks of performance (f) Human resource controls Solution 118 (10 min.) 1. (b) 2.

(c)

(e)

(a) and (e)

(d) and (e)

(f)

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Ex. 119 Using the following information, prepare a bank reconciliation for Gloss Corporation at July 31, 2015: 1. The unadjusted bank statement balance is $6,612. 2. The unadjusted cash account balance in the general ledger is $9,869. 3. Outstanding cheques totalled $1,170. 4. Deposits in transit are $4,350. 5. The bank service charge is $50. 6. A cheque for $196 for supplies was posted as $169 in the company’s general ledger. Solution 119 (10 min.) GLOSS CORPORATION Bank Reconciliation July 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $6,612 Add: (d) Deposit in transit ................................................................ 4,350 10,962 Less: (c) Outstanding cheques ......................................................... 1,170 Adjusted cash balance per books ........................................................ $9,792 Cash balance per books ...................................................................... Less: (f) Cheque amount error ($196 – $169) .................................. (e) Bank service charge .......................................................... Adjusted cash balance per books ........................................................

$9,869 $ 27 50

77 $9,792

Ex. 120 Using the following information, prepare a bank reconciliation for Biling Inc. at May 31, 2015: 1. The unadjusted bank statement balance is $7,200. 2. The unadjusted cash account balance is $6,024. 3. Outstanding cheques totalled $1,600. 4. Deposits in transit are $800. 5. The bank service charge is $24. 6. Electronic collections on account totalled $400. Solution 120 (10 min.) BILING INC. Bank Reconciliation May 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $7,200 Add: (d) Deposit in transit ................................................................ 800 8,000 Less: (c) Outstanding cheques ......................................................... 1,600 Adjusted cash balance ......................................................................... $6,400 Cash balance per books ...................................................................... Add: (f) Electronic collections .........................................................

$6,024 400

Internal Control and Cash

Less (e) Bank service charge .......................................................... Adjusted cash balance .........................................................................

6,424 24 $6,400

Ex. 121 Given the following information, determine the adjusted cash balance per books. 1. Unadjusted balance per books at March 31, $9,700. 2. Outstanding cheques, $1,600. 3. NSF cheque returned with bank statement, $190. 4. Deposit placed in night deposit the evening of March 31 (not on bank statement), $750. 5. Cheque printing charges $45. 6. Interest earned on chequing account, $100. Solution 121 (5 min.) $9,565 ($9,700 – $190 – $45+ $100)

Ex. 122 Seattle Coffee Limited's bank statement for the month of November 2015 showed a balance per bank of $7,000. The company's general ledger Cash account showed a balance of $5,659 at November 30. Other information is as follows: 1. Cash receipts for November 30 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 #119 payable in the amount of $248 to Holt Corporation was recorded in the general journal and cleared the bank for $248. A review of the accounts payable records shows a $36 credit balance in Holt’s account and that the total payment should have been for $284. 4. The total amount of cheques outstanding at November 30 was $5,800. 5. Cheque #138 was correctly written and paid by the bank for $409. The cash payment journal reflects an entry for Cheque #138 as a debit to Accounts Payable and a credit to Cash for $490. 6. The bank returned an NSF cheque from a customer for $560. 7. The bank statement included a deposit for $1,260, which represents the electronic collection of customer accounts which have not yet been recorded on the company’s books. Instructions (a) Prepare a bank reconciliation for Seattle Coffee Limited at November 30, 2015. (b) Prepare any adjusting entries necessary as a result of the bank reconciliation. Solution 122 (25 min.) (a) SEATTLE COFFEE LIMITED Bank Reconciliation November 30, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $ 7,000

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Add:

(1) Deposit in transit..................................................................

5,200 12,200 5,800 $ 6,400

Less: (4) Outstanding cheques .......................................................... Adjusted cash balance per bank .......................................................... Cash balance per books ...................................................................... Add: (5) Accounts payable error ($490 – $409)................................. (7) Electronic collections ........................................................... Less: (2) Cheque printing ................................................................... (6) NSF cheque ........................................................................ Adjusted cash balance per books ........................................................

$ 5,659 $ 81 1,260 $ 40 560

1,341 7,000 600 $ 6,400

Note: Item (3) is not relevant. (b) Nov 30

Cash .................................................................................. Accounts Payable ............................................................. (To correct error in recording Cheque #138)

Cash .................................................................................. Accounts Receivable................................................... (To record collection of accounts receivable)

1,260

Bank Charges Expense ..................................................... Cash ........................................................................... (To record cheque printing charges)

Accounts Receivable ......................................................... Cash ........................................................................... (To record NSF cheque)

560

1,260

560

Ex. 123 The bank statement for Indiana Inc. shows an unadjusted balance of $2,330 at June 30, 2015, while the unadjusted cash balance per books was $599. The following information pertains to the bank transactions for the company. 1. Deposits of $160, representing cash receipts of June 30, did not appear on the bank statement. 2. Outstanding cheques totalled $240. 3. Bank service charges for June were $9. 4. Electronic collections on account totalled $1,740, and have not yet been recorded by the company. 5. An NSF cheque for $80 from a customer was returned with the statement. Instructions (a) Prepare a bank reconciliation at June 30. (b) Prepare any adjusting entries necessary as a result of the bank reconciliation.

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Internal Control and Cash

Solution 123 (25 min.) (a) INDIANA INC. Bank Reconciliation June 30, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $2,330 Add: (1) Deposit in transit.................................................................. 160 2,490 Less: (2) Outstanding cheques .......................................................... 240 Adjusted cash balance per bank .......................................................... $2,250 Cash balance per books ...................................................................... Add: (4) Electronic collections on account ......................................... Less: (3) Bank service charge ............................................................ (5) NSF cheque ........................................................................ Adjusted cash balance per books ........................................................ (b) Jun 30

$ 599 1,740 2,339 $ 9 80

1,740

Accounts Receivable ......................................................... Cash ........................................................................... (To record NSF cheque)

Bank Charges Expense ..................................................... Cash ........................................................................... (To record bank service charges)

89 $2,250

1,740

Ex. 124 Smith’s Cafe Ltd. had the following information regarding its bank transactions for the month of April 2016: Unadjusted balance per books April 30 ......................................... $ 2,805 Unadjusted balance per bank statement April 30 .......................... 11,400 1. 2. 3. 4. 5. 6. 7.

Cheques written in April but still outstanding, $6,000. Cheques written in March but still outstanding, $2,800. Deposits of April 30 not yet recorded by bank, $6,100. A customer’s cheque for $700 was returned by the bank as NSF. Cheque #210 for $594 was correctly issued and paid by bank but incorrectly entered in the general journal as a payment on account for $549. Bank service charge for April was $50. A payment on account (Cheque #318) was incorrectly entered in the general journal and posted to the general ledger as $824. However it had been correctly prepared for $284. The cheque cleared the bank in April.

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Electronic collections on account totalled $6,150, and have not yet been recorded by the company.

Instructions Prepare a bank reconciliation for Smith’s Cafe Ltd. at April 30. Solution 124 (20 min.) SMITH’S CAFE LTD. Bank Reconciliation April 30, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $11,400 Add: (3) Deposit in transit................................................................. 6,100 17,500 Less: (1) April outstanding cheques .................................................. $6,000 (2) March outstanding cheques ............................................... 2,800 8,800 Adjusted cash balance per bank .......................................................... $ 8,700 Cash balance per books ...................................................................... Add: (7) Error on Cheque #318 (824 – 284) .................................... (8) Electronic collections on account ....................................... Less: (4) NSF Cheque ...................................................................... (5) Error on Cheque #210 (594 – 549) .................................... (6) Bank service charge .......................................................... Adjusted cash balance per books ........................................................

$2,805 $

540 6,150 $700 45 50

6,690 9,495

795 $ 8,700

Ex. 125 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 general journal for $230. 4. Deposit in transit 5. Bank returned a customer’s deposited cheque marked NSF. 6. Interest earned on bank account 7. Bank debit memorandum for cheque printing fees 8. Bank charged a cheque against the company, which should have been charged to

Internal Control and Cash

____

another company. A cheque for $236 was correctly paid by the bank but was incorrectly entered in the general journal for $263.

Solution 125 (10 min.) 1. D 2.

Ex. 126 The adjusted cash balance per books and per bank for Murdoch Ltd. at November 30, 2015 is $10,740.93. The following cheques and receipts were recorded for the month of December, 2015:

No. 17 18 19 20 21

Cheques Amount No. $372.96 22 780.62 23 157.00 24 587.50 25 234.15

Amount $ 578.84 1,687.50 921.30 246.03

Receipts Amount Date $ 843.86 Dec 5 941.54 21 808.58 27 1,067.00 31

In addition, the bank statement for the month of December is presented below:

Balance Last Statement

Amounts Deducted (Debits) Amounts Added (Credits) No. Total Amount No. Total Amount

Balance This Statement

$5,404.84 10 $3,632.19 5 $9,278.36 $11,051.01 ——————————————————————————————————————— Cheques and other debits Deposits Date Balance ——————————————————————— No. Amount No. Amount No. Amount ———————————————————————————————————————— 14 148.29 17 372.96 22 578.84 5,484.38 Dec 1 $9,789.13

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18 19 21

708.62 24 921.30 843.86 8 $9,003.07 157.00 25 246.03 941.54 23 $9,541.58 234.15 15.00 SC 808.58 29 $10,101.01 250.00 NSF 1,200.00 EFT 31 $11,051.01 ———————————————————————————————————————— Symbols: NSF (Not sufficient funds) SC (Service charge) EFT (Electronic funds transfer) ———————————————————————————————————————— Cheque #18 was correctly written for $708.62 for a payment on account. The NSF cheque was from Mr. S. Horn, a customer, in settlement of an account receivable. An entry had not been made for this. The EFT is for an electronic collection of accounts receivable in the amount of $1,200, which has not yet been recorded by the company. The bank service charge is $15. Instructions (a) Calculate the unadjusted cash balance at December 31, 2015. (b) Prepare a bank reconciliation at December 31, 2015. (c) Prepare any adjusting entries necessary as a result of the bank reconciliation. Solution 126 (30–35 min.) (a) Nov. 30 adjusted balance per books + receipts – cheques written = Dec. 31 unadjusted balance per books $10,740.93 + $3,660.98 – $5,565.90 = $8,836.01 (b) MURDOCH LTD. Bank Reconciliation December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank statement ................................................... $11,051.01 Add: Deposits in transit ................................................................ 1,067.00 12,118.01 Less: Outstanding cheques #20 ...................................................................................... $ 587.50 #23 ...................................................................................... 1,687.50 2,275.00 Adjusted cash balance per bank ..................................................... $ 9,843.01 Cash balance per books ................................................................. Add: Error in recording cheque #18 (780.62 – 708.62)................. $ 72.00 Electronic collection of accounts .......................................... 1,200.00 Less: Bank service charge ............................................................ NSF cheque ........................................................................ Adjusted cash balance per books ................................................... (c) Dec 31

$ 8,836.01 1,272.00 10,108.01

$ 15.00 250.00

265.00 $ 9,843.01

72 72

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Internal Control and Cash

1,200

Bank Charges Expense ..................................................... Cash ........................................................................... (To record bank service charge)

Accounts Receivable ......................................................... Cash ........................................................................... (To record NSF cheque from S. Horn)

250

1,200

250

Ex. 127 Yamamoto Corporation’s bank statement included two types of electronic funds transfers (EFT). One type of EFT totalled $10,000 and was from customers paying their accounts online. Another type of EFT totalled $16,500 and was from Yamamoto paying its accounts payable online. Instructions (a) How will each of these items affect Yamamoto's bank reconciliation, assuming the company does not record these until it receives the bank statement? (b) Prepare the required journal entries, if any, that Yamamoto will make to record the above information on its books. Solution 127 (10 min.) (a) Yamamoto Corporation must add the electronic collections from customers in payment of their accounts receivable to its cash balance per books on the bank reconciliation. It must deduct the electronic payments it made in payment of its accounts payable from its cash balance per books on the bank reconciliation. (b) Cash ............................................................................................. Accounts Receivable .............................................................

10,000

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

16,500

10,000

16,500

Ex. 128 The cash records of Emmett Corp. show the following: 1. The January 31 bank reconciliation indicated that deposits in transit totalled $950. During February, the general ledger account, Cash, shows deposits of $14,500, but the bank statement indicates that only $12,000 in deposits were received during the month. 2. The January 31 bank reconciliation also reported outstanding cheques of $2,200. During February, Emmett Corp.’s books show that $13,900 of cheques were issued, yet the bank statement showed that $13,300 of cheques cleared the bank in February. No errors were made by either the bank or Emmett Corp. Instructions

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(a) Calculate the amount of the deposits in transit at February 29. (b) Calculate the amount of the outstanding cheques at February 29. Solution 128 (10 min.) (a) Deposits in transit: Deposits per books in February..................................................... Deposits per the bank in February ................................................ Less: January 31 deposits in transit .............................................. February receipts deposited in February ....................................... Deposits in transit, February 29..................................................... (b) Outstanding cheques: Cheques per books in February .................................................... Cheques clearing the bank in February ......................................... Less: Outstanding cheques, January 31 ....................................... February cheques clearing in February ......................................... Outstanding cheques, February 29 ...............................................

$14,500 $12,000 950 11,050 $ 3,450

$13,900 $13,300 2,200 11,100 $ 2,800

Ex. 129 The records of Western Cattle Co. Ltd. show the following: 1. In February, deposits per the bank statement totalled $18,850; deposits per books $19,500; and deposits in transit at February 28 were $1,400. 2. In February, cheques issued per books were $17,750; cheques clearing the bank were $18,400; and outstanding cheques at February 28 were $1,250. No errors were made by either the bank or Western Cattle Co. Ltd. Instructions (a) Calculate the amount of the deposits in transit at January 31. (b) Calculate the amount of the outstanding cheques at January 31. Solution 129 (10 min.) (a) Deposits in transit: Deposits per bank statement in February ...................................... Add: Deposits in transit, February 28 ............................................ Total deposits to be accounted for ................................................ Less: Deposits per books .............................................................. Deposits in transit, January 31 ......................................................

$18,850 1,400 20,250 19,500 $ 750

(b) Outstanding cheques: Cheques clearing the bank in February ......................................... Add: Outstanding cheques, February 28 ....................................... Total cheques to be accounted for ................................................ Less: Cheques issued per books .................................................. Outstanding cheques, January 31 .................................................

$18,400 1,250 19,650 17,750 $ 1,900

Ex. 130 Listed below are items that may be useful in preparing the March 2015 bank reconciliation for

Internal Control and Cash

Moose Jaw Machine Works. Using the code letters below, insert in the space before each item the letter where the amount would be located or otherwise treated in the bank reconciliation process. Code A B C D E

Located or Treated Add to the cash balance per books Deduct from the cash balance per books Add to the cash balance per bank Deduct from the cash balance per bank Does not affect the bank reconciliation

____

1. Included with the bank statement materials was a cheque from Joe Terrell for $40 stamped "account closed." ____ 2. The bank statement included a bank service charge of $35 in payment of the annual safety deposit box fee. ____ 3. The bank statement included a bank service charge of $22 for four books of blank cheques for Moose Jaw Machine Works. ____ 4. The bank statement contains a credit of $42.75 for interest earned on the chequing account balance during the month. ____ 5. The deposits of March 30 and March 31, for $3,362 and $3,125 respectively, were not included on the bank statement. ____ 6. Two cheques totalling $316.86, which were outstanding at the end of February, cleared in March and were returned with the March statement. ____ 7. The bank statement included a credit of $62 for the monthly interest on a certificate of deposit that the company owns. ____ 8. Four cheques, #8712, #8716, #8718, #8719, totalling $5,369.65, did not clear the bank during March. ____ 9. On March 24, 2015, $3,400 was credited by the bank to Moose Jaw Machine Works’ bank account as an electronic funds transfer from a customer in payment of its account. This was not recorded in advance by the company. ____ 10. On March 31, 2015, Moose Jaw Machine Works paid its $700 utility bill using the bank online payment system. As Moose Jaw Machine Works initiated this payment, it recorded it in advance of receiving the bank statement. Solution 130 (10 min.) 1. B 2.

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10. E

Ex. 131 You have recently started a part time job in the accounting department of Home Energy Limited. The accountant, Joe Kool, had prepared the company's bank reconciliation for June 2015. After completing the reconciliation he made the following journal entry: Jun 30 Cash....................................................................................... Bank Charges Expense .......................................................... Accounts Receivable ($3,000 collection less $500 NSF) Interest Earned..............................................................

2,390 124 2,500 14

Joe was reviewing the bank reconciliation with you when unfortunately you spilled your coffee on it. He asks you to rewrite the reconciliation, in good form. He remembers that the only outstanding deposit was the last deposit for the month. You check the general ledger and the bank balance at June 30 was $24,527 (credit). You also check the bank statement and the balance was $22,314 (debit on the bank statement, that is, overdrawn). You look up the last deposit for the month—it was for $21,789. Instructions Using the above information prepare, in good form, the bank reconciliation for Home Energy Limited for June. Solution 131 (25–30 min.) HOME ENERGY LIMITED Bank Reconciliation June 30, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $(22,314) Add: Deposit in transit ....................................................................... 21,789 (525) Less: Outstanding cheques (see note below) ..................................... 21,612 Adjusted cash per bank........................................................................ $(22,137) Cash balance per books ...................................................................... Add: Electronic collection of account ................................................. Interest earned ......................................................................... Less: Bank service charge ................................................................. NSF cheque ............................................................................. Adjusted cash balance per books ........................................................

$(24,527) $3,000 14 $124 500

3,014 (21,513) 624 $(22,137)

Note: To solve, you complete the bank reconciliation with the information you know—the outstanding cheques and the adjusted cash per bank will be unknown. After you arrive at the adjusted balance per books, you enter this as the adjusted cash per bank and solve for the

Internal Control and Cash

outstanding cheques.

Ex. 132 About eight months ago, your friend Sydney Carton started her own bookkeeping business. She caters to small businesses, and has now developed a fairly large clientele. Yesterday, she called you and asked you to come over and give her some advice. It appears that although she has lots of business, she is having serious cash flow problems. “I can’t pay my bills!” she exclaims, “and I want to get a bank loan to get more up-to-date office equipment, but the bank won’t lend the business any money. Please come over and help me!” So today you went to Sydney’s office, and asked to see her general ledger and her latest financial statements. Although the records are up to date, including the receivables and payables, Sydney admits she hasn’t had time to prepare any financial statements yet. You ask her about the receivables, and she agrees they are rather high but all of her revenue is on account. She also adds that “The economy still isn’t very good, and most of my clients are selfemployed tradesmen, and I hate to ask them for money when they’re having a tough time.” You create a trial balance, based on the general ledger, which follows SYDNEY CARTON ENTERPRISES Trial Balance (date) ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Dr Cr Cash ........................................................................................... $ 2,700 Accounts receivable .................................................................... 45,000 Prepaid insurance ....................................................................... 1,800 Supplies ...................................................................................... 2,800 Equipment................................................................................... 9,000 Vehicle ........................................................................................ 25,000 Accounts payable........................................................................ $ 14,100 GST payable ............................................................................... 8,100 Dividends .................................................................................... 18,000 Common shares.......................................................................... 15,000 Bookkeeping revenue ................................................................. 110,000 Rent expense .............................................................................. 32,000 Telephone expense .................................................................... 4,000 Utilities expense .......................................................................... 3,000 General expenses ....................................................................... 3,900 _______ Totals .......................................................................................... $147,200 $147,200 Notes: The “official” credit terms for receivables and payables are n/30. Instructions Suggest ways that Sydney can improve her cash flows. Do not list generalities, but address her specific situation. Solution 132 (20 min.) (The following are some suggestions. Students may come up with others.)

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First of all, you must address your receivables to get more cash in. You have recorded $110,000 in revenue, and at this point, approximately 40% of it is still uncollected. I would suggest that you prepare an aged schedule of the receivables to find out which are the oldest, and you must pressure them to pay. You could suggest that you will not do any more work for them until they pay up.

Consider offering a cash discount for early payment and shorten your credit terms, for example, 2/10, n/20. Although you will incur a cost, this will encourage more clients to pay sooner.

For any new clients, you should require a deposit up front especially if this is standard industry practice. If they are not willing to do this, you probably don’t want them as a client anyway.

Your rent seems very high in comparison to your revenue (approximately 30%). Can you negotiate a lower rent with the landlord? Failing this, perhaps you should consider looking for cheaper premises.

As far as your “regular” payables are concerned, can you negotiate longer terms with any of them (to delay payment as long as possible). It’s worth a try.

I would suggest that you prepare a cash budget. This will show you when you will be short of cash and when you will have excess cash available. This won’t happen for a while, but if you follow my suggestions, it will.

If all else fails, you may have to approach the bank and offer personal assets as security to secure a loan.

Internal Control and Cash

MATCHING 133. Match the items below by entering the appropriate code letter in the space provided.

____ ____ ____ ____ ____ ____

A. B. C. D. E. F. G. H. I. J.

Prenumbered documents Custody of an asset should be kept separate from the record-keeping for that asset Television monitors, garment sensors and burglar alarms are examples Bonding employees Collusion Electronic funds transfer Invest idle cash Cancelled cheques NSF cheques Outstanding cheques

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

Segregation of duties Two or more employees circumventing prescribed procedures. Prevent a transaction from being recorded more than once. Physical controls Insurance protection against misappropriation of assets Transferring money electronically from one bank account to another without any paper money changing hands. Cheques that have been returned by the issuer's bank for lack of funds. Cheques that have been paid by the depositor's bank. Issued cheques that have not been paid by the bank. A basic principle of cash management

____ 7. ____ 8. ____ 9. ____ 10.

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ANSWERS TO MATCHING 1.

10. G

Internal Control and Cash

SHORT-ANSWER ESSAY QUESTIONS S-A E 134 Important objectives of a system of internal controls are to achieve reliable financial reporting, effective and efficient operations, and compliance with relevant laws and regulations. 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. Solution 134 The implementation of an internal control system is affected by cost-benefit considerations, the human element, and the size of the business. A company's internal control system 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 activities 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 internal control system 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 the business impacts internal controls because a smaller business may not have the necessary resources available to effect the implementation of desirable controls.

S-A E 135 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. Instructions Prepare a short paragraph, to be included in the training materials, describing the benefits of sound internal control activities, from the viewpoint of the employee. Solution 135 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, control activities clearly 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 control activities will discourage dishonest employees looking for opportunities to steal from the company. They will find such opportunities extremely limited. Finally, all these systems, practices, and procedures result in a

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well-managed company that is less likely to suffer unnecessary losses, and a much better place for you to work and build a career.

S-A E 136 Taylor Instruments Inc. is a rapidly growing manufacturer of engineering equipment. 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. Instructions "Internal controls exist because most people can't be trusted." Is this true? Explain. Solution 136 Internal controls exist, not because most people can't be trusted, but to protect the company's assets from those few who cannot 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. 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 proves to be dishonest.

S-A E 137 In business, electronic funds transfers (EFT) are very popular, with some companies, such as Sears, paying all their bills by EFT. Most companies now also pay their employees by EFT, with the net pay being deposited directly to the employee’s bank account. Individuals also are using EFT to pay their bills through on-line banking. Instructions Explain the implications of EFT payments from an internal control standpoint. Does EFT guarantee that fraud will be eliminated? Solution 137 EFT is a way of transferring money electronically from one bank account to another. Using EFT eliminates the need for cheques. This generally results in better internal control, since no cash or cheques are handled by company employees, thereby minimizing the possibility of having cheques stolen. However, they still have to be properly recorded, and this should be done by an employee who has no access to the EFT records (for example, the bank account numbers of the payees). Without proper authorization and segregation of duties, it is possible an employee could redirect electronic transfers to his/her personal bank account. So, no, the use of EFT does not guarantee that fraud will be eliminated. However, fraud is far less likely to occur than when cheques and cash are used to make payments.

S-A E 138 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

Internal Control and Cash

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. Solution 138 The cash balance per books may 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 (interest earned, NSF cheque, electronic funds transfers, and the like).

S-A E 139 You are busily working away at your new job in the accounting department of Humongous Enterprises Ltd. Your friend from the marketing department stops by to pick you up for lunch and asks what you are doing. You tell her you are preparing the bank reconciliation. She says she remembers doing that in an accounting course she took once but didn't think it would be necessary any more—given that most things were done by computers now and the banks and a big company like ours are both required to have internal control systems in place to prevent errors. Surely there can't be any reconciling things left. You sigh and start to explain it to her on your way to lunch. Instructions Prepare, in point form, the explanation you would give your friend. Solution 139 • The reconciliation is part of the company's control system. • It will identify any errors made by the bank or the company. • Most of the processing is done by computers but mistakes can still be made. • There will always be reconciling items because of the time lags. • Some items are recorded earlier in the books and take time to clear the bank (for example, cheques, deposits). • Some items are received first by the bank and are recorded in the books from the bank reconciliation – for example, NSF cheques, and bank service charges.

S-AE 140 You and your friend Pete are reviewing the latest financial reports from a large Canadian corporation. Although you are studying accounting at school, he is not. On the statement of financial position, Pete notices a line item called “Cash and Cash Equivalents.” “That doesn’t make sense!” he exclaims. “How can you have an equivalent to cash? Cash is cash! There is no equivalent!” Instructions Explain to Pete what “cash equivalents” are and why they are included with cash on the statement of financial position. Solution 140 In accounting, cash equivalents are short-term, trading investments subject to insignificant risk

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of changes in value, and that are highly liquid less any bank overdrafts. Short-term, highly liquid trading investments mean they can be converted to cash very quickly. There are limited items that fit this requirement; they are usually short-term investments in debt instruments (for example, guaranteed investment certificates). I know they are not “cash” in the traditional sense of coins and bills in your wallet, Pete, but for accounting purposes, these “cash equivalents” are considered cash for financial statement presentation, so that’s why they show on the same line as cash.

S-A E 141 Managing cash is one of the most important things a company has to do. Instructions (a) Identify some reasons why a company can have difficulty in managing its cash. (b) What can be done by management to manage its cash? Solution 141 (a) Reasons why a company can have difficulty in managing its cash: • Too many receivables that are slow in collection • Too much inventory that is not selling fast enough • Significant capital expenditures required • Too many expenses, or lack of profitability • Insufficient access to debt or equity financing (b) • • • • • •

Cash management techniques: Establish credit and collection policies Reduce inventory Defer capital expenditures or time them to match cash flow Review gross margins and profit margins Prepare and review budgets Obtain additional debt or equity financing

CHAPTER 8 REPORTING AND ANALYZING RECEIVABLES SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item

LOD

Item

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

1 1 1 1 1 1 1 1 1

E M E E E E E M M

10. 11. 12. 13. 14. 15. 16. 17. 18.

45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60.

1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2

H M E E E E E E E E M E M M M M

61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76.

122. 123. 124. 125.

1 1,2 1,2 1,2

E E M H

126. 127. 128. 129.

140.

1–3,5

141. 142. Note:

1 2

E E

E = Easy

143. 144.

SO LOD Item SO LOD Item True-False Statements 1 M 19. 2 M 28. 1 E 20. 2 M 29. 1 E 21. 2 M 30. 1 E 22. 2 E 31. 1 E 23. 2 M 32. 2 E 24. 2 E 33. 2 M 25. 2 E 34. 2 E 26. 2 E 35. 2 M 27. 2 E 36. Multiple Choice Questions 2 E 77. 2 M 93. 2 M 78. 2 E 94. 2 M 79. 2 M 95. 2 M 80. 2 E 96. 2 E 81. 2 M 97. 2 E 82. 2 E 98. 2 E 83. 2 M 99. 2 E 84. 2 E 100. 2 E 85. 2 M 101. 2 E 86. 2 M 102. 2 E 87. 2 M 103. 2 E 88. 2 M 104. 2 H 89. 2 E 105. 2 M 90. 2 E 106. 2 E 91. 3 E 107. 2 M 92. 3 E 108. Exercises 1,3 H 130. 2 M 134. 1–4 H 131. 2,4 E 135. 2 M 132. 3 M 136. 2 E 133. 3 H 137. Matching

2 2

SO LOD

Item

SO LOD

2 2 2 3 3 3 3 3 3

E H H E E E E E E

37. 38. 39. 40. 41. 42. 43. 44.

3 4 4 4 5 5 5 5

E E E E E E E E

3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3

E E E E E E E E E E M M M M M M

109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121.

3 3 3 3 3 4 5 5 5 5 5 5 5

E M M M E E E E E E E E M

3 3 3 5

E E E E

138. 139.

5 5

M M

Short-Answer Essay M 145. 5 M E 146. 5 M

M = Medium

H = Hard

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Item Study Objective 1 1. TF 6. TF 11. TF 46. MC 122. Ex 127. 2. TF 7. TF 12. TF 47. MC 123. Ex 140-1. 3. TF 8. TF 13. TF 48. MC 124. Ex 140-2. 4. TF 9. TF 14. TF 49. MC 125. Ex 140-3. 5. TF 10. TF 45. MC 50. MC 126. Ex 141. Study Objective 2 15. TF 26. TF 57. MC 68. MC 79. MC 90. 16. TF 27. TF 58. MC 69. MC 80. MC 123. 17. TF 28. TF 59. MC 70. MC 81. MC 124. 18. TF 29. TF 60. MC 71. MC 82. MC 125. 19. TF 30. TF 61. MC 72. MC 83. MC 127. 20. TF 51. MC 62. MC 73. MC 84. MC 128. 21. TF 52. MC 63. MC 74. MC 85. MC 129. 22. TF 53. MC 64. MC 75. MC 86. MC 130. 23. TF 54. MC 65. MC 76. MC 87. MC 131. 24. TF 55. MC 66. MC 77. MC 88. MC 140-4. 25. TF 56. MC 67. MC 78. MC 89. MC 140-5. Study Objective 3 31. TF 37. TF 96. MC 102. MC 108. MC 126. 32. TF 91. MC 97. MC 103. MC 109. MC 127. 33. TF 92. MC 98. MC 104. MC 110. MC 132. 34. TF 93. MC 99. MC 105. MC 111. MC 133. 35. TF 94. MC 100. MC 106. MC 112. MC 134. 36. TF 95. MC 101. MC 107. MC 113. MC 135. Study Objective 4 38. TF 39. TF 40. TF 114. MC 127. Ex 131. Study Objective 5 41. TF 44. TF 117. MC 120. MC 138. Ex 140-10. 42. TF 115. MC 118. MC 121. MC 139. Ex 145. 43. TF 116. MC 119. MC 137. Ex 140-9. Ma 146. Note:

TF MC

= True-False = Multiple Choice

Ma Ex

= Matching = Exercise

Type

Item

Type

MC Ex Ex Ex Ex Ex Ex Ex Ex Ma Ma

140-6. 142. 143. 144.

Ma SAE SAE SAE

Ex Ex Ex Ex Ex Ex

136. 140-7. 140-8.

Ex Ma Ma

Ex Ma Ma Ma SAE

Ex Ma SAE SAE

SAE = Short-Answer Essay

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CHAPTER STUDY OBJECTIVES 1.

Identify the types of receivables and record accounts receivable transactions. Receivables can include accounts receivable, notes receivable, and other types of receivables. Accounts and notes resulting from sales transactions are called trade receivables. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, sales tax recoverable, and income tax receivable. Accounts receivable arising from sales or services on credit is recorded at the invoice price, and is reduced by any sales returns and allowances and sales discounts. Sales or services using nonbank (company) credit cards result in a receivable from the credit card company. Accounts receivable subsidiary ledgers are used to keep track of individual account balances. When interest is charged on a past-due receivable, interest is added to the accounts receivable balance and is recognized as interest revenue.

Account for bad debts. The allowance method, using a percentage of receivables, is used to match bad debts expense against revenue, in the period in which the revenue was earned. A percentage of total receivables, or an aging schedule applying percentages to different categories of receivables, is used to estimate the uncollectible accounts or ending balance in the allowance for doubtful accounts. When a specific account receivable is determined to be uncollectible, it is written off and the allowance account reduced. When a previously written-off account is collected, the write off is reversed and the collection recorded. Bad debts expense is the difference between the estimated total uncollectible accounts (required balance in the allowance account) and the unadjusted balance in the allowance account.

Account for notes receivable. Notes receivable are recorded at their principal amount. Interest is earned from the date the note is issued until it matures and is recorded in a separate interest receivable account. Similar to accounts receivable, estimated uncollectible notes receivable are recorded as an allowance for doubtful notes. Notes can be held to maturity, at which time the principal plus any unpaid interest is due and the note is removed from the accounts when paid (honoured). In some situations, the maker of the note dishonours the note (defaults). If eventual collection is expected, an account receivable replaces the note receivable and any unpaid interest. If the amount is not expected to be repaid, the note is written off.

Explain the statement presentation of receivables. Each major type of receivable should be identified in the statement of financial position, with supplemental detail included in the statement or supporting notes. Companies must report the net realizable value of their receivables on the statement of financial position. The gross amount of receivables and allowance for doubtful accounts can be reported directly on the statement or in the notes. Bad debts expense is reported in the income statement as an operating expense, and interest revenue is shown in the nonoperating section of the statement.

Apply the principles of sound accounts receivable management. To properly manage receivables, management must (a) determine who to extend credit to, (b) establish a payment period, (c) monitor collections, and (d) evaluate the liquidity of receivables by calculating the receivables turnover and average collection period. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

The receivables turnover is calculated by dividing net credit sales by average gross accounts receivable. The average collection period converts the receivables turnover into days, dividing 365 days by the receivables turnover ratio.

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TRUE-FALSE STATEMENTS 1. Trade receivables occur when two companies trade or exchange notes receivables.

2. Trade receivables can be accounts receivable or notes receivable.

3. Other receivables include nontrade receivables such as loans to company officers.

4. Advances to employees are a type of accounts receivable.

5. Receivables are considered to be financial assets.

6. Both accounts receivable and notes receivable represent claims that are expected to be collected in cash.

7. Accounts receivable can be the result of either cash or credit sales.

8. If a company such as Sears sponsors its own credit card, when customers use their Sears card the sale is recorded as a cash sale.

9. A receivable is recognized when the sales effort is substantially complete.

10. A receivable is recognized regardless of collection risk.

11. A subsidiary ledger is a group of accounts that provides details about a control account in the general ledger.

12. When a subsidiary ledger and a control account are used, each journal entry that affects accounts receivable must be posted twice.

13. When posting is up-to-date, the balance in the accounts receivable subsidiary ledger must equal the balance in the general ledger.

14. Interest revenue is never earned on accounts receivable.

15. An aging of accounts receivable schedule is based on the premise that the longer the period an account remains unpaid, the greater the probability that it will eventually be collected. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

16. Under the allowance method for uncollectible accounts, bad debts expense is not recorded until a customer defaults.

17. Uncollectible accounts must be estimated because it is not possible to know which accounts will not be collected.

18. Under the allowance method for uncollectible accounts, the entry to write off an uncollectible account only involves statement of financial position accounts.

19. The percentage of receivables basis of estimating uncollectible accounts ignores the existing balance in the allowance account when the bad debts adjusting entry is recorded.

20. Under the aging method of estimating the allowance for doubtful accounts, the balance in the allowance account must be considered prior to adjusting for estimated uncollectible accounts.

21. It is possible for the allowance account to have a debit balance before the year end adjusting entry is recorded.

22. Allowance for Doubtful Accounts is credited when an account is determined to be uncollectible.

23. Under the allowance method for uncollectible accounts, the recovery of an account receivable previously written off results in a credit to the Bad Debt Expense account.

24. Allowance for Doubtful Accounts is a contra account that is deducted from Accounts Receivable on the statement of financial position.

25. The Allowance for Doubtful Accounts is a liability account.

26. Net realizable value is determined by adding the Allowance for Doubtful Accounts to Accounts Receivable.

27. Bad Debts Expense is a contra account to the Sales account.

28. Under the allowance method for uncollectible accounts, Bad Debts Expense is debited when an account is deemed uncollectible and must be written off.

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29. Under the allowance method for uncollectible accounts, the net realizable value of receivables is the same both before and after an account has been written off.

30. Under the allowance method for uncollectible accounts, the net realizable value of receivables is the same both before and after an account that had previously been written off is recovered.

31. A note receivable is a written promise by the maker to the payee to pay a specified amount of money at a definite time.

32. The two key parties to a note are the maker and the payee.

33. The maker of a promissory note is the party to whom the payment is to be made.

34. When the due date of a note is stated in months, the time factor in calculating interest, if it is due monthly, is the number of months divided by 12. 35. Interest on a 3-month, 3%, $20,000 note is calculated by multiplying $20,000  3%  3.

36. Uncollectible notes receivable should be estimated at year end and recorded as a debit to Bad Debts Expense and a credit to Notes Receivable.

37. A dishonoured note is a note that is not paid in full at maturity.

38. Both the gross amount of receivables and the Allowance for Doubtful Accounts must be reported either in the statement of financial position or notes to the financial statements.

39. Receivables are generally valued and reported in the statement of financial position at their gross amount less the allowance for doubtful accounts.

40. Both Bad Debts Expense and Interest Revenue are reported as operating expenses in the income statement.

41. A critical part of managing receivables is determining who should be extended credit and who should not.

42. The receivables turnover ratio is calculated by dividing gross credit sales by the average net receivables during the year.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

43. The average collection period is frequently used to assess the effectiveness of a company’s credit and collection policies.

44. The receivables turnover should be analyzed in conjunction with other ratios such as the current ratio and inventory turnover.

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7.

Ans. F T T F T T F

Item 8. 9. 10. 11. 12. 13. 14.

Ans. F T F T T T F

Item 15. 16. 17. 18. 19. 20. 21.

Ans. F F T T F T T

Item 22. 23. 24. 25. 26. 27. 28.

Ans. F F T F F F F

Item 29. 30. 31. 32. 33. 34. 35.

Ans. T F T T F T F

Item 36. 37. 38. 39. 40. 41. 42.

Ans. F T T T F T F

Item 43. 44.

Ans. T T

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 45. The receivable that is usually evidenced by a formal instrument of credit is a(n) (a) trade receivable. (b) note receivable. (c) account receivable (d) income tax receivable. 46. Which of the following receivables would not be classified as an "other receivable”? (a) advance to an employee (b) refundable income tax (c) notes receivable (d) interest receivable

47. Notes or accounts receivables that result from sales transactions are often called (a) sales receivables. (b) non-trade receivables. (c) trade receivables. (d) merchandise receivables.

48. The journal entry to record a credit card sale using a nonbank credit card (for example, Canadian Tire or Sears) includes a debit to the (a) Cash account. (b) Accounts Receivable account. (c) Bank Charges Expense account. (d) Sales account.

49. The term "receivables" refers to (a) amounts due from individuals or companies. (b) merchandise to be collected from individuals or companies. (c) cash to be paid to creditors. (d) cash to be paid to debtors.

50. To find the balance due from an individual customer, the accountant would refer to the (a) General Journal. (b) Sales account in the general ledger. (c) Accounts Receivable subsidiary ledger. (d) Accounts Receivable account in the general ledger.

51. Accounts receivable are valued and reported on the statement of financial position (a) in the non-current asset section. (b) at the gross amount less sales returns and allowances. (c) at net realizable value. (d) only if they are not past due. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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52. The account Allowance for Doubtful Accounts is necessary because (a) when recording bad debts expense, it is not possible to know which specific accounts will not be paid. (b) uncollectible accounts that are written off must be accumulated in a separate account. (c) a liability results when a credit sale is made. (d) management needs to accumulate all the credit losses over the years.

53. The account Allowance for Doubtful Accounts is classified as a(n) (a) liability. (b) contra account to Bad Debts Expense. (c) expense. (d) contra account to Accounts Receivable.

54. Under the allowance method for uncollectible accounts, Bad Debts Expense is recorded (a) when an individual account is written off. (b) when the amount of loss is known. (c) for an amount that the company estimates it will not collect. (d) several times during the accounting period.

55. Under the allowance method for uncollectible accounts, writing off an uncollectible account (a) affects only statement of financial position accounts. (b) affects both statement of financial position and income statement accounts. (c) affects only income statement accounts. (d) affects either statement of financial position or income statement accounts.

56. The net amount expected to be received in cash from receivables is termed the (a) net realizable value. (b) fair value. (c) gross cash value. (d) cash-equivalent value.

57. If a company fails to record estimated bad debts expense, then (a) net realizable value is understated. (b) expenses are understated. (c) revenues are understated. (d) receivables are understated.

58. If the amount of bad debts expense is understated at year end, then (a) profit will be understated. (b) shareholders’ equity will be understated. (c) Allowance for Doubtful Accounts will be overstated. (d) net Accounts Receivable will be overstated.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

59. When the allowance method is used to account for uncollectible accounts, Bad Debts Expense is debited when (a) a sale is made. (b) an account becomes uncollectible and is written off. (c) management estimates the amount of uncollectible accounts. (d) a customer's account becomes past due.

60. When an account becomes uncollectible and must be written off (a) Allowance for Doubtful Accounts should be credited. (b) Accounts Receivable should be credited. (c) Bad Debts Expense should be credited. (d) Sales should be debited.

61. The collection of an account that had been previously written off under the allowance method for uncollectible accounts (a) will increase profit in the period it is collected. (b) will decrease profit in the period it is collected. (c) requires a correcting entry for the period in which the account was written off. (d) does not affect profit in the period it is collected.

62. The collection of an account that had been previously written off under the allowance method for uncollectible accounts (a) increases profit in the period of collection. (b) involves a credit to Bad Debts Expense. (c) will usually require two journal entries. (d) is recorded by debiting Cash and crediting Bad Debts Expense.

63. An aging of a company's accounts receivable indicates that $6,500 is estimated to be uncollectible. If Allowance for Doubtful Accounts has a $1,200 credit balance, the adjustment to record bad debts for the period will require a (a) debit to Bad Debts Expense for $6,500. (b) debit to Allowance for Doubtful Accounts for $5,300. (c) debit to Bad Debts Expense for $5,300. (d) credit to Allowance for Doubtful Accounts for $7,700.

64. A debit balance in the Allowance for Doubtful Accounts (a) is the normal balance for that account. (b) indicates that actual bad debt write offs are higher than previous provisions for bad debts. (c) indicates that actual bad debt write offs have been less than what was estimated. (d) cannot occur if the percentage of receivables method of estimating bad debts is used.

65. Under the allowance method of accounting for uncollectible accounts, Bad Debts Expense is debited (a) when a credit sale is past due. (b) at the end of each accounting period. (c) whenever a pre-determined amount of credit sales have been made. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) when an account is determined to be uncollectible.

66. Estimated uncollectibles are recorded as a debit to (a) Allowance for Doubtful Accounts. (b) Bad Debts Expense. (c) Sales. (d) Accounts Receivable.

67. Bad Debts Expense is considered (a) an avoidable cost in doing business on a credit basis. (b) an internal control weakness. (c) a necessary risk of doing business on a credit basis. (d) avoidable unless there is a recession.

68. The Allowance for Doubtful Accounts is shown under (a) Expenses on the income statement. (b) Revenue on the income statement. (c) Current Liabilities on the statement of financial position. (d) Current Assets on the statement of financial position.

69. Writing off an uncollectible account involves (a) a debit to Bad Debts Expense. (b) a debit to Allowance for Doubtful accounts. (c) a debit to Sales Returns and Allowances. (d) a debit to Accounts Receivable.

70. Bad Debts Expense is reported on the income statement as (a) part of cost of goods sold. (b) an expense subtracted from gross sales to determine net sales. (c) an operating expense. (d) a non-operating expense.

71. Under the allowance method for uncollectible accounts, Bad Debts Expense is recorded (a) in the year after the credit sale is made. (b) in the same year as the credit sale. (c) as each credit sale is made. (d) when an account is written off as uncollectible.

72. To record estimated uncollectible accounts using the allowance method, the adjusting entry would be a debit to (a) Accounts Receivable and a credit to Allowance for Doubtful Accounts. (b) Bad Debts Expense and a credit to Allowance for Doubtful Accounts. (c) Allowance for Doubtful Accounts and a credit to Accounts Receivable. (d) Bad Debts Expense and a credit to Accounts Receivable.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

73. Under the allowance method for uncollectible accounts (a) the net realizable value of accounts receivable is greater before an account is written off than after it is written off. (b) Bad Debts Expense is debited when a specific account is written off as uncollectible. (c) the net realizable value of accounts receivable in the statement of financial position is the same before and after an account is written off. (d) Allowance for Doubtful Accounts is closed each year to Income Summary.

74. The balance in Allowance for Doubtful Accounts would have a debit balance when (a) the percentage of receivables basis is used. (b) an uncollectible account is later recovered. (c) write offs during the year have been less than previous provisions. (d) write offs during the year have exceeded previous provisions.

75. Allowance for Doubtful Accounts on the statement of financial position (a) is included in current liabilities. (b) increases the net realizable value of accounts receivable. (c) appears under the heading "Other Assets." (d) is deducted from accounts receivable.

76. When an account is written off using the allowance method for uncollectible accounts, the (a) net realizable value of total accounts receivable will increase. (b) net accounts receivable will decrease. (c) allowance account will increase. (d) net accounts receivable will stay the same.

77. If an account is collected after having been previously written off (a) the Allowance account should be debited. (b) only the control account needs to be credited. (c) both income statement and statement of financial position accounts will be affected. (d) there will be both a debit and a credit to Accounts Receivable.

78. You have just received notice that a customer with an Accounts Receivable balance of $500 has gone bankrupt and will not make any future payments. Assuming you use the allowance method for uncollectible accounts, the entry you make is to (a) debit Allowance for Doubtful Accounts and credit Bad Debts Expense. (b) debit Allowance for Doubtful Accounts and credit Accounts Receivable. (c) debit Bad Debts Expense and credit Allowance for Doubtful Accounts. (d) debit Bad Debts Expense and credit Accounts Receivable.

79. When an account is written off using the allowance method for uncollectible accounts, accounts receivable (a) is unchanged and the allowance account increases. (b) increases and the allowance account increases. (c) decreases and the allowance account decreases. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) decreases and the allowance account increases.

80. Under the allowance method for uncollectible accounts, when a specific account is written off (a) total assets will be unchanged. (b) net profit will decrease. (c) total assets will decrease. (d) total assets will increase.

81. An aging of a company's accounts receivable indicates that $13,000 is estimated to be uncollectible. If the Allowance for Doubtful Accounts has a $2,400 debit balance, the adjustment to record bad debts for the period will require a (a) debit to Bad Debts Expense for $15,400. (b) debit to Bad Debts Expense for $13,000. (c) debit to Bad Debts Expense for $10,600. (d) debit to Allowance for Doubtful Accounts for $13,000.

82. Under the allowance method for uncollectible accounts, when a year-end adjustment is made for estimated uncollectible accounts, (a) total assets decrease. (b) total assets are unchanged. (c) net profit is unchanged. (d) liabilities decrease.

83. One might infer from a debit balance in Allowance for Doubtful Accounts that (a) a posting error has been made. (b) more accounts have been written off than had been estimated would be uncollectible. (c) the percentage of receivables basis is being used. (d) bad debts expense has been overestimated.

84. The normal balance and type of account for the Allowance for Doubtful Accounts is (a) debit, contra-asset. (b) credit, asset. (c) credit, revenue account. (d) credit, contra-asset.

Use the following information for questions 85–86. Under the aging of a company's accounts receivable, the uncollectible accounts are estimated to be $12,000. The unadjusted balance for the Allowance for Doubtful Accounts is $2,000 credit.

85. What is the balance in the Allowance for Doubtful Accounts account after adjustment? (a) $14,000 (b) $12,000 (c) $2,000 (d) $10,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

86. What is the amount of bad debts expense for the year? (a) $14,000 (b) $12,000 (c) $2,000 (d) $10,000

87. Under the aging of a company's accounts receivable, the uncollectible accounts are estimated to be $26,000. If the unadjusted balance for the Allowance for Doubtful Accounts is $9,000 debit, what is the amount of bad debts expense for the year? (a) $17,000 (b) $18,000 (c) $26,000 (d) $35,000

88. The net realizable value of the Accounts Receivable is $21,000 before the write off of a $1,500 account. What is the net realizable value after the write off? (a) $22,500 (b) $21,000 (c) $19,500 (d) $18,000

89. The balance of the Allowance for Doubtful Accounts prior to making the adjusting entry to record Bad Debts Expense (a) is relevant when using the percentage of receivables basis. (b) is relevant when debit card sales are made. (c) is relevant when notes receivable are used. (d) will never show a debit balance at this stage in the accounting cycle.

90. When collecting a previously written-off account (a) Cash is debited and Bad Debts Expense is credited. (b) Accounts Receivable is debited and Sales is credited. (c) Accounts Receivable is debited and credited. (d) Accounts Receivable is not affected.

91. A promissory note (a) is not a formal credit instrument. (b) may be used to settle an account receivable. (c) has the party to whom the money is due as the maker. (d) cannot be factored to another party.

92. Which of the following is not true regarding promissory notes? (a) Promissory notes are not shown at net realizable value on the statement of financial position. (b) Promissory notes are usually interest-bearing. (c) Promissory notes give a stronger legal claim to the holder than accounts receivable. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) Promissory notes are frequently accepted from customers who need to extend the payment of an outstanding account receivable.

93. Interest is usually associated with (a) accounts receivable. (b) notes receivable. (c) doubtful accounts. (d) bad debts.

94. If Winner Ltd. accepts a note receivable from Loser Inc. for the sale of equipment (a) Loser is the payee of the note and Winner is the maker of the note. (b) Loser is the maker of the note and Winner is the payee of the note. (c) Loser is the creditor and Winner is the debtor. (d) Loser has a note receivable and Winner has a note payable.

95. LeBlanc Corp. signed a document promising to pay First Bank a specified amount of money at a definite future date at a certain interest rate. This transaction is reported as a(n) (a) note receivable on LeBlanc’s books and a note payable on First Bank’s books. (b) note payable on LeBlanc’s books and a note receivable on First Bank’s books. (c) account receivable on LeBlanc’s books and an account payable on First Bank’s books. (d) account payable on LeBlanc’s books and an account receivable on First Bank’s books.

96. The maturity date of a note is (a) the period of time from the note’s issue date to its due date. (b) the day the note must be repaid. (c) at the company’s year-end. (d) when adjusting journal entries are made.

97. The two key parties to a promissory note are the (a) maker and a bank. (b) debtor and the payee. (c) maker and the payee. (d) sender and the receiver.

98. Interest accrued on a note receivable is (a) credited to Notes Receivable. (b) debited to Interest Revenue. (c) credited to Interest Receivable. (d) debited to Interest Receivable.

99. The total interest on a $10,000, 4%, 3-month note receivable is (a) $ 100. (b) $ 200. (c) $ 400. (d) $1,200. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

100. The total interest on a $6,000, 4%, 2-month note receivable is (a) $ 20. (b) $ 40. (c) $ 240. (d) $6,040.

101. The total interest on a $10,000, 6%, 6-month note receivable is (a) $ 50. (b) $100. (c) $300. (d) $600.

102. A dishonoured note receivable (a) is paid in full at its maturity date. (b) is no longer a negotiable instrument. (c) can be used in place of a cheque. (d) can only be collected by a bank.

103. When a company receives an interest-bearing note receivable, it will (a) debit Notes Receivable for the maturity value of the note. (b) credit Notes Receivable for the maturity value of the note. (c) debit Notes Receivable for the principal value of the note. (d) credit Notes Receivable for the principal value of the note.

104. The principal value of a note refers to the amount (a) that has been dishonoured. (b) borrowed plus interest received at maturity from the maker. (c) at which the note receivable is recorded. (d) remaining after a service charge has been deducted.

105. Night Corp. receives a $4,000, 3-month, 8% note from Day Corp. in settlement of a past due account receivable. What entry will Night Corp. make upon receiving the note? (a) Notes Receivable ........................................................ 4,080 Accounts Receivable............................................ 4,080 (b) Notes Receivable ........................................................ 4,080 Accounts Receivable............................................ 4,000 Interest Revenue .................................................. 80 (c) Notes Receivable ........................................................ 4,000 Interest Receivable ..................................................... 80 Accounts Receivable............................................ 4,000 Interest Revenue .................................................. 80 (d) Notes Receivable ........................................................ 4,000 Accounts Receivable............................................ 4,000

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106. Day Corp. receives a $9,000, 8-month, 6% note from Night Corp. in settlement of a past due account receivable. What entry will Day Corp. make upon receiving the note? (a) Notes Receivable ........................................................ 9,360 Accounts Receivable............................................ 9,360 (b) Notes Receivable ........................................................ 9,360 Accounts Receivable............................................ 9,000 Interest Revenue ................................................. 360 (c) Notes Receivable ........................................................ 9,000 Accounts Receivable............................................ 9,000 (d) Notes Receivable ........................................................ 9,000 Interest Receivable ..................................................... 360 Accounts Receivable............................................ 9,000 Interest Revenue .................................................. 360

107. Gray Inc. lends White Ltd. $60,000 on April 1, accepting a 6-month, 4.5% interest note. Interest is due the first of each month, commencing May 1. Gray Inc. prepares financial statements on April 30. What adjusting entry should be made before the financial statements can be prepared? (a) Note Receivable ......................................................... 60,000 Cash .................................................................... 60,000 (b) Interest Receivable ..................................................... 225 Interest Revenue .................................................. 225 (c) Cash ........................................................................... 225 Interest Revenue .................................................. 225 (d) Interest Receivable ..................................................... 1,350 Interest Revenue .................................................. 1,350

108. The maturity value of a $20,000, 6%, 4-month note receivable dated July 3, with interest due at maturity, is (a) $ 400. (b) $20,000. (c) $20,400. (d) $21,200.

109. The maturity value of an $8,000, 6.5%, 3-month note receivable dated February 10, with interest due at maturity, is (a) $8,000. (b) $8,065. (c) $8,130. (d) $8,520. 110. When a note is dishonoured (but eventual collection is expected), the payee’s entry includes a (a) debit to Cash. (b) credit to Accounts Receivable. (c) debit to Interest Expense. (d) credit to Notes Receivable.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

111. A note receivable is issued in December, with interest due at maturity. When the note is paid the following February, the payee’s entry includes (assuming a calendar-year accounting period when adjusting entries are recorded) a (a) credit to Interest Receivable. (b) credit to Cash. (c) debit to Notes Receivable. (d) debit to Interest Revenue.

112. A $20,000, 9%, 3-month note receivable is issued on December 1, with interest due at maturity. When the note is paid the following February, the payee’s entry includes (assuming a calendar-year accounting period) a credit to Interest Revenue of (a) $ 150. (b) $ 300. (c) $ 450. (d) $20,450.

113. A note receivable is honoured when (a) it is written to settle an account. (b) it is recorded at face value. (c) the interest is accrued. (d) it is paid in full on time.

114. Which of the following is true about the presentation of receivables? (a) Companies must report gross accounts receivable on the statement of financial position. (b) Companies must report the net realizable value of accounts receivable on the statement of financial position. (c) Bad debts expense must be reported under non-operating expenses in the income statement. (d) The allowance for doubtful accounts must be reported in the liabilities section of the statement of financial position.

115. The receivables turnover ratio is used to analyze (a) profitability. (b) liquidity. (c) risk. (d) solvency.

116. A high receivables turnover ratio indicates that (a) the company’s sales are increasing. (b) a large proportion of the company’s sales are on credit. (c) customers are making payments very quickly. (d) customers are making payments very slowly.

117. The receivables turnover ratio is calculated by dividing (a) total sales by average gross accounts receivable. (b) total sales by average net accounts receivable. (c) net credit sales by average gross accounts receivable. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Receivables

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(d) net credit sales by ending average net accounts receivable.

118. The average collection period for receivables is calculated by dividing 365 days by (a) net credit sales. (b) average accounts receivable. (c) ending accounts receivable. (d) receivables turnover ratio.

Use the following information for questions 119–120. The financial statements of Bolero Manufacturing Inc. report net credit sales of $900,000 and accounts receivable of $80,000 and $40,000 at the beginning of the year and end of the year, respectively.

119. What is the receivables turnover ratio for Bolero? (a) 7.5 times (b) 11.25 times (c) 15.0 times (d) 22.5 times

120. What is the average collection period for accounts receivable in days (rounded)? (a) 16 (b) 24 (c) 32 (d) 49

121. A ratio that is related to the receivables turnover ratio is the (a) inventory turnover ratio. (b) days sales in inventory ratio. (c) bad debts ratio. (d) average collection period.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. Item Ans. Item Ans. 45. b 56. a 67. c 46. c 57. b 68. d 47. c 58. d 69. b 48. b 59. c 70. c 49. a 60. b 71. b 50. c 61. d 72. b 51. c 62. c 73. c 52. a 63. c 74. d 53. d 64. b 75. d 54. c 65. b 76. d 55. a 66. b 77. d

Item 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88.

Ans. b c a a a b d b d d b

Item 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99.

Ans. a c b a b b b b c d a

Item 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110.

Ans. b c b c c d c b c c d

Item 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121.

Ans. a b d b b c c d c b d

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EXERCISES Ex. 122 Presented below are various receivable transactions entered into by the Tractor Towing Corporation. Indicate whether the receivables are reported as accounts receivable, notes receivable, or other receivables on the statement of financial position. 1. Advanced $4,500 to a trusted employee. 2. Accepted a $7,000 promissory note from a customer as payment on account. 3. Determined that a $10,500 income tax refund is due from the government. 4. Sold goods to a customer on account for $5,000. 5. Recorded $350 accrued interest on a note receivable due next year. 6. Lent a company officer $10,000. Solution 122 (2–3 min.) 1. Other Receivables 2.

Notes Receivable

Other Receivables

Accounts Receivable

Other Receivables

Ex. 123 Prepare general journal entries without explanations to record the following transactions: Jan 1 Sold merchandise to Hillary Cosmis for $500 on account. The merchandise cost $300 and the company uses a perpetual inventory system. Feb 1 Received $150 from Cosmis. Jul 1 Wrote off the balance of Cosmis’ account as uncollectible. Sep 1 Unexpectedly received payment in full from Cosmis. Solution 123 (15 min.) Jan 1 Accounts Receivable ......................................................... Sales .......................................................................... Cost of Goods Sold ........................................................... Merchandise Inventory................................................ Feb 1

Jul

Sep 1

500 500 300 300

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

150

Allowance for Doubtful Accounts ....................................... Accounts Receivable ..................................................

350

Accounts Receivable ......................................................... Allowance for Doubtful Accounts ................................

350

150

350

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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

350 350

Ex. 124 The December 31, 2015 statement of financial position of Ocean Breezes Limited reported Accounts Receivable of $450,000 and the Allowance for Doubtful Accounts of $45,000. During 2016, the following transactions occurred: 1. service revenue billed on account, $1,500,000; 2. collections from customers, $1,300,000; 3. accounts written off $37,000; 4. previously written off accounts of $4,000 were collected (in addition to the “regular” collections). Instructions (a) Record the 2016 transactions. (b) If the company uses the percentage of receivables basis to estimate bad debts expense and determines that uncollectible accounts are expected to be 5% of accounts receivable, prepare the adjusting entry for bad debts expense at December 31, 2016. Solution 124 (15–20 min.) (a) Accounts Receivable .................................................................... 1,500,000 Service Revenue .................................................................... 1,500,000 (To record credit service revenue) Cash ............................................................................................. 1,300,000 Accounts Receivable.............................................................. 1,300,000 (To record collection of receivables) Allowance for Doubtful Accounts................................................... Accounts Receivable.............................................................. (To write off specific accounts)

37,000

4,000

Cash ............................................................................................. Accounts Receivable.............................................................. (To record collection of accounts)

4,000

(b) ACCOUNTS RECEIVABLE 450,000 1,500,000 1,300,000 4,000 37,000 4,000 Bal. 613,000

37,000

4,000

ALLOWANCE FOR DOUBTFUL ACCOUNTS 45,000 37,000 4,000 Bal. 12,000

Required balance ($613,000  5%) ...............................................

$30,650

Reporting and Analyzing Receivables

Balance before adjustment ........................................................... Adjustment required ...................................................................... Dec 31

Bad Debts Expense ...................................................... Allowance for Doubtful Accounts ............................

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12,000 $18,650 18,650 18,650

Ex. 125 An inexperienced accountant made the following entries. In each case, the explanation to the entry is correct. Dec 17 Cash .................................................................................. 4,900 Accounts Receivable .................................................. 4,900 (To record collection of Dec. 10 sales, net of $100 sales discount) 27

Cash .................................................................................. Bad Debts Expense .................................................... (Collection of account previously written off as uncollectible under allowance method)

1,200

Bad Debts Expense ........................................................... Accounts Receivable .................................................. (To reduce the receivables to their net realizable value of $580,000. Balances before adjustment: Accounts Receivable = $600,000 Allowance for Doubtful Accounts = $15,000 credit)

5,000

1,200

5,000

Instructions Prepare the correcting entries. Solution 125 (15 min.) Dec 17 Sales Discounts ................................................................. Accounts Receivable .................................................. (To correct accounts for sales discount) 27

100 100

Accounts Receivable ......................................................... Allowance for Doubtful Accounts ................................ (To reverse write off of collected account)

1,200

Bad Debts Expense ........................................................... Accounts Receivable .................................................. (To correct erroneous collection entry)

1,200

Accounts Receivable ......................................................... Allowance for Doubtful Accounts ................................ (To correct error in recording Bad Debts Expense)

5,000

1,200

5,000

Ex. 126 Prepare journal entries to record the following transactions entered into by Marble Corporation: 2015 Jun 1 Received a $5,000, 6%, 1-year note from Sue Granite as full payment on her account. Interest is due at maturity. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Nov 1 5 9 Dec 31 2016 Jun 1

Sold merchandise on account to Ceramic Inc. for $8,000, terms 2/10, n/30. The cost of the merchandise was $6,000 and Marble uses a perpetual inventory system. Ceramic Inc. returned unopened merchandise that they had paid $1,500 for, which had cost Marble $1,000. The inventory was returned to the store shelves. Received payment in full from Ceramic Inc. Accrued interest on Granite's note.

Sue Granite honoured her promissory note by sending the principal amount plus interest. No interest has been accrued in 2016.

Solution 126 (15 min.) 2015 Jun 1 Notes Receivable .............................................................. Accounts Receivable .................................................. Nov 1

Nov 5

Nov 9

Dec 31

2016 Jun 1

5,000 5,000

Accounts Receivable ......................................................... Sales .......................................................................... Cost of Goods Sold ........................................................... Merchandise Inventory................................................

8,000

Sales Returns and Allowances .......................................... Accounts Receivable .................................................. Merchandise Inventory ...................................................... Cost of Goods Sold .....................................................

1,500

Cash .................................................................................. Sales Discounts ($6,500  2%) .......................................... Accounts Receivable. .................................................

6,370 130

Interest Receivable ............................................................ Interest Revenue ($5,000  6%  7/12) ......................

175

Cash .................................................................................. Notes Receivable........................................................ Interest Receivable ..................................................... Interest Revenue ($5,000  6%  5/12) ......................

5,300

8,000 6,000 6,000

1,500 1,000 1,000

6,500

175

5,000 175 125

Ex. 127 L&S Sales Limited had the following transactions in June 2015. L&S uses a perpetual inventory system and its cost of goods sold is 40% of the selling price. 1. Sales on account for June 2015 were $120,000. 2. $168,000 was received as payments on account during the month. This included $7,500 from MiniStore Inc., which had previously been written off. 3. L&S received returned merchandise of $4,000 from a customer. The merchandise was unopened and was returned to the store shelves. The customer's account was credited for the full amount. 4. Colville Co. Limited contacted the credit department because it was having difficulty making payments on its account. On June 15, they signed a 5%, 2-month note for the balance in their account ($24,000). Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Receivables

5. 6.

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On June 30, the company advanced $6,000 to an employee. There is no interest on the amount and it is due in 6 months. Based on a review of the aged accounts receivable, the accountant estimates that $16,000 will be uncollectible. The balance in the Allowance for Doubtful Accounts at May 31, 2015 was a credit of $5,000. The balance in accounts receivable at June 1, 2015 was $210,000. There were no other receivables at June 1, 2015.

Instructions (a) Prepare entries for the above transactions and any month end adjustments and accruals required. (b) Calculate the balances and show how the receivables will be shown on the statement of financial position at June 30, 2015. Solution 127 (25–30 min.) (a) 1. Accounts Receivable .................................................................... Sales ......................................................................................

120,000 120,000

Cost of Goods Sold ($120,000 x 40%) .......................................... Inventory ................................................................................

48,000

Accounts Receivable. ................................................................... Allowance for Doubtful Accounts ............................................ Cash ............................................................................................. Accounts Receivable..............................................................

7,500

48,000

7,500 168,000 168,000

Sales Returns and Allowances...................................................... Accounts Receivable.............................................................. Inventory ($4,000 × 40%) .............................................................. Cost of Goods Sold ................................................................

4,000

Notes Receivable .......................................................................... Accounts Receivable.............................................................. Interest Receivable ($24,000 × 5% × 0.5/12) ................................ Interest Revenue ....................................................................

24,000

Other Receivables (Employee Advance) ....................................... Cash ......................................................................................

6,000

Bad Debt Expense ........................................................................ Allowance for Doubtful Accounts ............................................ ($5,000 credit + $7,500 credit = $12,500 unadjusted; balance should be $16,000; therefore, debit of $3,500 required)

3,500

4,000 1,600 1,600

24,000 50 50

6,000

3,500

(b) L&S SALES LIMITED Statement of Financial Position (partial) June 30, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Current Assets Accounts Receivable Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

($210,000 + $120,000 – $168,000 + $7,500 – $4,000 – $24,000) . Less: Allowance for Doubtful Accounts ......................................... Notes Receivable .......................................................................... Other Receivables ........................................................................ Interest Receivable .......................................................................

$141,500 16,000

125,500 24,000 6,000 50

Ex. 128 Broadway Limited had an $800 credit balance in Allowance for Doubtful Accounts at December 31, 2015, before the current year's provision for uncollectible accounts. An aging of the accounts receivable revealed the following: Estimated Percentage Uncollectible Current Accounts ...................................... $150,000 1% 1-30 days past due ................................... 15,000 3% 31-60 days past due ................................. 8,000 6% 61-90 days past due ................................. 5,000 12% Over 90 days past due .............................. 6,000 30% Total Accounts Receivable ........................ $184,000 Instructions (a) Prepare the adjusting entry at December 31, 2015, to recognize bad debts expense. (b) Assume the same facts as above except that the Allowance for Doubtful Accounts account had a $800 debit balance before the current year's provision for uncollectible accounts. Prepare the adjusting entry for the current year's bad debts. Solution 128 (15 min.) (a) Bad Debts Expense ...................................................................... Allowance for Doubtful Accounts ($4,830 – $800) .................. (To adjust the allowance account to total estimated uncollectible) Current 1-30 days past due 31-60 days past due 61-90 days past due Over 90 days past due

4,030 4,030

$150,000 x 1% = $1,500 15,000 x 3% = 450 8,000 x 6% = 480 5,000 x 12% = 600 6,000 x 30% = 1,800 $4,830

(b) Bad Debts Expense ...................................................................... Allowance for Doubtful Accounts ($4,830 + $800) .................. (To adjust the allowance account to total estimated uncollectible)

5,630 5,630

Ex. 129 Brinkley Corporation uses the perpetual inventory system and the allowance method for estimating uncollectible accounts. Instructions Prepare entries to record the following transactions for a company that uses the perpetual inventory method: Jan 5 Sold merchandise to Amy Ward for $1,500, terms n/15. The merchandise cost $900. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Receivables

Apr 15 Aug 21 Oct

Received partial payment of $500 from Amy Ward. Wrote off as uncollectible the balance of the Amy Ward account when she declared bankruptcy. Received a cheque for $350 from Amy Ward. No further collections are expected.

Solution 129 (10 min.) Jan 5 Accounts Receivable ......................................................... Sales ..........................................................................

Apr 15

Aug 21

Oct

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1,500 1,500

Cost of Goods Sold ........................................................... Merchandise Inventory................................................

900

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

500

Allowance for Doubtful Accounts ....................................... Accounts Receivable ..................................................

1,000

Accounts Receivable ......................................................... Allowance for Doubtful Accounts ................................

350

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

350

900

500

1,000

350

Ex. 130 For their fiscal year ended December 31, 2015, the Texas Tech Store had credit sales of $750,000. At year end, the unadjusted trial balance shows a debit balance of $1,800 in the Allowance for Doubtful Accounts, and $140,000 in Accounts Receivable. The credit manager prepared an aging schedule of accounts receivable and estimates that $5,200 will prove to be uncollectible. On March 4, 2016 the credit manager authorizes a write off of the $2,000 balance owed by Crystal Rivers. Instructions (a) Prepare the adjusting entry to record the estimated bad debts expense for 2015. (b) Show the statement of financial position presentation of accounts receivable at December 31, 2015. (c) On March 4, 2016, before the write off, assume the balance of Accounts Receivable account is $175,000 and the balance of Allowance for Doubtful Accounts is a credit of $5,500. Record the entry to write off the Rivers account. Also, show the statement of financial position presentation of accounts receivable before and after the write off. Solution 130 (15 min.) (a) Bad Debts Expense ($5,200 + $1,800) ......................................... Allowance for Doubtful Accounts ............................................ (b) Accounts Receivable .................................................. Less: Allowance for Doubtful Accounts .......................

7,000 7,000

$140,000 5,200 $134,800

2,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Accounts Receivable—A. Mountain .......................................

2,000

Before Write off Accounts Receivable .................................................. $175,000 Less: Allowance for Doubtful Accounts ....................... 5,500 Net Realizable Value .................................................. $169,500

After Write off $173,000 3,500 $169,500

Ex. 131 The general ledger of Arugula Corporation at December 31, 2015 shows the following balances, all of which are normal: Cash ......................................................... $ 28,000 Merchandise inventory .............................. 175,000 Prepaid expenses ..................................... 11,000 Accounts receivable .................................. 165,000 Allowance for doubtful accounts................ 12,000 Management estimates the net realizable value of accounts receivable should be $143,000. Instructions (a) Prepare the adjusting entry for bad debts for 2015. (b) Show how the current assets would be presented on the statement of financial position at December 31, 2015. Solution 131 (15 min.) (a) Bad Debts Expense ...................................................................... 10,000 Allowance for Doubtful Accounts ............................................ 10,000 ($165,000 – $143,000 = $22,000 required allowance balance; 22,000 – 12,000 = 10,000) (b) ARUGULA CORPORATION Statement of Financial Position (Partial) December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Current assets Cash ...................................................................................... $ 28,000 Accounts receivable ............................................................... $165,000 Less: Allowance for doubtful accounts ................................... 22,000 143,000 Merchandise inventory ........................................................... 175,000 Prepaid expenses .................................................................. 11,000 Total current assets ...................................................................... $357,000

Ex. 132 Calculate the maturity value associated with each of the following notes receivable, assuming interest is due at maturity. (Round your answers to the nearest cent.) (a) A $10,000, 7%, 3-month note dated April 20. (b) A $5,000, 5.5%, 4-month note dated March 5. (c) A $8,000, 3%, 1-month note dated September 10.

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Solution 132 (10 min.) (a) Maturity value: $10,175 $10,000 + ($10,000  7%  3/12) = $10,000 + $175 = $10,175.00 (b) Maturity value: $5,091.67 $5,000 + ($5,000  5.5%  4/12) = $5,000 + $91.67 = $5,091.67 (c) Maturity value: $8,020 $8,000 + ($8,000  3%  1/12) = $8,000 + $20 = $8,020.00

Ex. 133 Calculate the missing amount for each of the following notes: Principal Annual Interest Rate Time Total Interest ———————————————————————————————————————— (a) $60,000 5% 9 months ? ———————————————————————————————————————— (b) $120,000 ? 8 months $4,000 ———————————————————————————————————————— (c) ? 5% 6 months $1,250 ———————————————————————————————————————— (d) $40,000 8% ? $800 ———————————————————————————————————————— Solution 133 (15 min.) (a) $2,250 ($60,000  5%  9/12) (b) 5%

($4,000  12/8  $120,000)

Ex. 134 Record the following transactions for Kit-Kat Corporation: Jul 1 Received a $5,000, 4%, 3-month note, dated July 1, from Ruth Jordan in payment of her open account. Interest is due at maturity. Oct 1 Received notification from Ruth Jordan that she is unable to honour her note at this time. It is expected that Jordan will pay at a later date. Nov 15 Received full payment from Ruth Jordan for note receivable previously dishonoured. Solution 134 (15 min.) Jul 1 Notes Receivable .............................................................. Accounts Receivable .................................................. (To record acceptance of Ruth Jordan note as payment on account) Oct

Accounts Receivable ......................................................... Notes Receivable........................................................

5,000 5,000

5,050 5,000

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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Interest Revenue ($5,000  4%  3/12) ...................... (To record dishonoured note, $5,000, plus interest) Nov 15

Cash .................................................................................. Accounts Receivable .................................................. (To record payment on account)

5,050 5,050

Ex. 135 Greenland Distributors has the following transactions related to notes receivable during the last month of the year: Dec 1 Lent $60,000 cash to R. Pacific on a 1-year, 3.5% note. Interest is due the first of each month, commencing January 1. 15 Sold goods to S. Atlantic, receiving a $15,000, 4-month, 3% note. Interest is due the 15 of each month, commencing January 15. Greenland uses the periodic inventory method. 31 Accrued interest revenue on notes receivable. Instructions Record the above transactions for Greenland Distributors. Solution 135 (10 min.) Dec 1 Notes Receivable .............................................................. Cash ........................................................................... 15

60,000 60,000

Notes Receivable .............................................................. Sales ..........................................................................

15,000

Interest Receivable ............................................................ Interest Revenue* .......................................................

193.75

15,000

193.75

*Calculation of interest revenue Pacific note: $60,000  3.5%  1/12 ....... = $175 Atlantic note: $15,000  3%  0.5/12 ....... = 18.75 Total accrued interest ............... $193.75

Ex. 136 Red Sea Boating Inc. often requires customers to sign notes for major credit purchases. Record the following transactions for Red Sea Boating: Feb 12 Accepted a $30,000, 5%, 2-month note from Jack Sparrow for a 19-foot motorboat built to his specifications. Interest is due at maturity. The company uses the periodic inventory method. Apr 14 Received notification from Jack Sparrow that he was unable to honour his note but that he expects to pay the amount owed next month. May 26 Received a cheque from Jack Sparrow for the total amount owed. Jun 1 Received notification by the bank that Jack Sparrow’s cheque was being returned "NSF" and that Mr. Sparrow had declared personal bankruptcy. Solution 136 (15 min.) Feb 12 Notes Receivable .............................................................. Sales ..........................................................................

30,000 30,000

Reporting and Analyzing Receivables

Apr 14

May 26

Jun

Accounts Receivable ......................................................... Notes Receivable........................................................ Interest Revenue ($30,000  5%  2/12).....................

30,250

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

30,250

Accounts Receivable ......................................................... Cash ........................................................................... Allowance for Doubtful Accounts ....................................... Accounts Receivable ..................................................

30,250

Ex. 137 The following data are presented for Ratalan Ltd. for 2015. Beginning Accounts receivable ......................................... $135,500 Allowance for doubtful accounts ...................... 3,500 Net sales.......................................................... 0

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30,000 250

30,250

30,250 30,250 30,250

Ending $350,000 11,000 975,000

Instructions Calculate the receivables turnover and the average collection period for accounts receivable in days. Solution 137 (5 min.) Receivables turnover =

$975,000 ——————————---— ($135,500 + $350,000)  2

Average collection period =

365 days ————— = 91 days 4.0

= 4.0 times

Ex. 138 The following information is available from the financial statements of Amamco Corp. and Brindle Corp.: (in millions) Amamco Corp. Brindle Corp. Net sales ......................................................................... $45,000 $25,000 Beginning receivables, gross .......................................... 22,000 3,500 Ending receivables, gross ............................................... 17,500 4,000 Instructions (a) Calculate the following for each company: Receivables turnover. (Assume all sales were credit sales.) Average collection period. (b) What conclusion concerning the management of accounts receivable can be drawn from these data? Solution 138 (10 min.) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) 1.

Receivables turnover

Average collection period

Amamco Corp. $45,000 ($22,000 + $17,500) ÷ 2 $45,000 ÷ $19,750 = 2.3 times

Brindle Corp. $25,000 ($3,500 + $4,000) ÷ 2 $25,000 ÷ $3,750 = 6.7 times

365 days ÷ 2.3 = 159 days

365 days ÷ 6.7 = 54 days

(b) Generally, businesses like to have a high receivables turnover ratio and a correspondingly low average collection period. Since Brindle’s receivables are being collected much faster than Amamco’s, it appears that Brindle does a better job of managing accounts receivable than Amamco. However, some companies, such as heavy equipment manufacturers, do give extended credit terms, often up to six months or more. Thus, one should not make a snap judgment based on just two ratios. One should find out what type of business each company is in and examine other ratios as well (for example, current ratio, inventory turnover) to get a more complete picture.

Ex. 139 Complete the following table, indicating whether the transaction would: I - improve, W - worsen or NE have no effect on the items noted.

Transaction

Average Collection Period

Aging Schedule

Receivables Turnover

Aging Schedule

Receivables Turnover

NE I W

Average Collection Period NE I W

(a) Recorded cash sales (b) Recorded payment from a customer on account (c) Recorded sales on account (d) Recorded return of merchandise by a customer for credit to their account (e) Recorded write off of an account considered uncollectible (f) Recorded estimated bad debt expense for the month Solution 139 (10 min.)

Transaction (a) Recorded cash sales (b) Recorded payment on account (c) Recorded sales on account (d) Recorded return of merchandise by a customer for credit to their account (e) Recorded write off of an account considered uncollectible (f) Recorded estimated bad debt expense for the month

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MATCHING 140. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

_____

Aging the accounts receivable Recovery of an uncollectible account Promissory note Trade receivables Receivables turnover

F. G. H. I. J.

Allowance method for uncollectible accounts Other Receivables Dishonoured note Subsidiary ledger Average collection period

Notes and accounts receivable that result from sales transactions.

Nontrade receivables that do not result from the operation of business.

A group of accounts that provides details of a control account in the general ledger.

Analysis of customer account balances by length of time they have been unpaid.

Adjusts the net accounts receivable to its net realizable value.

Collection from a customer after the account has been written off.

A written promise to pay a specified amount on demand or at a definite time.

A note which is not paid in full at maturity.

A variation of the receivables turnover that is converted into terms of days.

10.

A measure of the liquidity of receivables.

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

8 - 36

ANSWERS TO MATCHING 1.

10. E

Reporting and Analyzing Receivables

8 - 37

SHORT-ANSWER ESSAY QUESTIONS S-A E 141 What is the benefit of using a subsidiary accounts receivable ledger? Solution 141 A subsidiary accounts receivable ledger provides the supporting detail to the general ledger control account by showing transactions on a customer by customer basis, thereby freeing the general ledger from excessive detail.

S-A E 142 (a) Explain the allowance method for uncollectible accounts. (b) Discuss why the allowance method accomplishes expense recognition. Solution 142 (a) Under the allowance method for uncollectible accounts, the emphasis is on establishing the net realizable value of the accounts receivable. Uncollectible accounts receivable are estimated and matched against sales in the same accounting period in which the sales occurred. (b) The allowance method estimates the uncollectible accounts at the end of each period. It matches the credit losses expected to result from sales in the accounting period that the revenue is earned, thus adhering to expense recognition.

S-A E 143 You are the accounting manager for Davidson Designs, and have just received a letter from Keresha King, a customer. Keresha had purchased $475 worth of clothing from Davidson Designs on credit some time ago. She has made two payments of $100 each. She has missed the last two payments, and has received a collection letter from Davidson Designs. Presently, Keresha’s total debt including interest and late fees is $302.50. In her letter, she asked for her debt to be forgiven. She said she had heard that companies make allowances for accounts they are doubtful about collecting, and that Davidson Designs certainly should have been doubtful about her, as a college student who had changed her major three times. Keresha also said that she could not enjoy a high quality of life when making such high payments, but that she didn't want to be embarrassed by bill collectors, either. She especially didn't want her parents to find out that she had not paid her debts. Having Davidson Designs write off her account seemed to her the best solution in the circumstances. Keresha added that the clothes she bought at Davidson Designs were among the best she had ever owned, and that she "told everybody that Davidson Designs was definitely the best place to get clothes.” Instructions Write a formal letter to Keresha explaining why her debt cannot be written off. Solution 143 (date) Ms. Keresha King 123 Any Street Any Town, Any Province Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Dear Ms.King, Thank you for your recent letter explaining the delay in paying your account. We appreciate hearing about your satisfaction with Davidson Designs clothing, and we are glad you tell your friends about us. As you know, your account has become seriously past due. As of this date, the total charges including late payment penalties and interest (detailed on the attached statement) are $302.50. Your account cannot be simply "forgiven" as you request in your letter. Our "Allowance for Doubtful Accounts" does not mean that we have certain customers whose debts we are willing to readily cancel. When Davidson Designs extends credit to anyone, it is our expression of confidence in that person's ability and willingness to pay. In other words, we aren't "doubtful" about any of our customers. The Allowance account is simply our recognition that a few customers, though very willing to pay, may become unable to do so because of circumstances beyond their control. If we detect some problem that may indicate a present or future unwillingness to pay, we do not extend credit. To do so would not be fair to Davidson Designs or to the customer. We were sure about your ability and willingness to pay when we granted you credit. We were very pleased to receive your first two payments right on time. Won't you reconsider, and send your next payment today? If you need to renegotiate the size of the payments, you may contact Beverly in the Credit Department to discuss the matter. I look forward to receiving your payment. Sincerely, Sally Sutton Accounting Manager

S-A E 144 Your friend Markham, a fellow student at college, is looking at the latest financial reports from a large public company he is thinking of investing in. He has only just started studying accounting, and is puzzled by the fact that the Bad Debts Expense on the income statement is not the same amount as the Allowance for Doubtful Accounts on the statement of financial position. “I thought they were the same thing,” he says to you, “but just the opposite sides of a coin, so to speak. Isn’t that right? If so, shouldn’t they be the same amount?” Instructions Explain to Markham why the Bad Debts Expense and the Allowance for Doubtful Accounts are not usually the same amount. Solution 144 Although it is possible for these two amounts to be the same, generally they are not. That is because they represent two different things. The Bad Debts Expense on the income statement represents the dollar amount related to the current year’s sales that management estimates may become uncollectible, or “bad.” In other words, it pertains only to the year being reported on the income statement. On the other hand, the Allowance for Doubtful Accounts (ADA) on the statement of financial position represents an accumulation of figures over many years. True, it is increased by the estimated bad debts expense each year. But it is also decreased by actual bad debt write offs over the years and increased by possible recoveries of bad debts, and these two types of transactions are independent of

Reporting and Analyzing Receivables

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the bad debts expense. Thus, the ADA balance is very unlikely to be the same as the Bad Debts Expense.

S-A E 145 New University College allows students to use credit and debit cards for materials purchased in its bookstore. While tuition fees may be paid by credit or debit card, it also allows students to open accounts and charge their fees, terms n/30. The Chief Accountant, Mr. Akbar, is finding that quite a number of the students are either not paying their tuition fees on time, or are taking longer than the credit period, or in some cases, not paying them at all. This is causing a cash flow problem. Instructions Make suggestions to Mr. Akbar as to how the university can monitor its accounts receivable and improve collections. Your response should be specific to this situation. Use point form. Solution 145 (25–35 min.) To monitor the accounts, the university should: prepare and review aged listings each month. have someone responsible for following up on accounts by letter, e-mail and phone. To improve collections, the university could: offer a reduced rate for early payment. enforce the due date and charge interest on past due accounts. require payment of fees before grades are released. require payment of fees from a previous semester before a student can register for a new semester. as a last resort, require payment upfront before the semester starts

S-A E 146 Your friend Dana Stephens manages a small company, Mountain of Gold Sales Ltd. She knows you are taking an accounting course and has asked for your help with her accounts receivable department. She tells you that sales have been increasing, but that the accounts receivable balance is increasing even faster. Dana is worried, since this is starting to cause cash flow problems. She would like your advice on how she can change this situation. Currently the sales people are paid a commission based on sales; they grant credit when they feel it is appropriate. Credit terms are n/45. There is no one person responsible for following up on outstanding accounts. Dana looks at the accounts when she has time and lets the salespeople know which customers are behind with their payments. Instructions Prepare a letter to Dana outlining the steps she can take to improve collection of accounts receivable. Your response should be specific to this situation. Solution 146 (date) Dana Stephens Mountain of Gold Sales Ltd. 123 Any Street Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Any Town, Any Province Dear Dana, You are correct in being concerned about your accounts receivable. An increasing balance could indicate collection problems and increased bad debt expense. It also means you have less cash coming in which could be a problem. In order to improve the situation, I suggest you consider some of the following solutions: Have someone other than the sales people establish credit limits. The sales people are focused on selling, and since they are paid a commission based on sales, they may grant credit where the likelihood of collection is low (high risk). Reduce the credit terms to 30 days and offer a discount for early payment. Experience shows that the longer an amount is outstanding, the more likely that it will not be collected. Charging interest on overdue accounts may also help speed up collections. Have a person other than the sales people prepare aged receivables listings on a monthly basis. This person should also review the list and follow up for payment by letter, e-mail and phone. You should regularly review the accounts yourself as well. Sincerely, A Good Student

CHAPTER 9 REPORTING AND ANALYZING LONG-LIVED ASSETS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item

SO LOD

Item

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

1 1 1 1 1 1 1 1 1 2

E M E E M M E E H E

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

2 2 2 2 2 2 2 2 2 2

46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2

E E M E E E E M M M H M E E M E M M M E E

67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87.

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Note:

E = Easy

LOD

M = Medium

Item SO LOD Item True-False Statements E 21. 2 M 31. E 22. 2 M 32. E 23. 2 H 33. E 24. 2 M 34. E 25. 2 E 35. E 26. 3 E 36. M 27. 3 E 37. E 28. 3 M 38. M 29. 3 E 39. M 30. 3 E 40. Multiple Choice Questions M 88. 2 H 109. E 89. 2 H 110. E 90. 2 H 111. E 91. 2 H 112. E 92. 2 H 113. E 93. 2 H 114. E 94. 2 H 115. M 95. 2 M 116. E 96. 2 M 117. M 97. 2 H 118. M 98. 2 M 119. H 99. 2 E 120. E 100. 2 E 121. E 101. 2 M 122. E 102. 2 M 123. M 103. 2 M 124. H 104. 2 E 125. E 105. 2 E 126. M 106. 2 M 127. M 107. 2 E 128. M 108. 2 H 129.

SO LOD

Item

SO LOD

4 4 4 4 4 4 4 4 4 5

M E E E E M M M M M

41. 42. 43. 44. 45.

5 5 6 6 6

E E M M M

3 3 3 3 3 3 3 3 3 3 3 4 4 4 4 4 4 4 4 4 4

E E E E E E E E M H E E E E E E E E E H E

130. 131. 132. 133. 134. 135. 136. 137. 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148. 149.

4 4 4 4 4 4 4 5 5 5 5 5 5 5 6 6 6 6 6 6

E E M E M M H E M E M E E E M M M H M M

H = Hard

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED) Item

LOD

Item

LOD

150. 151. 152. 153. 154. 155. 156. 157.

1 1 1 1 1 1 1,2 2

E E E E M E E M

158. 159. 160. 161. 162. 163. 164. 165.

2 2 2 2 2 2 2 2

E E E E E E E M

189.

1,2

190.

2–4,6

191. 192. 193.

1 1 2

E E M

194. 195. 196.

2 2 2

Note:

E = Easy

M = Medium

Item SO LOD Exercises 166. 2 H 167. 2 E 168. 2 H 169. 2 H 170. 2,3 H 171. 2,3 H 172. 2,3,5 E 173. 2,4 E Matching

M,H Short-Answer Essay E 197. 2 M M 198. 3 M M 199. 4 E

Item

SO LOD

Item

LOD

174. 175. 176. 177. 178. 179. 180. 181.

3 3 3 3 3 4 4 4

M E E E M E E E

182. 183. 184. 185. 186. 187. 188.

4 4 5 5 6 6 6

M H E E E H H

200. 201. 202.

4 5 6

H H M

H = Hard

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item

Type Item

Type

Item

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

TF TF TF TF TF TF

7. 8. 9. 46. 47. 48.

TF TF TF MC MC MC

49. 50. 51. 52. 53. 54.

10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22.

TF TF TF TF TF TF TF TF TF TF TF TF TF

23. 24. 25. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74.

TF TF TF MC MC MC MC MC MC MC MC MC MC

75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87.

26. 27. 28. 29.

TF TF TF TF

30. 109. 110. 111.

TF MC MC MC

112. 113. 114. 115.

31. 32. 33. 34. 35.

TF TF TF TF TF

36. 37. 38. 39. 120.

TF TF TF TF MC

121. 122. 123. 124. 125.

40. 41.

TF TF

42. 137.

TF MC

138. 139.

43. 44.

TF TF

45. 144.

TF MC

145. 146.

Note: TF = True-False MC = Multiple Choice

Type Item Type Item Study Objective 1 MC 55. MC 61. MC 56. MC 62. MC 57. MC 63. MC 58. MC 64. MC 59. MC 150. MC 60. MC 151. Study Objective 2 MC 88. MC 101. MC 89. MC 102. MC 90. MC 103. MC 91. MC 104. MC 92. MC 105. MC 93. MC 106. MC 94. MC 107. MC 95. MC 108. MC 96. MC 156. MC 97. MC 157. MC 98. MC 158. MC 99. MC 159. MC 100. MC 160. Study Objective 3 MC 116. MC 170. MC 117. MC 171. MC 118. MC 172. MC 119. MC 174. Study Objective 4 MC 126. MC 131. MC 127. MC 132. MC 128. MC 133. MC 129. MC 134. MC 130. MC 135. Study Objective 5 MC 140. MC 142. MC 141. MC 143. Study Objective 6 MC 147. MC 149. MC 148. MC 186. Ma = Matching Ex = Exercise

Type

Item

Type Item Type

MC MC MC MC Ex Ex

152. 153. 154. 155. 156. 189.

Ex Ex Ex Ex Ex Ma

191. 192.

SAE SAE

MC MC MC MC MC MC MC MC Ex Ex Ex Ex Ex

161. 162. 163. 164. 165. 166. 167. 168. 169. 170. 171. 172. 173.

Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex

189. 190. 193. 194. 195. 196. 197.

Ma Ma SAE SAE SAE SAE SAE

Ex Ex Ex Ex

175. 176. 177. 178.

Ex Ex Ex Ex

190. 198.

Ma SAE

MC MC MC MC MC

136. 173. 179. 180. 181.

MC Ex Ex Ex Ex

182. 183. 190. 199. 200.

Ex Ex Ma SAE SAE

MC MC

172. 184.

Ex Ex

185. 201.

Ex SAE

MC Ex

187. 188.

Ex Ex

190. 202.

Ma SAE

SAE = Short-Answer Essay

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

CHAPTER STUDY OBJECTIVES 1.

Determine the cost of property, plant, and equipment. The cost of land, land improvements, buildings, and equipment includes all expenditures that are necessary to acquire these assets and make them ready for their intended use. After acquisition, costs incurred that benefit future periods (capital expenditures) are also included in the cost of the asset. When applicable, cost also includes asset retirement costs. If a company leases an asset, depending on whether the risks and rewards of ownership are transferred, it may be accounted for as an operating lease or a finance lease. An operating lease results in rent expense on the income statement. A finance lease results in an asset on the statement of financial position, similar to a purchased asset.

Explain and calculate depreciation. Depreciation is the process of allocating the cost of a long-lived asset over the asset’s useful (service) life in a systematic way. There are three commonly used depreciation methods: straight-line, diminishing-balance, and units-of-production. Annual Depreciation Method Pattern Calculation Straight-line Constant (Cost – residual value) ÷ estimated amount useful life (in years) Diminishing balance

Diminishing amount

Carrying amount at beginning of year X depreciation-rate (straightline rate × multiplier)

Units-ofproduction

Varying amount

(Cost – residual value) ÷ estimated total units of activity X actual activity during the year

Other accounting issues related to depreciation include (1) identifying significant components of a long lived asset for which different depreciation methods or rates may be appropriate; (2) capital cost allowance (CCA) used for income tax purposes; (3) testing long-lived assets for impairment; (4) accounting for property, plant, and equipment using the cost or revaluation model; and (5) circumstances under which a revision of depreciation is required.

Account for the derecognition of property, plant, and equipment. The procedure for accounting for the disposal of property, plant, and equipment through sale or retirement is: Step 1: Update unrecorded depreciation for any partial period. Step 2: Calculate the carrying amount. Step 3: Calculate any gain (proceeds less carrying amount) or loss (carrying amount less proceeds) on disposal. Step 4: Derecognize (remove) the asset and accumulated depreciation accounts related to the sold or retired asset. Record the proceeds received and the gain or loss (if any).

Identify the basic accounting issues for intangible assets and goodwill. Intangible assets are reported at cost (if the cost model is used), which includes all expenditures that are necessary to prepare the asset for its intended use. An intangible asset with a finite life is amortized over the Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

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shorter of its useful life or legal life, usually on a straight-line basis. Like property, plant, and equipment, intangible assets with finite lives are tested for impairment only if indicators of impairment are present. Intangible assets with indefinite lives are not amortized and must be tested for impairment annually under IFRS but only when indicators of impairment are present under ASPE. Impairment losses can be reversed under IFRS but not under ASPE. Goodwill, which is the difference between the price paid for a business and the fair value of the identifiable assets less liabilities of the business, is not considered an intangible asset because it is not separately “identifiable.” Goodwill has an indefinite life and is not amortized. It is tested for impairment annually under IFRS but under ASPE it is only tested if indicators of impairment are present. Goodwill impairment losses are never reversed.

Illustrate how long-lived assets are reported in the financial statements. In the statement of financial position, land, land improvements, buildings, and equipment are usually combined and shown under the heading “Property, Plant, and Equipment.” Intangible assets with finite and indefinite lives are sometimes combined under the heading “Intangible Assets” or are listed separately. Goodwill must be presented separately. Either on the statement of financial position or in the notes to the financial statements, the cost of the major classes of long-lived assets is presented. The depreciation and amortization methods and rates must also be described in the notes to the statements. The accumulated depreciation and amortization of depreciable/amortizable assets and carrying amount by major classes is also disclosed, including a reconciliation of the carrying amount at the beginning and end of each period for companies reporting under IFRS. The company’s impairment policy and any impairment losses should be described and reported. The company must disclose whether it is using the cost or revaluation model. Depreciation expense, any gain or loss on disposal, and any impairment losses are reported as operating expenses in the income statement. In the statement of cash flows, any cash flows from the purchase or sale of long-lived assets are reported as investing activities.

Describe the methods for evaluating the use of assets. The use of assets may be analyzed using the return on assets and asset turnover ratios. Return on assets (profit ÷ average total assets) indicates how well assets are used to generate profit. This is really a function of the following two ratios: asset turnover (net sales ÷ average total assets), which indicates how efficiently assets are used to generate revenue, and profit margin (profit ÷ net sales), which measures the profit made on each sale.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

TRUE-FALSE STATEMENTS 1. All property, plant, and equipment must be depreciated for accounting purposes.

2. When purchasing land, the costs for clearing, draining, filling, and grading should be charged to a Land Improvements account.

3. When purchasing a delivery truck, the cost of painting the company logo on the side should be debited to the Vehicles account.

4. Land improvements are generally debited to the Land account.

5. If land is purchased with a building on it that is to be demolished, proceeds from any salvaged materials are reported in the Other Revenues and Expenses section of the income statement.

6. Asset retirement costs are added to the cost of a depreciable asset.

7. Under an operating lease, both the leased asset and the related lease obligation are shown on the statement of financial position.

8. Under a finance lease, both the leased asset and the related lease obligation are shown on the statement of financial position.

9. Leasehold improvements are depreciated over the remaining life of the lease or the useful life of the improvements, whichever is longer.

10. The carrying amount of property, plant, and equipment is always equal to its fair value.

11. Recording depreciation on equipment affects both the statement of financial position and the income statement.

12. The depreciable amount of property, plant, and equipment is its original cost minus the depreciation for the current year.

13. The Accumulated Depreciation account represents a cash fund available to replace property, plant, and equipment.

14. In calculating depreciation, cost, useful life, and residual value are all based on estimates. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

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15. Carrying amount is used in determining the amount that the diminishing-balance rate is applied to.

16. Using the units-of-production method of depreciation for equipment will generally result in more depreciation expense being recorded over the life of the asset than if the straight-line method had been used.

17. Using the diminishing-balance method results in higher expense in the early years, and therefore lower profit.

18. Canada Revenue Agency requires a company to use the same depreciation method on its income tax return that is used in preparing financial statements.

19. Under IFRS, companies must account for their property, plant, and equipment using the revaluation model, where depreciable assets are re-valued upward to their fair values.

20. The carrying amount of an asset is the original cost less anticipated residual value.

21. When an impairment loss is recorded for a depreciable asset, the offsetting credit is recorded in accumulated depreciation.

22. An item of property, plant, and equipment is considered to be impaired if its carrying amount exceeds its recoverable amount.

23. When a company has a piece of property, plant, or equipment which has different components that depreciate at different rates, the total cost should be allocated to each component and each component should be depreciated separately.

24. A change in the estimated residual value of property, plant, and equipment requires a restatement of prior years' depreciation.

25. When a change in estimate is made, there is no correction of previously recorded depreciation expense.

26. Normally, businesses only dispose of property, plant, and equipment by either sale or exchange.

27. If the proceeds from the sale of equipment exceed its carrying amount, a gain on disposal is reported.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

28. When an asset is retired, a gain or loss must be recorded.

29. A tangible asset must be fully depreciated before it can be removed from the books.

30. A loss on disposal results if the cash proceeds received from the asset sale are less than the asset's carrying amount.

31. Intangible assets involve rights, privileges, and/or competitive advantages that result from ownership of identifiable assets that do not possess physical substance.

32. The cost of a finite intangible asset is not amortized, but the asset is tested periodically for impairment.

33. The cost of a patent should be amortized over its legal life or useful life, whichever is shorter.

34. If an acquired franchise or licence is for an indefinite time period, then the cost of the asset should not be amortized.

35. An intangible asset must be identifiable.

36. If a trademark is developed internally, it cannot be recognized as an intangible asset on the statement of financial position.

37. When an entire business is purchased, goodwill is the excess of the purchase price over the carrying amount of the net identifiable assets acquired.

38. All research costs should be capitalized when incurred.

39. Impairment losses on goodwill are never reversed.

40. If a building is sold at a gain, the gain on disposal should be reported in the non-operating section of the income statement.

41. Depreciation expense and impairment losses are presented in the operating section of the income statement.

42. The cash flows from the purchase and sale of long-lived assets are reported in the operating activities section of the cash flow statement. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

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43. The asset turnover ratio is calculated as net sales divided by ending total assets.

44. Profit margin can be determined by multiplying the asset turnover by the return on assets.

45. The asset turnover indicates how efficiently a company uses its assets.

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7.

Ans. F F T F F T F

Item 8. 9. 10. 11. 12. 13. 14.

Ans. T F F T F F F

Item 15. 16. 17. 18. 19. 20. 21.

Ans. T F T F F F T

Item 22. 23. 24. 25. 26. 27. 28.

Ans. T T F T F T F

Item 29. 30. 31. 32. 33. 34. 35.

Ans. F T T F T T T

Item 36. 37. 38. 39. 40. 41. 42.

Ans. T F F T F T F

Item 43. 44. 45.

Ans. F F T

Reporting and Analyzing Long-Lived Assets

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MULTIPLE CHOICE QUESTIONS 46. A company purchased land for $120,000 cash; $7,000 was spent to demolish an old building on the land before construction of a new building could start; and $1,500 was received for material salvaged from the old building. The cost of the land would be recorded at (a) $120,000. (b) $125,500. (c) $127,000. (d) $128,500.

47. Which of the following should not be classified as property, plant and equipment? (a) building used as a factory (b) land used in ordinary business operations (c) a truck held for resale by an automobile dealership (d) land improvements, such as parking lots and fences

48. A characteristic of property, plant, and equipment is that it is (a) intangible. (b) used in the operations of a business. (c) held for sale in the ordinary course of the business. (d) not currently used in the business but held for future use.

49. Which one of the following items is not considered to be a part of the cost of a truck purchased for business use? (a) insurance during transit (b) motor vehicle licence (c) freight charges incurred when acquiring the truck (d) cost of lettering on the side of the truck

50. 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

51. Which of the following assets does not decline in service potential over the course of its useful life? (a) office equipment (b) furnishings (c) land (d) computers

52. The cost of land does not include (a) closing costs. (b) annual property taxes. (c) removal costs of an old building. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) title fees.

53. The Land account would include all of the following costs except (a) drainage costs. (b) the cost of building a parking lot. (c) title fees. (d) the cost of tearing down a building.

54. Pippen Clinic Ltd. purchases land for $287,500 cash. The title and legal fees totalled $1,200. The clinic has the land graded for $30,000. What amount does Pippen Clinic record as the cost for the land? (a) $287,500 (b) $288,700 (c) $317,500 (d) $318,700

55. Which of the following is not true for an operating expenditure? (a) It is recorded with a debit to a statement of financial position account. (b) It benefits the current period only. (c) It is incurred to maintain an asset in its normal operating condition. (d) It often recurs.

56. Cordelia Corp. acquires land for $120,000 cash. Additional costs are as follows: Removal of shed ...................................... $ 1,000 Filling and grading.................................... 3,000 Residual value of lumber from shed ......... 240 Paving of parking lot ................................ 16,000 Closing costs ........................................... 1,120 Cordelia will record the cost of the land as (a) $120,000. (b) $124,120. (c) $124,880. (d) $140,880.

57. Mercy General Hospital installs a new parking lot. The paving cost $25,000 and the lights to illuminate the new parking lot cost $13,000. Which of the following statements is true with respect to these expenditures? (a) $25,000 should be debited to Land. (b) $13,000 should be debited to Lighting Expense. (c) $38,000 should be debited to Land. (d) $38,000 should be debited to Land Improvements.

58. Land improvements should be depreciated over the useful life of the (a) land. (b) buildings on the land. (c) land or land improvements, whichever is longer. (d) land improvements. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

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59. The expected costs to retire an asset are called (a) off-balance sheet financing. (b) expected retirement costs. (c) disposal costs. (d) asset retirement costs.

60. Aye Corp. purchases a remote-site building for computer operations. The building will be suitable for operations after some necessary expenditures. The wiring must be replaced to handle the computer specifications. The roof is leaking and must be replaced. All rooms must be repainted and re-carpeted and there will also be some updating of the plumbing needed. Which of the following statements is true? (a) The cost of the building will include the repainting and re-carpeting costs. (b) The cost of the building will include the cost of replacing the roof. (c) The cost of the building is the purchase price of the building, while the additional expenditures are all capitalized as Building Improvements. (d) The wiring replacement will be part of the computer costs, not the building cost.

61. Dallas Corporation purchases a new delivery truck for $35,000. The company logo is painted on the side of the truck for $1,800. The motor vehicle licence is $160. Annual insurance is $1,700. At what amount does Dallas record the cost of the new truck? (a) $35,000 (b) $35,160 (c) $36,800 (d) $36,860

62. Which of the following is not an advantage of an operating lease? (a) reduced risk of obsolescence (b) 100 percent financing (c) income tax advantages (d) accelerated depreciation

63. Interest incurred on the construction of a building can be included in the cost of the building (a) during the construction period of a building. (b) for as long as the interest is payable. (c) if the building is financed by a mortgage. (d) under no circumstances.

64. Which of the following is included in the cost of constructing a building? (a) cost of paving a parking lot (b) cost of grading the land on which the building is to be constructed (c) interest incurred during construction (d) cost of removing the demolished building that existed on the land when it was purchased

65. Assuming there are no impairment losses, the balance in the Accumulated Depreciation account represents the Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) cash fund to be used to replace assets. (b) amount to be deducted from the cost of the asset to arrive at its fair value. (c) amount charged to depreciation expense in the current period. (d) amount charged to depreciation expense since the acquisition of the asset.

66. Which of the following is not an acceptable method of depreciation? (a) straight-line (b) increasing-balance (c) diminishing-balance (d) units-of-production

67. Which statement is correct regarding the use of the cost model and the revaluation model? (a) The cost model is not allowed under IFRS. (b) The revaluation model is the only model allowed under IFRS. (c) The cost model is the only model allowed under ASPE. (d) Either the cost model or the revaluation model can be under ASPE.

68. Depreciation is a process of (a) determining the asset’s fair value. (b) asset valuation. (c) cost allocation. (d) determining the asset’s residual value.

69. The cost of a depreciable long-lived 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.

70. The carrying amount of an asset is equal to the (a) asset's fair value less its original cost. (b) “blue-book” amount relied on by secondary markets. (c) replacement cost of the asset. (d) asset's cost less accumulated depreciation.

71. Which of the following is not a consideration when calculating depreciation? (a) the method of payment for the asset (b) the cost of the asset (c) the useful life of the asset (d) the residual value of the asset 72. The difference between a depreciable asset’s cost and its residual value is called (a) the annual depreciation. (b) accumulated depreciation. (c) the depreciable amount. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) the revaluation amount.

73. In calculating depreciation, residual value is (a) the fair value of the asset on the date of acquisition. (b) subtracted from accumulated depreciation to determine the asset's depreciable cost. (c) an estimate of the asset's value at the end of its useful life. (d) ignored in all the depreciation methods.

74. 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.

75. Equipment was purchased for $20,000. It is estimated that the equipment will have a $3,000 residual value at the end of its 5-year useful life. Using the straight-line method, annual depreciation expense will be (a) $3,400. (b) $4,000. (c) $4,600. (d) $5,000.

76. Equipment was purchased for $25,000. Freight charges amounted to $700 and there was a cost of $3,000 for building a foundation and installing the equipment. It is estimated that the equipment will have a $1,600 residual value at the end of its 5-year useful life. Using the straight-line method, annual depreciation expense will be (a) $4,540. (b) $4,680. (c) $5,420. (d) $5,740.

77. Equipment with a cost of $160,000, an estimated residual value of $10,000, and an estimated life of 4 years, was purchased on April 1, 2015. If the straight-line method is used, the depreciation expense for calendar 2015 is (a) $40,000. (b) $37,500. (c) $30,000. (d) $28,125.

78. A truck was purchased for $40,000 and it was estimated to have a $4,000 residual value. Using the straight-line method, monthly depreciation expense of $600 was recorded. Therefore, the annual depreciation rate expressed as a percentage is (a) 2%. (b) 17%. (c) 18%. (d) 20%. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

79. A company purchased factory equipment on May 1, 2015 for $30,000. It is estimated that the equipment will have a $4,200 residual value at the end of its 8-year useful life. Using straight-line depreciation, the depreciation expense for the years ended December 31, 2015 and 2016 is (a) $2,500 in 2015 and $3,750 in 2016. (b) $3,225 in 2015 and $3,225 in 2016. (c) $2,150 in 2015 and $3,225 in 2016. (d) None of the above.

80. The diminishing-balance method of depreciation produces a(n) (a) decreasing depreciation expense each period. (b) increasing depreciation expense each period. (c) diminishing percentage rate each period. (d) constant amount of depreciation expense each period.

Use the following information for questions 81–83. On January 1, 2015, Sundry Corp. purchased equipment for $55,000. It was expected to last 8 years, after which it will be sold for $3,000. It is expected to be used for a total of 8,000 machine hours, and was used for 900 hours during the year ended December 31, 2015.

81. The depreciation expense for 2015 using the straight-line method will be (a) $5,850. (b) $6,500. (c) $6,875. (d) $7,250.

82. The depreciation expense for 2015 using the units-of-production method will be (a) $5,850. (b) $6,188. (c) $6,500. (d) $13,750.

83. The depreciation expense for 2015 using the double diminishing-balance method will be (a) $ 6,875. (b) $12,375. (c) $13,000. (d) $13,750.

84. Management should select the depreciation method that (a) is easiest to apply. (b) best measures the asset's fair value each period over its useful life. (c) best reflects the pattern in which the asset's future economic benefits are to be consumed. (d) is required by the government. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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85. The depreciation method that applies a constant percentage to the carrying amount at the beginning of the period in calculating depreciation is called (a) straight-line. (b) units-of-production. (c) diminishing-balance. (d) component depreciation.

86. On October 1, 2015, Ming Wo Ltd. places a new asset into service. The cost of the asset is $16,000 with an estimated 5-year life and $4,000 residual value. If Ming Wo uses straight-line depreciation, the depreciation expense for the year ended January 31, 2016 is (a) $ 600. (b) $ 800. (c) $1,067. (d) $2,400.

87. On July 1, 2015, a machine with a useful life of five years and a residual value of $4,000 was purchased for $20,000. Under straight-line depreciation, what is the depreciation expense for calendar 2016? (a) $4,000 (b) $3,556 (c) $3,200 (d) $1,600

88. Equipment was purchased on January 1 for $39,000 with an estimated residual value of $3,000. The current year's Depreciation Expense is $4,000, calculated on the straight-line basis, and the balance of the Accumulated Depreciation account at the end of the year is $12,000. The remaining useful life of the equipment is (a) 3 years. (b) 5 years. (c) 6 years. (d) 9 years.

89. Beynon Corp. purchased office equipment for $20,000, with an estimated residual value of $4,000 at the end of its 8-year useful life. Assuming the double diminishing-balance method is used, the constant percentage to be applied against the carrying amount each year is (a) 10%. (b) 12.5%. (c) 25%. (d) not determinable.

90. Jemima Ltd. purchased factory equipment for $200,000, and estimated that the equipment will have a $20,000 residual value at the end of its estimated 5-year useful life. If Jemima uses the double diminishing-balance method of depreciation, the depreciation expense for the second year after purchase would be (a) $43,200. (b) $48,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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91. Tran Inc. purchased equipment for $48,000, and estimated that the equipment will have a $4,000 residual value at the end of its 8-year useful life. Using the double diminishing-balance method, the depreciation expense for the third year would be (a) $9,000. (b) $6,750. (c) $6,188. (d) $5,500.

92. On January 1, 2015, a machine with a useful life of five years and a residual value of $2,500 was purchased for $25,000. Using the double diminishing-balance method, the depreciation expense for the year ending December 31, 2016 would be (a) $10,000. (b) $ 9,000. (c) $ 6,000. (d) $ 5,400.

93. On April 1, 2015, a machine was purchased for $33,600. It was estimated that it would have a $3,200 residual value at the end of its 5-year useful life. It was also estimated that the machine would be used for a total of 80,000 hours over the 5 years. If the actual number of machine hours used in 2015 was 12,000 hours and the company uses the units-of-production method of depreciation, the depreciation expense for 2015 would be (a) $5,040. (b) $4,560. (c) $3,780. (d) $3,420.

94. A machine that cost $72,000 has an estimated residual value of $6,000 and an estimated useful life of 5 years or 30,000 hours. Using the units-of-production method, the depreciation expense for the second year, during which the machine was used 5,000 hours, would be (a) $14,400. (b) $13,200. (c) $12,000. (d) $11,000.

95. Equipment that cost of $180,000 has an estimated residual value of $15,000 and an estimated useful life of 4 years or 25,000 hours. Using the units-of-production method, the depreciation expense for the first year, during which the machine was used 3,300 hours, would be (a) $45,000. (b) $41,500. (c) $23,760. (d) $21,780.

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96. On October 1, 2015, Ming Wo Ltd. places a new asset into service. The cost of the asset is $9,000 with an estimated 5-year life and $1,500 residual value. Assuming that Ming Wo uses the double diminishing-balance method of depreciation, what is the carrying amount of the asset at December 31, 2015? (a) $8,100 (b) $6,750 (c) $6,000 (d) $5,400

97. Vickers Ltd. uses the units-of-production depreciation method. A new asset is purchased for $27,000 that will produce an estimated 125,000 units over its useful life. Estimated residual value is $2,000. What is the depreciable cost per unit? (a) $2.20 (b) $2.16 (c) $0.22 (d) $0.20

98. Units-of-production 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 company is a manufacturing company. (d) the asset's use varies significantly from one period to another.

99. The calculation of depreciation using the diminishing-balance method (a) ignores residual value in determining the amount to which a constant rate is applied. (b) multiplies a constant percentage times the previous year's depreciation expense. (c) yields an increasing depreciation expense each period. (d) multiplies a diminishing percentage times a constant carrying amount.

Use the following information for questions 100–101. On January 1, 2014, Flowers Unlimited purchased a new delivery van. The van cost $35,000 with an estimated life of 5 years and $5,000 residual value. Double diminishing-balance depreciation will be used.

100. What is the depreciation expense for calendar 2014? (a) $ 3,000 (b) $ 6,000 (c) $12,000 (d) $14,000

101. What is the balance in the Accumulated Depreciation account at the end of 2015? (a) $22,400 (b) $19,200 (c) $12,600 (d) $10,800 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

102. With regard to depreciation and income taxes, which of the following statements is not true? (a) When calculating taxable income, the taxpayer must choose the method that best reflects the pattern in which the asset’s future economic benefits are consumed. (b) When calculating taxable income, the taxpayer must use the rate set by Canada Revenue Agency. (c) When calculating taxable income, the taxpayer must use the diminishing-balance method for most assets. (d) When calculating taxable income, the amount of depreciation calculated for income tax purposes must be deducted, rather than the amount of depreciation calculated for financial reporting purposes.

103. Which of the following statements is not true? (a) CCA will be the same whether a company uses the straight-line, diminishing-balance, or units-ofproduction method. (b) Cash flow will be affected by the use of different depreciation methods. (c) Over the life of the asset, total depreciation expense will be the same whether a company uses the straight-line, diminishing-balance, or units-of-production method. (d) The diminishing-balance depreciation method will result in lower profit compared to the straight-line depreciation method in the early years.

104. A change in the estimated useful life of equipment requires (a) a retroactive change in the amount of depreciation recognized in previous years. (b) that no change be made to depreciation calculations, so that depreciation expense amounts are comparable over the life of the asset. (c) that the amount of depreciation expense be changed in the current and future years. (d) that profit for the current year be increased.

105. Mandeep Ltd. has decided to change the estimate of the useful life of an asset that has been in service for two years. Which of the following statements describes the proper way to revise a useful life estimate? (a) Revisions in useful life are permitted if approved by Canada Revenue Agency. (b) Both the current and future years will be affected by the revision. (c) Retroactive changes must be made to correct previously recorded depreciation. (d) Only future years will be affected by the revision.

106. Which of the following statements is incorrect? (a) Under the revaluation model, the carrying amount of property, plant and equipment is adjusted to reflect its fair value. (b) With the revaluation model, revaluation gains are recorded in Other Comprehensive Income. (c) Companies can choose to use the cost model or the revaluation model for property, plant and equipment. (d) Reversals of revaluation gains or write-ups are prohibited.

107. Anali Corporation has determined that its drilling equipment is impaired. The cost of the equipment is $210,000. Accumulated depreciation recorded to date is $140,000. Anali has determined, that based on market data, the recoverable amount will be $45,000. Determine the amount of the impairment loss that Anali will be required to record. (a) $25,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) $70,000 (c) $45,000 (d) $210,000

108. When an impairment loss is recorded what is the effect (if any) on Depreciation? (a) no effect (b) credit Accumulated Depreciation (c) debit Accumulated Depreciation (d) Credit Depreciation Expense

109. When an asset is sold, a gain is reported that is equal to the amount that the (a) proceeds received exceed the carrying amount of the asset sold. (b) proceeds received exceed the original cost of the asset sold. (c) carrying amount exceeds the proceeds received for the asset sold. (d) proceeds received exceed the depreciable cost of the asset sold.

110. The carrying amount of an asset is the difference between the (a) replacement cost of the asset and its original cost. (b) 2 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.

111. On December 31, 2015, Cee Corp. sells an asset that originally cost $300,000 for $75,000. The accumulated depreciation account has a balance of $200,000 after the current year's depreciation of $15,000 had been recorded. The company should recognize a gain or loss on disposal of (a) $ 25,000 gain. (b) $ 25,000 loss. (c) $125,000 gain. (d) $125,000 loss.

112. A truck costing $15,000 and on which $14,000 of accumulated depreciation has been recorded was discarded as having no value. The entry to record this event would include a (a) gain of $1,000. (b) loss of $1,000. (c) credit to Accumulated Depreciation for $14,000. (d) credit to Equipment for $1,000.

113. A truck costing $14,000 and on which $12,000 of accumulated depreciation has been recorded was disposed of for $3,000 cash. The entry to record this event would include a (a) loss on disposal of $1,000. (b) gain on disposal of $1,000. (c) credit to the Truck account for $3,000. (d) credit to Accumulated Depreciation for $12,000.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) not recorded for the year. (b) recorded for the whole year. (c) recorded for the fraction of the year to the date of the disposal. (d) not recorded if the asset is scrapped.

115. If an asset is fully depreciated and retired for proceeds equal to its residual value (a) a gain on disposal will be recorded. (b) depreciation must continue to be taken as though the asset were still on the books. (c) a loss on disposal will be recorded. (d) no gain or loss on disposal will be recorded.

116. If the carrying amount of an asset equals its selling price at the date of sale, then (a) a gain on disposal is recorded. (b) no gain or loss on disposal is recorded. (c) the asset is fully depreciated. (d) a loss on disposal is recorded.

117. A truck costing $32,000 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 $37,000 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) credit to the Truck account for $16,000. (c) credit to the Accumulated Depreciation account for $16,000. (d) gain on disposal of $21,000.

118. On July 1, 2015, Happy Hound Kennels Inc. sells equipment for $20,000. The equipment originally cost $80,000, had an estimated 5-year life and an expected residual value of $10,000. The Accumulated Depreciation account had a balance of $49,000 on January 1, 2015, using the straight-line method. The gain or loss on disposal is (a) $4,000 gain. (b) $4,000 loss. (c) $11,000 loss. (d) $11,000 gain.

119. An asset with a cost of $45,000 and accumulated depreciation of $37,500 is sold for $9,500. What is the amount of the gain or loss on disposal? (a) $2,500 loss (b) $2,500 gain (c) $2,000 gain (d) $2,000 loss

120. Intangible assets are the rights and privileges that result from ownership of assets that (a) must be generated internally. (b) benefit only the current period. (c) have physical substance. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) do not have physical substance.

121. An intangible asset should (a) not be amortized if it has an finite life. (b) not be amortized if it has an indefinite life. (c) be amortized over its legal or useful life, whichever is longer. (d) be amortized over 5 years or less.

122. The cost of successfully defending a patent in an infringement suit should be (a) charged to Legal Expenses. (b) deducted from the carrying amount of the patent. (c) added to the cost of the patent. (d) recognized as a loss in the current period.

123. An asset that cannot be sold separately in the market place is (a) a patent. (b) goodwill. (c) a copyright. (d) a trade name.

124. 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 a purchase of an entire business.

125. On July 1, 2015, Arvolo Corporation purchased a copyright for $90,000. It is estimated that the copyright will have a useful life of 5 years with no residual value. The amount of Amortization Expense recognized for the year 2015 would be (a) $ 0. (b) $ 9,000. (c) $18,000. (d) $90,000.

126. Which of the following is an intangible asset with a finite life? (a) copyright (b) trademark (c) goodwill (d) trade name

127. Which of the following is not considered to be an intangible asset? (a) a copyright (b) an oil well (c) a franchise (d) a patent Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

128. Which of the following statements concerning research and development costs is not true? (a) All research costs should be expensed as incurred. (b) Development costs with probable future benefits should be capitalized. (c) All development costs should be capitalized. (d) Development costs associated with successful commercial research would be amortized over the useful life of the product or process developed.

129. The cost allocation of an intangible asset is referred to as (a) amortization. (b) impairment. (c) depreciation. (d) depletion.

130. A patent (a) has a legal life of 20 years. (b) is not amortized. (c) can be renewed indefinitely. (d) is rarely subject to litigation because it is an exclusive right.

131. If a company incurs legal costs in unsuccessfully defending its patent, these costs would be debited to (a) Legal Expense. (b) an Intangible Loss account. (c) the Patent account. (d) Other Comprehensive Income.

132. Copyrights are granted by the Canadian Intellectual Property Office (a) for the life of the creator or 50 years, whichever is longer. (b) for the life of the creator plus 50 years. (c) for the life of the creator or 50 years, whichever is shorter. (d) for 50 years.

133. Goodwill (a) can be recorded when generated internally. (b) can be subdivided and sold in parts. (c) can only be identified with the business as a whole. (d) need not be tested annually for impairment.

134. Goodwill (a) is always expensed upon purchase. (b) can be sold by itself to another company. (c) can be purchased and charged directly to shareholders’ equity. (d) is the excess of cost paid to acquire a business over the fair value of the net identifiable assets of the business. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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135. In 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 carrying amounts. (c) goodwill, if it exists, is never recorded. (d) goodwill is recorded as the excess of cost over the carrying amount of identifiable net assets.

136. Research costs (a) are classified as intangible assets. (b) must be expensed when incurred. (c) should be included in the cost of the asset they relate to. (d) are capitalized and then amortized over their estimated useful life.

137. A loss on disposal of an asset is reported in the financial statements (a) in the operating section of the income statement. (b) in the non-operating section of the income statement. (c) as part of Other Comprehensive Income. (d) as part of Cost of Goods Sold.

138. Which of the following statements concerning financial statement presentation is false? (a) Goodwill is reported separately from intangible assets. (b) Companies must disclose their policy for testing impairments in the notes to their statements. (c) Companies reporting under ASPE must include a reconciliation of the changes during the year in the carrying amount for each class of long-lived asset in the notes to their statements. (d) Companies reporting under IFRS must disclose whether they are using the cost or revaluation model for each class of long-lived asset in the notes to their statements.

139. Which of the following statements concerning financial statement presentation is false? (a) Intangibles may be reported separately. (b) The balances of major classes of assets should be disclosed in the notes. (c) The balances of the accumulated depreciation of major classes of assets should be disclosed in the notes. (d) The balances of all individual assets, as they appear in the subsidiary ledger, should be disclosed in the notes.

140. Intangible assets (a) must be reported under the heading Property, Plant, and Equipment. (b) are not reported on the statement of financial position because they lack physical substance. (c) should be reported as Current Assets on the statement of financial position. (d) should be reported separately from Property, Plant, and Equipment.

141. Action Advertising Corp. has the following assets: Buildings and Equipment, net of accumulated depreciation of $2,500,000 ................ Trade Receivables .................................................

$11,000,000 1,200,000

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Inventory ................................................................ 2,000,000 Land....................................................................... 4,000,000 The total amount reported under Property, Plant, and Equipment would be (a) $15,000,000. (b) $18,200,000. (c) $20,500,000. (d) $27,500,000.

142. Property, plant, and equipment are ordinarily presented on the statement of financial position (a) at fair values. (b) at replacement cost. (c) at cost less accumulated depreciation. (d) in a separate section along with investments.

143. On the statement of cash flows, cash flows from the purchase and sale of long-lived assets are shown in which section? (a) Operating activities (b) Investing activities (c) Financing activities (d) They are not reported on the statement of cash flows.

Use the following information for questions 144–146. During 2015, Richlieu Corporation reported: Net sales .............................................. $30,000,000 Profit .................................................... 1,500,000 Depreciation expense .......................... 400,000 Beginning total assets .......................... $12,000,000 Ending total assets............................... 20,000,000 Property, plant, and equipment ............ 8,000,000 Accumulated depreciation .................... 2,000,000

144. Richlieu’s return on assets is (a) 7.5%. (b) 7.9%. (c) 9.4%. (d) 12.5%. 145. Richlieu’s profit margin is (a) 3.7%. (b) 5.0%. (c) 6.3%. (d) 8.0%. 146. Richlieu’s asset turnover ratio is (a) 2.5 times. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) 1.9 times. (c) 1.5 times. (d) 1.3 times.

147. If the return on assets is positive, an increase in total assets will result in (a) an increase in the return on assets. (b) a decrease in the return on assets. (c) no change in the return on assets. (d) The effect cannot be determined.

148. If a company wants to increase its return on assets, it should not (a) increase the profit margin. (b) increase the asset turnover. (c) decrease average total assets. (d) increase average total assets.

149. The asset turnover ratio is calculated by (a) multiplying net sales by average total assets. (b) dividing net sales by average total assets. (c) dividing net profit by average total assets. (d) dividing average total assets by net sales.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61.

Ans. b c b b d c b b d a c d d d b c

Item 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77.

Ans. d a c d b c c b d a c c a a c d

Item 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93.

Ans. d c a b a d c c b c c c b b c b

Item Ans. Item 94. d 110. 95. d 111. 96. a 112. 97. d 113. 98. d 114. 99. a 115. 100. d 116. 101. a 117. 102. a 118. 103. b 119. 104. c 120. 105. b 121. 106. d 122. 107. a 123. 108. b 124. 109. a 125.

Ans. c b b b c d b d b c d b c b d b

Item 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139. 140. 141.

Ans. a b c a a a b c d a b a c d d a

Item 142. 143. 144. 145. 146. 147. 148. 149.

Ans. c b c b b b d b

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EXERCISES Ex. 150 Millenium Corporation purchased land adjacent to its plant to improve access for trucks making deliveries. Expenditures/receipts incurred in developing the land were as follows: Purchase price ............................................................ $45,000 Title search and other fees .......................................... 4,000 Demolition of an old building on the property .............. 6,000 Grading ....................................................................... 1,100 Proceeds received from selling scrap.......................... 1,500 Laying and paving driveway ........................................ 22,000 Lighting ....................................................................... 6,800 Signs........................................................................... 600 Instructions Calculate the amount to be debited to the Land account. Solution 150 (5 min.) Purchase price ................................................................... Title search and other fees ................................................ Demolition of an old building on the property ..................... Grading .............................................................................. Proceeds from selling scrap ............................................... Land acquisition cost .........................................................

$45,000 4,000 6,000 1,100 (1,500) $54,600

Ex. 151 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. Fencing _____ 9. Unpaid (past) property taxes paid on purchase _____ 10. Cost of tearing down a building when property is purchased with an old building on it Solution 151 (5 min.) 1. LI 2.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

10. L

Ex. 152 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 computer purchased _____ 8. Material and labour costs incurred to construct factory _____ 9. Cost of tearing down a warehouse on land just purchased _____ 10. Utility cost during first year Solution 152 (5 min.) 1. E 2.

10. X

Reporting and Analyzing Long-Lived Assets

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Ex. 153 For each entry below, prepare any correcting entry necessary. If the entry is correct, then state "No entry required." (a) The $100 cost of repairing a printer was charged to Equipment. The repair is not expected to increase the operating efficiency of the printer. (b) The $6,500 cost of a major engine overhaul was debited to Repair Expense. The overhaul is expected to increase the operating efficiency of the vehicle. (c) The $4,000 closing costs associated with the acquisition of land were debited to Legal Expense. (d) A $150 charge for transportation expenses on new equipment purchased was debited to Transportation Expense. Solution 153 (10 min.) (a) Repair Expense ............................................................................ Equipment ..............................................................................

100 100

(b) Vehicles ........................................................................................ Repair Expense......................................................................

6,500

(c) Land.............................................................................................. Legal Expense .......................................................................

4,000

(d) Equipment..................................................................................... Transportation Expense .........................................................

150

6,500

4,000

150

Ex. 154 The McReynolds Corporation was organized on January 1. During the first year of operations, the following expenditures and receipts were recorded in random order in the general ledger account, Land. Expenditures 1. Cost of real estate purchased as a plant site (land and building) ..................... $ 130,000 2. Cost of demolishing building to make land suitable for construction of a new building ........................................................................................................... 9,000 3. Architect's fees for new building plans............................................................. 12,000 4. Excavation costs for new building ................................................................... 27,000 5. Cost of filling and grading the land .................................................................. 2,500 6. Insurance and taxes during construction of building ........................................ 3,000 7. Interest paid during the year, of which $52,000 pertains to the construction period.......................................................................................... 68,000 8. Full payment to building contractor ................................................................. 750,000 9. Cost of parking lots and driveways .................................................................. 32,000 10. Property taxes paid for the current year on the land ........................................ 5,000 Total ......................................................................................................... $1,038,500 Receipts 11. Proceeds from salvage of demolished building ............................................... 3,500 Total ......................................................................................................... $3,500 Instructions

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Analyze 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. Land Item Land Improvements Building Other Account Title Solution 154 (15 min.) Item Land 1. $130,000 2. 9,000 3. 4. 5. 2,500 6. 7. 8. 9. 10. 11. (3,500) Totals $138,000

Land Improvements

Building

Other

Account Title

$16,000

Interest Expense

5,000 _______ $21,000

Property Tax Expense

$ 12,000 27,000 3,000 52,000 750,000 $32,000 _______ $32,000

________ $844,000

Ex. 155 Langdon Inc. purchased a machine on January 1, 2015. Besides the purchase cost, the following additional costs were incurred: (a) increase in annual insurance premium to include new machine (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) lubrication of the machinery gearing before the machinery was placed into service (f) lubrication of the machinery gearing after the machinery was placed into service (g) annual city business licence Instructions Indicate whether the items (a) through (g) are capital or operating expenditures using the codes: C = Capital, O = Operating. Solution 155 (5 min.) (a) Operating (b) Capital (c) Operating (d) Capital (e) Capital Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(f) Operating (g) Operating Ex. 156 Watmore Ltd. purchased, for cash, factory equipment with an invoice price of $80,000. Other costs incurred were freight costs, $1,600; installation, wiring and foundation, $13,500; material and labour costs in testing equipment, $500; oil lubricants and supplies to be used while operating the equipment, $750; fire insurance policy covering equipment, $1,400. The equipment is estimated to have a $10,000 residual value at the end of its 8-year useful service life. Instructions (a) Calculate the cost of the equipment. (b) Record the purchase of the equipment. (c) Calculate the annual depreciation expense, assuming the straight-line method of depreciation is used. Solution 156 (10 min.) (a) Invoice cost ................................................................................... Freight costs ................................................................................. Installation, wiring and foundation ................................................. Material and labour costs in testing ............................................... Cost .............................................................................................. (b) Equipment..................................................................................... Cash ......................................................................................

$80,000 1,600 13,500 500 $95,600 95,600 95,600

Ex. 157 A machine was acquired on January 1, 2015, at a cost of $80,000. The machine was originally estimated to have a residual value of $5,000 and an estimated life of 5 years. The machine is expected to produce a total of 100,000 components during its life, as follows: 15,000 in 2015, 20,000 in 2016, 20,000 in 2017, 30,000 in 2018, and 15,000 in 2019. Instructions (a) Calculate the amount of depreciation to be charged each year, using each of the following methods: 1. Straight-line method 2. Units-of-production 3. Double diminishing-balance (b) Which method results in the highest depreciation expense during the first two years? Over all five years? Solution 157 (a) 1. Straight-line Date Jan. 1, 2015 Dec. 31, 2015

Asset Cost $80,000

Depreciation Rate 20%

Depreciable Cost

Depreciation Accumulated Carrying Expense Depreciation Amount $80,000 $75,000 $15,000 $15,000 65,000

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Dec. 31, 2016 Dec. 31, 2017 Dec. 31, 2018 Dec. 31, 2019

20% 20% 20% 20%

75,000 75,000 75,000 75,000

15,000 15,000 15,000 15,000

30,000 45,000 60,000 75,000

50,000 35,000 20,000 5,000

Straight-line rate: 1 ÷ 5 = 20% Annual depreciation: ($80,000 – $5,000) ÷ 5 years = $15,000

(a) 2. Units-of-production Asset Depreciation Date Cost Per Component Jan. 1, 2015 $80,000 $0.75 Dec. 31, 2015 0.75 Dec. 31, 2016 0.75 Dec. 31, 2017 0.75 Dec. 31, 2018 0.75 Dec. 31, 2019

Number Of Components

Depreciation Expense

15,000 20,000 20,000 30,000 15,000 100,000

$11,250 15,000 15,000 22,500 11,250

Accumulated Carrying Depreciation Amount $80,000 $11,250 68,750 26,250 53,750 41,250 38,750 63,750 16,250 75,000 5,000

Depreciation per component: ($80,000 – $5,000) ÷ 100,000 units = $0.75

(a) 3. Double diminishing-balance Asset Depreciation Asset Carrying Depreciation Accumulated Carrying Date Cost Rate Amount Expense Depreciation Amount Jan. 1, 2015 $80,000 $80,000 40% $80,000 $32,000 $32,000 48,000 Dec. 31, 2015 40% 48,000 19,200 51,200 28,800 Dec. 31, 2016 40% 28,800 11,520 62,720 17,280 Dec. 31, 2017 40% 17,280 6,912 69,632 10,368 Dec. 31, 2018 40% 10,368 *5,368 75,000 5,000 Dec. 31, 2019 DDB rate: 1 ÷ 5 = 20% x 2 = 40% * Amount required to reduce carrying amount to residual value. (b) The double diminishing-balance results in the highest depreciation in the first two years. Over the five year life of the asset, all of the methods result in the same amount of depreciation expense as the asset is depreciated to the residual value.

Ex. 158 Certossi Service Ltd. uses straight-line depreciation. The company's fiscal year end is December 31. The following transactions and events occurred during their first three years of operations: 2014 Jul 1 Purchased equipment for $32,000 cash, with shipping costs of $2,000. Nov 3 Incurred ordinary repairs on the computer of $360. Dec 31 Recorded 2014 depreciation on the basis of a four-year life and estimated residual value of $200. 2015 Dec 31 Recorded 2015 depreciation. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

2016

Jan

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Paid $1,600 for a major upgrade of the equipment. This expenditure is expected to increase the operating efficiency and capacity of the equipment.

Instructions Prepare journal entries to record the above events. (Show calculations.) Solution 158 (15 min.) 2014 Jul 1 Equipment ................................................................ Cash ($32,000 + $2,000) ................................... Nov 3

Dec 31

2015 Dec 31

2016 Jan

34000 34,000

Repairs Expense ...................................................... Cash ..................................................................

360

Depreciation Expense .............................................. Accumulated Depreciation ................................. [($34,000 – $200)/4  6/12]

4,225

Depreciation Expense .............................................. Accumulated Depreciation ($34,000 – $200)/4 ..

8,450

Equipment ................................................................ Cash ..................................................................

1,600

360

4,225

8,450

1,600

Ex. 159 Ratched Limited purchased a new computer system for $80,000. It is estimated that the computer will have an $8,000 residual value at the end of its 5-year useful service life. The double diminishing-balance method of depreciation will be used. Instructions Prepare a depreciation schedule that shows the annual depreciation expense on the computer for its 5year life. Solution 159 (10 min.) Diminishing-balance rate = 1 ÷ 5 = 20% x 2 = 40% Carrying Amount Beginning Depreciation Year of Year  Rate = 1 $80,000  40% 2 48,000  40% 3 28,800  40% 4 17,280  40% 5 10,368  40%

Annual Depreciation Expense $32,000 19,200 11,520 6,912 2,368*

Accumulated Depreciation $32,000 51,200 62,720 69,632 72,000

Carrying Amount End of Year $48,000 28,800 17,280 10,368 8,000

*Adjusted to $2,368 because ending carrying amount should not be less than expected residual value.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 160 Chevrette Corporation purchased equipment on January 1, 2014 for $87,000. It is estimated that the equipment will have a $7,000 residual value at the end of its 8-year useful life. It is also estimated that the equipment will produce 160,000 units over its 8-year life. Instructions (a) Using straight-line depreciation, calculate the depreciation expense for the year ended December 31, 2014. (b) Now assume Chevrette uses the units-of-production depreciation. If 16,000 units of product are produced in 2014 and 24,000 units are produced in 2015, what is the carrying amount of the equipment at December 31, 2015? (c) Now assume Chevrette uses double diminishing-balance depreciation. What is the balance of the Accumulated Depreciation—Equipment account at December 31, 2016? Round amounts to the nearest dollar. Solution 160 (15 min.) C = Cost RV = Residual value (a) Straight-line method:

C – RV ——–––— = Useful life

$87,000 – $7,000 ——————–—— 8

C – RV $87,000 – $7,000 (b) Units-of-production method: —–––––––—— = —————–——— Total estimated 160,000 units Units of activity 2014 16,000 units  $0.50 = $ 8,000 2015 24,000 units  $0.50 = 12,000 Accumulated depreciation = $20,000 Cost of asset Less: Accumulated depreciation Carrying amount at December 31, 2015

= $10,000 per year.

= $.50 per unit

$87,000 20,000 $67,000

(c) Double diminishing-balance method. Rate is 1 ÷ 8 = 12.5% x 2 = 25% Carrying Amount Beginning Diminishing Depreciation Accumulated of Year  Balance Rate = Expense Depreciation 2014 $87,000 25% $21,750 $21,750 2015 65,250 25% 16,313 38,063 2016 48,937 25% 12,234 50,297

Carrying Amount End of Year $65,250 48,937 36,703

Ex. 161 Equipment acquired on October 1, 2015, at a cost of $750,000, has an estimated useful life of 10 years. The residual value is estimated to be $80,000. Instructions Calculate the depreciation expense for the first two years using the (a) straight-line method. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

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(b) double diminishing-balance method. Solution 161 (10 min.) (a) Straight-line method

Year 1 Year 2

$750,000 – $80,000 —————————  3/12 = $16,750 10 years $67,000

(b) Double diminishing-balance method Rate is 1 ÷ 10 = 10% x 2 = 20% Year 1 $750,000  20%  3/12 = $37,500 Year 2 ($750,000 – $37,500)  20% = $142,500

Ex. 162 Craving for Crepes, a popular Crepe and Waffle restaurant, has a thriving delivery business. The business has a fleet of three delivery vans. Before the adjusting entry for this year's depreciation expense, the details of each van are as follows: Accumulated Kilometres Estimated Depreciation Operated Van Cost Residual value Life in Kilometres Beg. of the Year During Year 1 $32,000 $5,000 150,000 $7,800 22,000 2 28,000 2,500 160,000 6,000 40,000 3 17,000 1,900 170,000 4,550 36,000 Instructions (a) Calculate the depreciation rates per kilometre for each van. (b) Calculate the depreciation expense for each van for the current year. (c) Prepare one compound journal entry to record the annual depreciation expense for the fleet. Solution 162 (10 min.) $32,000 – $5,000 (a) Van 1 ———————— = $0.18 per km 150,000 km

(b)

Van 2

$28,000 – $2,500 ———————— = $0.16 per km 160,000 km

Van 3

$17,000 – $1,900 ———————— = $0.09 per km 170,000 km

Van 1 Van 2 Van 3

22,000 km  $0.18 = $3,960 40,000 km  $0.16 = $6,400 36,000 km  $0.09 = $3,240

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(c) Depreciation Expense ................................................................... Accumulated Depreciation—Van 1 ......................................... Accumulated Depreciation—Van 2 ......................................... Accumulated Depreciation—Van 3 .........................................

13,600 3,960 6,400 3,240

Ex. 163 Caring Clinic purchased a new surgical laser for $88,000. 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 1,700 hours in year 1; 2,300 hours in year 2; 2,500 hours in year 3; 1,500 hours in year 4; 1,600 hours in year 5; 400 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. (b) If you were the administrator of the clinic, which method would you deem as more appropriate? Justify your answer. (c) Which method would result in the lower reported profit for the first two years? Which method would result in the lower total reported profit over the six-year period? Solution 163 (20 min.) $88,000 – $4,000 Straight-line method: ———————— = $14,000 per year 6 years

(a) 1.

$88,000 – $4,000 Units-of-production method: ——––—————— = $8.40/hour 10,000 hours

Year

1 2 3 4 5 6

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Total (b)

1,700 2,300 2,500 1,500 1,600 400

     

$8.40 8.40 8.40 8.40 8.40 8.40

Straight-Line $14,000 14,000 14,000 14,000 14,000 14,000 $84,000

= $ 14,280 = 19,320 = 21,000 = 12,600 = 13,440 = 3,360 Units-of-Production $14,280 19,320 21,000 12,600 13,440 3,360 $84,000

The units-of-production method would be more appropriate, given the variable usage expected of the laser during its useful life. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

(c)

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The units-of-production method provides the higher depreciation expense for the first two years, and therefore the lower profit. Over the six year period, both methods result in the same total depreciation expense ($84,000) and, therefore, the same total profit.

Ex. 164 Northwest Airlines purchased an aircraft on January 1, 2016, at a cost of $35,000,000. The estimated useful life of the aircraft is 25 years, with an estimated residual value of $5,000,000. Instructions Calculate the accumulated depreciation and carrying amount at December 31, 2018 using the straight-line method and the double diminishing-balance method. Solution 164 (20 min.) Straight-Line Depreciable Depreciation Annual Year Amount  Rate = Depreciation 2016 $30,000,000 4% $1,200,000 2017 30,000,000 4% 1,200,000 2018 30,000,000 4% 1,200,000

Accumulated Depreciation $1,200,000 2,400,000 3,600,000

Carrying Amount $33,800,000 32,600,000 31,400,000

Double Diminishing-Balance (rate is 1/25 = 4% x 2 = 8%) Carrying Amount Depreciation Annual Year Beginning Year  Rate = Depreciation 2016 $35,000,000 8% $2,800,000 2017 32,200,000 8% 2,576,000 2018 29,624,000 8% 2,369,920

Accumulated Depreciation $2,800,000 5,376,000 7,745,920

Carrying Amount $32,200,000 29,624,000 27,254,080

Ex. 165 Zen Fitness Inc. purchased a machine on April 1, 2015 for $120,000. The machine is expected to have an estimated residual value of $5,000 at the end of its 5 year life. Although Zen has a policy of using straightline depreciation for machinery, the company accountant neglected to follow policy and depreciated it in 2015 using the double diminishing-balance method. Profit before income tax for the year ended December 31, 2015 was $73,000 as the result of depreciating the machine incorrectly. Instructions Using the method of depreciation that company policy requires, prepare the correcting entry and determine the correct profit. Ignore income tax. (Show calculations.) Solution 165 (15 min.) Depreciation recorded ($120,000 – 0)  40% (1 ÷5 = 20% x 2) x 9/12 . Correct depreciation ($120,000 – $5,000)/5 x 9/12 .............................. Overstatement of depreciation ............................................................. Accumulated Depreciation ................................................................... Depreciation Expense ................................................................... Correct profit (before income tax): Profit as reported ................................................................................. Add: overstatement of depreciation expense .......................................

$36,000 17,250 $18,750 18,750 18,750

$73,000 18,750

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Correct profit ........................................................................................

$91,750

Ex. 166 On January 1, 2014, North Woods Corporation purchased and installed a telephone system at a cost of $42,000. The equipment was expected to last five years with no residual value. On January 1, 2015 more telephone equipment was purchased for $6,000 to augment the existing system. The new equipment is expected to have a useful life of four years. Through an error, the new equipment was debited to Telephone Expense. North Woods Corporation uses straight-line depreciation. Instructions Prepare a schedule showing the effects of the error in dollars on Telephone Expense, Depreciation Expense, and profit for each year and in total beginning in 2015 through the useful life of the new equipment. Use the following format: Telephone Expense Depreciation Expense Profit Overstated Overstated Overstated Year (Understated) (Understated) (Understated) ——————————————————————————————————————————— 2015 2016 2017 2018 Solution 166 (20 min.) Telephone Expense Depreciation Expense Profit Overstated Overstated Overstated Year (Understated) (Understated) (Understated) ——————————————————————————————————————————— 2015 $6,000 $(1,500)* $(4,500) 2016 (1,500) 1,500 2017 (1,500) 1,500 2018 (1,500) 1,500 Total $6,000 $(6,000) -0* $6,000  4 = $1,500

Ex. 167 On July 1, 2015, Ashtanga Inc. purchased a used piece of equipment for $65,000. The company spent another $28,000 overhauling it and getting it ready for use, and $2,000 testing it. Ashtanga estimated the useful life to be 6 years, and the residual value $5,000. The company uses straight-line depreciation for all its equipment. Instructions (a) Prepare the journal entries to record the purchase (assume payments were made in cash) and depreciation expense for 2015 and 2016. (b) How much will the accumulated depreciation be on June 30, 2021? Solution 167 (15 min.) (a) Purchase Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

Equipment..................................................................................... Cash ...................................................................................... Equipment..................................................................................... Cash ...................................................................................... Equipment..................................................................................... Cash ......................................................................................

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65,000 65,000 28,000 28,000 2,000 2,000

(Note these entries could be combined.) Depreciation 2015 Depreciation Expense ................................................................. Accumulated Depreciation ................................................... ($95,000 – $5,000)/6 × 6/12 = $7,500 Depreciation 2016 Depreciation Expense ................................................................... Accumulated Depreciation ..................................................... ($95,000 – $5,000)/6 = $15,000 (b)

7,500 7,500

15,000 15,000

On June 30, 2021, at the end of the asset’s useful life, the asset will be fully depreciated; therefore the accumulated depreciation will be $90,000, the full depreciable amount.

Ex. 168 Sunny Falls Ltd. (SFL) tests its property, plant and equipment annually for impairment. On Jan 1, 2014, SFL purchased equipment for $400,000, and, at Dec 31, 2014, recorded straight-line depreciation based on an eight-year life with no residual value. However, at Dec 31, 2014, SFL also determined that the recoverable amount of this equipment was $280,000. Instructions (a) What is the formula to determine an impairment loss? (b) Calculate the equipment’s carrying amount at Dec 31, 2014 (c) Calculate the amount of the impairment loss Sunny Falls will be required to record at Dec 31, 2014. Solution 168 (15 min.) (a) The formula to determine the value of an impairment loss is: Carrying Amount (Cost- Acc. Dep.)

- Recoverable Amount

Impairment Loss

(b) Carrying amount at Dec 31, 2014 $400,000 – $0 —————— 8 years

= $50,000 annual depreciation expense

Carrying amount at Dec 31, 2014: $400,000 – $50,000 = $350,000 (c) Impairment Loss $350,000 – $280,000= $70,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 169 At the beginning of 2016, Griffin Corp. reviewed the expected useful life and residual value of their main packaging machine. This machine had cost $725,000 on Jan 1, 2006, had been expected to last for 20 years, with $50,000 residual value (straight-line depreciation). Now, ten years later, Griffin is revising the expected life to a total of 25 years (that is, 15 years remaining) with a $25,000 residual value. Instructions (a) Calculate the machine’s carrying amount at Dec 31, 2015. (b) As a result of this revision, will the depreciation expense for 2016 and subsequent years be higher or lower? Explain. (You do not have do show any detailed calculations.) (c) With this revision, will Griffin have to revise previous years’ depreciation expense? Why or why not? Solution 169 (15 min.) (a) Annual depreciation: $725,000 – $50,000 —————––––— 20 years

= $33,750

Carrying amount at Dec 31, 2015: $725,000 – (10 x $33,750) = $387,500 (b) The depreciation expense will be lower, since we are reducing the residual value (increases depreciable amount) and increasing the expected remaining life from the original ten years left to fifteen. Optional (not illustrated in text): the revised annual deprecation will be: $387,500 – $25,000 ————––––—— 15 years

= $24,167

(c) No, this is considered a change in estimate, and reported in current and future years only (prospectively). The rationale is that the original calculation for depreciation was based on the best information available at the time (Jan 2006). Now, ten years later, new information has become available that was not available before, thus the change should only affect current and future periods.

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Ex. 170 Solve for the missing items, assuming straight-line depreciation is used:

Cost Residual value Useful life Depreciation rate Annual depreciation amount Number of years owned Accumulated depreciation at disposal date Proceeds of disposal Gain (loss) on disposal

Machine A $150,000 $15,000 20 years A B 12 C $42,000 D

Machine B $60,000 E F 20% $12,000 3.5 G H $2,000

Machine C I $10,000 40 years J $6,000 K L $220,000 $18,000

Machine A $150,000 $15,000 20 years 5% $6,750 12 $81,000 $42,000 $(27,000)

Machine B $60,000 0 5 years 20% $12,000 3.5 $42,000 $20,000 $2,000

Machine C $250,000 $10,000 40 years 2.5% $6,000 8 $48,000 $220,000 $18,000

Solution 170 (15 min.) Cost Residual value Useful life Depreciation rate Annual depreciation amount Number of years owned Accumulated depreciation at disposal date Proceeds of disposal Gain (loss) on disposal

Ex. 171 Hertford Manufacturing Inc. sold two machines in 2015. The following information pertains to the two machines: Purchase Useful Residual Depreciation Sale Machine Cost Date Life Value Method Date Sold Price #1 $76,000 Jul 1/12 5 yrs. $6,000 Straight-line Jun 30/15 $28,000 #2 $60,000 Jul 1/14 8 yrs. $3,000 Double diminishing- Dec 31/15 $45,000 balance Instructions (a) Calculate the depreciation on each machine to the date of disposal. (b) Prepare the journal entries to record 2015 depreciation and the sale of each machine. Solution 171 (20 min.) (a) Machine #1 Annual Year Depreciable Amount 2012 $70,000 2016 70,000 2014 70,000 2015 70,000 *Half a year only.

Depreciation Rate = 20% (1 ÷ 5) 20% 20% 20%

Accumulated Depreciation $ 7,000* 14,000 14,000 7,000*

Depreciation $ 7,000 21,000 35,000 42,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Machine #2 Carrying Amount Year Beginning of Year  2014 $60,000 2015 52,500

DDB Rate 25% 25%

Annual Depreciation $7,500* 13,125

Accumulated Depreciation $7,500 20,625

DDB rate: 1 ÷ 8 = 12.5% x 2 = 25% *Half a year only. (b) Machine #1 Depreciation Expense ................................................................... Accumulated Depreciation ..................................................... Cash ............................................................................................. Loss on Disposal........................................................................... Accumulated Depreciation ............................................................ Equipment .............................................................................. *$76,000 – $42,000 = $34,000; $28,000 – $34,000 = ($6,000) loss. Machine #2 Depreciation Expense ................................................................... Accumulated Depreciation ..................................................... Cash ............................................................................................. Accumulated Depreciation ............................................................ Equipment .............................................................................. Gain on Disposal .................................................................... **$60,000 – $20,625 = $39,375; $45,000 – $39,375 = $5,625 gain.

7,000 7,000 28,000 6,000* 42,000 76,000

13,125 13,125 45,000 20,625 60,000 5,625**

Ex. 172 Kootney Corporation, a publicly-traded company, purchased a piece of equipment on January 1, 2014, for $260,000. It has an estimated useful life of five years and a $30,000 residual value. Kootney uses straightline depreciation and has a December 31 year end. At December 31, 2015, the equipment had a recoverable value of $150,000. Instructions (a) Calculate the equipment’s carrying amount at December 31, 2015. (b) Calculate the amount of the impairment loss at Dec 31, 2015. (c) Where should the impairment loss be reported in the financial statements? Solution 172 (10 min.) (a) Calculate the carrying amount at December 31, 2015: $260,000 – $30,000 ————————— 5 years

= $46,000 annual depreciation expense

Equipment has been depreciated for 2 years: $46,000  2 = $92,000

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Carrying amount at December 31, 2015: $260,000 – $92,000 = $168,000 (b) Impairment Loss $168,000 – $150,000= $18,000 (c) The impairment loss is reported in the operating section of the income statement.

Ex. 173 For each item listed below, enter a code letter in the blank space to indicate the usual allocation terminology for the item. Use the following codes for your answer: A—Amortized D—Depreciated N—Neither ____ 1. Copyrights ____ 6. Licenses ____ 2. Land ____ 7. Equipment ____ 3. Buildings ____ 8. Franchises ____ 4. Patents ____ 9. Goodwill ____ 5. Trademarks ____ 10. Land Improvements Solution 173 (10 min.) 1. A 2.

10. D

Ex. 174 (a) Alpha Corporation purchased equipment in 2008 for $120,000 and estimated a $12,000 residual value at the end of the equipment's 10-year useful life. At December 31, 2014, there was $75,600 in the Accumulated Depreciation account for this equipment using straight-line depreciation. On March 31, 2015, the equipment was sold for $28,000. Prepare the appropriate journal entries to remove the equipment from the books of Alpha Corporation on March 31, 2015. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) On July 31, 2015, Beta Corporation sold a delivery truck for $10,000. The truck originally cost $38,000 on January 1, 2007. It was estimated that the truck would have a useful life of 12 years with a residual value of $2,000. The straight-line method was used. Prepare the appropriate journal entry to record the sale of the delivery truck. Assume depreciation is up-to-date. (c) Gamma Corporation sold office equipment that had a carrying amount of $3,500 for $5,200. The office equipment originally cost $12,000. It is now estimated that it would cost $16,000 to replace this equipment. Prepare the appropriate journal entry to record the sale of the office equipment. Assume depreciation is up-to-date. Solution 174 (15 min.) (a) Depreciation Expense ................................................................... Accumulated Depreciation—Equipment ................................. ($120,000 – 12,000)/10 × 3/12 = $2,700)

2,700 2,700

Cash ............................................................................................. Loss on Disposal........................................................................... Accumulated Depreciation—Equipment ($75,600 + $2,700) ......... Equipment ..............................................................................

28,000 13,700 78,300

(b) Cash ............................................................................................. Accumulated Depreciation—Vehicles ........................................... Loss on Disposal........................................................................... Vehicles .................................................................................

10,000 25,500 2,500

120,000

38,000

Accumulated depreciation to July 31, 2015: $38,000 – $2,000 ———————— = $3,000 annual depreciation expense 12 years 8 ½ years have been depreciated, therefore total depreciation would be 8.5 x 3,000 = $25,500. (c) Cash ............................................................................................. Accumulated Depreciation—Equipment ($12,000 – $3,500) ......... Office Equipment.................................................................... Gain on Disposal ....................................................................

5,200 8,500 12,000 1,700

Ex. 175 Prepare the journal entries to record the following transactions for Antigua Inc., which has a calendar year end and uses straight-line depreciation. (a) (b)

On June 30, 2015, the company sold office equipment for $16,000. The office equipment originally cost $26,000 and had accumulated depreciation to the date of disposal of $12,000. On September 30, 2015, the company sold delivery equipment for $12,500. The equipment was purchased on January 1, 2013, for $24,000 and was estimated to have a $3,000 residual value at the end of its 7-year life. Depreciation on the delivery equipment has been recorded through December 31, 2014.

Reporting and Analyzing Long-Lived Assets

Solution 175 (15 min.) (a) June 30, 2015 Cash ........................................................................................ Accumulated Depreciation—Equipment ................................... Equipment .................................................................... Gain on Disposal ($26,000 – $16,000 - $12,000) .......... (b)

Sept 30, 2015 Depreciation Expense .............................................................. Accumulated Depreciation—Equipment........................... ($24,000 - $3,000)/7  9/12 = $2,250) Cash ........................................................................................ Accumulated Depreciation—Equipment ($6,000 + $2,250) ...... Loss on Disposal ($24,000 - $12,500 - $8,250) ........................ Equipment .......................................................................

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16,000 12,000 26,000 2,000

2,250 2,250

12,500 8,250 3,250 24,000

Ex. 176 (a) A machine that cost $21,000, with accumulated depreciation of $13,000, was sold for $5,400. Calculate the gain or loss on disposal. (b) Instead, assume that the machine was retired (no proceeds). Calculate the gain or loss on disposal. (c) Instead, assume that the machine was sold for $9,500. Calculate the gain or loss on disposal. Solution 176 (10 min.) (a) $2,600 loss ($21,000 – $13,000 = $8,000 carrying amount; $5,400 – $8,000 = $2,600 loss) (b) $8,000 loss ($21,000 – $13,000 = $8,000 carrying amount, all loss) (c) $1,500 gain ($21,000 – $13,000 = $8,000 carrying amount; $9,500 – $8,000 = $1,500 gain)

Ex. 177 Presented below are selected transactions for Benton Inc. for 2015: Jan 1 Retired a machine that was purchased on January 1, 2005. The machine cost $210,000, and had been estimated to have a useful life of 10 years with no residual value. Jun 30 Sold another machine for $50,000 that was purchased on January 1, 2012. The machine cost $115,000, and had a useful life of 5 years with no residual value. Sep 30 Retired a business automobile (no proceeds) that was purchased on September 30, 2009. The car cost $21,600 and was depreciated on an 8-year useful life with a residual value of $1,600. Instructions Record all entries required as a result of the above transactions. Benton Inc. uses straight-line depreciation and has recorded depreciation through December 31, 2014. Solution 177 (15 min.) Jan 1 Accumulated Depreciation—Equipment............................. 210,000 Equipment .................................................................. 210,000 (note: machine is at the end of its service life, therefore fully depreciated) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Jun 30

Sep 30

Depreciation Expense........................................................ Accumulated Depreciation—Equipment ...................... ($115,000 ÷ 5) = $23,000 annually  6/12 = $11,500)

11,500

Cash .................................................................................. Accumulated Depreciation—Equipment ($23,000  3.5 yrs) Equipment .................................................................. Gain on Disposal ($50,000 – $34,500)........................

50,000 80,500

Depreciation Expense ($21,600 – $1,600)/8) = $2,500 x 9/12 Accumulated Depreciation—Vehicles .........................

1,875

Accumulated Depreciation—Vehicles ($2,500  6) ............ Loss on Disposal ............................................................... Vehicles ......................................................................

15,000 6,600

11,500

115,000 15,500

1,875

21,600

Ex. 178 Birmingham Limited sold the following two assets in 2015:

Cost Purchase date Useful life Residual value Depreciation method Date sold Selling price

Furniture $143,500 July 1, 2010 8 years $5,000 Straight-line September 30, 2015 $30,000

Equipment $162,000 January 1, 2012 5 years $33,000 Straight-line August 1, 2015 $75,000

Instructions Record all entries required to update depreciation and record the sales of the two assets in 2015. Birmingham has a December 31 year-end. Solution 178 (20 min.) Aug 1 Depreciation Expense........................................................ Accumulated Depreciation—Equipment ...................... ($162,000 – $33,000)/5  7/12 = $15,050

Sep 30

15,050 15,050

Cash .................................................................................. Accumulated Depreciation—Equipment** .......................... Equipment .................................................................. Gain on Disposal ($162,000 - $75,000 – $92,450) ...... **(($162,000 – $33,000)/5  3)+ $15,050 = $92,450

75,000 92,450

Depreciation Expense........................................................ Accumulated Depreciation—Furniture ........................ ($143,500 – $5,000)/8  9/12 = $12,985

12,985

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

30,000

162,000 5,450

12,985

Reporting and Analyzing Long-Lived Assets

Accumulated Depreciation—Furniture* .............................. Loss on Disposal ($143,500 - $30,000 – $90,891) ............. Furniture .....................................................................

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90,891 22,609 143,500

*($143,500 – $5,000)/8  5.25 years = 90,891

Ex. 179 (a) On January 1, 2015, Delta Corp. purchased a patent for $1,500,000. The patent's legal life is 20 years but the company estimates that its useful life will only be 5 years from the date of acquisition. As an addition to the patent account shortly after acquisition, Delta paid legal costs of $180,000 in successfully defending the patent in an infringement suit. Any legal costs to be capitalized will be amortized effective the date of acquisition of the patent, January 1. Prepare the entry to amortize the patent at year end, December 31, 2015. (b) On January 1, 2015, Epsilon Ltd. purchased a franchise from the Wing Food Company for $500,000. The franchise is for an indefinite time period and gives Epsilon the exclusive rights to sell Wing products in a particular territory. Record the acquisition of the franchise and any necessary adjusting entry at year end, December 31, 2015. Epsilon follows ASPE. (c) In 2015, Kappa Corporation incurred research costs of $350,000 to develop a new product. Record this event. Solution 179 (15 min.) (a) December 31, 2015 Amortization Expense ................................................................... Accumulated Amortization–Patent ......................................... (To record patent amortization) ($1,500,000 + $180,000) /5 years .......................................... (b) January 1, 2015 Franchise ...................................................................................... Cash ...................................................................................... (To record acquisition of Wing Food franchise)

336,000 336,000 $336,000

500,000 500,000

December 31, 2015—no entry. The franchise has an indefinite life, therefore is not amortized. However, if there are indicators of impairment, then the franchise should be tested for impairment and written down if necessary. (c) 2015 Research Expense........................................................................ Cash ...................................................................................... (To record research expense for the current year)

350,000 350,000

Ex. 180 (a) A patent acquired for $950,000 at the beginning of the current year expires in 12 years and is expected to have economic value for 4 years. Present the adjusting entry to amortize the patent for the current year. (b) A renewable trade name purchased for $300,000 was recorded in the accounts at the beginning of the current fiscal year. Determine the minimum amount to be amortized for the current fiscal year. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Solution 180 (10 min.) (a) Amortization Expense ($950,000/4) .............................................. Accumulated Amortization—Patent ........................................

237,500 237,500

(b) Zero. Trade names normally have indefinite lives and are not amortized.

Ex. 181 For each of the following unrelated transactions, (a) determine the amount of the amortization for the current year, and (b) present the adjusting entries required to record amortization at year end. 1. Costs of $37,000 were incurred on January 1 to obtain a patent. Shortly thereafter, $35,000 was spent in legal costs to successfully defend the patent against competitors. The patent has an estimated legal life of 12 years. 2. A company purchased a renewable trademark for $80,000. Solution 181 (10 min.) 1. (a) Legal costs to successfully defend a patent are capitalized. ($37,000 + $35,000)  12 years = $6,000) (b) Amortization Expense ............................................................ Accumulated Amortization—Patent ................................. 2.

6,000 6,000

(a) Trademarks have an indefinite life and are not amortized. (b) No entry required.

Ex. 182 During the current year, Mastiff Inc. 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 amortized. Explain your answer. (a) Spent $65,000 in legal costs in a patent defence suit. The patent defence was unsuccessful. (b) Purchased a trademark from another company. The trademark can be renewed indefinitely, and Mastiff expects the trademark to contribute to revenue indefinitely. (c) Acquired a patent for $4,200,000. The company selling the patent has spent $1,250,000 on its research and development. The patent has a remaining life of 15 years. (d) Mastiff 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 and development. Mastiff is hopeful it will obtain this patent in the next few years, but has not been successful as yet. Solution 182 (10 min.) (a) Operating Expense. Only successful patent defence costs can be capitalized. (b) Intangible Asset. Trademarks are renewable. Since the trademark has an indefinite life, it is not amortized. (c) Intangible Asset. The patent cost of $4,200,000 should be amortized over its remaining useful life of 15 years because this is a shorter period of time than the patent’s legal life. The amount the selling company spent is irrelevant for Mastiff.

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(d) Operating Expense. All research costs must be expensed. Development costs must also be expensed, unless they satisfy strict criteria.

Ex. 183 Nova Futures Inc. is a company that creates new products through research and development and has a December 31 fiscal year. In fiscal 2014, Nova Futures spent $452,000 researching a new process. The research was completed in fiscal 2015 at an additional cost of $80,000; as well, $5,000 was spent obtaining the patent. Then further costs related to the patented process of $180,000 were incurred to create a marketable product. The product was completed and ready for market half-way through the fiscal year. The new product was advertised heavily in 2015 at a cost of $90,000. Soon after the launch of the new product, $60,000 was spent defending the patent. The defence was successful. The product is expected to have a life cycle of 5 years. Instructions Explain how the expenditures above should be presented in the financial statements for 2014 and 2015. Support your answer with calculations. Solution 183 (10 min.) 2014 $452,000 research costs shown as an expense on the income statement. 2015 Patent – shown as an intangible asset on the statement of financial position: Cost ($5,000 + $180,000 + $60,000)............................................. $245,000 Amortization $245,000 ÷ 5 years x 1/2 year ................................. 24,500 Net amount shown on the statement of financial position .............. $220,500 Research – $80,000 research costs shown as an expense on the income statement. Advertising – $90,000 shown as an expense on the income statement.

Ex. 184 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 answers: PPE Property, plant, and equipment I Intangible assets O Other asset E Expense ____ 1. Goodwill

___

6. Research Costs

____ 2. Land Improvements

___

7. Land

____ 3. Buildings

___

8. Franchises

____ 4. Accumulated Depreciation

___

9. Accumulated Amortization

____ 5. Trademarks

___ 10. Equipment

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Solution 184 (5 min.) 1. O Goodwill 2. PPE

Land Improvements

3. PPE

Buildings

4. PPE

Accumulated Depreciation

Trademarks

Research Costs

7. PPE

Land

Franchises

Accumulated Amortization

10. PPE

Equipment

Ex. 185 Presented below is information related to tangible and intangible assets at year end, December 31, 2015, for Round Mound Corporation: Buildings ..................................................................... $ 1,200,000 Goodwill ...................................................................... 160,000 Patents ....................................................................... 392,000 Land............................................................................ 1,500,000 Accumulated Depreciation—Buildings ........................ 600,000 Accumulated Amortization—Patents ........................... 196,000 Instructions Prepare a partial statement of financial position for Round Mound Corporation that shows how the above items would be presented. Solution 185 (10 min.) ROUND MOUND CORPORATION Statement of Financial Position (Partial) December 31, 2015 Property, plant, and equipment Land................................................................................ Buildings ......................................................................... Less: Accumulated depreciation ..................................... ................................................................................... Intangible assets Patents ........................................................................... Less: Accumulated amortization ..................................... Goodwill .................................................................................

$1,500,000 $1,200,000 600,000

$392,000 196,000

600,000 2,100,000

196,000 160,000

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Ex. 186 The following information is available from recent annual reports of Competitor A and Competitor B: (in millions) Competitor A Competitor B Net profit $ 490 $ 1,444 Sales 22,500 30,275 Average total assets 17,750 11,900 Instructions (a) Based on this information, calculate the following ratios for each company to one decimal: 1. Profit margin. 2. Asset turnover. 3. Return on assets. (b) What conclusion concerning the management of assets can be drawn from these data? Solution 186 (15 min.) (a) 1. Profit margin

Competitor A $490 ÷ $22,500 = 2.2%

Competitor B_ $1,444 ÷ $30,275 = 4.8%

2. Asset turnover ratio

$22,500 ÷ $17,750 = 1.3 times

$30,275 ÷ $11,900 = 2.5 times

3. Return on assets

$490 ÷ $17,750 = 2.8%

$1,444 ÷ $11,900 = 12.1%

(b) All of Competitor B’s numbers are better than those of Competitor A. Competitor B is using its assets much more efficiently. It is generating close to the same amount of sales with only two-thirds the assets. Competitor B’s return on assets is four times that of Competitor A. It also has more than twice the profit margin.

Ex. 187 Calculate the missing amounts in the table.

Sales Operating income Average total assets Profit margin Asset turnover Return on assets

Acme Corp. $8,500,000 950,000 (a) (b) (c) 20%

Barker Limited (d) $280,000 (e) 7% (f) 14%

Connors Inc. (g) (h) $600,000 4% 3 times (i)

Acme Corp. $ 8,500,000 950,000

Barker Limited (d) $4,000,000 280,000

Connors Inc. (g) $1,800,000 (h) 72,000

Solution 187 (20 min.)

Sales Operating income

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Average total assets Profit margin Asset turnover Return on assets

(a) 4,750,000 (b) 11.2% (c) 1.8 times 20.0%%

(e) 2,000,000 7.0% (f) 2.0 times 14%

600,000 4.0% 3 times (i) 12.0%

Acme (a) $950,000 ÷ 20% = $4,750,000 (b) $950,000 ÷ $8,500,000 = 11.2% (c) $8,500,000 ÷ $4,750,000 = 1.8 times Barker (d) $280,000 ÷ 7% = $4,000,000 (e) $280,000 ÷ 14% = $2,000,000 (f) $4,000,000 ÷ $2,000,000 = 2.0 times Connors (g) $600,000 x 3 = $1,800,000 (h) $1,800,000 x 4% = $72,000 (i) $72,000 ÷ $600,000 = 12.0%

Ex. 188 Assuming that the ratios are initially positive, complete the following table to show the effect of the transactions on the ratios (I - increase; D - decrease; NE - no effect; X - can't determine). Assume all other items are unchanged. Profit Margin 1. Increase in net sales 2. Increase in average total assets 3. Decrease in profit margin due to decrease in net profit 4. Decrease in net profit 5. Decrease in asset turnover due to decrease in net sales

Return on Assets

Asset Turnover

Leave Blank Leave Blank

Solution 188 (20 min.)

1. Increase in net sales 2. Increase in average total assets 3. Decrease in profit margin due to decrease in profit 4. Decrease in profit 5. Decrease in asset turnover due to decrease in net sales

Profit Margin D X Leave Blank D

Return on Assets X D

Asset Turnover I D

NE Leave Blank

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MATCHING QUESTIONS SET 1 189. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Property, plant, and equipment Depreciation Carrying amount Residual value Straight-line method

F. G. H. I. J.

Units-of-production method Diminishing-balance method CCA or Capital Cost Allowance Operating 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. Results in an 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. Material expenditures that increase an asset's operating efficiency, productive capacity, or useful life.

____

9. The Canada Revenue Agency term for depreciation for income tax purposes.

____ 10. Method used if a vehicle is depreciated based on the kilometres driven.

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ANSWERS TO MATCHING SET 1 1.

10. F

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MATCHING QUESTIONS SET 2 190. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Development costs Loss on disposal Licences Revaluation model Asset turnover

F. G. H. I. J.

Return on assets Goodwill Impairment loss Intangible asset Research

____

1. The amount by which the carrying amount of an asset exceeds its recoverable amount.

____

2. Arise from the application of research to a plan or design for a new or improved product or process.

____

3. Examples are franchises and trademarks.

____

4. Under IFRS, alternative to the cost model.

____

5. Can be identified only with a business as a whole.

____

6. Operating rights to use property granted by a government agency.

____

7. When the carrying amount of an asset is greater than the proceeds received from its sale.

____

8. Original planned investigation done to gain new knowledge and understanding.

____

9. Calculated as profit divided by average total assets.

____ 10. Indicates how efficiently a company uses its total assets to generate sales.

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ANSWERS TO MATCHING SET 2 1.

10. E

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SHORT-ANSWER ESSAY QUESTIONS S-A E 191 Distinguish between a capital expenditure and an operating expenditure for cash outlays subsequent to acquisition of an asset. Give an example of each type. Explain how each type is recorded. Solution 191 An expenditure is classified as a capital expenditure if it increases (rather than maintains) the efficiency, productive capacity, or expected useful life of the asset, and therefore benefits more than one accounting period. Capital expenditures are usually large amounts that occur infrequently during the life of the asset. Overhauling a truck engine is an example. The cost is debited to the asset account. An expenditure is classified as an operating expenditure if it maintains the operating efficiency and expected productive life of the asset and primarily benefits the current accounting period only. Operating expenditures are usually for small amounts that occur frequently throughout the life of the asset and are often called ordinary repairs. An example is replacing the tires on a truck or repainting a building. The cost is debited to an expense account.

S-A E 192 In general, how does one determine whether or not an expenditure should be included in the acquisition cost of property, plant, and equipment? Solution 192 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.

S-A E 193 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.” Solution 193 This comment is not valid. Depreciation is the process of allocating to expense the cost of property, plant, and equipment over its useful (service) life in a systematic manner. Consider the journal entry to record depreciation: Debit Depreciation Expense and credit Accumulated Depreciation. There is no cash included in this journal entry so recognizing 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.

S-A E 194 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 such a method. Solution 194 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 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(as with computers). In such situations, an accelerated method would properly recognize depreciation expense.

S-A E 195 This year, Meadows Manufacturing Ltd. decided the useful life of one of their heavy machines should be extended to 15 years from the 10 years originally estimated when they purchased it six years ago. The machine is still operating well, and management sees no reason why it can’t be useful for the extra five years. The President, when instructing you (the Controller) to change the estimated useful life, says “I guess we’ll have to go back and correct the depreciation on the past six years’ income statements to reflect this new estimate. Ah well, with computer programs, I’m sure you’ll find the math quite easy.” Instructions Is the President correct is saying the previous six income statements will have to be corrected? If not, explain your reasoning. Solution 195 The President is correct in that the depreciation for this machine will have to be revised. However, since this change is the result of new information (and not the correction of an earlier error), this will be treated as a change in estimate. Changes in estimate are accounted for prospectively, that is, in the current and future periods only. Thus, it will not be necessary to go back and “correct” the previous years’ figures.

S-A E 196 What is a “significant component?” How does it affect calculation of depreciation? Solution 196 If a property, plant and equipment item has individual components for which different depreciation methods are appropriate, then the cost must be split between the components, and each component depreciated separately. For instance, a building will consist of the roof, walls, heating/cooling system, plumbing system, flooring, etc. If these components should be depreciated differently (e.g., over different lengths of time or with different methods) then they must be set up in separate accounts and depreciated separately. However, any components that can be depreciated by the same method and have similar useful lives can be grouped together.

S-A E 197 What is the difference between accounting depreciation and Capital Cost Allowance? Solution 197 Capital Cost Allowance (CCA) is the income tax “version” of depreciation. Accounting depreciation is not an expense for income tax purposes. Instead, all taxpayers are required to use the CCA rules for income tax purposes, regardless of the method of depreciation used for financial statements.

S-A E 198 Tackle-it Unlimited (TU) is a company specializing in the restoration of old homes. To showcase its work, TU purchased an old Victorian home in downtown Azilda for $125,000. A new heating and air-conditioning system was installed for $30,000. The house was completely rewired and re-plumbed at a cost of $50,000. Custom cabinets were added, and the floors and trim were refurbished to their original condition, all of which cost $75,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Long-Lived Assets

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The project was such a success, that TU decided to purchase another large home, this time in nearby Hanmer. A realtor offered to purchase the home in Azilda for $175,000. He plans to lease it as luxury short-term apartments for visiting dignitaries. TU 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 Velletta, does not believe that a loss is possible. "We sold that house for more than we paid for it," she said. "I know we put some money in it, but didn’t we take depreciation on it for three years? How in the world can we have a loss?" Instructions Write a short memo to Ms. Velletta explaining how it would be possible to have a loss. Do not try to use specific numbers. Solution 198 MEMO DATE: today TO:

Ms. Dale Velletta, President

FROM: Martha King, Accountant RE:

Loss on Azilda showcase house

I understand that you are concerned about the loss on the Azilda 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 asset to generate a loss when it is 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. 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 fair value; we'll still have to rely on real estate agents for that. Let me know if you have further questions. (signature)

S-A E 199 Discuss the differences between finite-life and indefinite-life intangibles. Solution 199 If an intangible asset has a finite life, its amortizable cost (cost less residual value) should be allocated over the shorter of the estimated useful (economic) life and the legal life.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Normally, the useful life of an intangible asset is the shorter period. Intangible assets are typically amortized on a straight-line basis. Examples of intangible assets with finite lives include patents and copyrights. If the life is indefinite, the asset is not amortized, but is tested annually for impairment. Examples of intangible assets with indefinite lives include trademarks and licences.

S-A E 200 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 their competition. 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 the case. 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, Tina Bianco, initially recorded the cash payments as "Loss from Lawsuit" and "Product Development," respectively. However, H. J. Franz, the controller, instructed Tina 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, and besides, there is no point in amortizing this cost.” Instructions (a) What are the ethical issues here? (b) What should Tina do? Solution 200 (a) The following are some of the ethical issues: • whether PRS should continue to obtain its information by the deceptive methods it has been using • whether PRS makes a practice of developing software based on observations made at competitor’s presentations • whether the attempt to hide the losses from the lawsuit and software agreement is indicative of the state of the accounting system at PRS (b) Tina should explain to her boss that goodwill arises only when a business is purchased. The second payment for $1.3 million could be viewed as part of the lawsuit costs (they would not have been paid if the lawsuit was won) and should also be expensed. On the other hand one could view that payment as the purchase of a license but further information would have to be obtained with regard to the Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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exact nature of this arrangement including its duration. She cannot allow her integrity to be compromised by mis-recording these economic events. She could also point out that Mr. Franz'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.

S-A E 201 Under International Financial Reporting Standards (IFRS), what are the requirements regarding presentation of long-lived assets? Solution 201 Normally, long-lived (non-current) assets are presented under such headings as Property, Plant and Equipment, Intangible Assets, and Goodwill. Note Goodwill must be presented separately as it is not considered to be an intangible asset. IFRS has extensive requirements regarding presentation. Either on the statement of financial position or in the notes, IFRS also requires disclosure of: 1. whether the entity is using the cost or revaluation model 2. cost and accumulated depreciation/amortization of each major asset class 3. reconciliation of the carrying amounts of major asset classes at the beginning and end of the period. Thus they must show additions, disposals and depreciation/amortization. 4. if the revaluation model is being used, any increases or decreases from revaluations must be disclosed 5. the policy on testing long lived assets for impairment. If there is any impairment loss recorded, a reconciliation of the impaired asset(s) must also be disclosed including any reversals of impairment losses incurred in the current year. On the income statement, depreciation/amortization expense, gains/losses from disposal, and impairment losses are all to be presented in the operating section.

S-A E 202 Jill Jinnah, the CEO of ProfitMax Inc., has just come back from a luncheon meeting at the Chamber of Commerce. She has come to talk to you, ProfitMax's Chief Accountant, about some of the items discussed at the luncheon. Jill tells you that there was a lot of talk about improving a company's performance with respect to its use of long-lived assets (property, plant, and equipment and intangibles). Some people seemed to think that asset turnover was the key while others thought return on assets was more important. One person commented that it was all just accounting numbers and that different depreciation or amortization methods and estimates could change it all anyway. She would like you to clarify these points for her. Instructions Prepare, in point form, the points you would make to clarify these items for Jill. Solution 202 • Asset turnover and return on assets are both useful in evaluating the use of long-lived assets. • Return on assets is an overall measure of profitability. It is calculated as profit divided by average total assets. • Asset turnover shows how efficiently a company is at generating sales with a given amount of assets. It is calculated as net sales divided by average total assets. • The key difference is that asset turnover considers only sales, while return on assets considers profitability. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Both ratios are useful. Depreciation and amortization policies and methods will affect both ratios because it will impact the average total assets. If depreciation or amortization is taken at a higher rate, net assets will be lower and the ratios will improve. For return on assets, the profit will also decrease if depreciation or amortization is taken at a higher rate.

CHAPTER 10 REPORTING AND ANALYZING LIABILITIES SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY Item SO LOD 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

1 1 1 1 1 1 1 1 1 1 1 1 1

M E M E E M E E M M M M M

64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74.

1 1 1 1 1 1 1 1 1 1 1

M H H M M E M H M M M

Note:

E = Easy

Item SO LOD Item SO LOD Item SO LOD True-False Statements 14. 1 M 27. 2 E 40. 3 E 15. 1 M 28. 2 M 41. 3 M 16. 1 E 29. 2 E 42. 3 E 17. 1 M 30. 2 M 43. 3 M 18. 2 E 31. 2 M 44. 3 E 19. 2 E 32. 2 M 45. 3 M 20. 2 E 33. 2 E 46. 3 E 21. 2 E 34. 2 M 47. 3 M 22. 2 35. 2 48. 3 M M E 23. 2 M 36. 2 M 49. 3 M 24. 2 M 37. 3 M 50. 3 M 25. 2 M 38. 3 M 51. 4 E 26. 2 M 39. 3 E 52. 4 M Multiple Choice Questions 75. 1 M 86. 2 H 97. 3 H 76. 1 M 87. 2 M 98. 3 H 77. 1 E 88. 2 H 99. 3 E 78. 2 M 89. 2 E 100. 4 M 79. 2 E 90. 2 M 101. 4 E 80. 2 E 91. 2 M 102. 4 M 81. 2 M 92. 3 E 103. 4 M 82. 2 M 93. 3 E 104. 4 M 83. 2 M 94. 3 M 105. 4 M 84. 2 H 95. 3 H 106. 4 M 85. 2 M 96. 3 H 107. 4 M M = Medium

Item SO LOD 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63.

4 4 4 4 4 4 4 4 4 4 4

M E M M M M M M H H E

108. 109. 110. 111. 112. 113. 114.

4 4 4 4 4 4 4

E M M M H H M

H = Hard

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVE AND LEVEL OF DIFFICULTY (CONTINUED) Item SO LOD

Item SO LOD

115. 116. 117. 118. 119.

1 1 1 1 1

120. 121. 122. 123. 124.

2 2 2 2 2

M E M M M

136.

1–4 E,M

137. 138.

1 1

139. 140.

2 4

E E

Note:

E = Easy

E M M E H

M E

M = Medium

Item SO LOD Exercises 125. 2 M 126. 2 H 127. 3 E 128. 3 M 129. 3 M Matching

Item SO LOD

130. 131. 132. 133. 134.

3 3 4 4 4

E M E M M

135.

Short-Answer Essay 141. 4 M 143. 142. 4 M

H = Hard

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type 1. 2. 3. 4. 5. 6.

TF TF TF TF TF TF

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

TF TF TF TF TF TF

13. 14. 15. 16. 17. 64.

18. 19. 20. 21. 22. 23.

TF TF TF TF TF TF

24. 25. 26. 27. 28. 29.

TF TF TF TF TF TF

30. 31. 32. 33. 34. 35.

37. 38. 39. 40.

TF TF TF TF

41. 42. 43. 44.

TF TF TF TF

45. 46. 47. 48.

51. 52. 53. 54. 55. 56.

TF TF TF TF TF TF

57. 58. 59. 60. 61. 62.

TF TF TF TF TF TF

63. 100. 101. 102. 103. 104.

Note: TF = True-False MC = Multiple Choice

Item Type Item Type Item Type Item Study Objective 1 TF 65. MC 71. MC 77. MC 136. TF 66. MC 72. MC 115. Ex 137. TF 67. MC 73. MC 116. Ex 138. TF 68. MC 74. MC 117. Ex TF 69. MC 75. MC 118. Ex MC 70. MC 76. MC 119. Ex Study Objective 2 TF 36. TF 83. MC 89. MC 123. TF 78. MC 84. MC 90. MC 124. TF 79. MC 85. MC 91. MC 125. TF 80. MC 86. MC 120. Ex 126. TF 81. MC 87. MC 121. Ex 136. TF 82. MC 88. MC 122. Ex 139. Study Objective 3 TF 49. TF 94. MC 98. MC 129. TF 50. TF 95. MC 99. MC 130. TF 92. MC 96. MC 127. Ex 131. TF 93. MC 97. MC 128. Ex 136. Study Objective 4 TF 105. MC 111. MC 134. Ex 143. MC 106. MC 112. MC 135. Ex MC 107. MC 113. MC 136. Ma MC 108. MC 114. MC 140. SAE MC 109. MC 132. Ex 141. SAE MC 110. MC 133. Ex 142. SAE

Ma = Matching Ex = Exercise

Type Ma SAE SAE

Ex Ex Ex Ex Ma SAE Ex Ex Ex Ma SAE

SAE = Short-answer Essay

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

CHAPTER STUDY OBJECTIVES 1.

Account for current liabilities. A current liability is a debt that will be paid (1) from existing current assets or through the creation of other current liabilities, and (2) within one year. An example of a current liability is an operating line of credit that results in bank indebtedness. Current liabilities also include sales taxes, payroll deductions, and employee benefits, all of which the company collects on behalf of third parties. Other examples include property taxes and interest on notes or loans payable, which must be accrued until paid. The portion of non-current debt that is due within the next year must be deducted from the total noncurrent debt and reported as a current liability. All of the above are “certain” or determinable liabilities. Contingent liabilities are “uncertain” liabilities awaiting confirmation by a future event that are not recorded unless probable. When recorded, these liabilities are called provisions. The terms and nature of each recorded provision and contingent liability should be described in the notes accompanying the financial statements.

Account for instalment notes payable. Long-term notes payable are usually repayable in a series of instalment payments. Each payment consists of (1) interest on the unpaid balance of the note, and (2) a reduction of the principal balance. These payments can be either (1) fixed principal payments plus interest or (2) blended principal and interest payments. With fixed principal payments plus interest, the reduction in principal is constant but the cash payment and interest expense decrease each period as the principal decreases. With blended principal and interest payments, the reduction of principal increases while the interest expense decreases each period. In total, the cash payment (principal and interest) remains constant each period.

Identify the requirements for the financial statement presentation and analysis of liabilities. In the income statement, interest expense (finance cost) is reported as “other revenues and expenses.” In the statement of financial position, current liabilities are usually reported first, followed by non-current liabilities. The liquidity of a company may be analyzed by calculating the current ratio, in addition to the receivables and inventory turnover ratios. The solvency of a company may be analyzed by calculating the debt to total assets and times interest earned ratios. Another factor to consider is unrecorded debt, such as operating lease obligations.

Account for bonds payable (Appendix 10A). Bonds are issued at their present (market) value. When they are issued, the Cash account is debited and the Bonds Payable account is credited for the issue price of the bonds. Bond discounts and bond premiums represent the difference between a bond’s face value and present value. They are amortized to interest expense over the life of the bond using the effective-interest method of amortization. Amortization is calculated as the difference between the interest paid and the interest expense. Interest paid is calculated by multiplying the bonds’ face value by the coupon interest rate. Interest expense is calculated by multiplying the bonds’ carrying amount (which is equal to their present value at that time) at the beginning of the interest period by the market interest rate. The amount of the discount or premium that is amortized is equal to the change in the present value of the bond during

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that period. The amortization of a bond discount increases interest expense and the bond’s carrying amount. The amortization of a bond premium decreases interest expense and the bond’s carrying amount. When bonds are retired at maturity, Bonds Payable is debited and Cash is credited. There is no gain or loss at retirement.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

TRUE-FALSE STATEMENTS 1. Amounts available to be drawn in the future from an operating line of credit improve a company’s liquidity.

2. Property tax payable is classified as a non-current liability because it is related to property, which is a non-current asset. 3. If a company’s fiscal year is the same as the calendar year used for property tax purposes, there should be no prepaid property tax on its year-end financial statements but there may be a property tax liability.

4. Notes payable usually require the borrower to pay interest.

5. Notes payable are sometimes used instead of accounts payable.

6. If interest is due at maturity, a $50,000, 4%, 9-month note payable requires an interest payment of $1,500.

7. Most notes and bank loans are not interest bearing.

8. If drawing on an operating line of credit results in a negative cash balance, a current liability known as bank indebtedness results.

9. Interest expense on a bank loan payable is only recorded at maturity.

10. When a business sells an item and collects Harmonized Sales Tax (HST) on it, a current liability arises. 11. Payroll liabilities include the employer’s share of CPP contributions and EI premiums.

12. If any portion of a non-current liability is to be paid in the next year, the entire debt should be classified as a current liability. 13. “Current maturities of non-current debt” refers to the amount of interest on notes payable that must be paid in the current year.

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14. Even though current and non-current debt must be shown separately on the statement of financial position, it is not necessary to prepare a journal entry to recognize this.

15. Provisions are liabilities of uncertain timing or amount, along with some uncertainty as to whether the liability will have to be paid.

16. A contingent liability may materialize in the future because of something that happened in the past.

17. Under IFRS, contingent liabilities should be recorded in the accounts if there is a remote possibility that the contingency will actually occur.

18. A mortgage payable is often secured by collateral such as a building.

19. All long-term notes payable must be secured.

20. A financial liability means there is a contractual obligation to pay cash in the future.

21. While short-term notes are generally repayable in full at maturity, most long-term notes are repayable in a series of periodic payments called instalments.

22. With fixed principal payments on a long-term note payable, the principal portion increases each period.

23. With fixed principal payments on a long-term note payable, the interest portion decreases each period.

24. With fixed principal payments on a long-term note payable, the interest portion does not change each period.

25. With blended principal and interest payments, the equal periodic payments result in the interest portion increasing each period.

26. With blended principal and interest payments, the equal periodic payments result in the principal portion increasing each period.

27. A non- current liability is an obligation that is expected to be paid within one year.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

28. Unearned revenue is a financial liability.

29. Long term notes payable are a common form of debt financing.

30. Long term notes payable can only have floating interest rates.

31. Secured notes are also known as mortgages.

32. Unsecured notes are issued against the general credit of the borrower.

33. Instalments are always paid monthly.

34. Instalment payments consist of a mix of interest on the unpaid balance of the loan and a reduction of the loan principal.

35. Instalment notes with fixed principal payment are repayable in equal periodic amounts which include interest.

36. Since a portion of the principal is repaid each month, the outstanding balance will increase each month.

37. The classification of a liability as current or non-current is important because it may affect the evaluation of a company’s liquidity.

38. The debt to total assets ratio measures the percentage of the total assets provided by creditors.

39. The times interest earned ratio is calculated by dividing net profit by interest expense.

40. Current liabilities are generally presented on the statement of financial position in order or liquidity, but IFRS allows presentation in reverse order of liquidity as well. 41. “Off-balance-sheet financing” refers to a situation where liabilities are recorded in the income statement instead of the statement of financial position.

Reporting and Analyzing Liabilities

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42. Interest (finance) expenses are separately reported in the “other gain and revenues” section of the income statement.

43. The terms of an operating line of credit and a notes (loans) payable are disclosed in the notes to the financial statements.

44. Current liabilities are listed in order of descending dollar value.

45. All companies are prohibited to report current liabilities in reverse order of liquidity.

46. Full disclosure of non- current debt is very important.

47. Detailed information such as a list showing the amounts of non current debt that is scheduled to be paid off in each of the next five years should be disclosed in the notes to the financial statements. 48. Liquidity ratios measure a company’s long term ability to pay debt. 49. Solvency ratios measure a company’s ability to repay current debt.

50. A high liquidity ratio generally indicates that a company has a greater ability to meet its current obligations.

51. Bonds are often traded on an organized exchange, such as the Toronto Stock Exchange (TSX).

52. The face value of a bond is the amount of principal and interest due at the maturity date.

53. If a bond has a face value of $10,000 and a 6% coupon interest rate, then the semi-annual interest payment will be $600.

54. If bonds are redeemable, they can be retired by the issuer before they mature.

55. All transactions between bondholders and other investors must be recorded by the issuing corporation.

56. The carrying amount of bonds issued at a discount will initially be higher than the face value.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

57. The calculation of interest to be paid each interest period for a bond payable is not influenced by any premium or discount upon issue.

58. If $150,000 face value bonds are issued at 102.5, the proceeds received will be $102,500.

59. If the market interest rate at the date of a bond issue is greater than the coupon interest rate, the bond will be issued at a premium.

60. If bonds are issued at a discount, the issuing corporation will pay a principal amount that is less than the face amount of the bonds on the maturity date.

61. Amortization of a bond premium decreases interest expense recorded by the issuer.

62. The carrying amount of a bond is its face value less any unamortized premium or plus any unamortized discount.

63. The effective-interest method is required for companies reporting under IFRS, but optional for companies using ASPE if other methods do not result in material differences.

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7. 8. 9.

Ans. T F T T T T F T F

Item 10. 11. 12. 13. 14. 15. 16. 17. 18.

Ans. T T F F T F T F T

Item 19. 20. 21. 22. 23. 24. 25. 26. 27.

Ans. F T T F T F F T F

Item 28. 29. 30. 31. 32. 33. 34. 35. 36.

Ans. F T F T T F T F F

Item 37. 38. 39. 40. 41. 42. 43. 44. 45.

Ans. T T F T F F T F F

Item 46. 47. 48. 49. 50. 51. 52. 53. 54.

Ans. T T F F T T F F T

Item 55. 56. 57. 58. 59. 60. 61. 62. 63.

Ans. F F T F F F T F T

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 64. Under IFRS, which of the following would most likely be classified as a current liability? (a) mortgage payable (b) bonds payable (c) bank indebtedness (d) contingent liability

65. Failure to record a liability will probably (a) result in overstated profit. (b) result in overstated total liabilities and shareholders’ equity. (c) have no effect on profit. (d) result in overstated total assets.

66. Killarney Exhibits Inc. received its annual property tax bill for $21,500 in January. It was paid when due on March 31. Killarney Exhibits year end is Dec 31. The Dec 31 balances should be (a) $5,375 for Prepaid Property Tax; $16,125 for Property Tax Expense. (b) $5,375 for Prepaid Property Tax; $5,375 for Property Tax Payable. (c) $0 for Prepaid Property Tax; $0 for Property Tax Payable. (d) $1,792 for Prepaid Property Tax; $19,708 for Property Tax Expense. 67. Roofer’s Inc. had an operating line of credit of $100,000 and overdrew its bank balance to result in a negative cash balance of $33,000 at year-end. This would be reported in the statement of financial position as (a) a current liability of $33,000. (b) a non-current liability of $67,000. (c) a current asset of $67,000. (d) a current asset of $(33,000).

68. Interest expense on a note payable, with interest due at maturity, is (a) always equal to zero. (b) accrued over the life of the note. (c) only recorded at the time the note is issued. (d) only recorded at maturity when the note is paid.

Use the following information for questions 69–70. On January 1 of this year, Gertoni Lenders agrees to lend Ester Corp. $150,000. Ester Corp. signs a $150,000, 6%, 9-month loan. Interest is due at maturity.

69. The entry made by Ester Corp. on January 1 to record the receipt of the loan is (a) Interest Expense ........................................................................... 6,750 Cash ............................................................................................. 145,500

Reporting and Analyzing Liabilities

Bank Loan Payable ................................................................ (b) Cash ............................................................................................. Bank Loan Payable ................................................................ (c) Cash ............................................................................................. Interest Expense ........................................................................... Bank Loan Payable ................................................................ (d) Cash ............................................................................................. Interest Expense ........................................................................... Bank Loan Payable ................................................................ Interest Payable .....................................................................

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150,000 150,000 150,000 150,000 6,750 156,750 150,000 6,750 150,000 6,750

70. What entry will Ester Corp. make to repay the loan on September 30, assuming no further adjusting entries have been made since June 30? (a) Bank Loan Payable ....................................................................... 156,750 Cash....................................................................................... 156,750 (b) Bank Loan Payable ....................................................................... 150,000 Interest Payable ............................................................................ 6,750 Cash....................................................................................... 156,750 (c) Interest Expense ........................................................................... 3,375 Bank Loan Payable ....................................................................... 150,000 Cash....................................................................................... 153,375 (d) Interest Payable ............................................................................ 4,500 Bank Loan Payable ...................................................................... 150,000 Interest Expense ........................................................................... 2,250 Cash....................................................................................... 156,750

Use the following information for questions 71–72. On October 1, 2015, Mekhi’s Golf Service Limited borrows $80,000 from Rigor Bank by signing a 3-month, $80,000, 4% bank loan. Interest is due the first of each month.

71. What adjusting entry is required at December 31, 2015? (a) Interest Payable ............................................................................ Interest Expense .................................................................... (b) Interest Expense ........................................................................... Interest Payable ..................................................................... (c) Interest Expense ........................................................................... Interest Payable ..................................................................... (d) Interest Expense ........................................................................... Bank Loan Payable ................................................................

800 800 800 800 267 267 267 267

72. The entry by Mekhi’s Golf Service to record payment of the loan and accrued interest on January 1, 2016 is (a) Bank Loan Payable ....................................................................... 83,200 Cash....................................................................................... 83,200 (b) Bank Loan Payable ....................................................................... 80,000 Interest Payable ............................................................................ 267

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Cash....................................................................................... (c) Bank Loan Payable ....................................................................... Interest Payable ............................................................................ Cash....................................................................................... (d) Bank Loan Payable ....................................................................... Interest Expense ........................................................................... Cash.......................................................................................

80,267 80,000 800 80,800 80,000 800 80,800

73. A customer paid a total of $8,960 for a purchase, including 13% HST (Harmonized Sales Tax). How much was the HST? (a) $8,960 (b) $8,000 (c) $1,075 (d) $1,031

74. On January 1, 2015, Junction Limited, a calendar-year company, issued $160,000 of notes payable, of which $65,000 is due on January 1 for each of the next four years. The proper statement of financial position presentation on December 31, 2015, is (a) Current Liabilities, $160,000. (b) Non-current Liabilities, $160,000. (c) Current Liabilities, $65,000; Non-current Liabilities, $95,000. (d) Current Liabilities, $95,000; Non-current Liabilities, $65,000.

75. Harmonized Sales Tax (HST) collected by a retailer are expenses (a) of the retailer. (b) of the customers. (c) of the government. (d) that are not recognized by the retailer until they are submitted to the government.

Use the following information to answer questions 76–77. The following totals for the month of April were taken from the payroll register of Yandeau Corp.: Gross salaries ................................. $19,500 CPP withheld .................................. 965 Income taxes withheld ..................... 4,200 Medical insurance deductions ......... 675 EI withheld ...................................... 347 Union dues withheld ........................ 324

76. The journal entry to record payment of the net payroll would include a (a) debit to Salaries Payable for $12,989. (b) debit to Salaries Payable for $15,300. (c) debit to Salaries Payable for $19,500. (d) credit to Cash for $19,500.

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77. The journal entry to record the accrual of the employee’s portion of Canada Pension Plan (CPP) would include a (a) credit to CPP Payable of $965. (b) debit to CPP Expense of $965. (c) credit to Employee Benefits Expense of $965. (d) debit to CPP Payable of $965.

78. When a long-term note payable with a fixed interest rate has fixed principal payments, it means that (a) the periodic payment amount is fixed. (b) the periodic payment increases over time. (c) the periodic payment decreases over time. (d) no conclusion can be made on the periodic payment.

79. A financial liability is a (a) contractual obligation to receive cash in the future. (b) contractual obligation to pay cash in the future. (c) contractual obligation to issue common shares in the future. (d) contractual obligation to issue a mortgage payable.

80. Interest rates on notes and loans are usually stated as a(n) (a) monthly rate. (b) daily rate. (c) semi-annual rate. (d) annual rate.

81. A long-term note may be secured by a document called a (a) premium. (b) debenture. (c) bond. (d) mortgage.

82. As blended principal and interest payments are made on a long-term loan, (a) the interest portion increases and the principal portion decreases. (b) the interest and principal portions remain the same. (c) the interest portion decreases and the principal portion increases. (d) both the interest portion and the principal portion decrease.

83. A five-year, 6%, $47,000 note payable is issued on January 1. Terms include fixed annual principal payments of $9,400, plus interest on the outstanding balance. The entry to record the first instalment payment will include a (a) debit to Notes Payable of $9,400. (b) credit to Interest Expense of $2,820. (c) credit to Notes Payable of $12,220. (d) debit to Cash of $9,400.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

84. On March 1, Brutto Corp. issues a 3 year 5%, $60,000 note payable. The terms of the note include monthly blended principal and interest payments of $1,799. The entry to record the second instalment payment will include a (a) debit to Notes Payable of $1,555. (b) debit to Cash of $1,799. (c) debit to Interest Expense of $250. (d) credit to Interest Expense of $244.

85. On March 2, Conroy and Conrad Inc. obtained a loan for $120,000 for 5 years at 7%. Payments are $2,000. What type of loan is this considered to be? a) fixed principal payments b) blended principal payments c) floating principal payments d) prime principal payments

86. One example of a liability that is not a financial liability is a) notes payable. b) unearned revenue. c) bonds payable. d) financial lease.

87. Long term notes may have a) fixed rates of interest only. b) floating interest rates only. c) no interest rates. d) fixed or floating interest rates.

88. With fixed principal payments, the interest ___ each period as the principal ___. a) decreases, decreases b) increases, increases c) increases, decreases d) decreases, increases

89. Instalments can be paid a) monthly. b) quarterly. c) semi annually. d) all of the above.

90. Fixed principal payments and interest are repayable in a) equal periodic amounts plus interest. b) varying periodic amounts plus interest. c) equal periodic amounts including interest.

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d) varying periodic amounts including interest.

91. Blended principal and interest payments are repayable in a) equal periodic amounts plus interest. b) varying periodic amounts plus interest. c) equal periodic amounts including interest. d) varying periodic amounts including interest.

92. The relationship between current assets and current liabilities is (a) useful in determining profitability. (b) useful in evaluating a company’s liquidity. (c) useful in evaluating a company’s solvency. (d) useful in determining the amount of a company’s non-current debt.

93. Liquidity ratios measure a company's (a) operating cycle. (b) revenue-producing ability. (c) short-term debt-paying ability. (d) long-range solvency.

94. A measure of a company's solvency is the (a) inventory turnover ratio. (b) current ratio. (c) times interest earned ratio. (d) asset turnover ratio.

95. The times interest earned ratio is calculated by dividing (a) profit by interest expense. (b) profit plus income tax expense by interest expense. (c) profit plus interest expense by interest expense. (d) profit plus interest expense plus income tax expense by interest expense. 96. Last year, Mocha’s Coffee Shop Inc.’s income statement reported the following: profit, $227,500; interest expense, $45,000; and income tax expense, $78,475. The company’s times interest earned ratio is (a) 7.8 times. (b) 6.2 times. (c) 5.8 times. (d) 4.5 times.

97. Under IFRS, if a company can determine a reasonable estimate of an expected loss from a lawsuit and it is probable it will lose the suit, it should (a) disclose the basic facts regarding the suit in the notes to its financial statements. (b) accrue the loss.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

98. Under ASPE, a contingent liability is recorded in the accounting records (a) if it is likely that a future event will confirm that a liability has been incurred and the amount of the related loss can be estimated. (b) if the contingency has not already been disclosed in the notes to the financial statements. (c) if the amount can be estimated, but the possibility of occurrence is remote. (d) under no circumstances.

99. Off-balance sheet financing usually is found in connection with (a) finance leases. (b) operating leases. (c) both finance and operating leases. (d) neither finance nor operating leases.

100. On March 1, Brutto Corp. issues a 3 year, 5%, $60,000 note payable. The terms of the note include monthly blended principal and interest payments of $1,799. The entry to record the first instalment payment will include a (a) debit to Notes Payable of $1,799. (b) debit to Cash of $1,799. (c) credit to Interest Expense of $3,000. (d) debit to Interest Expense of $250.

101. Bonds that are subject to retirement at a stated dollar amount prior to maturity at the option of the issuer are called (a) early retirement bonds. (b) redeemable bonds. (c) options. (d) debentures.

102. A bond with a face value of $100,000 and a quoted price of 102.25 would have a selling price of (a) $ 97,800. (b) $100,000. (c) $102,250. (d) $122,250.

103. If the market interest rate is 4.5%, a $100,000, 5.6%, 10-year bond that pays interest semiannually would sell at an amount (a) less than face value. (b) equal to the face value. (c) greater than face value. (d) that cannot be determined.

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104. $8 million, 6%, 10-year bonds are issued at less than face value. Interest will be paid semiannually. When calculating the market price of the bond, the present value of (a) $480,000 received for 10 periods must be calculated. (b) $240,000 received for 10 periods must be calculated. (c) $240,000 received for 20 periods must be calculated. (d) $480,000 received for 20 periods must be calculated.

105. $5 million, 8%, 10-year bonds are issued when the market rate is 6%. Interest will be paid semi-annually. When calculating the issue price of the bond, the interest rate to be used to calculate the present value of the face amount and the present value of the periodic interest payments is (a) 8%. (b) 6%. (c) 4%. (d) 3%.

106. The market interest rate is often called the (a) stated interest rate. (b) effective interest rate. (c) contractual interest rate. (d) coupon interest rate.

107. When bonds are issued at a premium, the total interest cost of the bonds over the life of the bonds is equal to the amount of the (a) interest paid over the life of the bond. (b) interest paid over the life of the bond plus the amount of premium amortized. (c) interest paid over the life of the bond minus the amount of premium amortized. (d) premium.

108. The carrying amount of a bond not issued at face value will always move (a) towards the face value. (b) away from the face value. (c) upwards. (d) downwards.

109. For bond amortization, private companies reporting under ASPE (a) must use the effective-interest method. (b) are not allowed to use the effective-interest method. (c) may use any amortization method they wish, as long as the results do not differ materially from the effective-interest method. (d) may use any amortization method they wish, regardless of the results.

110. The journal entry to record the issue of bonds at a discount will include a (a) debit to Cash for the face amount of the bonds.

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(b) debit to Cash for the face amount of the bonds plus the amount of the discount. (c) debit to Cash for the face amount of the bonds minus the amount of the discount. (d) credit to Cash for the face amount of the bonds.

Use the information below to answer questions 111–113. Sail and Sink Inc. issues $425,000 of 6%, 5-year bonds for cash proceeds of $390,529. The market interest rate is 8%. Interest is paid semi-annually.

111. To the nearest dollar, how much bond interest expense is recorded on the first interest date? (a) $12,750 (b) $15,621 (c) $17,000 (d) $2,871

112. To the nearest dollar, what is the carrying amount of the bonds after the first interest payment? (a) $395,600 (b) $ 387,658 (c) $ 393,400 (d) $ 425,000

113. What is the total interest cost over the life of the bonds? (a) $127,500 (b) $34,471 (c) $ 255,000 (d) $161,971

114. When a bond is issued at a discount, the amount of interest expense for an interest period is calculated by (a) multiplying the carrying amount times the market interest rate. (b) multiplying the carrying amount times the coupon interest rate. (c) multiplying the face amount of the bonds by the coupon interest rate. (d) multiplying the face amount of the bonds by the market interest rate.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 64. 65. 66. 67. 68. 69. 70. 71.

Ans. c a c a b b d c

Item Ans. 72. b 73. d 74. c 75. b 76. a 77. a 78. c 79. b

Item 80. 81. 82. 83. 84. 85. 86. 87.

Ans. d d c a a b b d

Item Ans. 88. a 89. d 90. a 91. c 92. b 93. c 94. c 95. d

Item 96. 97. 98. 99. 100. 101. 102. 103.

Ans. a a a b d b c c

Item 104. 105. 106. 107. 108. 109. 110. 111.

Ans. c d b c a c c b

Item 112. 113. 114.

Ans. c d a

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 115 Your friend, Malaya Claire, recently opened a retail shoe store. She knows she needs to pay sales tax but isn't sure how much. The GST and PST are calculated by the cash register. The GST rate is 5% and the PST rate is 8%. Sales, before taxes, for the first month of operations based on the cash register reports were $125,000. All sales are for cash, debit card, or bank credit card. Cost of goods sold is 50% of sales and a perpetual inventory system is used. Instructions (a) Calculate the amount of GST and PST. (b) Prepare the journal entry to record the sales and sales taxes, and cost of goods sold. Solution 115 (10–15 min.) (a) GST: $125,000 × 5% = $ 6,250 PST: $125,000 × 8% = $10,000 (b) Cash ............................................................................................. Sales Tax Payable ($6,250 + $10,000)................................... Sales Revenue .......................................................................

141,250

Cost of Goods Sold ($125,000 × 50%) .......................................... Inventory ................................................................................

62,500

16,250 125,000

62,500

Ex. 116 On April 1, Aces Corporation borrows $160,000 from Rigor Bank by signing an 8-month, 3%, bank loan. Interest is due at maturity. Instructions Prepare the entries listed below associated with the bank loan on the books of Aces Corporation. Its year end is June 30. (a) The entry on April 1 when the loan was received. (b) Any adjusting entries necessary on June 30. Assume no other interest accrual entries have been made. (c) The entry to record repayment of the loan at maturity. Solution 116 (10 min.) (a) Apr 1 Cash ........................................................................... Bank Loan Payable ..............................................

160,000

Interest Expense ($160,000  3%  3/12) ................... Interest Payable ...................................................

1,200

Bank Loan Payable ..................................................... Interest Payable .......................................................... Interest Expense ($160,000 x 3% x 5/12).................... Cash ....................................................................

160,000 1,200 2,000

(b) Jun 30

160,000

1,200

163,200

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Ex. 117 On June 1, Babar Corporation borrows $40,000 from the bank by signing a 2-month, 4.5%, bank loan. Interest is due at the beginning of each month, commencing July 1. Instructions Prepare the entries listed associated with the bank loan on the books of Babar Corporation. (a) Prepare the entry on June 1 when the loan was received. (b) Prepare any adjusting entries necessary on June 30 in order to prepare the monthly financial statements. Assume no other interest accrual entries have been made. (c) Prepare the entry to record the payment of the interest on July 1. (c) Prepare the entry to record repayment of the loan at maturity on August 1. Solution 117 (10 min.) (a) Jun 1 Cash ........................................................................... Bank Loan Payable ..............................................

40,000

Interest Expense ($40,000  4.5% x 1/12) .................. Interest Payable ...................................................

150

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

150

Bank Loan Payable ..................................................... Interest Expense ($40,000  4.5% x 1/12) .................. Cash ....................................................................

40,000 150

(b) Jun 30

(d) Aug 1

40,000

150

40,150

Ex. 118 Marlboro Corporation had cash sales of $90,000 for the month of June. Sales are subject to 13% harmonized sales tax (HST). Prepare the entry to record the sales. Solution 118 (5 min.) Cash ............................................................................................. Sales Revenue ....................................................................... Sales Tax Payable ($90,000 x 13%).......................................

101,700 90,000 11,700

Ex. 119 Fantastic Fashions has just completed its first quarter of operations. Below are transactions that have not yet been recorded. Prepare the journal entries listed below. Jan 1 Pre-tax cash sales amounted to $75,000. HST is collected on all sales at a rate of 13%. Jan 15 Signed a three month note for $12,000 to extend amounts owing on account to Trendy Taste Inc. Interest is 6% annually and due at maturity. Mar 1 Received the annual property tax bill for $7,500 payable on June 1. Apr 1 Paid salaries of $10,000; of this amount $495 is CPP, $178 is EI and $3,465 is for income taxes (record the employer portion as well).

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Apr 15 Paid the note due. Apr 29 A customer sued Fantastic Fashions for $200,000. Legal counsel has advised that it is unlikely damages will be awarded. Jun 1 Paid the property taxes bill in full. Solution 119 Jan 1

Cash ($75,000 + $9,750) ........................................................ Sales ............................................................................... Sales Tax Payable ( $75,000 x 13%) ...............................

84,750

Jan 15 Accounts Payable—Trendy Taste Inc..................................... Notes Payable—Trendy Taste Inc. ..................................

12,000

Mar 1

Property Tax Expense ($7,500 x 2/12) ................................... Property Tax Payable ......................................................

1,250

Salaries expense .................................................................... CPP Payable ................................................................... EI Payable ....................................................................... Income Tax Payable ........................................................ Cash ................................................................................

10,000

Employee benefit expense ..................................................... CPP Payable ................................................................... EI Payable .......................................................................

744

Apr 15 Notes Payable ........................................................................ Interest Expense (12,000 x 6% x 3/12) ................................... Cash ................................................................................

12,000 180

Apr 1

75,000 9,750

12,000

1,250

495 178 3,465 5,862

495 249

12,180

Apr 29 No provision should be recorded or contingent liability disclosed because the probability of a loss is not probable or possible. Jun 1

Property Tax Payable ............................................................. Property Tax Expense ($7,500 x 3/12) ................................... Prepaid Property Tax ($7,500 x 7/12) ..................................... Cash ................................................................................

1,250 1,875 4,375 7,500

Ex. 120 On December 31, 2015, Industrial Exporters issues a $365,000, 6%, 20-year mortgage. The terms require monthly payments of $2,615 (principal and interest – blended payment). Instructions Prepare the journal entry for Jan 31, 2016 to record the first monthly payment. Include your calculations. Solution 120 (5 min.) Jan 31 Interest Expense..............................................................

1,825

Reporting and Analyzing Liabilities

Mortgage Payable ........................................................... Cash ......................................................................... To record mortgage payment

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790 2,615

Calculations: $365,000  6% x 1/12 = $1,825 interest $2,615 – $1,825 = $790 principal repayment

Ex. 121 On January 1, 2015, Pardeep Inc. issues a $240,000, 5%, 10-year note payable. The terms require semi-annual fixed principal payments of $12,000 plus applicable interest. Instructions: Prepare the journal entry at Dec 31, 2015 to record the second semi-annual payment. Include your calculations. Solution 121 Dec. 31 Interest Expense [($240,000 – $12,000)  5% x 6/12] ..... Notes Payable ................................................................. Cash ......................................................................... To record note payment

5,700 12,000 17,700

Ex. 122 On December 31, 2015, Rabin Realty Limited issues a 10-year, 6%, $200,000 mortgage payable to finance the construction of a building. The terms provide for monthly instalment payments at the end of each month, commencing January 31, 2016. Instructions (a) Record the issue of the mortgage payable on December 31, 2015. (b) Record the first two instalment payments on January 31, 2016 and February 28, 2016, assuming the payment is (1) a fixed principal payment of $1,667, and (2) a blended principal and interest payment of $2,220. Round your answers to the nearest dollar. Solution 122 (a) Dec 31, 2015

(b) (1) Jan 31, 2016

Feb 28, 2016

Cash ........................................................................... Mortgage Payable ................................................

200,000

Mortgage Payable ....................................................... Interest Expense ($200,000 x 6% x 1/12).................... Cash ($1,667 + $1,000) .......................................

1,667 1,000

Mortgage Payable ....................................................... Interest Expense [($200,000 – $1,667) x 6% x 1/12] ... Cash ($1,667 + $992) ..........................................

1,667 992

200,000

2,667

2,659

(b) (2)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Jan 31, 2016

Feb 28, 2016

Mortgage Payable ($2,220 – $1,000) .......................... Interest Expense ($200,000 x 6% x 1/12).................... Cash ....................................................................

1,220 1,000

Mortgage Payable ($2,220 – $994) ............................. Interest Expense [($200,000 – $1,220) x 6% x 1/12] ... Cash ....................................................................

1,226 994

2,220

Ex. 123 The following instalment payment schedule is for a long-term instalment mortgage payable: Interest Period Cash Payment Interest Expense Reduction of Principal Principal Balance Issue date $120,000.00 1 $28,487.57 $7,200.00 $21,287.57 98,712.43 2 28,487.57 $5,922.75 22,564.82 76,147.61 3 28,487.57 $4,568.86 23,918.71 52,228.89 4 28,487.57 $3,133.73 25,353.84 26,875.06 5 28,487.57 $1,612.50 26,875.06 0.00

Instructions (a) Is this a fixed principal or blended principal and interest payment schedule? (b) Assuming payments are made annually, what is the interest rate on the mortgage? (c) Prepare the journal entry to record the first instalment payment. (d) What are the current and non-current portions of the mortgage at the end of period 1? Solution 123 (a) This is a blended interest and payment schedule. Note that the cash payment is constant each period while the interest and principal amounts change. (b) The annual interest rate is 6% ($7,200 ÷ $120,000). (c) Mortgage Payable ......................................................................... 21,287.57 Interest Expense ........................................................................... 7,200.00 Cash....................................................................................... 28,487.57 (d) Current portion = $22,564.82 Non-current portion = $76,147.61 Total liability = $22,564.82 + $76,147.61 = $98,712.43

Ex. 124 On January 1, Wonder Water borrowed $300,000 for 5 years at 4.5% to finance expansion. Fixed Principal Payments are to be made quarterly beginning Mar 1. Below is an instalment schedule for Wonder Water.

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WONDER WATER INSTALMENT PAYMENT SCHEDULE- FIXED PRINCIPAL PAYMENTS Interest Period Jan 1 Mar 1 Jun 1 Sep 1 Dec 1

Cash Pmt ? 8,320 ? ?

Interest Expense

Reduction of Principal

3,375 ? 3,263 ?

5,000 5,000 ? 5,000

Principal 300,000 295,000 ? 285,000 ?

Instructions (a) Determine the missing values (round to the nearest dollar). (b) Prepare the journal entries for the payments made on March 1 and Sept 1. Solution 124 (a) Interest Period Jan 1 Mar 1 Jun 1 Sep 1 Dec 1

Cash Pmt

Interest Expense

8,375 (1) 8,319 8,263 (4) 8,206 (6)

3,375 3,319 (2) 3,263 3,206 (5)

Reduction of Principal 5,000 5,000 5,000 5,000

Principal 300,000 295,000 290,000 (3) 285,000 280,000 (7)

(1) $300,000 x 4.5% x 3/12 = $3,375; $3,375 + $5,000 = $8,375 (2) $295,000 x 4.5% x 3/12 = $3,319 (3) $295,000 – $5,000 = $290,000 (4) $5,000+ $3,263 = $8,263 (5) $285,000 x 4.5% x 3/12 = $3,206 (6) $3,206 +$5,000 = $8,206 (7) $285,000 – $5,000 = $280,000 (b) Mar 1

Sep 1

Interest Expense .................................................................... Loan Payable ......................................................................... Cash ................................................................................

3,375 5,000

3,263 5,000

8,375

8,263

Ex. 125 On January 1, Marvelous Metals borrowed $1,200,000 at 7% for 15 years to begin the development of a new mine. Blended Principal Payments must be made on the first day of each month. Instructions

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(a) Complete the instalment schedule listed below (round to the nearest dollar). (b) Assuming the year end is March 31, prepare the necessary adjusting entry. (c) Prepare the journal entries for the payments made on May 1 and June 1. MARVELOUS METALS INSTALMENT PAYMENT SCHEDULE- BLENDED PRINCIPAL PAYMENTS Interest Period Jan 1 Feb 1 Mar 1 Apr 1 May 1 Jun 1

Cash Pmt

Interest Expense (D x 7% x 1/12)

Reduction of Principal

? ? 6,956 ? ?

3,785 3,807 ? ? ?

Interest Expense (D x 7% x 1/12)

Reduction of Principal

7,000 (1) 6,978 (2) 6,956 6,933 (6) 6,911 (8)

3,785 3,807 3,829 (4) 3,852 (7) 3,874 (9)

10,785 ? 10,785 10,785 ?

Principal 1,200,000 1,196,215 ? ? 1,184,727 ?

Solution 125 (a) Interest Period Jan 1 Feb 1 Mar 1 Apr 1 May 1 Jun 1

Cash Pmt 10,785 10,785 10,785 10,785 10,785

Principal 1,200,000 1,196,215 1,192,408 (3) 1,188,579 (5) 1,184,727 1,180,853 (10)

(1) $1,200,000 x 7% x 1/12 = $7,000 (2) $1,196,215 x 7% x 1/12 = $6,978 (3) $1,196,215 – $3,807 = $1,192,408 (4) $10,785 – $6,956 = $3,829 (5) $1,192,408 – $3,829 = $1,188,579 (6) $1,188,579 x 7% x1/12 = $6,933 (7) $10,785 – $ 6,933 = $3,852 (8) $1,184,727 x 7% x 1/12 = $6,911 (9) $10,785 – $6,911 = $3,874 (10) $1,184,727 – $3,874 = $1,180,853 (b) Mar 31 Interest Expense .................................................................... Interest Payable............................................................... (c) May 1

Jun 1

6,956 6,956

Interest Expense .................................................................... Bank Loan Payable ................................................................ Cash ................................................................................

6,933 3,852

Interest Expense ....................................................................

6,911

10,785

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

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3,874 10,785

Ex. 126 On January 1, 2015 Calcium Inc. has the following two alternatives in regards to financing: Loan A – $210,000, 4.5% for 5 years. Fixed Principal Payments of $21,000 due semi-annually on June 30 and December 31. Loan B – $210,000, 4.5% for 5 years. Blended Principal Payments of $23,685 due semiannually on June 30 and December 31. Instructions (a) Prepare an instalment schedule for each alternative for June 30, and Dec 31. (b) Which alternative will reduce the principal on the loan quicker in year 1? (c) Which alternative will report the least interest expense on the income statement in year 1? (d) If Calcium wanted to increase net income which alternative would you recommend? Solution 126 (a) CALCIUM INC. INSTALMENT PAYMENT SCHEDULE- FIXED PRINCIPAL PAYMENTS (LOAN A) Interest Period Jan 1 Jun 30 Dec 31 Totals

Cash Pmt

Interest Expense (D x 4.5% x 6/12)

Reduction of Principal

25,725 25,253 50,978

4,725 4,253 8,978

21,000 21,000 42,000

Principal 210,000 189,000 168,000

CALCIUM INC. INSTALMENT PAYMENT SCHEDULE- BLENDED PRINCIPAL PAYMENTS (LOAN B) Interest Period Jan 1 Jun 30 Dec 31 Totals

Cash Pmt

Interest Expense (D x 4.5% x 6/12)

Reduction of Principal

23,685 23,685 47,370

4,725 4,298 9,023

18,960 19,387 38,347

Principal 210,000 191,040 171,653

(b) Loan A will reduce principal balance to $168,000 which is lower than the balance outstanding under Loan B of $171,653. (c) Loan A will report the least interest of $8,978. Loan B will report a higher interest expense of $9,023. (d) To increase net income, Calcium would want to report fewer expenses; therefore Loan A will report a lower amount of expense in regards to financing.

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Ex. 127 Spring Water Corporation has the following selected accounts at December 31, 2015 after posting adjusting entries: Accounts Payable ...................................................... $ 67,500 Bank Loan Payable, 3-month ..................................... 135,000 Accumulated Depreciation—Equipment ..................... 14,000 Notes Payable, 5-year, 4% ......................................... 55,000 Employee Benefits Expense ...................................... 6,000 Interest Payable ......................................................... 7,550 Mortgage Payable ...................................................... 135,000 Sales Tax Payable ..................................................... 14,000 Instructions (a) Prepare the current liability section of Spring Water Corporation's statement of financial position, assuming $19,500 of the mortgage is payable next year. (b) Comment on Spring Water’s liquidity, assuming total current assets are $575,000. Solution 127 (10 min.) (a) SPRING WATER CORPORATION Statement of Financial Position (partial) December 31, 2015 Current Liabilities Current portion of long-term debt .................................................. Bank loan payable, 3-month .......................................................... Accounts payable .......................................................................... Sales tax payable .......................................................................... Interest payable............................................................................. Total current liabilities .............................................................

$ 19,500 135,000 67,500 14,000 7,550 $243,550

(b) The liquidity position looks favourable. If all current liabilities are paid out of current assets, there would still be $331,450 of current assets (working capital). The current ratio is 2.4:1 and it appears as though Spring Water Corporation has sufficient current resources to meet current obligations when due.

Ex. 128 The following information is available from the 2015 financial statements of Alpha Inc. and Omega Ltd.: (in millions) Alpha Inc. Omega Ltd. Income tax expense .......................................... $ 361 $ 766 Interest expense................................................ 480 1,423 Profit ................................................................. 654 948 Total assets....................................................... 24,750 37,525 Total current liabilities ....................................... 5,970 14,109 Total liabilities ................................................... 16,485 31,816 Instructions

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(a) Based on the information given, calculate the following ratios for each company: 1. Debt to total assets 2. Times interest earned (b) What conclusion concerning each company’s long-run solvency can be drawn from these ratios? Solution 128 (15 min.) (a) 1. Debt to total assets:

Times interest earned:

Alpha Inc. $16,485 ÷ $24,750 = 66.7%

Omega Ltd. $31,816 ÷ $37,525 = 84.8%

$654 + $361 + $480 $480 = $1,495 ÷ 480 = 3.1 times

$948 + $766 + $1,423 $1,423 = $3,137 ÷ $1,423 = 2.2 times

(b) Generally, businesses prefer to maintain a lower debt to total assets ratio and a higher times interest earned ratio. Since Alpha’s debt ratio is 27% [(84.8% – 66.7%) ÷ 66.7%] lower than Omega’s ratio and Alpha’s times interest earned ratio is 41% [(3.1 – 2.2) ÷ 2.2] higher than Omega’s, it can be concluded that Alpha is in a better position regarding longrun solvency than Omega. Omega’s debt load is extremely high, and should be a cause for alarm.

Ex. 129 Village Home Products Ltd. sells furniture and appliances. It has been in business for many years and until now has not had any short-term loans. It has approached Friendly Bank for an operating line of credit. Its current ratio, receivable turnover, and inventory turnover for the past 2 years are presented below. You are the credit manager dealing with the application. Instructions Comment on the ratios presented in terms of the application for the line of credit and also indicate what additional information you would like to receive from the company.

Current ratio Receivable turnover Inventory turnover

2016 1.6:1 5.2 6.8

2015 1.2:1 7.5 9.4

Solution 129 (10–15 min.) 1. The fact that the current ratio increased initially seems positive. 2.

However, the fact that the receivable and inventory turnovers have declined may indicate problems.

Current assets may include an increasing amount of inventory that may be subject to obsolescence. This is supported by the decrease in the inventory turnover ratio.

The decrease in the receivable turnover may indicate an issue with receivable collections.

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Other information that would be useful includes: (a) industry averages for the ratios (b) information on what makes up current assets and liabilities (c) reasons for the change in ratios (d) profitability information

Ex. 130 Below is a list of Accounts for Crib Inc. Beside each account determine if it is a Current Liability (C) or a Non- current Liabilities (NC). 1. Accounts Payable 2. Notes Payable (due 9 months) 3. Bank Loan payable (due 16 months) 4. Unearned Revenue 5. Mortgage Payable (due in 20 years) 6. Salaries Payable 7. Sales Tax Payable 8. Current portion of Mortgage Payable 9. Notes payable (due in 12 months) 10. Operating Line of Credit Solution 130 1. C 2.

10. C

Ex. 131 Kahluha Manufacturers Inc. reported the following information in its financial statements: KAHLUHA MANFACTURERS INC. Statement of Financial Position June 30

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Assets ......................................................................................... 2015 Cash .................................................................................... $32,000 Accounts receivable ............................................................. 7,500 Prepaid Insurance ................................................................ 1,100 Inventory .............................................................................. 220,000 Building ................................................................................ 145,000 Equipment ............................................................................ 36,000 Total Assets ................................................................................ $441,600

2014 $29,000 5,500 1,450 175,000 155,000 40,000 $405,950

Liabilities and shareholders’ equity Accounts Payable ................................................................ $ 12,500 Notes Payable ...................................................................... 10,000 Bonds Payable ..................................................................... 145,000 Long Term Debt ................................................................... 116,000 Common shares ................................................................... 25,000 Retained earnings ................................................................ 133,100 Total liabilities and shareholders’ equity ...................................... $441,600

$14,500 0 95,000 175,000 25,000 96,450 $405,950

Revenue ..................................................................................... $450,000 Operating expenses .................................................................... 300,000 Profit from operations .................................................................. 150,000 Interest expense ......................................................................... 6,000 Income tax expense .................................................................... 36,000 Profit ........................................................................................... $108,000

$300,000 210,000 90,000 9,000 20,250 $60,750

Instructions (a) Calculate the company’s debt to total assets and times interest earned ratios for each year. (b) Determine if the change from 2014- 2015 is an improvement or deterioration. (c) If industry averages for debt to total assets is 57% and times interest earned is 6 times, are Kahluha ratios comparable? Solution 131 (a) Debt to total assets

2015 =12,500+10,000+145,000+116,000 441,600 = 64.2%

Times Interest Earned

=108,000+6,000+36,000 6,000 = 25 times

2014 =14,500+95,000+175,000 405,950 = 70.1% =60,750+9,000+20,250 9,000 = 10 times

(b) Debt to total assets ratio is improving. Times interest earned ratio is also improving. (c) Kahluha’s debt to total assets ratio is higher than the industry which means they may have more debt or less assets than the industry averages. Overall debt to total assets varies across industries because different financing options are appropriate for different industries.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Kahluha’s times interest earned ratio is better than industry average which means Kahluha has a greater ability to meet interest payments as they come due than industry average.

Ex. 132 On January 1, 2016, Yawney Inc. issued bonds with a face value of $500,000. The bonds have a coupon interest rate of 4%, payable each July 1 and January 1. Instructions (a) Prepare the journal entry for the issue, assuming the bonds are issued at 97.5. (b) Prepare the journal entry for the issue, assuming the bonds are issued at 102.5. Solution 132 (5 min.) (a) Cash ($500,000 x 0.975) ............................................................... Bonds Payable ....................................................................... (b) Cash ($500,000 x 1.025) ............................................................... Bonds Payable .......................................................................

487,500 487,500 512,500 512,500

Ex. 133 On January 1, 2016, Ainsle Corp. issued $600,000, 7%, 10-year bonds. The bonds pay semiannual interest on July 1 and January 1. The market interest rate at the time of issue was 6%. Instructions (a) Calculate the issue price (round to nearest dollar). (b) Record the issue of the bonds on Jan. 1. (c) Record the first interest payment on July 1. Solution 133 (20 min.) (a) Periodic interest payments $600,000 x 7% x 6/12 = $21,000 n = 10 x 2 = 20 periods i = 6% x 6/12 = 3% Present value factor for the principal is 0.55368 Present value factor for the interest is 14.87747 $600,000 x 0.55368 = $21,000 x 14.877478 = Issue price

$332,208 312,427 $644,635

OR (using calculator) N 20 I 3 (6%/2) PMT -21000 FV -600000 CPT PV ➔ 644,632 (note that rounding discrepancies can sometimes arise between calculations using present value tables and financial calculators) (b) January 1, 2016 Cash ............................................................................................. Bonds Payable ....................................................................... To record sale of bonds (c) July 1, 2016 Interest Expense ...........................................................................

644,635 644,635

19,339

Reporting and Analyzing Liabilities

Bonds Payable .............................................................................. Cash....................................................................................... To record semi-annual payment of interest $644,635 x 3% = $19,339

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1,661 21,000

Ex. 134 On January 1, 2016, Pinehill Ltd. issued $200,000, 8%, 10-year bonds, when the market interest rate was 10%. Interest is payable semi-annually on July 1 and January 1. The company has a calendar year end. Instructions (a) Using a calculator, calculate the issue price. Round to nearest dollar. (b) Record the issue of the bonds. (c) Record the first interest payment on July 1, 2016. Round to nearest dollar. Solution 134 (20 min.) (a) (using calculator) N 20 OR

I 5 (10%/2) PMT -8000 FV -200000 CPT PV ➔ 175,076

Periodic interest payments $200,000 x 8% x 6/12 = $8,000 n = 10 x 2 = 20, i = 10% x 6/12 = 5% Present value factor for the principal = 0.37689 Present value factor for the interest = 12.46221 $200,000 x 0.37689 = $ 75,378 $8,000 x 12.46221 = 99,698 Issue price $175,076

(b) Jan 1 Cash .................................................................................. Bonds Payable ............................................................ (c) Jul 1

Interest Expense ($175,076 x 5%) ..................................... Bonds Payable ............................................................ Cash ($200,000 x 8% x ½) ..........................................

175,076 175,076 8,754 754 8,000

Ex. 135 On January 1, 2016, North West Suppliers Ltd. issues $500,000, 6%, five-year bonds, with interest payable on July 1 and January 1. Since the market interest rate is 5%, the bonds sell for $521,880. Instructions For the issue date and first semi-annual period, complete (A) through (E) in the table below and show your calculations.

Period

(A) Interest to be Paid

(B) Interest Expense to be Recorded

(D) (E) Unamortized Bond Premium Carrying amount

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Solution 135 (10 min.) (A) (B) Interest Interest Expense Period to be Paid to be Recorded 1

$15,000

$13,047

(D) (E) Unamortized Bond Premium Carrying amount $21,880 $521,880 19,927 519,927

(A) $500,000 × 6% x 6/12 = $15,000 (B) Market interest rate 5% x 6/12 = 2.5% semi-annual 2.5% × $521,880 (bond carrying amount) = $13,047 (C) Premium amortization = $15,000 – $13,047 = $1,953 (D) Unamortized premium = $21,880 – $1,953 = $19,927 (E) Bond carrying amount = $500,000 + $19,927 = $519,927

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MATCHING 136. Match the items below by entering the appropriate code letter in the space provided. A. Operating line of credit F. Payroll deductions B. Unsecured debt G. Times interest earned ratio C. Mortgage H. Redeemable bonds D. Market interest rate I. Contingent liabilities E. Discount (on bonds payable) J. Financial liability _____ 1.

Bonds subject to retirement at a stated dollar amount prior to maturity at the option of the issuer

_____ 2.

A long-term secured loan that pledges property as collateral

_____ 3.

Pre-authorization by the bank to borrow money, up to a pre-set limit

_____ 4.

Existing or possible obligations arising from past events

_____ 5.

A measure of a company’s solvency

_____ 6.

A form of financial instrument, represented by a contractual obligation to pay cash in the future

_____ 7.

The rate investors demand for loaning funds to a corporation

_____ 8.

Debt, such as notes or bonds, that has been issued against the general credit of the borrower

_____ 9.

Occurs when the coupon interest rate is less than the market interest rate

_____10.

Deductions from gross pay to determine the amount of a paycheque

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MATCHING 1.

10. F

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SHORT-ANSWER ESSAY QUESTIONS S-A E 137 Lucious Corporation 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. Instructions Is it ethical for a company to have a secret system like the one described? Explain. Solution 137 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 unauthorized information, or to commit some other crime, that is unethical.

S-A E 138 Under what circumstances is a contingent liability recorded in the accounting records as though an actual liability exists? Solution 138 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 the contingent loss and liability. Note that if the company is reporting under IFRS, “probable” means “more likely than not,” usually interpreted to mean a more than 50% probability of occurrence. But under ASPE, “probable” is defined as “likely,” a higher level of probability.

S-A E 139 Your cousin Gerald runs a successful business, and now wants to borrow money to buy a new delivery van for the business. He has never borrowed money from the bank before (always had interest-free loans from his parents), and is confused after speaking to his loans officer, Mr Rich. He said he would be glad to lend Gerald the money, but he needed to know if he wanted to pay the money back by paying monthly fixed principal payments plus interest, or by paying monthly blended payments of principal and interest. So he is asking you to explain this. “Does it make a difference how I repay the loan? I know I have to pay interest, so what difference does the type of payment make? Will I pay more interest with one type, rather than the other?” Instructions Explain to your cousin the difference between repaying a loan by fixed principal payments plus

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

interest versus blended payments. Solution 139 First of all, it really doesn’t matter which way you go with this: you will pay approximately the same amount of interest over the life of the loan. However, consumer loans such as this are generally repaid by making blended payments. With blended payments, you pay the same amount each month, which makes it easier for budgeting. Part of the payment goes to interest, and the rest goes to principal. As you go along, you will pay less and less interest as the principal is reduced, thus more and more goes to pay off the principal. With a fixed principal payments plus interest loan, this is exactly what it says. You will pay the same amount of principal off each month. For instance, if you borrowed $27,000 for a three year term, you would pay $27,000/36 = $750 on the principal each month, plus applicable interest. Again, as you go along and pay more off the principal each month, the interest will reduce. This means that your payments will reduce as you go along. You will start out paying larger payments than if it were a blended payment, but as time goes by, the payments will become smaller.

S-A E 140 When determining the issue price of a bond using present value, what are the two components used in the calculation? Solution 140 One component is the periodic interest payments over the life of the bonds, discounted using the market interest rate to calculate the present value. The other component is the present value of the face value to be paid at maturity, also based on the market interest rate.

S-A E 141 When a bond sells at a discount, what is probably true about the value of the market interest rate versus the coupon interest rate? Discuss. Solution 141 For someone to purchase a bond at a discount, the coupon interest rate normally must be below the market interest rate for similar bonds. Investors will make up the difference by paying less than the face value of the bonds.

S-A E 142 Bonds are frequently issued at amounts higher or lower than face value. Describe how the market interest rate, relative to the coupon interest rate, affects the selling price of bonds. Solution 142 The market interest rate is often different from the coupon interest rate, and therefore bonds are frequently issued at amounts higher or lower than face value. When the market interest rate is higher than the coupon interest rate, investors can find better investments elsewhere, and consequently there is less demand for the bonds. So to make the bonds more attractive, the issue price will be lowered and the bonds will be issued at a discount. Conversely, if the market interest rate is lower than the coupon interest rate, there will be greater demand for the bonds because of the higher interest rate. Thus, the issue price will be higher than face value and the

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bonds will be issued at a premium.

S-A E 143 Sally Smith works for Peterson Press, a fairly large book publishing firm. Her best friend and rival, Molly Murray, works for Lifeline Books, a smaller publisher. Both companies issued $100,000 in bonds on July 1. Peterson's bonds were issued at a discount, while Lifeline's were issued at a premium. Molly sent Sally an email the next day. She told Sally that it was obvious who the better publisher was—the market had shown its preference! She reminded Sally again of her recent increase in salary as further proof of the superiority of Lifeline Books. Instructions Draft a short note for Sally to send to Molly. Explain how such a result could occur. Solution 143 Many answers are possible. The format should be fairly informal, and the point that a discount or premium is not necessarily a judgement on the strength or weakness of a company should be addressed. A suggested note follows: Molly— I can't believe that Lifeline can survive with people like you handling their money! I also can't believe their lack of judgement in giving you a raise! Just kidding! Seriously, though, you can't prove that Peterson is a bad company just by the bond price. Our bonds were issued at a discount, not because of the market's evaluation of our company, but because we underestimated interest rates. Lifeline got a premium because it overestimated interest rates. You'll have to find some other evidence to prove your company is better (which you can't, because it isn't.) Seriously (again), congratulations on your raise. Shall we still meet for lunch on Wednesday? How about trying our luck with chopsticks at the Chinese Panda? Let me know if your plans change. (signed)

CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVES AND LEVEL OF DIFFICULTY Item

LOD

Item

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

1 1 1 1 1 1 1 1

E M E E E E M E

9. 10. 11. 12. 13. 14. 15. 16.

1 1 1 1 2 2 2 2

39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

M E M M E E M E M M E M E M M M H H M E

59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78.

1 1 2 2 2 2 2 2 2 2 2 2 2 2 2 3 3 3 3 3

137. 138. 139. 140. 141.

1 1 2 2 2

E E E E E

142. 143. 144. 145. 146.

2 2,3 2,3 2,3 2,4

161.

1–5 E,M,H

162. 163.

1,2 2,3

164. 165.

3 3

Note:

E = Easy

E M

LOD

M = Medium

Item SO LOD Item True-False Statements E 17. 2 E 25. E 18. 2 M 26. H 19. 2 E 27. M 20. 3 E 28. M 21. 3 M 29. E 22. 3 E 30. M 23. 3 M 31. M 24. 3 M 32. Multiple Choice Questions M 79. 3 E 99. E 80. 3 H 100. E 81. 3 E 101. E 82. 3 H 102. M 83. 3 M 103. M 84. 3 E 104. H 85. 3 E 105. E 86. 3 M 106. E 87. 3 E 107. E 88. 3 E 108. E 89. 3 E 109. E 90. 3 M 110. M 91. 3 M 111. H 92. 3 M 112. H 93. 3 E 113. E 94. 3 E 114. M 95. 3 E 115. E 96. 3 M 116. M 97. 3 E 117. E 98. 3 E 118. Exercises E 147. 2,4 M 152. E 148. 3 E 153. H 149. 3 M 154. E 150. 3 H 155. M 151. 3,4 H 156. Matching

E M

Short-Answer Essay 166. 4 E 167. 5 H

168.

LOD

Item

LOD

3 4 4 4 4 4 4 4

E E E E E E E M

33. 34. 35. 36. 37. 38.

4 5 5 5 5 5

M M M M E E

3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 4 4

E E M H E E M M E E H E M E H E H E E M

119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136.

4 4 4 4 4 4 4 4 4 4 4 5 5 5 5 5 5 5

E M E H M E E E E M M E E M M E M M

4 4 4 4 4

M M E H H

157. 158. 159. 160.

4 4 4 5

E E M E

H = Hard

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type 1. 2. 3. 4. 5. 6.

TF TF TF TF TF TF

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

TF TF TF TF TF TF

39. 40. 41. 42. 43. 44.

MC MC MC MC MC MC

13. 14. 15. 16. 17.

TF TF TF TF TF

18. 19. 61. 62. 63.

TF TF MC MC MC

64. 65. 66. 67. 68.

MC MC MC MC MC

20. 21. 22. 23. 24. 25. 74. 75. 76.

TF TF TF TF TF TF MC MC MC

77. 78. 79. 80. 81. 82. 83. 84. 85.

MC MC MC MC MC MC MC MC MC

86. 87. 88. 89. 90. 91. 92. 93. 94.

MC MC MC MC MC MC MC MC MC

26. 27. 28. 29. 30. 31.

TF TF TF TF TF TF

32. 33. 117. 118. 119. 120.

TF TF MC MC MC MC

121. 122. 123. 124. 125. 126.

MC MC MC MC MC MC

34. 35. 36.

TF TF TF

37. 38. 130.

TF TF MC

131. 132. 133.

MC MC MC

Note: TF = True-False MC = Multiple Choice

Item

Study Objective 1 45. MC 51. 46. MC 52. 47. MC 53. 48. MC 54. 49. MC 55. 50. MC 56. Study Objective 2 69. MC 139. 70. MC 140. 71. MC 141. 72. MC 142. 73. MC 143. Study Objective 3 95. MC 104. 96. MC 105. 97. MC 106. 98. MC 107. 99. MC 108. 100. MC 109. 101. MC 110. 102. MC 111. 103. MC 112. Study Objective 4 127. MC 152. 128. MC 153. 129. MC 154. 146. Ex 155. 147. Ex 156. 151. Ex 157. Study Objective 5 134. MC 160. 135. MC 161-10. 136. MC 167. Ma = Matching Ex = Exercise

Type

Item

Type

Item

Type

MC MC MC MC MC MC

57. 58. 59. 60. 137. 138.

MC MC MC MC Ex Ex

161-1. 162.

Ma SAE

Ex Ex Ex Ex Ex

144. 145. 146. 147. 161-2.

Ex Ex Ex Ex Ma

161-3. 162. 163.

Ma SAE SAE

MC MC MC MC MC MC MC MC MC

113. 114. 115. 116. 143. 144. 145. 148. 149.

MC MC MC MC Ex Ex Ex Ex Ex

150. 151. 161-4. 161-5. 161-6. 163. 164. 165.

Ex Ex Ma Ma Ma SAE SAE SAE

Ex Ex Ex Ex Ex Ex

158. 159. 161-7. 161-8. 161-9. 166.

Ex Ex Ma Ma Ma SAE

Ex Ma SAE

168.

SAE

SAE = Short-Answer Essay

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CHAPTER STUDY OBJECTIVES 1.

Identify and discuss the major characteristics of a corporation. The major characteristics of a corporation are separate legal existence, limited liability of shareholders, transferable ownership rights, the ability to acquire capital, a continuous life, separation of corporation management from ownership, increased cost and complexity of government regulations, and the possibility of reduced corporate income tax. Corporations issue shares for sale to investors. The proceeds received from the issue of shares become the company’s legal capital. Shares then trade among investors on the secondary stock market and do not affect the company’s financial position.

Record share transactions. If only one class of shares is issued, they are considered to be common shares. When shares are issued for noncash goods or services in a company using IFRS, the fair value of the goods or services received is used to record the transaction if it can be reliably determined. If not, the fair value of the common shares is used. For a private company following ASPE, the more reliable of the two fair values should be used, which is usually also the fair value of the goods or services received. The accounting for preferred shares is similar to the accounting for common shares. Preferred shares have contractual provisions that give them preference over common shares for dividends and assets in the event of liquidation. Dividends are quoted as an annual rate (such as $5 preferred), but are normally paid quarterly. In addition, preferred shares may have other preferences, such as the right to convert, redeem, and/or retract. However, preferred shares do not have the right to vote—only common shares have voting rights.

Prepare the entries for cash dividends, stock dividends, and stock splits, and understand their financial impact. Entries for both cash and stock dividends are required at the declaration date and the payment or distribution date. There is no entry (other than a memo entry) for a stock split. The overall impact of a cash dividend is to reduce assets (cash) and shareholders’ equity (retained earnings). Stock dividends increase common shares and decrease retained earnings but do not affect assets, liabilities, or shareholders’ equity in total. Stock splits also have no impact on assets, liabilities, or shareholders’ equity. The number of shares increases with both stock dividends and stock splits.

Indicate how shareholders’ equity is presented in the financial statements. In the shareholders’ equity section of the statement of financial position for companies using IFRS, share capital, retained earnings, and accumulated other comprehensive income, if any, are reported separately. If additional contributed capital exists, then the caption “Contributed capital” is used for share capital (preferred and common shares) and additional contributed capital that may have been created from various sources. A statement of changes in equity explains the changes in each shareholders’ equity account, and in total, for the reporting period. Notes to the financial statements explain details about authorized and issued shares, restrictions on retained earnings, and dividends in arrears, if there are any. For private companies reporting using ASPE, comprehensive income is not reported and a statement of changes in equity is not required. Instead, a statement of retained earnings is prepared that explains the changes in the retained earnings account for the reporting period. Changes to share capital and any other equity items are disclosed in the notes to the statements. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Evaluate dividend and earnings performance. A company’s dividend record can be evaluated by looking at what percentage of profit it chooses to pay out in dividends, as measured by the dividend payout ratio (dividends divided by profit) and the dividend yield ratio (dividends per share divided by the share price). Earnings performance can be measured by two profitability ratios: earnings per share (profit less preferred dividends divided by the weighted average number of common shares) and the return on common shareholders’ equity ratio (profit less preferred dividends divided by average common shareholders’ equity).

Reporting and Analyzing Shareholders’ Equity

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TRUE-FALSE STATEMENTS 1. The trading of a corporation's shares on the secondary market has no impact on the corporation's financial position.

2. A company can control the market value of its shares.

3. Most companies in Canada have an unlimited amount of authorized shares.

4. A corporation is not an entity that is separate and distinct from its owners. 5. The liability of a shareholder is usually limited to the shareholder’s investment in the corporation.

6. The sale of shares in a corporation by one shareholder to another affects the total capital of the corporation.

7. Legal capital cannot be distributed to the shareholders, but must remain invested in the corporation for the protection of its creditors.

8. A corporation acts under its’ own name rather than in the name of its shareholders.

9. A shareholder owning common shares has the right to vote in the election of the board of directors.

10. An initial public offering occurs the first time a corporation sells shares to the public.

11. The market capitalization of a company is calculated by multiplying the number of shares authorized by the share price at any given date.

12. The number of common shares authorized can never be greater than the number of shares issued.

13. Contributed capital is the amount shareholders paid or contributed to the corporation in exchange for shares of ownership.

14. The issue of common shares affects both share capital and retained earnings.

15. One of the reasons a company may reacquire its own shares is to reduce the market value to make the shares more affordable. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

16. Preferred shares have a contractual preference over common shares in certain areas, but do not have the right to vote.

17. Preferred shares are generally issued to appeal to a larger segment of potential investors.

18. $3 cumulative preferred shares means that each preferred shareholder is eligible to receive a quarterly dividend of $3 per share.

19. When preferred shares are cumulative, preferred dividends not declared in a given period are called dividends in arrears.

20. Cash dividends are not a liability of the corporation until they are declared by the board of directors.

21. The liability for a cash dividend is recorded on the date of record, because it is on that date that the shareholders who will receive the dividend are identified. 22. Declaration and distribution of a stock dividend does not affect the total amount of shareholders’ equity.

23. Stock Dividends Distributable is reported as a liability on the statement of financial position.

24. A stock split results in a transfer at market value from retained earnings to share capital.

25. The main purpose of a stock split is to increase the marketability of the shares.

26. Retained earnings represents the amount of cash available for dividends.

27. If a corporation reports a profit, it should be closed to retained earnings. If it reports a loss, it should be closed to a contributed capital account.

28. A debit balance in the Retained Earnings account is called a deficit.

29. Retained earnings that are restricted are unavailable for dividends. 30. The statement of changes in equity discloses changes in total shareholders’ equity for the period as well as changes in each shareholders’ equity account. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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31. Corporations reporting under IFRS have the option of preparing either a statement of changes in equity or a statement of retained earnings. 32. Accumulated other comprehensive income is reported in the shareholders’ equity section of the statement of financial position for a publicly-traded company.

33. Total comprehensive income equals profit plus other comprehensive income.

34. The payout ratio is calculated by dividing the cash dividends paid on common shares by retained earnings. 35. Return on common shareholders’ equity is calculated by dividing profit by ending shareholders’ equity.

36. Investors tend to buy shares with low payout ratios and dividend yields if they are looking for more capital appreciation from the shares.

37. Earnings per share is calculated by dividing the profit available to common shareholders by the number of common shares issued at year end.

38. Companies reporting under ASPE must disclose earnings per share, but companies reporting under IFRS do not.

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6.

Ans. T F T F T F

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

Ans. T T T T F F

Item 13. 14. 15. 16. 17. 18.

Ans. T F F T T F

Item 19. 20. 21. 22. 23. 24.

Ans. T T F T F F

Item 25. 26. 27. 28. 29. 30.

Ans. T F F T T T

Item 31. 32. 33. 34. 35. 36.

Ans. F T T F F T

Item 37. 38.

Ans. F F

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MULTIPLE CHOICE QUESTIONS 39. Under the corporate form of business organization (a) a shareholder is personally liable for the debts of the corporation. (b) a shareholder’s acts can bind the corporation even though he/she has not been appointed as an agent of the corporation. (c) the corporation's life is continuous. (d) shareholders wishing to sell their shares must get the approval of other shareholders. 40. Shareholders directly elect the corporation’s (a) president. (b) board of directors. (c) controller. (d) auditor.

41. Those most responsible for the major policy decisions of a corporation are the (a) shareholders. (b) board of directors. (c) management. (d) employees.

42. Which one of the following would not be considered an advantage of the corporate form of organization? (a) limited liability of shareholders (b) separate legal existence (c) continuous life (d) government regulation

43. The two ways that a corporation can be classified by ownership are (a) publicly held and privately held. (b) shares and non-shares. (c) federal and provincial. (d) majority and minority.

44. Which of the following would not be true of a privately held corporation? (a) It is sometimes called a closely held corporation. (b) Its shares are regularly traded on the Toronto Stock Exchange. (c) It does not offer its shares for sale to the general public. (d) It is usually smaller than a publicly held company.

45. Which of the following is not true of a corporation? (a) It may buy, own, and sell property. (b) It may sue and be sued. (c) The acts of its shareholders bind the corporation. (d) It may enter into binding legal contracts in its own name. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

46. Ford Harrison has invested $650,000 in a corporation. The corporation does not do well and must declare bankruptcy. What amount does Harrison stand to lose? (a) up to his total investment of $650,000 (b) zero (c) the $650,000 plus any personal assets the creditors demand (d) $325,000

47. Which of the following statements reflects the transferability of ownership rights in a corporation? (a) If a shareholder decides to transfer ownership, he/she must transfer all of his/her shares. (b) A shareholder may dispose of part or all of his/her shares. (c) A shareholder must obtain permission of the board of directors before selling shares. (d) A shareholder must obtain permission from at least three other shareholders before selling shares.

48. A corporate board of directors does not generally (a) select officers. (b) formulate operating policies. (c) declare dividends. (d) execute policy.

49. Limited liability of shareholders means (a) dividends will be paid regardless of profits. (b) creditors have no legal claim on a shareholder’s personal assets. (c) the life of the corporation is limited. (d) deferral or reduction of taxes.

50. The ability of a corporation to obtain capital is (a) enhanced because of limited liability and ease of share transferability. (b) less than a partnership. (c) restricted because of the limited life of the corporation. (d) about the same as a proprietorship.

51. Which of the following statements is considered an advantage of the corporate form of organization? (a) additional income tax (b) government regulations (c) limited liability of shareholders (d) increased disclosure requirements

52. All of the following are advantages of the corporate form of organization except (a) government regulation. (b) reduced income tax. (c) ease of transfer of ownership. (d) continuous life.

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53. A disadvantage of the corporate form of organization is (a) its status as a separate legal entity. (b) continuous existence. (c) government regulation. (d) ease of transfer of ownership.

54. Which one of the following is not an ownership right of a common shareholder? (a) to vote in the election of officers (b) to declare dividends on the common shares (c) to share in assets upon liquidation (d) to share in corporate profits

55. Which of the following factors does not affect the initial market price of a share? (a) the company's anticipated future profit (b) the legal value of the share (c) the current state of the economy (d) the expected dividend rate per share

56. Legal capital (a) cannot be distributed to shareholders. (b) reflects the most recent market price. (c) is voted on by the shareholders. (d) is indicative of the worth of the share.

57. Mrs. Exe sold 200 shares of Tee Corp. to Mrs. Wye for $3,150. As a result of this transaction, Tee Corp.’s (a) shareholders’ equity did not change. (b) shareholders’ equity increased by $3,150. (c) shareholders’ equity decreased by $3,150. (d) assets increased by $3,150.

58. The authorization of common shares (a) must be approved by Canada Revenue Agency. (b) does not require a journal entry. (c) increases shareholders’ equity. (d) decreases shareholders’ equity.

59. Authorized shares of a corporation (a) are the minimum amount of shares that must be issued. (b) increase shareholders’ equity. (c) are specified in its articles of incorporation. (d) must be recorded by a formal accounting entry. 60. The number of shares that may be issued according to the corporation’s articles of incorporation is Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

referred to as the (a) authorized shares. (b) issued shares. (c) unissued shares. (d) redeemable shares.

61. If Valley Corporation issues 2,000 common shares for $140,000, which account will be credited? (a) Common Shares (b) Retained Earnings (c) Contributed Capital (d) Cash

62. The sale of common shares should be recorded as a (a) debit to Retained Earnings and a credit to Cash. (b) debit to Cash and a credit to Retained Earnings. (c) debit to Cash and a credit to Common Shares. (d) debit to Common Shares and a credit to Cash.

63. When setting the price of a new share issue, a corporation does not need to consider (a) future profit. (b) expected dividend rate. (c) current financial position. (d) future trading on the secondary market.

64. Which of the following usually represents the largest number of common shares? (a) restricted shares. (b) issued shares. (c) treasury shares. (d) authorized shares.

65. For a corporation reporting under IFRS, when shares are issued for a non-cash consideration and a ready market for the shares exists, they are recorded at (a) zero. (b) the fair value of the shares. (c) the fair value of the assets acquired. (d) the average of the fair value of the shares and the fair value of the assets acquired.

66. A company may reacquire its own shares for all of the following reasons except to (a) enhance market value. (b) reduce market value. (c) increase earnings per share. (d) have additional shares available for use.

67. Which of the following is not a right or preference associated with preferred shares? (a) the right to vote Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) first claim to dividends (c) preference to corporate assets in case of liquidation (d) to receive dividends in arrears before common shareholders receive dividends

Use the following information for questions 68–69. Air Ace Corporation issues 5,000 preferred shares for $40 per share.

68. The entry to record the transaction will consist of a debit to Cash for $200,000 and a credit or credits to (a) Preferred Shares for $200,000. (b) Preferred Shares for $150,000 and Share Capital for $50,000. (c) Preferred Shares for $150,000 and Retained Earnings for $50,000. (d) Investment in Preferred Shares for $200,000.

69. In the statement of financial position, the effects of the above transaction will be reported under (a) Liabilities. (b) Retained Earnings. (c) Share Capital. (d) Accumulated Other Comprehensive Income.

70. Dividends in arrears on cumulative preferred shares (a) never have to be paid, even if common dividends are paid. (b) must be paid before common shareholders can receive a dividend. (c) should be recorded as a current liability until they are paid. (d) enable the preferred shareholders to share equally in corporate profits with the common shareholders.

71. Dividends in arrears on cumulative preferred shares (a) are considered to be a non-current liability. (b) are considered to be a current liability. (c) only occur when preferred dividends have been declared. (d) should be disclosed in the notes to the financial statements.

72. Dividends in arrears are dividends on (a) cumulative preferred shares that have been declared but have not been paid. (b) non-cumulative preferred shares that have not been declared for a given period of time. (c) cumulative preferred shares that have not been declared for a given period of time. (d) common dividends that have been declared but have not been paid.

73. Retractable preferred shares are (a) included in contributed capital on the statement of financial position. (b) callable at the corporation’s option. (c) never issued. (d) presented under liabilities on the statement of financial position. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

74. 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.

75. The board of directors of Wessex Inc. declared a cash dividend on November 15, 2015, to be paid on December 15, 2015, to shareholders owning shares on November 30, 2015. Given these facts, the date of November 30, 2015, is referred to as the (a) declaration date. (b) record date. (c) payment date. (d) authorization date.

76. The effect of the declaration of a cash dividend is to Increase Decrease (a) Shareholders’ equity Assets (b) Assets Liabilities (c) Liabilities Shareholders’ equity (d) Liabilities Assets

77. The cumulative effect of the declaration and payment of a cash dividend on a company's financial statements is to (a) decrease both total liabilities and shareholders' equity. (b) increase both total expenses and total liabilities. (c) increase both total assets and shareholders' equity. (d) decrease both total assets and shareholders' equity.

78. Which of the following is the appropriate general journal entry to record the declaration of cash dividends? (a) Cash Dividends Cash (b) Dividends Payable Cash (c) Share Capital Dividends Payable (d) Cash Dividends Dividends Payable

Use the following information for questions 79–82. On July 15, 2015, the board of directors of George Easton Limited declared a cash dividend of $0.50 per share on 84,000 common shares. The dividend is to be paid on August 15, 2015, to shareholders of record on July 31, 2015.

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79. The journal entry to be recorded on July 15, 2015, will include a (a) debit to Dividends Payable. (b) debit to Cash Dividends. (c) credit to Cash. (d) credit to Retained Earnings.

80. The effects of the journal entry to record the declaration of the dividend on July 15, 2015, are to (a) decrease shareholders’ equity and increase liabilities. (b) decrease shareholders’ equity and decrease assets. (c) increase shareholders’ equity and increase liabilities. (d) increase shareholders’ equity and decrease assets.

81. The correct entry to be recorded on August 15, 2015 will include a (a) debit to Cash Dividends. (b) credit to Retained Earnings. (c) credit to Dividends Payable. (d) debit to Dividends Payable.

82. The effects of the journal entry to record the payment of the dividend on August 15, 2015, are to (a) decrease shareholders’ equity and decrease liabilities. (b) decrease liabilities and decrease assets. (c) increase shareholders’ equity and increase liabilities. (d) increase shareholders’ equity and decrease assets. 83. The net effect on the corporation’s books of the declaration and payment of a cash dividend are to (a) decrease liabilities and decrease shareholders’ equity. (b) increase shareholders’ equity and decrease liabilities. (c) decrease assets and decrease shareholders’ equity. (d) increase assets and increase shareholders’ equity.

84. A corporation 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.

85. Stock Dividends Distributable is classified as a(n) (a) asset account. (b) shareholders' equity account. (c) expense account. (d) liability account.

86. The effect of a stock dividend is to (a) decrease total assets and shareholders' equity. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) change the composition of shareholders' equity. (c) decrease total assets and total liabilities. (d) increase the book value per share of common shares.

87. If a corporation declares a 10% stock dividend on its common shares, the account to be debited on the date of declaration is (a) Stock Dividends Distributable. (b) Common Shares. (c) Share Capital. (d) Stock Dividends.

88. Which one of the following events would not require a journal entry on a corporation's books? (a) 2 for 1 stock split (b) 100% stock dividend (c) 2% stock dividend (d) $1 per share cash dividend

89. Which of the following would not affect the balance of the Retained Earnings account? (a) profit (b) stock dividend (c) stock split (d) cash dividend

90. Stock dividends and stock splits have the following effects on retained earnings: Stock Splits Stock Dividends (a) Increase No change (b) No change Decrease (c) Decrease Decrease (d) No change No change

91. The main purpose of a stock split is to (a) decrease the marketability of the stock by increasing the price. (b) increase the marketability of the stock by increasing the price. (c) increase the marketability of the stock by decreasing the price. (d) reduce the number of issued shares.

92. Cash dividends are declared out of (a) Dividends Payable. (b) Preferred Shares. (c) Common Shares. (d) Retained Earnings.

93. Which of the following is not a significant date with respect to dividends? (a) the declaration date (b) the incorporation date Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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94. On the dividend record date (a) a dividend becomes a current obligation. (b) no entry is required. (c) an entry may be required if it is a stock dividend. (d) dividends payable is debited.

95. Which of the following statements regarding the date of a cash dividend declaration is not true? (a) The dividend can be cancelled once it has been declared. (b) The corporation is committed to a legal, binding obligation. (c) The board of directors formally authorizes the cash dividend. (d) A liability account must be created or increased.

96. Indicate the respective effects of the declaration of a cash dividend on the following statement of financial position sections: Total Assets Total Liabilities Total Shareholders' Equity (a) Increase Decrease No change (b) No change Increase Decrease (c) Decrease Increase Decrease (d) Decrease No change Increase

97. Which of the following statements about dividends is not correct? (a) Cash dividends are generally declared quarterly as a dollar amount per share. (b) Dividends can be declared on both preferred and common shares. (c) The board of directors is obligated to declare dividends. (d) Dividends can be in cash or stock.

98. The declaration and distribution of a stock dividend will (a) increase total shareholders' equity. (b) increase total assets. (c) decrease total assets. (d) have no effect on total assets.

99. JKL Inc. has 10,000, $2, noncumulative preferred shares and 150,000 common shares issued. What is the total annual dividend on the preferred shares? (a) $10,000 (b) $20,000 (c) $150,000 (d) $300,000

100. At December 31, 2015, Gem Garments Inc. has 10,000, $5, cumulative preferred shares issued. If the board of directors declares a $40,000 dividend at this date (a) the company will still owe the preferred shareholders $10,000 and should record a dividend payable Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

for this amount. (b) the company will owe the preferred shareholders nothing further. (c) $10,000 will be disclosed as dividends in arrears in the notes to the financial statements. (d) the company still has to pay the preferred shareholders $50,000, regardless of what amount was declared.

101. Coombs Corp. declared a two-for-one stock split. Solly Fogarty owned 500 shares of Coombs that were trading for $20 each before the split. Which of the following is likely to be true after the split? (a) The number of shares Solly owns will increase by 50%. (b) The market price per share will drop by 50%. (c) The total market value of Solly’s shares will double. (d) The market price per share will increase by 100%.

102. Cambridge Corp. declared a 5% stock dividend. Will Wales owned 300 shares of Cambridge before the dividend. Cambridge shares were trading at $21 before the dividend. Which of the following will be true after the dividend is distributed? (a) The total market value of Will’s shares was $6,300 before the stock dividend but will probably decrease after the stock dividend. (b) The total market value of Will’s shares was $6,300 before the stock dividend and $6,615 after the stock dividend. (c) Will owned 300 shares before the stock dividend and 315 shares after the stock dividend. (d) Fewer investors will be able to buy Cambridge shares.

103. The board of directors must assign a per share value to a stock dividend declared that is equal to the (a) average cost. (b) zero. (c) original issue price. (d) fair value.

104. Corporations generally issue stock dividends in order to (a) increase the market price per share. (b) exceed shareholders' dividend expectations. (c) increase the marketability of the shares. (d) decrease the amount of capital in the corporation.

105. If the statement of financial position is prepared after a stock dividend has been declared but before it has been distributed, the stock dividend distributable would be reported in the (a) liabilities section. (b) contributed capital section of shareholders’ equity. (c) assets section. (d) It would not be reported in the statement of financial position.

106. When stock dividends are distributed (a) Stock Dividends Distributable is decreased. (b) Retained Earnings is decreased. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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107. A stock dividend results in a decrease in (a) current liabilities. (b) profit. (c) share capital. (d) retained earnings.

108. The journal entry to record the declaration of a stock dividend includes (a) a credit to Stock Dividends Distributable. (b) a credit to Stock Dividends Payable. (c) a credit to Stock Dividends. (d) a credit to Cash.

109. Identify the effect the declaration of a cash dividend and a stock dividend has on the total shareholders’ equity of a corporation: Cash Dividend Stock Dividend (a) Increase Decrease (b) No effect Increase (c) Decrease No effect (d) No effect Decrease

110. The declaration of a stock dividend will (a) increase share capital. (b) change total shareholders' equity. (c) increase total liabilities. (d) increase total assets.

Use the following information for questions 111–112. On January 1, Brunhilde Corporation had 240,000 common shares issued. On March 17, the company declared a 5% stock dividend to be distributed on March 30. The market value of the shares was $9 on March 17 and $12 on March 30.

111. The entry to record the transaction of March 17 would include a (a) credit to Retained Earnings for $12,000. (b) credit to Cash for $108,000. (c) credit to Stock Dividends Distributable for $108,000. (d) debit to Stock Dividends Distributable for $144,000.

112. The entry to record the transaction of March 30 would include a (a) credit to Cash for $108,000. (b) debit to Stock Dividends Distributable for $108,000. (c) credit to Retained Earnings for $144,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) debit to Stock Dividends for $108,000.

113. Which of the following shows the proper effect of a stock split and a stock dividend? Item Stock Split Stock Dividend (a) Total share capital Increase Increase (b) Total retained earnings Decrease Decrease (c) Total shareholders’ equity Decrease Increase (d) Number of shares Increase Increase

114. A stock split will (a) have no effect on retained earnings. (b) increase total share capital. (c) increase total assets. (d) decrease the number of shares issued.

115. Which of the following statements about a 2 for 1 stock split is not true? (a) The market value of the shares will probably decrease. (b) A shareholder with 200 shares before the split owns 400 shares after the split. (c) Legal capital per share is reduced to half of what it was before the split. (d) Total share capital increases.

116. Irwin Inc. had 300,000 common shares before a stock split occurred and 600,000 shares after the stock split. The stock split was (a) 1 for 2. (b) 4 for 1. (c) 1 for 4. (d) 2 for 1.

117. If the board of directors authorizes a $250,000 restriction of retained earnings for a future plant expansion, the effect of this action is to (a) decrease total assets and total shareholders' equity. (b) increase shareholders' equity and to decrease total liabilities. (c) decrease total retained earnings and increase total liabilities. (d) reduce the amount of retained earnings available for dividend declarations.

118. Retained earnings are occasionally restricted (a) to set aside cash for dividends. (b) to keep the legal capital associated with share capital intact. (c) due to contractual loan restrictions. (d) if preferred dividends are in arrears.

119. When retained earnings are restricted, total retained earnings (a) are unaffected. (b) increase. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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120. Placing a restriction on retained earnings will (a) ensure that the corporation has sufficient cash for a specific purpose. (b) increase total shareholders’ equity. (c) inform readers that a portion of retained earnings is unavailable for dividends. (d) decrease shareholders’ equity.

121. A loss (a) occurs if operating expenses exceed cost of goods sold. (b) is not closed to Retained Earnings if it would result in a debit balance in that account. (c) is closed to Retained Earnings even if it would result in a debit balance in that account. (d) is closed to the Common Shares account.

122. Based on the following account balances, what is the total shareholders’ equity? Common Shares ......................................................... $600,000 Stock Dividends Distributable...................................... 40,000 Retained Earnings ...................................................... 190,000 Preferred Shares......................................................... 20,000 Cash Dividends Payable ............................................. 30,000 (a) $620,000 (b) $800,000 (c) $820,000 (d) $850,000

123. In the shareholders' equity section of the statement of financial position, (a) Stock Dividends Distributable will be classified as a contra account to Retained Earnings. (b) Stock Dividends Distributable will appear in its own subsection of shareholders' equity. (c) Preferred and Common Shares appear under the subsection Share Capital. (d) Dividends in Arrears will appear as a restriction of Retained Earnings.

124. A retained earnings restriction would appear in the financial statements under (a) share capital. (b) retained earnings. (c) notes to financial statements. (d) a liability.

125. Two classifications appearing in the share capital section of the statement of financial position are (a) dividends payable and dividends distributable. (b) share capital and retained earnings. (c) preferred shares and common shares. (d) contributed capital and retained earnings. 126. All of the following are normally found in a publicly-traded corporation’s shareholders’ equity Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

section except (a) dividends in arrears. (b) accumulated other comprehensive income. (c) share capital. (d) retained earnings.

127. A debit balance in retained earnings is called a (a) loss. (b) capital surplus. (c) deficit. (d) contributed capital.

128. At January 1, 2015, Jay Corporation had a credit balance of $5,450,000 in its retained earnings account. During the year, Jay paid $250,000 in dividends, reported profit of $560,000 and other comprehensive income of $750,000. The December 31 balance of retained earnings is (a) $5,760,000. (b) $5,950,000. (c) $6,200,000. (d) $6,450,000.

129. Under IFRS, which of the following describes how other comprehensive income should be reported? (a) Must be reported in a statement of comprehensive income (b) Should not be reported in the financial statements, but should only be disclosed in the footnotes (c) Must be reported in the income statement (d) Must be reported in the shareholders’ equity section of the statement of financial position

130. The payout ratio is calculated by dividing (a) total cash dividends paid by retained earnings. (b) dividends paid per share by profit. (c) total cash dividends paid by profit. (d) dividends paid per share by year-end share price. 131. The return on common shareholders’ equity is calculated by dividing profit (a) by ending common shareholders’ equity. (b) by average common shareholders’ equity. (c) less preferred dividends by ending common shareholders’ equity. (d) less preferred dividends by average common shareholders’ equity.

132. Which of the following is false about the dividend yield ratio? (a) Dividend yield ratio = Dividends per share ÷ Market price per share (b) Measures the profit generated by each share for the shareholder based on the market price of the shares (c) A low dividend yield is neither bad nor good by itself (d) Dividend yield ratio = Market price per share ÷ Dividends per share

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133. Return on common shareholders’ equity is a ratio that (a) is calculated by dividing profit plus preferred dividends by average common shareholders’ equity. (b) shows the relationship between profit available for common shareholders and average common shareholders’ equity. (c) cannot be calculated if the company has preferred shares in addition to common shares. (d) is calculated by dividing profit plus preferred dividends by average common shareholders’ equity and shows the relationship between profit available for common shareholders and average common shareholders’ equity.

134. For last year, Roxy Corporation reported profit of $500,000, and paid $125,000 in dividends to the 250,000 preferred shares issued. The weighted average of common shares was 1,500,000 shares. Roxy’s earnings per share was (a) $0.33. (b) $0.29. (c) $0.25. (d) $0.21.

135. Diluted earnings per share (a) is sometimes higher than basic earnings per share. (b) takes into account all securities issued that can be converted into common shares. (c) shows how many dollars were earned for each dollar invested by common shareholders. (d) is not required to be disclosed for corporations reporting under IFRS.

136. For 2015, Ardeen Ltd. reported net sales of $1,800,000, profit of $100,000 and year end total assets of $2 million. For the year, Ardeen’s average common shareholders’ equity was $1 million. There are no preferred shares issued. Therefore, for 2015, Ardeen’s return on common shareholders’ equity is (a) 10.0%. (b) 6.7%. (c) 5.7%. (d) 5.0%.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. 39. c 40. b 41. b 42. d 43. a 44. b 45. c 46. a 47. b 48. d 49. b 50. a 51. c 52. a

Item 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66.

Ans. c b b a a b c a a c d d c b

Item 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80.

Ans. a a c b d c d a b c d d b a

Item 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94.

Ans. d b c d b b d a c b c d b b

Item 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108.

Ans. a b c d b c b c d c b a d a

Item 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122.

Ans. c a c b d a d d d c a c c d

Item 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136.

Ans. c c c a c a a c d d b c b a

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EXERCISES Ex. 137 Identify (by letter) each of the following characteristics as being an advantage, a disadvantage, or not applicable to the corporate form of business organization. A = Advantage D = Disadvantage N = Not Applicable Characteristics _____ 1. Separate legal entity _____ 2.

May result in reduced taxes

_____ 3.

Continuous life

_____ 4.

Limited liability of shareholders

_____ 5. Government regulation _____ 6.

Separation of ownership and management

_____ 7.

Ability to acquire capital

_____ 8.

Ease of transfer of ownership

_____ 9.

Disclosure requirements

Solution 137 (3–5 min.) 1. A 2.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Solution 138 (3 min.) Advantages of a corporation: 1. separate legal existence 2. limited liability of shareholders 3. transferable ownership rights 4. continuous life 5. ability to acquire capital 6. potentially lower income tax 7. separation of management and ownership

Ex. 139 The corporate charter of Downy Corporation allows the issue of a maximum of 5,000,000 common shares. During its first three years of operation, Downy issued 2,500,000 shares at $12 per share. Instructions Based on the above information, answer the following questions: (a) How many shares were authorized? (b) How many shares were issued? (c) What is the balance of the Common Shares account? Solution 139 (8–11 min.) (a) 5,000,000 shares were authorized. (b) 2,500,000 shares were issued. (c) The balance of the Common Shares account is $30,000,000 ($12 × 2,500,000 shares).

Ex. 140 In its first year of operations, Jagger Ltd. had the following transactions relating to its common shares: Feb 1 Issued 5,000 shares for cash at $45 per share. Jul 1 Issued 3,000 shares for cash at $43 per share. Nov 1 Issued 4,000 shares for the acquisition of land. The land has a fair value of $160,000 and the shares are currently trading at $44 each. Instructions Record the above transactions. Solution 140 (10 min.) Feb 1 Cash .................................................................................. Common Shares ......................................................... Issued 5,000 shares at $45 per share Jul

Nov 1

225,000 225,000

Cash .................................................................................. Common Shares ......................................................... Issued 3,000 shares at $43 per share

129,000

Land ..................................................................................

160,000

129,000

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Common Shares .........................................................

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160,000

Ex. 141 The following items were shown on the statement of financial position of Kettle Corporation on December 31, 2015: Shareholders’ Equity Share capital $8, noncumulative preferred shares, 24,000 shares authorized, 8,000 shares issued ...................................................................... Common shares, 1,000,000 shares authorized, _?_ shares issued ..... Total share capital ......................................................................... Retained earnings ....................................................................................... Total shareholders' equity ....................................................................

$ 120,000 3,600,000 3,720,000 500,000 $4,220,000

Instructions Complete the following statements and show your calculations. (a) If the average issue price was $9, the number of common shares issued was ___________ (b) The average issue price of the preferred shares was $_____________. Solution 141 (6 min.) (a) $3,600,000 ÷ $9 = 400,000 shares issued. (b) $120,000 ÷ 8,000 = $15 per share.

Ex. 142 Lactose Inc. reported the following transactions: 1. Issued 10,000 preferred shares for $7.50 cash per share. 2. Issued 14,000 common shares for $84,000 cash. Instructions Prepare the appropriate journal entries. Solution 142 (5 min.) 1. Cash (10,000 x $7.50) .................................................................. Preferred Shares ....................................................................

75,000

84,000

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

75,000

84,000

Ex. 143 Herold Corporation is authorized to issue 2,000,000 common shares. During 2015, Herold had the following share transactions: Jan 15 Issued 550,000 shares at $3 per share. Dec 6 Declared a $0.20 per share dividend to shareholders of record on December 25, payable January 5, 2016. Instructions Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Record the above transactions for Herold Corporation. Solution 143 (5–7 min.) Jan. 15 Cash (550,000 x $3) .......................................................... 1,650,000 Common Shares ......................................................... 1,650,000 Dec. 6

Cash Dividends ................................................................. Dividends Payable (550,000 × $0.20) .........................

110,000 110,000

Ex 144 During 2015, Maldives Corporation reported the following selected transactions: Jan 1 Issued 20,000 common shares at $15 per share. Jun 15 Issued 2,000 common shares at $14 per share in exchange for equipment valued at $27,000. Sep 30 The board of directors declared a 10% common stock dividend. The market price of the common shares on this date was $12 per share. Oct 10 The 10% common stock dividend is distributed. Nov 30 The board of directors declared a cash dividend of $0.22 per share to shareholders of record on December 15, payable on December 20. Instructions Prepare the journal entries to record the above transactions assuming Maldives Corporation follows IFRS. Solution 144 (15–20 min.) Jan

Jun 15

Sep 30

Oct 10

Nov 30

Dec 20

Cash .................................................................................. Common Shares (20,000 x $15) .................................

300,000

Equipment ......................................................................... Common Shares .........................................................

27,000

Stock Dividends ................................................................. Stock Dividend Distributable ....................................... (22,000 x 10% x $12)

26,400

Stock Dividend Distributable .............................................. Common Shares .........................................................

26,400

Cash Dividends ([22,000 x 1.1 x $0.22) ............................. Dividends Payable ......................................................

5,324

Dividends Payable ............................................................. Cash ...........................................................................

5,324

300,000

27,000

26,400

5,324

Ex. 145 On January 1, 2016, Spider Corporation had 55,000 common shares issued. During the year, the following transactions occurred: Mar 1 Issued 45,000 common shares for $450,000. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Shareholders’ Equity

Jun 1 Jun 30

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Declared a cash dividend of $0.75 per share to shareholders of record on June 15. Paid the $0.75 cash dividend.

Instructions Prepare journal entries to record the above transactions. Solution 145 (10 min.) Mar 1 Cash .................................................................................. Common Shares .........................................................

450,000

Jun

Cash Dividends ................................................................. Dividends Payable ...................................................... (100,000 × $0.75 = $75,000)

75,000

Dividends Payable ............................................................. Cash ...........................................................................

75,000

Jun 30

450,000

75,000

Ex. 146 As of December 31, 2015, Donnelly Corporation had 350,000 common shares authorized, 250,000 of which had been issued for proceeds of $2.5 million. The Retained Earnings balance was $1,200,000 and Accumulated Other Comprehensive Income was $2,500,000. On January 18, 2016, 40,000 common shares were issued at $20 per share. Profit for 2016 was $180,000. No dividends were declared in 2016. Instructions (a) Prepare the entry to record the common share issue on January 18. (b) Prepare the shareholders' equity section of the statement of financial position at December 31, 2016. Solution 146 (10 min.) (a) Jan. 18 Cash ........................................................................... Common Shares .................................................. To record issue of 40,000 common shares

800,000

(b) Shareholders' equity Share capital Common shares, 350,000 shares authorized; 290,000 shares issued .................................................................. Retained earnings*............................................................................... Accumulated other comprehensive income .......................................... Total shareholders' equity .............................................................

800,000

$3,300,000 1,380,000 2,500,000 $7,180,000

* $1,200,000 + $180,000 = $1,380,000

Ex. 147 On January 1, 2015, Blue Corporation reported $3,000,000 in its Common Shares account (200,000 issued) and retained earnings of $1,000,000. During 2015, the following events occurred: 1. On July 1, the company issued 100,000 common shares at $17 per share. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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2. 3. 4.

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

On December 15, the board of directors declared a 15% stock dividend to common shareholders of record on December 31, payable on January 15, 2016. The market value of Blue Corporation common shares was $16 per share on December 15 and $14 per share on December 31. Profit for 2015 was $625,000.

Instructions (a) Record the issue of shares on July 1 and the declaration of the stock dividend on December 15. (b) Prepare the shareholders' equity section of the statement of financial position at December 31, 2015. Solution 147 (10–15 min.) (a) Jul 1 Cash ........................................................................... 1,700,000 Common Shares .................................................. 1,700,000 Issued 100,000 shares at $17/share. Dec 15

Stock Dividends (45,000 × $16) .................................. Stock Dividends Distributable............................... (200,000 + 100,000) × 15% = 45,000 shares)

720,000 720,000

(b) BLUE CORPORATION Statement of Financial Position (partial) December 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Shareholders' equity Share capital Common shares, 300,000 shares issued ............................................. $4,700,000 Stock dividend distributable .................................................................. 720,000 Total share capital ......................................................................... 5,420,000 Retained earnings* ..................................................................................... 905,000 Total shareholders' equity ............................................................. $6,325,000 * Retained earnings = $1,000,000 – $720,000 + $625,000 = $905,000

Ex. 148 Maha Corporation has 2,000,000 authorized common shares. As of June 30, 2015, there were 350,000 shares issued. On this date, the board of directors declared a $0.25 per share cash dividend to be paid on August 1, 2015 to shareholders of record on July 7, 2015. 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. If no entry is needed write “No entry required.” Solution 148 (5–10 min.) (a) Jun 30 Cash Dividends........................................................... Dividends Payable ............................................... (350,000 × $0.25) (b) Jul

87,500 87,500

No entry required.

Reporting and Analyzing Shareholders’ Equity

Dividends Payable ...................................................... Cash ....................................................................

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87,500 87,500

Ex. 149 The shareholders' equity section of Starr Corporation at December 31, 2015, included the following: $3 preferred shares, cumulative, 10,000 shares authorized, 9,000 shares issued ................................... $ 900,000 Common shares, 500,000 shares authorized, 400,000 shares issued ........ 2,000,000 Dividends were not declared on the preferred shares in 2015 and are in arrears. On September 15, 2016, the board of directors declared dividends on the preferred shares for 2015 and 2016, to shareholders of record on October 1, 2016, payable on October 15, 2016. On November 1, 2016, the board of directors declared a $0.50 per share dividend on the common shares, payable November 30, 2016, to shareholders of record on November 15, 2016. Instructions Prepare the journal entries that should be made by Starr Corporation on the following dates in 2016: September 15, October 1, October 15, November 1, November 15, and November 30. If no entry is needed write “No entry required.” Solution 149 (12–15 min.) Sep 15 Cash Dividends ................................................................. 54,000 Dividends Payable ...................................................... To record declaration of dividends in arrears and the current year's preferred dividend (9,000 shares × $3 × 2) Oct

Oct 15

Nov 1

54,000

No entry required. Dividends Payable ............................................................. Cash ........................................................................... To record payment of cash preferred dividend

54,000

Cash Dividends ................................................................. Dividends Payable ...................................................... To record declaration of a cash dividend on common shares (400,000 shares × $0.50)

200,000

Nov 15

No entry required.

Nov 30

Dividends Payable ............................................................. Cash ........................................................................... To record payment of common share cash dividends

54,000

200,000

200,000 200,000

Ex. 150 Determine whether a cash dividend, stock dividend, or stock split will result in the effect listed in the first column. For example, for the first item, indicate by inserting a yes or no in the space provided whether a cash dividend will result in a decrease in total assets; whether a stock dividend will result in a decrease in total assets; and whether a stock split will result in a decrease in total assets. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Effect Decrease in total assets Decrease in total shareholders' equity Increase in share capital Decrease in retained earnings Increase in the number of shares

Possible Transaction Cash Dividend Stock Dividend

Stock Split

Possible Transaction Cash Dividend Stock Dividend Yes No Yes No No Yes Yes Yes No Yes

Stock Split No No No No Yes

Solution 150 (10 min.)

Effect Decrease in total assets Decrease in total shareholders' equity Increase in share capital Decrease in retained earnings Increase in the number of shares

Ex. 151 Glenn Corporation's shareholders' equity section at December 31, 2015 appears below: Shareholders' equity Share capital Common shares, 82,000 issued .................................................... $ 799,860 Retained earnings ................................................................................ 150,000 Accumulated other comprehensive income .......................................... 450,000 Total shareholders' equity ........................................................................... $1,399,860 On June 30, 2016, the board of directors declared a 15% stock dividend, distributable on July 31 to shareholders of record on July 15. The fair value of Glenn Corporation's shares on June 30 was $14. On December 1, 2016, the board of directors declared a 2 for 1 stock split effective December 15. Glenn Corporation's shares were selling for $20 on December 1, 2016, before the stock split was declared. Profit for 2016 was $230,000 and there were no cash dividends declared. Instructions (a) Prepare the journal entries on the appropriate dates to record the stock dividend and the stock split. If no entry is needed write “No entry required.” (b) Prepare all closing entries required on December 31, 2016. (c) Fill in the amounts that would appear in the shareholders' equity section for Glenn Corporation at December 31, 2016, for the following items: 1. Common shares $____________ 2. Number of shares issued ____________ 3. Legal capital per share $____________ 4. Retained earnings $____________ 5. Total shareholders' equity $____________ Solution 151 (20 min.) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Shareholders’ Equity

(a) Jun 30

Stock Dividends .......................................................... Stock Dividends Distributable ............................... To record declaration of stock dividend (82,000 × 15% = 12,300 × $14 = $172,200)

172,200 172,200

Jul 15

No entry required.

Jul 31

Stock Dividends Distributable ..................................... 172,200 Common Shares .................................................. To record issue of 12,300 shares in a stock dividend

Dec 1

No entry required.

Dec 15

Memo: 188,600 common shares (82,000 + 12,300) × 2

(b) Dec 31

Retained Earnings ...................................................... Stock Dividends ................................................... To close dividends

172,200

Income Summary........................................................ Retained Earnings ............................................... To close profit for year

230,000

Dec 31

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172,200

230,000

Common shares ($799,860 + $172,200) .................................................. $972,060 Number of shares issued [(82,000 + 12,300) x 2] ..................................... 188,600 Legal capital per share ($972,060  188,600) .......................................... $5.15 Retained earnings ($150,000 + $230,000 – $172,200)............................. $207,800 Total shareholders' equity ($1,399,860 + $230,000)................................. $1,629,860

Ex. 152 As of December 31, 2015, Shaka Son Inc. had the following share capital: 1. 750,000 common shares authorized, 350,000 of which had been issued for a total of $5,250,000. 2. 100,000 noncumulative, $10.50 preferred shares authorized, 10,000 of which had been issued at $200 per share Instructions Prepare the share capital section of the statement of financial position at December 31, 2015. Solution 152 (5–10 min.) SHAKA SON INC. Statement of Financial Position (partial) December 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Share capital $10.50 preferred shares, noncumulative, 100,000 shares authorized, 10,000 shares issued .................................................................... $2,000,000 Common shares, 750,000 shares authorized, 350,000 shares issued.. 5,250,000 Total share capital ......................................................................... $7,250,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 153 The following accounts appear on the adjusted trial balance of Airway Machinery Inc. at December 31, 2015: Common Shares, 1,000,000 shares authorized, 800,000 shares issued ..... $1,600,000 Stock Dividends Distributable...................................................................... 240,000 $4 Preferred Shares, 10,000 shares authorized, 5,000 shares issued ........ 750,000 Retained Earnings ...................................................................................... 925,000 Accumulated Other Comprehensive Income ............................................... 250,000 Instructions Prepare the shareholders' equity section at December 31, 2015, assuming that retained earnings is restricted for plant expansion in the amount of $250,000. Solution 153 (15–20 min.) AIRWAY MACHINERY INC. Statement of Financial Position (partial) December 31, 2015 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Shareholders' equity Share Capital $4 preferred shares, 10,000 shares authorized, 5,000 shares issued... $ 750,000 Common shares, 1,000,000 shares authorized, 800,000 shares issued 1,600,000 Stock dividends distributable ................................................................ 240,000 Total share capital ......................................................................... 2,590,000 Retained earnings (see note) ...................................................................... 925,000 Accumulated other comprehensive income ................................................. 250,000 Total shareholders' equity .................................................................... $3,765,000 Note: Retained earnings is restricted in the amount of $250,000 for plant expansion.

Ex. 154 Before closing, the Retained Earnings account of Cong Casings Ltd. has a credit balance of $165,000 at December 31, 2015. There was a loss of $200,000 for 2015. The share capital consists of 20,000 common shares issued for $360,000. Instructions Prepare the shareholders’ equity section of the statement of financial position at December 31, 2015. Solution 154 (5 min.) CONG CASINGS LTD. Statement of Financial Position (partial) December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Shareholders' equity Common shares, 20,000 shares issued ................................................. $360,000 Deficit ($165,000 – $200,000) ................................................................ (35,000) Total shareholders’ equity ............................................................................. $325,000

Reporting and Analyzing Shareholders’ Equity

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Mean Green Corporation had the following shareholders’ equity balances at January 1, 2015: Common shares, unlimited authorized, 200,000 issued .............................. $800,000 Retained earnings ....................................................................................... 120,000 Accumulated other comprehensive income ................................................. 30,000 The following events occurred in 2015: 1. Issued 50,000 common shares for $150,000 cash. 2. Declared and paid dividends of $25,000. 3. Reported profit of $40,000. 4. Reported other comprehensive income of $10,000. Instructions Prepare a statement of changes in equity using the following tabular format:

Retained Earnings

Accumulated Other Comprehensive Income

Total

Common Shares

Retained Earnings

Accumulated Other Comprehensive Income

Total

$800,000

$120,000

Common Shares Jan 1, 2015

Dec 31, 2015 Solution 155 (10 min.)

Jan 1, 2015 Issued common shares Declared Dividends

150,000

Profit

$950,000

$950,000 150,000

(25,000)

40,000

Other comprehensive income Dec 31, 2015

$30,000

$135,000

(10,000)

$20,000

$1,105,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 156 At December 31, 2014, Williamson Corp. reported the following adjusted balances: Common shares: 400,000 issued................................................................ $2,500,000 Preferred shares: 100,000 issued ............................................................... 750,000 Additional contributed capital ...................................................................... 30,000 Retained earnings ....................................................................................... 400,000 Accumulated other comprehensive income ................................................. 120,000 The following events occurred in 2015: 1 Issued 50,000 preferred shares, $500,000. 2. Reported total comprehensive income of $120,000, which included profit of $150,000 and other comprehensive income of $30,000. 3. Declared and paid dividends to the preferred shareholders of $100,000. Instructions Using the tabular format provided, prepare a statement of changes in equity for the year ended December 31, 2015.

Common Shares

Additional Contributed Capital

Retained Earnings

Accumulated Other Comprehensive Income

Total

Preferred Shares

Common Shares

Additional Contributed Capital

Retained Earnings

Accumulated Other Comprehensive Income

Total

$750,000

$2,500,000

$30,000

$400,000

$120,000 $3,800,000

150,000

Preferred Shares Jan. 1, 2015

Dec 31, 2015 Solution 156 (15 min.)

Jan. 1, 2015 Profit Other comprehensive income Issued preferred

(30,000) $500,000

(30,000) 500,000

Reporting and Analyzing Shareholders’ Equity

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shares Paid dividends Dec 31, 2015

$1,250,000

$2,500,000

$30,000

(100,000)

$450,000

$90,000 $4,320,000

Ex. 157 At December 31, 2015, Magnolia Inc., a private company reporting under ASPE, had the following shareholders’ equity: Common shares, 100,000 issued................................................................ $1,000,000 Retained earnings ....................................................................................... 1,600,000 During 2016, the following events occurred: 1. On June 1, the company declared and paid a $0.50 cash dividend. 2. On October 14, the company issued another 30,000 shares at $10 each. 3. At December 31, the company reported a profit of $325,000 for the year. Instructions Prepare a statement of retained earnings for the year ended December 31, 2016. Solution 157 (10 min.) MAGNOLIA INC. Statement of Retained Earnings Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Balance, January 1 ............................................................................................ $1,600,000 Add: Profit .......................................................................................................... 325,000 $1,925,000 Less: Cash dividends (100,000 x $0.50) ............................................................ (50,000) Balance, December 31 ...................................................................................... $1,875,000

Ex. 158 At December 31, 2015, Red Roberts Limited, a private company reporting under ASPE, had the following shareholders’ equity: Common shares, 75,000 issued.................................................................. $300,000 Retained earnings ....................................................................................... 750,000 During 2016, the following events occurred: 1. On February 1, the company declared and paid a $0.50 cash dividend. 2. On June 10, the company split the common shares two for one. 3. On December 1, the company declared and paid a $0.40 cash dividend. 4. At December 31, the company reported a loss of $106,000 for the year. Instructions (a) Prepare a statement of retained earnings for the year ended December 31, 2016. (b) If Red River were a publicly traded corporation, would it still prepare a statement of retained earnings? Explain. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Solution 158 (15 min.) (a) RED ROBERTS LIMITED Statement of Retained Earnings Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Balance, January 1 ............................................................................................ $750,000 Less: Loss ......................................................................................................... (106,000) Less: Cash dividends (75,000 x $0.50) + (150,000 x $0.40) .............................. (97,500) Balance, December 31 ...................................................................................... $546,500 (b) If Red Roberts were a publicly traded corporation, it must report under IFRS, and thus, instead of a statement of retained earnings, must prepare a statement of changes in equity. This is a more detailed statement which explains the changes in each shareholder’s equity account (for example, common shares), not just retained earnings.

Ex. 159 At December 31, 2015, Blue Lake Corp., a private company reporting under ASPE, had the following shareholders’ equity: Preferred shares, 10,000 issued ................................................................. $100,000 Common shares, 50,000 issued.................................................................. 325,000 Retained earnings ....................................................................................... 525,000 During 2016, the following events occurred: 1. On May 1, the company declared a 10% common stock dividend. The fair value of the common shares was estimated to be $7 at this time. The shares were distributed on June 1. 2. On September 10, the company issued 20,000 common shares at $6.95 each. 3. On December 15, the company declared a cash dividend of $0.25 per share to the common shareholders of record on December 31, payable on January 15, 2014. It also declared a cash dividend of $1 per share to the preferred shareholders, on the same dates. 4. At December 31, the company reported a profit of $260,000 for the year. Instructions (a) Prepare a statement of retained earnings for the year ended December 31, 2016. (b) If Blue Lake were a publicly traded corporation, why would it not prepare a statement of retained earnings? Explain. Solution 159 (20 min.) (a) BLUE LAKE CORP. Statement of Retained Earnings Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Balance, January 1 ............................................................................................ $525,000 Add: Profit .......................................................................................................... 260,000 785,000 Less: Cash dividends ($18,750 + $10,000) ....................................................... (28,750)1 Less: Stock dividends (50,000 x 10% x $7)........................................................ (35,000) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Shareholders’ Equity

Balance, December 31 ...................................................................................... 1

11 - 39

$721,250

Common dividend: (50,000 + 5,000 + 20,000) x $0.25 = $18,750 Preferred dividend 10,000 x $1 = $10,000

Note: the cash dividend is deducted from retained earnings because it has been declared. The payment date is irrelevant. (b) If Blue Lake were a publicly traded corporation, it must report under IFRS, and IFRS requires the preparation of a statement of changes in equity. This is a more detailed statement which explains the changes in each shareholder’s equity account (for example, preferred and common shares), not just retained earnings.

Ex. 160 Using the following information, calculate the payout ratio and the return on common shareholders’ equity: Dividends .................................................................................................... $192,000 Dividends per share .................................................................................... $0.32 Profit ........................................................................................................... $1,200,000 Share price at end of year ........................................................................... $26.00 Average common shareholders’ equity ....................................................... $35,000,000 Solution 160 (5 min.) $192,000 Payout ratio: ———–––— x 100 = 16.0% $1,200,000 Return on common shareholders’ equity:

$1,200,000 ————––— x 100 = 3.4% $35,000,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MATCHING 161. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Stock split Deficit Payout ratio Stock dividend Declaration date

F. G. H. I. J.

Retained earnings restrictions Legal capital Private corporation Cumulative feature Statement of changes in equity

____ 1. A corporation whose shares are not available on a public stock exchange. ____ 2. The amount that must be retained in the business for the protection of creditors. ____ 3. Preferred shareholders have a right to receive current and unpaid prior year dividends before common shareholders receive any dividends. ____ 4. The date the board of directors formally declares a dividend. ____ 5. Does not affect total share capital, retained earnings, or shareholders’ equity. ____ 6. A pro rata distribution of the corporation’s own shares to shareholders. ____ 7. A portion of the balance is unavailable for dividends. ____ 8. A debit balance in retained earnings. ____ 9. A statement detailing the changes in the components of shareholders’ equity prepared by publicly-traded corporations. ____ 10. Measures the percentage of profit distributed in the form of dividends to common shareholders.

Reporting and Analyzing Shareholders’ Equity

11 - 41

ANSWERS TO MATCHING 1.

10. C

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS S-A E 162 Companies frequently issue both preferred shares and common shares. What are the major differences in the rights of shareholders between these two classes of shares? Solution 162 Common shareholders have the right to vote on corporate actions that require shareholders’ approval, while preferred shareholders generally do not have voting rights. However, preferred shareholders will receive (1) dividends and (2) assets in the event of liquidation prior to common shareholders. Preferred shareholders may also have a cumulative dividend feature that increases the amount of dividends paid to the preferred shareholders.

S-A E 163 Jake Granville, the president and CEO of Earth Systems, Inc., a waste management firm, was recently hospitalized, suffering from exhaustion and a heart ailment. Immediately prior to his hospitalization, Earth Systems had experienced a sharp decline in its share 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 the management team called a meeting to determine what they should do. Roger Hastings, the marketing manager, suggested that the company purchase a large number of its own shares on the open market. In that way, investors might notice that activity had picked up, and might decide to buy some more shares. However, this plan would use up most of the company's available cash, so that there will be no money available for cash dividends. Earth Systems has paid cash dividends every quarter for over ten years. Instructions (a) Is Mr. Hastings's suggestion ethical? Explain. (b) Is it ethical to discontinue the cash dividend? Explain. Solution 163 (a) There is no definite answer as to whether Mr. Hastings'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 share 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 purchase 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 share price high (assuming that this purchase will enhance the share 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 determinant of whether an action is ethical (or not). (b) A company may discontinue its dividend at will. Common shareholders should know that they are not entitled to dividends, even when they have been declared and paid every year. There is no express or implied contract to pay a dividend to common shareholders, and so the discontinuance of the dividend is ethical. However, the company may lose more in share price by discontinuing a Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Reporting and Analyzing Shareholders’ Equity

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long-standing dividend than it gains by a large purchase of its own shares.

S-A E 164 Copper Corp. has just split its stock 2 for 1. (a) Why would Copper Corp. have done this? (b) What impact would the split have on the share price? (c) Why would the share price change? Solution 164 (a) Copper Corp. probably split its stock in order to bring its share price down and improve the marketability of its shares. (b) The price should drop by about 50%, but, it may not fall by quite that much due to the increased marketability. (c) The number of shares has doubled, while the net assets have not changed. The “pie” has been sliced into twice as many pieces, so each slice represents a smaller portion than before.

S-A E 165 Why must a corporation meet a two-part solvency test before it may declare cash dividends? Solution 165 A corporation must meet the following solvency test before declaring and paying cash dividends: 1. It must have sufficient cash or resources to be able to pay its liabilities as they become due after the dividend is declared and paid, and 2. The net realizable value of its assets must exceed the total of its liabilities and share capital. Corporations must ensure that a payment of dividends does not result in the company being unable to pay its liabilities as they become due or render the company insolvent as a protection for its creditors. In addition, corporations are frequently constrained by agreements with their lenders to pay dividends only from retained earnings.

S-A E 166 As part of a Careers in Accounting program sponsored by accounting organizations and supported by your company, you will be taking a group of high school students through the accounting department in your company. You will also provide them with various materials to explain the work of an accountant. One of the materials you will provide is a statement of changes in equity. Instructions Describe the statement, including how it links to the statement of financial position. Solution 166 The statement of changes in equity discloses changes in total shareholders’ equity for the period, as well as changes in each shareholders’ equity account, including contributed capital, retained earnings, and accumulated other comprehensive income. The ending account balances listed on the statement of changes in equity appear in the shareholders’ equity section of the statement of financial position. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

S-A E 167 Your friend Antonia is studying accounting ratios, and asks you to explain the difference between earnings per share and return on common shareholders’ equity. “Aren’t they practically the same thing?” she asks. “After all, they’re both a function of the profit available to common shareholders.” Instructions Explain to your friend the difference between these two ratios. Solution 167 You are right, Antonia, in that both of these ratios use profit available to common shareholders (i.e., profit less preferred dividends) as the numerator. However, they have different denominators because they measure two different things. Earnings per share (EPS) uses the weighted average of common shares outstanding during the year, and when you divide the profit available to common shareholders by this figure, the result is the amount of profit earned (on paper) by each common share for that year. On the other hand, return on common shareholders’ equity (or just “return on equity”) uses the average common shareholders’ equity from the statement of financial position, and when you divide the profit available to common shareholders by this figure, the result shows the percentage return on the shareholders’ investment for that year. Note this is a percentage, whereas EPS is a dollar amount.

S-A E 168 “I can’t figure out the difference between the payout ratio and the dividend yield!” exclaimed your classmate Jonathan. “I know they both have to do with dividends paid by a corporation. But why do we need to know both?” Instructions Explain to Jonathan what each ratio is and the significance of each one. Solution 168 The payout ratio is calculated by dividing the total cash dividends paid during the year by the profit for the year, i.e., it uses figures from the corporation records. It measures the percentage of profit distributed as cash dividends (if any). A high ratio means that the company is paying out a lot of its profit as dividends. This is usually alright if it is a solid, well-established company, but would not be good for a comparatively new company planning on expanding and growing. One would expect such a company to have a low or zero payout ratio (i.e. not paying dividends at all) since they should be retaining as much of their profit as possible to invest in their future growth. The dividend yield looks at the shareholder’s return on investment (ROI) in the form of dividends received, and is calculated by dividing the dividend per share (not total dividends) by the market price. It shows the percentage return to the investor based on the market price. Investors look for a high dividend yield. However, like the payout ratio, a high dividend yield suggests the corporation is paying out a high percentage of its profit and not retaining it for future growth. Therefore again, for a growth oriented company, one would expect a low (or zero) dividend yield.

CHAPTER 12 REPORTING AND ANALYZING INVESTMENTS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVES AND LEVEL OF DIFFICULTY Item SO

LOD

Item

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

1 1 1 1 1 1 1 1 1 1

M M M M M E M M E M

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64.

1 1 1 1 1 1 1 1 1 2 2 2 2 2 2

M E M E E M M E E H E E H M M

65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79.

124. 125. 126.

2 2 2

E M E

127. 128. 129.

138.

1–4 E,M,H

139.

Note:

E = Easy

140.

LOD Item SO LOD Item True-False Statements 1 M 21. 3 M 31. 1 M 22. 3 E 32. 2 E 23. 3 E 33. 2 H 24. 3 E 34. 2 E 25. 3 E 35. 2 M 26. 3 E 36. 2 E 27. 3 M 37. 2 M 28. 3 M 38. 2 M 29. 3 E 39. 2 M 30. 3 E 40. Multiple Choice Questions 2 M 80. 3 M 95. 2 E 81. 3 H 96. 2 E 82. 3 H 97. 2 E 83. 3 H 98. 2 H 84. 3 H 99. 2 M 85. 3 E 100. 2 M 86. 3 M 101. 3 E 87. 3 H 102. 3 M 88. 3 H 103. 3 E 89. 3 M 104. 3 H 90. 3 E 105. 3 M 91. 3 M *106. 3 E 92. 3 M *107. 3 E 93. 3 E *108. 3 E 94. 3 E *109. Exercises 2,3 M 130. 2,4 M 133. 2,3 M 131. 2,4 M 134. 2,3 H 132. 2,4 M 135. Matching

2,3,4

M = Medium

Short-Answer Essay M 141. 2,4 M 142.

SO LOD

Item

SO LOD

3 4 4 4 4 4 4 4 4 4

E M M M M H M E H M

41. *42. *43. *44. *45. *46. *47. *48. *49.

4 5 5 5 5 5 5 5 5

H E M M E M M H M

3 3 3 4 4 4 4 4 4 4 4 5 5 5 5

E M M M M M M M H E H M H H E

*110. *111. *112. *113. *114. *115. *116. *117. *118. *119. *120. *121. *122. *123.

5 5 5 5 5 5 5 5 5 5 5 5 5 5

E E M H E E H E M M M M M M

3 3 3,4

E E E

*136. *137.

5 5

M M

2,4

143.

3,4

H = Hard

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type 1. 2. 3. 4.

TF TF TF TF

5. 6. 7. 8.

TF TF TF TF

9. 10. 11. 12.

TF TF TF TF

13. 14. 15. 16. 17.

TF TF TF TF TF

18. 19. 20. 59. 60.

TF TF TF MC MC

61. 62. 63. 64. 65.

MC MC MC MC MC

21. 22. 23. 24. 25. 26. 27.

TF TF TF TF TF TF TF

28. 29. 30. 31. 72. 73. 74.

TF TF TF TF MC MC MC

75. 76. 77. 78. 79. 80. 81.

MC MC MC MC MC MC MC

32. 33. 34. 35.

TF TF TF TF

36. 37. 38. 39.

TF TF TF TF

40. 41. 98. 99.

TF TF MC MC

*42. *43. *44. *45.

TF TF TF TF

*46. *47. *48. *49.

TF TF TF TF

*106. *107. *108. *109.

MC MC MC MC

Note: TF = True-False MC = Multiple Choice

Study Objective 1 50. MC 54. 51. MC 55. 52. MC 56. 53. MC 57. Study Objective 2 66. MC 71. 67. MC 124. 68. MC 125. 69. MC 126. 70. MC 127. Study Objective 3 82. MC 89. 83. MC 90. 84. MC 91. 85. MC 92. 86. MC 93. 87. MC 94. 88. MC 95. Study Objective 4 100. MC 104. 101. MC 105. 102. MC 130. 103. MC 131. *Study Objective 5 *110. MC *114. *111. MC *115. *112. MC *116. *113. MC *117.

Ma = Matching Ex = Exercise

Item

Type

Item

Type

MC MC MC MC

58. 138. 139.

MC Ma SAE

MC Ex Ex Ex Ex

128. 129. 130. 131. 132.

Ex Ex Ex Ex Ex

138. 140. 141. 142.

Ma SAE SAE SAE

MC MC MC MC MC MC MC

96. 97. 127. 128. 129. 133. 134.

MC MC Ex Ex Ex Ex Ex

135. 138. 140. 143.

Ex Ma SAE SAE

MC MC Ex Ex

132. 135. 138. 140.

Ex Ex Ma SAE

141. 142. 143.

SAE SAE SAE

MC MC MC MC

*118. *119. *120. *121.

MC MC MC MC

*122. *123. *136. *137.

MC MC Ex Ex

SAE = Short-Answer Essay

*This topic is dealt with in an Appendix to the chapter.

Reporting and Analyzing Investments

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CHAPTER STUDY OBJECTIVES 1.

Identify reasons to invest, and classify investments. Corporations generally purchase investments in debt and equity securities for a variety of reasons. The investment may be purchased as a non-strategic investment to generate investment income or it might be purchased as a strategic investment to influence or control the operations of another company. Non-strategic investments may include debt securities that are purchased to earn investment income through the receipt of interest payments. Sometimes, though, a debt security may be held for trading purposes. Non-strategic equity investments can be held for trading purposes or to earn dividend revenue and can be held for any length of time.

Account for non-strategic investments. Non-strategic investments include investments in debt and equity securities. There are four major models that can be used to account for some of these investments. The fair value through profit or loss model reports debt or equity investments at their fair values on the statement of financial position while all related investment income, such as interest, dividends, and both unrealized and realized gains and losses, are reported in the income statement under other revenues and expenses. The fair value through other comprehensive income model is very similar to the above except that both unrealized and realized gains and losses are reported in other comprehensive income rather than on the income statement. Furthermore, this model is used for equity, not debt-related investments. The amortized cost model is used for debt investments that have premiums or discounts that need to be amortized over time. Under this model, if interest is received, it is recorded in the income statement, as is the effect of any amortization. The investment is not adjusted to reflect fair value so no unrealized gains or losses are recorded. Any realized gains and losses arising on the sale of the investment are recorded in the income statement. The cost model is identical to the amortized cost model but would not be used on an investment with a discount or premium.

Account for strategic investments. When an investor company makes a strategic investment, it is usually done to influence or control the investee. Significant influence is usually achieved when at least 20% of the investee’s shares are acquired, although qualitative factors should also be evaluated to determine the existence of significant influence. If the investor is not able to exert significant influence over the investee company, the investment is accounted for as if it were a non-strategic equity investment. When significant influence exists (there is share ownership of usually 20% or more along with qualitative evidence of influence), the equity method should be used. The equity method records investment revenue from an associate (a significantly influenced investee) based on the investor’s proportion of the associate’s income. If the investor receives dividends from the associate, they reduce the carrying amount of the investment account because that company’s equity has fallen. When the investor obtains control (usually more than 50% of the shares) of the investee, the subsidiary’s financial statements are consolidated into those of the parent company.

Explain how investments are reported in the financial statements. Realized gains and losses, unrealized gains and losses, dividend revenue, and interest revenue are shown in the income statement as other revenues and expenses, with two exceptions. The first exception applies to equity investments accounted for under the fair value through OCI model, where

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

unrealized and realized gains and losses are not shown in the income statement but are instead reported in OCI. The second exception arises when using the equity method, where dividend revenue is not recorded in the income statement but is instead shown as a reduction to the investment account. Under both IFRS and ASPE, non-strategic equity investments are usually held for trading purposes and would be shown in the current assets section of the statement of financial position using the fair value through profit or loss model. If a non-strategic equity investment is not held for trading, it may be shown as a long-term investment on the statement of financial position. These non-trading, non-strategic investments can be accounted for using the fair value through OCI model under IFRS, but because ASPE does not use other comprehensive income, this option is not available under ASPE. Debt investments that are held to earn interest revenue until maturity may be shown as current assets or long-term investments, depending on their maturity date. Under both IFRS and ASPE, these debt investments would be accounted for under the amortized cost model, although under IFRS, there is an option to use fair value through profit or loss. Under ASPE, if fair value cannot be measured, the cost model for equity investments or the amortized cost model for debt investments would be used. Strategic investments in significantly influenced associates are shown as long-term investments. Under IFRS, they are accounted for using the equity method. Under ASPE, if fair value is known, they are accounted for using the equity or fair value through profit or loss method, and if fair value is not known, they can be accounted for using the equity method or cost model. Strategic investments in subsidiaries where control has been obtained would require the preparation of consolidated financial statements by the parent company under IFRS. In this case, the investment account is replaced by the specific assets and liabilities of the subsidiary. Under ASPE, parent companies can choose to use consolidation or can account for the investment using the equity method or the cost model, but if a fair value for the investment can be determined, the fair value through profit or loss model rather than the cost model must be used. Accumulated other comprehensive income is presented in the shareholders’ equity section of the statement of financial position. Other comprehensive income is closed out at the end of the year into accumulated other comprehensive income. Changes in share capital, retained earnings, and accumulated comprehensive income are shown in the statement of changes in equity.

Compare the accounting for a bond investment and a bond payable (Appendix 12A). The accounting for a bond investment is similar to that of a bond payable in that any premium or discount is amortized using the effective-interest method of amortization. Companies using ASPE can choose to use the straight-line method instead if the results do not materially differ from the effective-interest method. Premiums and discounts are not amortized for nonstrategic investments that are held for trading purposes and would normally be accounted for under the fair value through profit and loss model.

Reporting and Analyzing Investments

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TRUE-FALSE STATEMENTS 1. Corporations purchase investments in debt or equity securities for the income tax write-off.

2. Only equity securities can be purchased for the strategic purpose of influencing relationships between companies.

3. When investing excess cash for short periods of time, corporations generally invest in equity securities.

4. Strategic investments are debt or equity securities that are usually purchased to generate investment income.

5. Non-strategic investments can be classified as short or long-term investments.

6. Only debt investments can be purchased as strategic investments.

7. Debt investments earn interest revenue over time and the borrower has an obligation to return the original amount of the investment on a fixed maturity date.

8. When investing excess cash for short periods, investors generally invest in debt securities that have both high liquidity and high risk.

9. Non-strategic investments that are held for the purpose of earning capital gains are called trading investments.

10. The degree of influence determines how a strategic investment is classified.

11. Preferred shares are often purchased as strategic investments.

12. Equity securities are always classified as long-term investments.

13. At acquisition, non-strategic investments are recorded at their purchase cost.

14. Under both the fair value model and the amortized cost model, investments are adjusted upwards or downwards to reflect their fair value at year end.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

15. The cost model is used only for equity investments.

16. No unrealized gains and losses are recorded when using the amortized cost model.

17. Using the fair value through profit or loss model, both unrealized and realized gains and losses would be reported in the income statement.

18. The cost model reports realized gains and losses on the income statement.

19. Only debt investments can be accounted for using the fair value through other comprehensive income model.

20. If the fair value through other comprehensive income model is used, then unrealized gains and losses are not used to evaluate management.

21. The cost model is used to account for equity investments where there is significant influence.

22. When an investee can be significantly influenced, it is known as an associate.

23. Dividends received on investments are accounted for in the same way under the fair value through profit or loss model cost and the equity method.

24. Unless there is evidence to the contrary, an investor owning at least 20% of the shares of an investee is assumed to have significant influence.

25. Under the equity method, revenue is recognized when profit is earned by the associate.

26. When the equity method is used to account for an investment in shares, dividends received are accounted for as a reduction in the investment account.

27. Using the fair value through profit and loss model of accounting for an equity investment, the journal entry to record the receipt of dividends involves a credit to Dividend Revenue.

28. At acquisition, the investment account is debited for the cost of the shares under both the cost and equity methods of accounting for strategic investments.

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29. Under the equity method, the investment account is adjusted annually for a portion of associate’s net profit and for dividends received.

30. Under the equity method, the receipt of dividends from the investee results in an increase in the investment account.

31. Under the equity method, the receipt of dividends from the investee results in a credit to the Dividend Revenue account.

32. Under both IFRS and ASPE, investors can use either the cost model or the equity method for significantly influenced investments.

33. Investments in associates are reported as current assets on the statement of financial position at their fair value.

34. Both equity and debt investments are reported as current assets on the statement of financial position at their fair value.

35. Realized gains and losses are always reported in the income statement.

36. One source of comprehensive income is created when unrealized gains and losses are recorded for trading investments.

37. Trading investments are always classified as current assets.

38. Other comprehensive income (loss) increases (decreases) accumulated other comprehensive income.

39. Like profit (loss), other comprehensive income (loss) increases (decreases) retained earnings.

40. Debt investments held to earn interest revenue are reported at amortized cost in the statement of financial position.

41. Consolidated financial statements are appropriate when one company has significant influence over another company.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

*42. When an investment in bonds is made, the investment account is debited for the face value of the bond less any premium or plus any discount.

*43. Premiums and discounts must be amortized on all bond investments.

*44. Short-term investments in bonds are accounted for using the fair value through profit or loss model.

*45. The amortization of a bond investment is recorded in an Interest Expense account.

*46. The amortization of a bond investment is recorded in an Interest Revenue account.

*47. If there is a bond premium on a long-term bond investment, the carrying amount of the investment is reduced by the amount of the amortization.

*48. Interest revenue is calculated by multiplying the carrying amount of the bond investment by the market rate of interest when the bond was purchased prorated by the portion of the payment period covered during the year.

*49. Under both IFRS and ASPE, the investor must use the effective-interest method to amortize bond premium or discount.

Reporting and Analyzing Investments

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Ans. F T F F T F T F T T

Item 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

Ans. F F T F T T T T F T

Item 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

Ans. F T F T T T T T T F

Item 31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

Ans. F F F F F T F T F T

Item 41. *42. *43. *44. *45. *46. *47. *48. *49.

Ans. F F F T F F T T F

*This topic is dealt with in an Appendix to the chapter.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 50. Corporations invest in other companies for all of the following reasons except to (a) use excess cash until needed. (b) generate investment revenue. (c) meet strategic goals. (d) influence the market value.

51. When investing excess cash for short periods of time, corporations generally invest in any of the following, except (a) money-market funds. (b) bankers’ acceptances. (c) equity securities. (d) treasury bills.

52. Which of the following would never be classified as a long-term investment? (a) strategic investments (b) trading investments (c) investments in associates (d) bonds with a ten-year maturity

53. Debt investments include all of the following except (a) common shares. (b) guaranteed investment certificates. (c) treasury bills. (d) bonds.

54. Which one of the following would not be classified as a non-strategic investment? (a) money-market securities (b) idle cash in a chequing account (c) trading investments (d) long-term bonds

55. Trading investments are all of the following except (a) debt or equity securities. (b) securities purchased to generate a profit from short-term price fluctuations. (c) securities held for the purpose of earning capital gains. (d) strategic investments.

56. All of the following statements concerning strategic investments are true, except (a) they include trading investments. (b) they are purchased for the strategic purpose of influencing relationships between companies. (c) they are generally long-term investments.

Reporting and Analyzing Investments

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(d) they are equity securities.

57. Debt investments are all of the following except (a) low risk. (b) classified according to maturity. (c) equity securities. (d) debt securities.

58. Which of the following statements is not correct regarding strategic investments? (a) They are purchased with the purpose of influencing the investee company. (b) They are generally classified as investments in associates. (c) They are frequently debt securities. (d) The degree of influence determines how a strategic investment is classified.

59. Which of the following statements is not true? (a) Under the fair value through other comprehensive income model gains and losses are critical to the evaluation of management. (b) Under the fair value through profit or loss model, both realized and unrealized gains and losses are reported in the income statement. (c) Under the amortized cost model, no unrealized gains or losses are reported. (d) Non-strategic investments are purchased to generate investment income.

60. All of the following investments are generally shown at their fair value except (a) short-term debt investments. (b) trading investments. (c) bond investments intended to be held to maturity. (d) shares purchased with the intention of achieving a capital gain on sale.

61. Which of the following is not true about the accounting for trading investments? (a) They are reported as current assets on the statement of financial position. (b) Realized gains and losses are reported on the income statement. (c) They are valued at fair value. (d) Unrealized gains and losses are reported on the statement of comprehensive income.

62. If a trading investment in bonds is sold one month after its value was adjusted at year-end, the investment account is (a) debited for the carrying amount of the bonds at the sale date. (b) credited for the cost of the bonds at the sale date. (c) credited for the carrying amount of the bonds at the sale date. (d) debited for the cost of the bonds at the sale date.

63. Jaleem Corporation buys 1,000 shares of Samuel Ltd.'s common shares as a trading investment. The shares are purchased for $30 a share. At year-end the shares are trading at $32. The adjusting entry at year-end is

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) Cash ............................................................................................. Investment Revenue .............................................................. (b) Trading Investments...................................................................... Unrealized Gain on Trading Investments ................................ (c) Trading Investments...................................................................... Realized Gain on Trading Investments ................................... (d) No entry is required.

2,000 2,000 2,000 2,000 2,000 2,000

64. On September 15, 2015, Spirit Ltd. sells 100 common shares of Ghoul Corp., which were being held as a trading investment. The shares were acquired six months ago at $100 a share. Spirit sells the shares for $80 a share. The entry to record the sale is (a) Cash ............................................................................................. 8,000 Realized Loss on Trading Investments.......................................... 2,000 Trading Investments ............................................................... 10,000 (b) Cash ............................................................................................. 10,000 Realized Gain on Trading Investments ................................... 2,000 Trading Investments ............................................................... 8,000 (c) Cash ............................................................................................. 8,000 Trading Investments ............................................................... 8,000 (d) Trading Investments...................................................................... 8,000 Realized Loss on Trading Investments.......................................... 2,000 Cash....................................................................................... 10,000

65. On June 1, 2015, Rock Corp. purchased Chan Corp. common shares for $9,300 as a trading investment. Three months later, Rock sold these shares for $10,000. The entry to record the sale would include a (a) debit to Cash of $9,300. (b) credit to Interest Revenue of $700. (c) credit to Trading Investments of $10,000. (d) credit to Realized Gain on Trading Investments of $700.

Use the following information to answer questions 66–69. Wells Inc. reported these transactions relating to marketable trading investments intended to generate profits and to be sold in the near term: Feb 1 Purchased 500 shares of Taylor Corp. for $7,500 cash. Jun 1 Received cash dividends of $3 per share on Taylor shares. Oct 1 Sold 200 shares of Taylor Corp. for $3,800. Dec 31 Taylor shares were trading at $13.50 per share.

66. The entry to record the purchase of the Taylor shares on Feb 1 would include a (a) debit to Long- Term Trading Investments. (b) debit to Trading Investments. (c) debit to Strategic Investments. (d) debit to Investment in Associates.

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67. The entry to record the receipt of the dividends on Jun 1 would include a (a) debit to Trading Investments for $1,500. (b) debit to Dividend Revenue for $1,500. (c) credit to Dividend Revenue for $1,500. (d) credit to Strategic Investments for $1,500.

68. The entry to record the sale of the shares on Oct 1 would include a (a) credit to Trading Investments for $3,800. (b) credit to Realized Gain for $800. (c) credit to Unrealized Gain for $800. (d) debit to Unrealized Gain for $3,800.

69. The entry, if any is required, to record the value of the investment on December 31 would include a debit to (a) Realized Loss for $450. (b) Unrealized Loss for $750. (c) No entry is required. (d) Unrealized Loss of $450.

70. An advantage of using the fair value through other comprehensive income is that (a) the effect on other comprehensive income is reported in the income statement. (b) unrealized gains and losses are not used to evaluate management. (c) unrealized losses must be reported on the income statement, but unrealized gains are reported in other comprehensive income. (d) unrealized gains must be reported on the income statement, but unrealized losses are reported in other comprehensive income.

71. On October 1 of last year, Canadian Trader Corp. (CTC) purchased 1,000 shares of the Regal Bank for $50,000 as a trading investment. At year end, December 31, the fair value of these shares was $52,000. On February 1 of this year, CTC sold all these shares for $51,000. The realized gain (loss) that CTC will report this year is (a) a gain of $1,000. (b) a gain of $2,000. (c) a loss of $2,000. (d) a loss of $1,000.

72. When an investee can be significantly influenced, it is known as a(n) (a) subsidiary. (b) associate. (c) trading investment. (d) parent.

73. Under the equity method of accounting for an investment (a) Dividend Revenue is credited when dividends are received. (b) an Unrealized Gain account is credited when the investee reports a profit.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(c) the Investment account is credited when the investee reports a profit. (d) the Investment account is credited when dividends are received.

74. If 30% of the common shares of an investee are purchased as a long-term investment, the appropriate classification for this investment is most likely (a) trading investments. (b) equity investments. (c) non-strategic investments. (d) investment in associates.

75. When the cost method is used to account for an equity investment, the carrying amount of the investment is affected by (a) the profit of the investee. (b) dividend distributions of the investee. (c) both the profit and the dividend distributions of the investee. (d) neither the profit nor the dividend distributions of the investee.

76. The equity method should generally be used to account for an investment in shares when the level of ownership is (a) less than 10%. (b) between 10% and 20%. (c) 20% or more. (d) 10% or more.

77. The ability of an investor to affect the operating and financial activities of another company, even though the investor does not control the company, is known as (a) significant influence. (b) control. (c) a combination. (d) influence and control.

78. Under the equity method of accounting for investments in common shares, when a dividend is received from the investee, (a) the Dividend Revenue account is credited. (b) the Investment account is increased. (c) the Investment account is decreased. (d) no entry is necessary.

79. The receipt of dividends from an investment affects the investment account when which of the following methods is used? (a) cost method (b) equity method (c) fair value through profit or loss model (d) fair value through other comprehensive income model

Reporting and Analyzing Investments

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80. Greene Limited owns a 30% interest in the shares of Fields Corporation. During the year, Fields pays $20,000 in dividends to Greene and reports $120,000 profit. Greene’s investment in Fields will increase Greene’s profit by (a) $36,000. (b) $30,000. (c) $20,000. (d) $ 6,000.

81. Behnke Corp. owns a 10% interest in the common shares of DeLonghi Ltd. During this year, DeLonghi pays a total of $15,000 in dividends and reports $130,000 profit. Behnke’s investment in DeLonghi will increase Behnke’s profit by (a) $15,000. (b) $13,000. (c) $12,500. (d) $ 1,500.

82. Jet Inc. owns a 25% interest in the shares of Winnipeg Corp. During the year, Winnipeg pays $5,000 in dividends to Jet and reports a net loss of $50,000. Jet’s investment in Winnipeg will affect Jet’s profit by (a) $5,000 increase. (b) $1,000 increase. (c) $12,500 decrease. (d) $11,250 decrease.

83. Edmonton Ltd. owns 10% interest in the shares of Jasper Corporation. During the year, Jasper pays $5,000 in dividends to Edmonton and reports a net loss of $50,000. Edmonton’s investment in Jasper will affect Edmonton’s profit by (a) $500 increase. (b) $5,000 increase. (c) $5,000 decrease. (d) $4,500 decrease.

84. On January 1, 2016, Toppers Corp. purchased 25% of the common shares of Great Lakes Corp. for $400,000. During 2016, Great Lakes Corp. reported profits of $60,000 and paid total cash dividends of $12,000. The balance in the Investment in Associates (Great Lakes) account on Toppers’ books at December 31, 2016 is (a) $460,000. (b) $415,000. (c) $412,000. (d) $400,000.

85. Under the equity method, the Investment in Associates account is increased when the (a) associate reports profits. (b) associate pays a dividend. (c) associate reports a loss.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) investment is sold at a gain.

86. Which of the following is the correct match concerning an investor's influence on the operations and financial affairs of an investee? % of Investor Ownership Presumed Influence (a) Less than 20% Significant (b) More than 20% Significant (c) More than 50% Insignificant (d) Between 20%-50% Control

87. Which of the following is the correct match concerning the appropriate accounting for strategic investments? % of Investor Ownership Accounting method (a) Less than 20% Fair value (b) More than 20% Fair value (c) More than 50% Fair value or equity method (d) Less than 10% Consolidation

88. If the equity method is used to account for an investment in common shares (a) it is presumed that the investor has no significant influence on the investee. (b) profits of the investee are ignored by the investor. (c) profits of the investee are recorded as realized gains, but dividends received are credited to the investment account. (d) the investment account may be at times greater than the acquisition cost.

89. If a company acquires a 40% interest in another company (a) the equity method is usually applicable. (b) it would always have a controlling interest. (c) One of the fair value models is usually applicable. (d) the investor does not have the ability to exert significant influence over the investee.

90. If the equity method is being used, cash dividends received (a) are credited to the Dividend Revenue account. (b) do not require an entry because the investee’s profits have already been recorded at the proper proportion on the investor's books. (c) are credited to the Investment in Associates account. (d) are credited to the Revenue from Investment in Associates account.

91. If the equity method is being used, the Revenue from Investment in Associates account is (a) another name for a Dividend Revenue account. (b) credited when dividends are declared by the investee. (c) credited when profits are reported by the investee. (d) debited when profits are reported by the investee.

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92. Under the equity method, the Investment in Associates account is credited when the (a) associate reports profits. (b) associate reports a net loss. (c) associate is originally acquired. (d) both when the investee reports profits and when the investment is originally acquired.

93. When an investor owns more than 50% of the common shares of another company, (a) consolidated financial statements are usually prepared. (b) the fair value through profit or loss model is used. (c) the investor is called a subsidiary. (d) the investor recognizes revenue only when dividends are received.

94. The company that has the majority of its voting shares owned by a parent company is called the (a) controlled company. (b) subsidiary company. (c) investee company. (d) sibling company.

95. A company that controls the common shares of another company is known as the (a) charge company. (b) subsidiary company. (c) parent company. (d) management company.

96. If one company owns more than 50% of the common shares of another company (a) the cost method should be used to account for the investment. (b) a partnership exists. (c) a parent-subsidiary relationship exists. (d) the company whose shares are owned must be liquidated.

97. When a company controls the common shares of another company (a) affiliated financial statements are prepared. (b) consolidated financial statements are prepared. (c) controlling financial statements are prepared. (d) no financial statements are prepared.

98. If a company reporting under ASPE decides to use the cost model to account for an investment in common shares, dividends received should be (a) credited to the Investment account. (b) credited to the Dividend Revenue account. (c) debited to the Investment account. (d) recorded only when 20% or more of the shares are owned.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

99. When an investor reporting under IFRS owns more than 20% of the common shares of a corporation, it is generally presumed that the investor (a) has insignificant influence on the investee and that the cost method should be used to account for the investment. (b) should use the fair value through profit or loss model to account for the investment. (c) will prepare consolidated financial statements. (d) has significant influence on the investee and that the equity method should be used to account for the investment.

100. If an investment in an associate is sold at a gain, the gain (a) is reported as operating revenue. (b) is reported under a special section, "Discontinued Investments," on the income statement. (c) is reported in the Other Revenues and Gains section on the income statement. (d) contributes to gross profit on the income statement. 101. “Other comprehensive income” does not include (a) revaluations of property, plant and equipment. (b) certain translation gains and losses on foreign currency. (c) realized gains and losses on trading investments. (d) unrealized gains and losses on trading investments.

102. Laski Corp. holds two trading investments and has decided to use the fair value through profit or loss model. At year end, one has an unrealized gain of $2,000 and the other has an unrealized loss of $4,500. The trading investments would be reported at fair value and Laski Corp. would report a net unrealized loss of (a) $2,500 in the income statement. (b) $4,500 in the income statement. (c) $2,500 in the statement of comprehensive income. (d) $4,500 in the statement of comprehensive income.

103. During its first year of operation, Lenton Limited (a public company) acquired three securities as trading investments. Investment A cost $50,000 and had a year-end fair value of $60,000. Investment B cost $35,000 and had a year-end fair value of $20,000. Investment C cost $26,000 and had a year-end fair value of $24,000. What amount should be reported as an unrealized loss in Lenton's income statement for the first year of operation? (a) $0 (b) $7,000 (c) $17,000 (d) $27,000

104. Trading investments are listed on the statement of financial position immediately below (a) cash. (b) inventory. (c) accounts receivable. (d) prepaid expenses.

Reporting and Analyzing Investments

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105. Information flows among financial statements in this order: (a) statement of financial position to statement of changes in equity to statement of comprehensive income to income statement. (b) income statement to statement of changes in equity to statement of comprehensive income to statement of financial position. (c) income statement to statement of comprehensive income to statement of changes in equity to statement of financial position. (d) statement of changes in equity to statement of financial position to statement of comprehensive income to income statement.

*106. Short-term investments in bonds are accounted for using the (a) equity method. (b) short-term method. (c) fair value through profit or loss model. (d) amortized cost model.

*107. Amortization of bond premiums for bond investments will (a) increase Interest Revenue and increase the Investment account. (b) increase Interest Revenue and decrease the Investment account. (c) decrease Interest Revenue and decrease the Investment account. (d) decrease Interest Revenue and increase the Investment account.

*108. Amortization of bond discounts for bond investments will (a) increase Interest Revenue and increase the Investment account. (b) increase Interest Revenue and decrease the Investment account. (c) decrease Interest Revenue and decrease the Investment account. (d) decrease Interest Revenue and increase the Investment account.

Use the following information for questions *109–*111. On January 1, 2015, Soo Park Corp. purchased at face value, a $5,000, 5%, bond investment that pays interest on January 1 and July 1. Soo Park classified the investment as long-term. Soo Park has a calendar year end.

*109. The entry for the receipt of interest on July 1, 2015, is (a) Cash ............................................................................................... Interest Revenue .................................................................... (b) Cash ............................................................................................. Interest Revenue .................................................................... (c) Interest Receivable ....................................................................... Interest Revenue .................................................................... (d) Interest Receivable ....................................................................... Interest Revenue ....................................................................

125 125 250 250 125 125 250 250

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

*110. The adjusting entry on December 31, 2015, is (a) No entry required. (b) Cash ............................................................................................. Interest Revenue .................................................................... (c) Interest Receivable ....................................................................... Interest Revenue .................................................................... (d) Long-Term Investments ................................................................ Interest Revenue ....................................................................

*111. The entry for the receipt of interest on January 1, 2016 is (a) Cash ............................................................................................. Interest Revenue .................................................................... (b) Cash ............................................................................................. Interest Receivable................................................................. (c) Cash ............................................................................................. Interest Revenue .................................................................... (d) Cash ............................................................................................. Interest Receivable.................................................................

125 125 125 125 125 125

250 250 250 250 125 125 125 125

Use the following information for questions *112–*116. On January 1, 2015, Marianne Corp. purchased $50,000, of Robin Ltd.’s 4%, 10-year bonds for $48,000, since the market interest rate was approximately 4.5%. The bonds pay interest on January 1 and July 1. Marianne has a calendar year end, and classified the bonds as long-term investments. The fair value on December 31, 2015 was $48,500. Marianne sold the bonds on January 2, 2016 for $48,500.

*112. The entry for the receipt of interest on July 1, 2015 is (a) Cash ............................................................................................. Long-Term Investments.......................................................... Interest Revenue .................................................................... (b) Cash .................................................................................. Long-Term Investments ................................................................ Interest Revenue .................................................................... (c) Cash .................................................................................. Interest Revenue .................................................................... (d) Cash .................................................................................. Interest Revenue ....................................................................

*113. The adjusting entry for interest on December 31, 2015, is (a) No entry required. (b) Interest Receivable ....................................................................... Long-Term Investments ................................................................ Interest Revenue .................................................................... (c) Interest Receivable ....................................................................... Long-Term Investments ................................................................ Interest Revenue ....................................................................

1,080 80 1,000 1,000 80 1,080 1,000 1,000 1,080 1,080

1,000 80 1,080 1,000 82 1,082

Reporting and Analyzing Investments

(d) Cash ............................................................................................. Long-Term Investments ................................................................ Interest Revenue ....................................................................

*114. The entry to adjust to fair value on December 31, 2015 is (a) No entry required. (b) Long-Term Investments ................................................................ Unrealized Gain on Long-Term Investments .......................... (c) Long-Term-Investments ................................................................ Unrealized Gain on Long-term Investments............................ (d) Long-Term Investments ................................................................ Realized Gain on Long-Term Investments..............................

*115. The entry for the receipt of interest on January 1, 2016 is (a) Cash ............................................................................................. Interest Receivable................................................................. (b) Cash ............................................................................................. Interest Receivable................................................................. (c) Cash ............................................................................................. Interest Revenue .................................................................... (d) Cash ............................................................................................. Interest Revenue ....................................................................

*116. The entry for the sale of the bonds on January 2, 2016 is (a) Cash ............................................................................................. Realized Gain on Bond Sale................................................... Long-Term Investments.......................................................... (b) Cash ............................................................................................. Long-Term Investments.......................................................... (c) Cash ............................................................................................. Realized Gain on Bond Sale................................................... Long-Term Investments.......................................................... (d) Cash ............................................................................................. Realized Gain on Bond Sale................................................... Long-Term Investments..........................................................

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1,000 82 1,082

500 500 338 338 500 500

1,080 1,080 1,000 1,000 1,082 1,082 2,000 2,000

48,500 500 48,000 48,500 48,500 48,500 420 48,080 48,500 338 48,162

Use the following information for questions *117–*119. On January 1, 2015, Warner Inc. purchased 3.5%, $50,000 face value Jackson Corp. bonds at face value. Interest is payable semi-annually on July 1 and January 1. The bonds are classified as trading investments. The bonds were sold on July 2, 2015 for $53,000. *117. Warner’s entry to record the purchase would include a debit to (a) Trading Investments for $50,000. (b) Cash for $50,000. (c) Bonds Payable for $50,000.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) Long-Term Investments for $50,000. *118. Warner’s entry to record the receipt of the July 1 interest payment would include a (a) debit to Interest Expense for $875. (b) credit to Interest Revenue for $875. (c) credit to Interest Revenue for $1,750. (d) credit to Trading Investments for $875. *119. Warner’s entry to record the sale on July 2, after the July 1 interest was received and recorded, would include a (a) debit to Cash for $53,875. (b) credit to Interest Revenue for $875. (c) credit to Realized Gain on Trading Investments for $3,000. (d) credit to Trading Investments for $53,000.

*120. On January 1, Saskatoon Corporation purchased as a trading investment a $1,000, 6% bond for $1,060. The bond pays interest on January 1 and July 1. After receiving and recording the interest, the bond is sold on July 1 for $1,100. What is the entry to record the cash proceeds at the time the bond is sold? (a) Cash ............................................................................................. 1,060 Trading Investments ............................................................... 1,060 (b) Cash ............................................................................................. 1,100 Trading Investments ............................................................... 1,060 Realized Gain on Trading Investments ................................... 40 (c) Cash ............................................................................................. 1,100 Trading Investments ............................................................... 1,060 Unrealized Gain on Trading Investments ................................ 40 (d) Cash ............................................................................................. 1,100 Trading Investments ............................................................... 1,100

Use the following information for questions *121–*123. On January 1, 2015, Burkett Corporation purchased, as a long-term investment, a $25,000, 5% bond, for $21,595. At this time, the market rate of interest was approximately 7%. The bond pays interest on January 1 and July 1. On December 31, 2015, the fair value of the bonds was $23,950.

*121. What is the entry to record the purchase? (a) Long-Term Investments ................................................................ Cash....................................................................................... (b) Long-Term Investments ................................................................ Unrealized Loss on Long-Term Investments ................................. Cash....................................................................................... (c) Long-Term Investments ................................................................ Unrealized Gain on Long-Term Investments .......................... Cash....................................................................................... (d) Long-Term Investments ................................................................

21,595 21,595 21,595 3,405 25,000 25,000 3,405 21,595 25,000

Reporting and Analyzing Investments

Interest Revenue .................................................................... Cash.......................................................................................

*122. What is the entry to record the receipt of the interest on July 1, 2015? (a) Cash ............................................................................................. Long-Term Investments.......................................................... (b) Cash ............................................................................................. Interest Revenue .................................................................... (c) Cash ............................................................................................. Interest Revenue .................................................................... (d) Cash ............................................................................................. Long-Term Investments ................................................................ Interest Revenue ....................................................................

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3,405 21,595

625 625 756 756 625 625 625 131 756

*123. What is the entry (if any) to record the fair value adjustment on December 31, 2015? Assume the adjusting entry for the interest accrual has already been recorded. (a) No entry required. (b) Long-Term Investments ................................................................ 216 Unrealized Gain on Long-Term Investments .......................... 216 (c) Long-Term Investments ................................................................ 216 Realized Gain on Long-Term Investments.............................. 216 (d) Long-Term Investments ................................................................ 181 Unrealized Gain on Long-Term Investments .......................... 181

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62.

Ans. d c b a b d a c c a c d c

Item 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

Ans. b a d b c b d b d b d d d

Item 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88.

Ans. c a c b a d c b c a b a d

Item 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101.

Ans. a c c b a b c c b b d c c

Item 102. 103. 104. 105. *106. *107. *108. *109. *110. *111. *112. *113. *114.

Ans. a b a c c c a a c d b c a

Item *115. *116. *117. *118. *119. *120. *121. *122. *123.

Ans. b d a b c b a d a

*This topic is dealt with in an Appendix to the chapter.

Reporting and Analyzing Investments

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EXERCISES Ex. 124 On January 1, Kensington Corporation, as a trading investment, purchased a three month, 3%, $20,000 term deposit. Instructions Prepare entries for the purchase and maturity of the term deposit. Solution 124 (2–4 min.) Jan 1 Trading Investments .......................................................... Cash ...........................................................................

20,000

Mar 31

20,150

Cash .................................................................................. Trading Investment ..................................................... Interest Revenue ($20,000 x 3% x 3/12) .....................

20,000

20,000 150

Ex. 125 Glover Corporation reported the following transactions relating to its trading investments: Jan 1 Purchased $100,000 Chandler Corporation 6% bonds for $104,000. Interest is receivable semi-annually on July 1 and January 1. Jul 1 Received semi-annual interest on the Chandler Corporation bonds. Jul 2 Sold one-half of the Chandler Corporation bonds for $53,000. Instructions (a) Record the above transactions. (b) Prepare the adjusting entry for the accrual of interest on December 31. Solution 125 (10–15 min.) (a) Jan 1 Trading Investments .......................................................... Cash ........................................................................... Jul

(b) Dec 31

104,000 104,000

Cash ($100,000 × 6% × 6/12) ............................................ Interest Revenue.........................................................

3,000

Cash .................................................................................. Trading Investments ($104,000 x ½) ........................... Realized Gain on Trading Investments .......................

53,000

Interest Receivable ............................................................ Interest Revenue......................................................... ($50,000 × 6% × 6/12)

1,500

3,000

52,000 1,000

1,500

Ex. 126 The following transactions regarding their trading investments were made by Amarillo Limited:

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Jun Jul

2 1 31 Sep 15 Dec 31 31 31

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Purchased 200 Clark Corporation common shares for $45 per share. Purchased 100 Lewis Corporation bonds for $110,000. Received a cash dividend of $2 per share from Clark Corporation. Sold 80 shares of Clark Corporation for $50 per share. Received semi-annual interest cheque for $5,500 from Lewis Corporation. Received a cash dividend of $2 per share from Clark Corporation. Fair values: Lewis bonds $113,500; Clark shares $48 per share.

Instructions Record the above transactions and events, including any required adjustments on Dec 31. Solution 126 (10–15 min.) Jun 2 Trading Investments .......................................................... Cash (200 x $45) ........................................................ Jul

Sep 15

Dec 31

9,000 9,000

Trading Investments .......................................................... Cash ...........................................................................

110,000

Cash .................................................................................. Dividend Revenue .......................................................

400

Cash (80 × $50) ................................................................. Trading Investments (80 × $45) .................................. Realized Gain on Trading Investments .......................

4,000

Cash .................................................................................. Interest Revenue.........................................................

5,500

Cash (120 × $2) ................................................................. Dividend Revenue .......................................................

240

Trading Investments (120 × ($48 – $45) ............................ Trading Investments ($113,500 – $110,000) ...................... Unrealized Gain on Trading Investments ....................

360 3,500

110,000

400

3,600 400

5,500

240

3,860

Ex. 127 Lion Limited purchased 40,000 common shares of Tiger Corp. for $800,000, as a long-term investment. During the year, Tiger Corp. reported profits of $200,000 and paid total dividends of $90,000. The fair value of the shares on Dec. 31 was $820,000. Instructions (a) Assuming that the 40,000 shares represent a 10% interest in Tiger Corp. and this is classified as a trading investment: 1. Prepare the journal entry to record Lion’s investment in Tiger shares. 2. Prepare any entries that Lion should make in accounting for its investment in Tiger shares during the year. 3. What is the balance of the investment account on Lion's books at December 31?

Reporting and Analyzing Investments

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(b) Repeat requirement (a) above except assume that the 40,000 shares represent a 40% interest in Tiger Corp. Solution 127 (15–20 min.) (a) Fair value through profit or loss model 1. Trading Investments ............................................................... Cash ................................................................................ 2.

Cash ($90,000 x 10%) ............................................................ Dividend Revenue ........................................................... Trading Investments ............................................................... Unrealized Gain on Trading Investments .........................

800,000 9,000 9,000 20,000 20,000

The Trading Investments account balance at the end of the year is $820,000 ($800,000 + $20,000).

(b) Equity Method 1. Investment in Associates ........................................................ Cash ................................................................................ 2.

800,000

Investment in Associates (40% × $200,000) ........................... Revenue from Investment in Associates .......................... Cash (40% × $90,000) ........................................................... Investment in Associates .................................................

800,000 800,000 80,000 80,000 36,000 36,000

The Investment in Associates account balance at the end of the year is $844,000 ($800,000 + $80,000 – $36,000)

Ex. 128 Information relating to equity investments made in 2015 by Mahdi Corporation follows: 1. On January 1, 2015, Mahdi obtained significant influence over Webster Inc. by buying 30% of Webster's 120,000 issued common shares at $24 per share. On June 15, 2015, Webster declared and paid a cash dividend of $1.50 per share. On December 31, Webster's reported profit was $280,000, and their shares were trading at $25.50. 2. On March 1, 2015, as a trading investment, Mahdi acquired 12% of the 250,000 issued common shares of Noah Limited at $8 per share. On July 1, 2015, Noah declared and paid a cash dividend of $2 per share. On December 31, 2015, Noah's reported profit was $654,000 for the year and its shares were trading at $7.50. Instructions Prepare all necessary journal entries relating to these two investments for 2015 for Mahdi Corporation. Solution 128 (15–20 min.) Jan 1 Investment in Associates ................................................... Cash (30% × 120,000 × $24) ......................................

864,000

Mar 1

240,000

Trading Investments .......................................................... Cash (250,000 × 12% × $8) ........................................

864,000

240,000

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Jun 15

Jul

Dec 31

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Cash (36,000 × $1.50) ....................................................... Investment in Associates ............................................

54,000

Cash (30,000 × $2) ............................................................ Dividend Revenue .......................................................

60,000

Investment in Associates ................................................... Revenue from Investment in Associates. .................... ($280,000 × 30%)

84,000

Unrealized Loss on Trading Investments ........................... Trading Investments ................................................... (30,000 × ($8.00 – $7.50)

15,000

54,000

60,000

84,000

15,000

Note that, using the equity method, the year end fair value of the Webster shares is not relevant, unless there is a permanent decline in the fair value of the shares.

Ex. 129 Complete the following table. The shares are purchased at the beginning of the year and sold at the end of the year.

Number of common shares purchased by investor Purchase price per share Total number of shares issued by investee Dividends received (per share) Reported profit of investee Proceeds per share Gain/loss on sale

Case A 50

Case B 1,500

Case C 12,500

Case D 25,000

Case E 2,000

A 100,000 $0.40 $534,000 $6 $50

$7.50 10,000 $0 $8,500 B $150

$20 50,000 $1.00 $234,000 $24 C

D 100,000 $2.50 $487,000 $69 $(93,000)

$150 5,000 E $(150,000) $125 $17,000

Case A 50

Case B 1,500

Case C 12,500

Case D 25,000

Case E 2,000

$5 100,000 $0.40 $534,000 $6 $50

$7.50 10,000 $0 $8,500 $7.60 $150

$20 50,000 $1.00 $234,000 $24 $4,000

$70.35 100,000 $2.50 $487,000 $69 $(93,000)

$150 5,000 $3.50 $(150,000) $125 $17,000

Solution 129 (25–35 min.)

Fair value through profit or loss model: 50 ÷ 100,000 = 0.05% ownership Gain on sale is $50 on 50 shares = $1 per share Therefore paid $6 - $1 = $5 per share

Reporting and Analyzing Investments

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Fair value through profit or loss model: 1,500 ÷ 10,000 = 15% ownership Cost = $11,250 ($7.50 × 1,500) Cost + $150 gain = $11,400 proceeds ÷ 1,500 = $7.60 proceeds/share

Equity method: 12,500 ÷ 50,000 = 25% ownership Cost = 12,500 × $20 = $250,000 Carrying amount at sale = $296,000 [$250,000 + ($234,000 profit × 25%) – (12,500 × $1 dividends)] Proceeds = $300,000 (12,500 × $24) – $296,000 carrying amount = $4,000 gain

Equity method: 25,000 ÷ 100,000 = 25% ownership Proceeds = $1,725,000 (25,000 × $69) + $93,000 loss = $1,818,000 carrying amount Carrying amount = $1,818,000 = Cost + ($487,000 profit × 25%) – (25,000 × $2.50 dividends) Cost = $1,758,750 ÷ 25,000 shares = $70.35 cost/share

Equity method: 2,000 ÷ 5,000 = 40% ownership Cost = $300,000 (2,000 × $150) Proceeds = $250,000 (2,000 × $125) - $17,000 gain = $233,000 carrying amount Carrying amount = $233,000 = $300,000 - ($150,000 loss × 40%) – (2,000 × dividends) Dividends = $7,000 ÷ 2,000 shares = $3.50 dividend/share

Ex. 130 Platinum Corporation reported the following transactions relating to its trading investments. Platinum Corporation follows IFRS and has elected to report trading investments under the fair value through profit and loss model. Jan 1 Purchased 1,200 Silver Corporation shares for $20 cash each. Jun 1 Received cash dividends of $0.50 per share on Silver Corporation shares. Sep 15 Sold 600 shares of Silver Corporation for $13,800 ($23 each). Dec 1 Received cash dividends of $0.75 per share on Silver Corporation shares. Dec 31 Silver shares were trading at $27 each. Instructions (a) Record the above transactions and events. (b) Indicate where any revenues and gains or losses (realized or unrealized) would appear in the financial statements. Solution 130 (15 min.) (a) Jan. 1 Trading Investments .......................................................... Cash (1,200 x $20) ..................................................... Jun

Sep 15

Dec 1

24,000 24,000

Cash (1,200 x $0.50) ......................................................... Dividend Revenue .......................................................

600

Cash .................................................................................. Realized Gain on Trading Investments ....................... Trading Investments (600 × $20) ................................

13,800

Cash (600 × $0.75) ............................................................

450

600

1,800 12,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Dividend Revenue ....................................................... Dec 31

450

Trading Investments .......................................................... 4,200 Unrealized Gain on Trading Investments (600 × ($27–$20)

4,200

(b) Since the fair value through profit or loss model is used for trading investments, dividend revenue and both realized and unrealized gains are reported under Other Revenues and Gains on the income statement.

Ex. 131 Ontario Corporation (a private corporation) reported the following transactions relating to its trading investments: Jan 1 Purchased 1,000 Manitoba Corporation shares for $45,000 cash. Jun 1 Received cash dividends of $0.50 per share from Manitoba Corporation. Sep 15 Sold 400 shares of Manitoba Corporation for $14,875. At year end (December 31), the Manitoba shares were trading at $42. Instructions (a) Record the above transactions. (b) Prepare the adjusting entry, if any, regarding the Manitoba shares at December 31. (c) Indicate where any revenues and gains or losses (realized or unrealized) would appear in the financial statements. Solution 131 (10–15 min.) (a) Jan 1 Trading Investments .......................................................... Cash ........................................................................... Jun

Sep 15

(b) Dec 31

45,000 45,000

Cash (1,000 × $0.50) ......................................................... Dividend Revenue .......................................................

500

Cash .................................................................................. Realized Loss on Trading Investments .............................. Trading Investments ($45,000 x 40%) .........................

14,875 3,125

Unrealized Loss on Trading Investments (600 × ($45 – $42) Trading Investments ...................................................

1,800

500

18,000

1,800

(c) Since the fair value through profit or loss model is used for trading investments, dividend revenue is reported under Other Revenues and Gains, and realized and unrealized losses are reported under Other Expenses and Losses on the income statement.

Ex. 132 Cornwall Corporation reported the following transactions relating to its trading investments: Jan 1 Purchased 850 shares of Waterloo Ltd. shares for $46,750 cash. Jun 1 Received cash dividends of $7 per share on the Waterloo shares.

Reporting and Analyzing Investments

Sep 15 Dec 31

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Sold 350 Waterloo shares for $18,550. The fair value of the Waterloo shares was $28,550.

Instructions (a) Record the above transactions and events. (b) Indicate where any revenues and gains or losses (realized or unrealized) would appear in the financial statements. Solution 132 (10–15 min.) (a) Jan 1 Trading Investments .......................................................... Cash ........................................................................... Jun

Sep 15

Dec 31

46,750 46,750

Cash (850 × $7) ................................................................. Dividend Revenue .......................................................

5,950

18,550 700

Trading Investments .......................................................... Unrealized Gain on Trading Investments ....................

1,000

5,950

19,250

1,000

(b) Since the fair value through profit or loss model is used for trading investments, dividend revenue and unrealized gains are reported under Other Revenues and Gains, and realized losses are reported under Other Expenses and Losses on the income statement.

Ex. 133 On January 1, Oak Corporation purchased a 40% equity investment in Pine Corporation for $600,000. On December 31, Pine paid a $20,000 dividend and reported a net loss of $120,000. The fair value of the shares on December 31 was $550,000. Instructions (a) Record the above transactions and events. (b) Determine the amount to be reported as the investment in Pine Corporation at December 31. Solution 133 (15 min.) (a) Jan 1 Investment in Associates ................................................... Cash ........................................................................... Dec 31

600,000 600,000

Cash ($20,000 × 40%) ....................................................... Investment in Associates—Pine Shares ......................

8,000

Loss from Investment in Associates ($120,000 × 40%) ...... Investment in Associates ............................................

48,000

(b) Purchase price ........................................................... Less dividend received ...............................................

8,000

48,000

$600,000 (8,000)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Less loss from investment .......................................... Balance, December 31 ...............................................

(48,000) $544,000

Ex. 134 On January 1, 2016, McLaughlin Corp. purchased 10,000 Langlois Inc. shares for $650,000. This investment represents 40% of the total issued common shares of Langlois Inc. During 2016, Langlois paid total dividends of $45,000 and reported profits of $290,000. At December 31, 2016, the fair value of the Langlois Inc. shares was $825,000. Instructions (a) Calculate the revenue that McLaughlin reports for 2016 related to this investment. (b) Determine the amount to be reported on the statement of financial position under “Investment in Associates” at December 31, 2016. Solution 134 (10 min.) (a) Revenue for 2016 ($290,000 × 40%) .........................

$116,000

(b) Investment in Associates: Purchase price ................................................... Less dividend received ($45,000 × 40%) ............. Plus investment revenue ($290,000 × 40%) ........ Ending balance, December 31, 2016 .........................

$650,000 (18,000) 116,000 $748,000

Note that, using the equity method, the year end fair value is not relevant, unless there is a permanent decline in the fair value of the shares.

Ex. 135 On January 1, 2015, as a long-term investment, Samantha Ltd. purchases 2,000 Marvel Corp. common shares for $10 each, which represents 50% of the issued shares. Marvel Corp. is a private company not traded on the stock market. Samantha is also a private company, reporting under ASPE, and chooses to use the cost method to account for the Marvel investment. On July 1, 2015, Marvel pays a total dividend of $38,000. At year end, December 31, 2015, a fair value of the Marvel shares is not available, but Samantha estimates the fair value is $11.50. On November 1, 2016, Samantha sells 40% of its holdings back to Marvel for $12,500. Instructions Prepare all necessary journal entries relating to this investment on Samantha’s books. Solution 135 (15 min.) 2015 Jan 1 Long-Term Investments ..................................................... Cash (2,000 x $10) ..................................................... Jul

Cash ($38,000 x 50%) .......................................................

20,000 20,000 19,000

Reporting and Analyzing Investments

Dividend Revenue ....................................................... Dec 31 2016 Nov 1

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19,000

no entry required

Cash .................................................................................. Long-Term Investments (40% x $20,000) ................... Realized Gain on Long-Term Investments ..................

12,500 8,000 4,500

*Ex. 136 On January 1, 2015, Marianne Corp. purchased $50,000 of Robbin Company’s 4%, 10-year bonds for $48,000, since the market rate was approximately 4.5%. The bonds pay interest on January 1 and July 1. Marianne Corp. has a calendar year end, and classified the bonds as a long-term investment. On December 31, 2015, the fair value of these bonds was $48,400. On January 2, 2016, Marianne sold the bonds for $48,400. Instructions Prepare the required entries to record the above transactions and events. Round all values to the nearest dollar. *Solution 136 (20–25 min.) 2015 Jan 1 Cash .................................................................................. Long-Term Investment ................................................ Jul

Dec 31

Dec 31 2016 Jan 1

Jan

48,000 48,000

Cash ($50,000 x 4% x 6/12)............................................... Long-Term Investment ....................................................... Interest Revenue ($48,000 × 4.5% × 6/12)..................

1,000 80

Interest Receivable ............................................................ Long-Term Investment ....................................................... Interest Revenue ($48,080 × 4.5% × 6/12)..................

1,000 82

1,080

1,082

No entry required to adjust investment to fair value (amortized cost model being used).

Cash .................................................................................. Interest Receivable .....................................................

1,000

Cash .................................................................................. Long-Term Investment ($48,000 + $80 + $82) ............ Realized Gain on Long-Term Investment ....................

48,400

1,000

48,162 238

*Ex. 137 On January 1, 2015, Palermo Corp. purchased $50,000 of Sicilia Ltd.’s 5%, 5-year bonds for $52,250, since the market interest rate was approximately 4%. The bonds pay interest on January 1 and July 1. Palermo Corp. has a calendar year end, and classified the bonds as a long-term investment. The fair value of the bonds on December 31, 2015 was $51,500. On January 2, 2016, Palermo sold the bonds for $51,000.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Instructions Prepare the required entries to record the above transactions and events. Round all values to the nearest dollar. *Solution 137 (20–25 min.) 2015 Jan 1 Long-Term Investment ....................................................... Cash ........................................................................... Jul

Dec 31

Dec 31 2016 Jan 1

Jan

52,250 52,250

Cash ($50,000 × 5% × 6/12) .............................................. Long-Term Investment ................................................ Interest Revenue ($52,250 × 4% × 6/12).....................

1,250

Interest Receivable ............................................................ Long-Term Investment ................................................ Interest Revenue ($52,045 × 4% × 6/12).....................

1,250

205 1,045

209 1,041

No entry required to adjust investment to fair value (amortized cost model being used).

Cash .................................................................................. Interest Receivable .....................................................

1,250

Cash .................................................................................. Realized Loss on Long-Term Investment ........................... Long-Term Investment ($52,250 – $205 – $209) ........

51,000 836

1,250

51,836

Reporting and Analyzing Investments

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MATCHING 138. Match the items below by entering the appropriate code letter in the space provided. A. Debt investments F. Consolidated financial statements B. Subsidiary company G. Associate C. Equity method H. Significant influence D. Amortized cost model I. Strategic investment E. Unrealized gain or loss J. Non-strategic investment

____ 1. Investments in money-market instruments, bonds, and commercial paper ____ 2. An investment that is purchased mainly to generate investment income ____ 3. An investment that is purchased to influence or control another company ____ 4. Difference between the fair value and the carrying amount of a trading investment which is still held by the investor ____ 5. Method of valuing debt investments that are held to earn cash flows with specified payment dates in the contract ____ 6. Ability of an investor to influence decisions made by an investee ____ 7. An investee that is significantly influenced by an investor ____ 8. The investment account is adjusted for the investor’s share of the investee’s profit and dividends declared. ____ 9. Company whose shares are controlled by the parent company ____ 10. Financial statements that combine the assets and liabilities of the parent and subsidiary companies

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

12 - 36

ANSWERS TO MATCHING 1.

10.

Reporting and Analyzing Investments

12 - 37

SHORT-ANSWER ESSAY QUESTIONS S-A E 139 Gigantico Corp. is a large manufacturing enterprise with operations throughout Canada. Recently, as a long-term investment, they purchased a 40% interest in the common shares of Smalltown Manufacturing Ltd., a public company, with the intention of obtaining representation on Smalltown’s board of directors. Is this investment considered to be a non-strategic or strategic investment? Explain your reasoning. Solution 139 This would be a strategic investment. With such a comparatively large block of shares, Gigantico hopes to be able to elect the directors they want, and thus to be able to significantly influence Smalltown’s policies.

S-A E 140 Brookside Racing Inc. operates several horse-racing tracks throughout Canada. Since most facilities are outdoor tracks only, most of Brookside’s cash receipts are received from April through October. These funds are usually invested in short-term, highly liquid investments, such as equities and treasury bills, which are classified as trading investments. Among the equities purchased last year was Servitronics, a company specializing in automatic vending equipment. Brookside decided not to sell its Servitronics shares at the end of last year, and has purchased more Servitronics shares this year. Brookside intends to continue to purchase shares until it holds enough to make a takeover bid for the company. The accountants have been instructed to continue to classify the investment as trading investments until the takeover is accomplished, so that less attention will be directed to it. (Presently, Brookside has no other long-term investments in shares). Instructions (a) Is it ethical for Brookside to attempt to take over another company? Explain. (b) Is it ethical for Brookside to leave its investment in the trading investment category? Explain. Solution 140 (a) Yes, Brookside may attempt to take over or purchase another company. The means that it uses to accomplish its goal must be ethical, and certainly building up a portfolio of the shares in question is ethical. Unethical takeovers are those in which a company is purchased for its assets and "harvested," leaving employees without jobs, and possibly irreparably damaging a community. (b) It is not ethical for the company to leave the shares in the trading investments (current) category if it no longer meets the criterion for a current investment. It would depend upon whether the company was serious in its intention to purchase a controlling interest in Servitronics. Since there is no evidence to the contrary, it appears that Brookside's investment should be classified as non-current.

S-A E 141

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

When a year-end adjustment is made to reduce the trading investments portfolio to fair value, what effect, if any, will the adjustment have on the financial statements if a) the company uses the fair value through profit and loss model. b) the company uses the fair value through other comprehensive income model. Solution 141 The Unrealized Loss on Trading Investments would be reported in the Other Expenses and Losses section of the income statement. The Trading Investments account would be reduced to fair value on the statement of financial position. The Unrealized Loss on Trading Investments would be reported on the statement of other comprehensive income. The Trading Investments account would be reduced to fair value on the statement of financial position.

S-A E 142 Stephanie Fielding is the daughter of Stephen Fielding, the founder and president of High Sky Enterprises Ltd. Stephanie has been working in various departments during school vacations throughout high school. She burst into the accounting department excitedly one morning. She said that the share prices of several of the firm's trading investments are up, and that her father said that the company had made over $10,000 because of this jump in share prices. Stephanie asks to see how the increase is recorded. Instructions As the accountant, prepare a brief response to Stephanie's question. Solution 142 Dear Stephanie, You asked to see how we recorded the $10,000 that the company had "earned" because of the jump in the price of some of the shares we hold. An increase in the value of trading investments is an unrealized gain. An “unrealized gain” is recognized and reported in the income statement (assuming the fair value through profit and loss model is used). This reflects the difference between our carrying value and the current fair value, and the result is that the investments are reported on the statement of financial position at fair value. When the investments are sold, we then record a “realized” gain (or loss), which is also reported on the income statement. I hope this answers your question.

(signed) Josephine Accountant

S-A E 143 If a company has an investment that is properly accounted for by the equity method, what will be the effect on the financial statements when it receives a dividend from the investee?

Reporting and Analyzing Investments

12 - 39

Solution 143 There will be no effect on the income statement. However, on the statement of financial position, Cash will be increased by the same amount that the Investment in Associates account is decreased.

CHAPTER 13 STATEMENT OF CASH FLOWS SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVES AND LEVEL OF DIFFICULTY Item

SO LOD Item

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

1 1 1 1 1 1 1 1 1 1

1 1 1 1 1 1 1 1 2 2

E M M M E M E E M M

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

LOD Item SO LOD Item True-False Statements M M E M M M M E E E

21. 22. 23. 24. 25. 26. 27. 28. 29. 30.

2 2a 2a 2a 2a 2b 2b 2b 2b 2b

M M M H M H M E M M

31. 32. 33. 34. 35. 36. 37. 38. 39. 40.

LOD Item

LOD

2b 3 3 3 3 4 4 4 4 5

M E E M E E E E M E

41. 42. 43. 44. 45. 46.

5 6 6 6 6 6

M E E E E M

Multiple Choice Questions 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64.

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2

E E E E E E M M E M M M M M E M E E

65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82.

2 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a

M E E H H E M M M M M M M H E E E M

83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100.

133. 134. 135. 136. 137. 138.

1 1 1 2a 2a 2a

M M E E E M

139. 140. 141. 142. 143. 144.

2a 2a 2a,3,4 2a,3,5 2a,3-5 2a,3-5

M H M M H H

145. 146. 147. 148. 149. 150.

2a,3,4 E

160.

2b,3,4

163. 164.

1 1,2

E M

2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2a 2b 2b 2b 2b 2b

H H M H H H M H H H M E M M M M M M

101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118.

2b 2b 2b 2b 2b 2b 2b 2b 2b 2b 3 3 3 3 3 3 4 4

M M M E M M E M M M E M E M M M M M

119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132.

4 4 4 4 4 4,5 4,5 5 5 6 6 6 6 6

E M E M M M M M E M M E E H

M H E E E M

151. 152. 153. 154. 155. 156.

2b 2b 2b,3-5 2b,3-5 2b,3-5 2b,3-5

M M H H M M

157. 158.

6 6

M M

2a,2b 2b

E E

169.

Exercises 2a,3-5 2a,3-5 2b 2b 2b 2b

Matching 159.

Short-Answer Essay 161. 162.

1 1

M M

Note:

E = Easy

M = Medium

165. 166.

2a 2a,2b

E M

167. 168.

H = Hard

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type

Item

Type

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

TF TF TF TF TF TF

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

TF TF TF TF TF TF

19. 20.

TF TF

21. 63.

TF MC

22. 23. 24. 25. 66. 67. 68.

TF TF TF TF MC MC MC

69. 70. 71. 72. 73. 74. 75.

MC MC MC MC MC MC MC

26. 27. 28. 29. 30.

TF TF TF TF TF

31. 96. 97. 98. 99.

TF MC MC MC MC

32. 33. 34. 35.

TF TF TF TF

111. 112. 113. 114.

MC MC MC MC

36. 37. 38. 39.

TF TF TF TF

117. 118. 119. 120.

MC MC MC MC

40. 41. 124.

TF TF MC

125. 126. 127.

MC MC MC

42. 43.

TF TF

44. 45.

TF TF

Item

Type Item Type Item Type Study Objective 1 13. TF 47. MC 53. MC 14. TF 48. MC 54. MC 15. TF 49. MC 55. MC 16. TF 50. MC 56. MC 17. TF 51. MC 57. MC 18. TF 52. MC 58. MC Study Objective 2 64. MC 162. SAE 164. SAE 65. MC 163. SAE Study Objective 2a (Indirect Method) 76. MC 83. MC 90. MC 77. MC 84. MC 91. MC 78. MC 85. MC 92. MC 79. MC 86. MC 93. MC 80. MC 87. MC 94. MC 81. MC 88. MC 95. MC 82. MC 89. MC 136. Ex Study Objective 2b (Direct Method) 100. MC 105. MC 110. MC 101. MC 106. MC 147. Ex 102. MC 107. MC 148. Ex 103. MC 108. MC 149. Ex 104. MC 109. MC 150. Ex Study Objective 3 115. MC 143. Ex 153. Ex 116. MC 144. Ex 154. Ex 141. Ex 145. Ex 155. Ex 142. Ex 146. Ex 156. Ex Study Objective 4 121. MC 125. MC 145. Ex 122. MC 141. Ex 146. Ex 123. MC 143. Ex 153. Ex 124. MC 144. Ex 154. Ex Study Objective 5 142. Ex 145. Ex 154. Ex 143. Ex 146. Ex 155. Ex 144. Ex 153. Ex 156. Ex Study Objective 6 46. TF 129. MC 131. MC 128. MC 130. MC 132. MC

Note: TF = True-False MC = Multiple Choice

Ma = Matching Ex = Exercise

Item

Type

Item

Type

59. 60. 61. 62. 133. 134.

MC MC MC MC Ex Ex

135. 161. 162. 163. 164.

Ex SAE SAE SAE SAE

137. 138. 139. 140. 141. 142. 143.

Ex Ex Ex Ex Ex Ex Ex

144. 145. 146. 159. 165. 166. 167.

Ex Ex Ex Ma SAE SAE SAE

151. 152. 153. 154. 155.

Ex Ex Ex Ex Ex

156. 160. 166. 167. 168.

Ex Ma SAE SAE SAE

159. 160.

Ma Ma

155. 156. 159. 160.

Ex Ex Ma Ma

157. 158.

Ex Ex

169.

SAE

SAE = Short-Answer Essay

Statement of Cash Flows

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CHAPTER STUDY OBJECTIVES 1.

Describe the purpose and content of the statement of cash flows. The statement of cash flows provides information about the cash receipts and cash payments resulting from the operating, investing, and financing activities of a company during a specific period. Operating activities include the cash effects of transactions that create revenues and expenses used in the determination of profit. Operating activities are affected by noncash items in the income statement and changes in certain noncash current asset and current liability accounts in the statement of financial position. Investing activities involve cash flows resulting from changes in non-current asset items. Financing activities involve cash flows resulting from non-current liabilities, and shareholders’ equity items. These are general guidelines, to which there are a few exceptions.

Prepare the operating activities section of a statement of cash flows using one of two approaches: (a) the indirect method or (b) the direct method. The first step in the preparation of a statement of cash flows is to determine the net cash provided (used) by operating activities using either the indirect or direct method (preferred). In the indirect method, we convert profit from an accrual basis to a cash basis. In the direct method, we convert each individual revenue and expense account from an accrual basis to a cash basis.

Prepare the investing activities section of a statement of cash flows. The second step in the preparation of a statement of cash flows is to analyze the changes in non-current asset accounts and record them as investing activities, or as significant noncash transactions.

Prepare the financing activities section of a statement of cash flows. The third step in the preparation of a statement of cash flows is to analyze the changes in the non-current liability and equity accounts and record them as financing activities, or as significant noncash transactions.

Complete the statement of cash flows. The fourth and final step in the preparation of a statement of cash flows is to complete the statement of cash flows and determine the overall cash flow for the year and add it to the opening amount of cash and cash equivalents to determine the ending amount of cash and cash equivalents.

Use the statement of cash flows to evaluate a company’s liquidity and solvency. Liquidity can be measured by the cash-based cash current debt coverage ratio (net cash provided or used by operating activities divided by average current liabilities) and compared with the accrual-based current ratio (current assets divided by current liabilities). Solvency can be measured by the cash-based cash total debt coverage ratio (net cash provided or used by operating activities divided by average total liabilities) and compared with the accrual-based debt to total assets ratio (net cash provided or used by operating activities divided by average total liabilities) and compared with the accrual-based debt to total assets

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ratio (total liabilities divided by total assets). Free cash flow (net cash provided or used by operating activities minus net capital expenditures minus dividends) is another measure of solvency.

Statement of Cash Flows

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TRUE-FALSE STATEMENTS 1. Cash flow information is useful in assessing a company’s ability to generate future cash flows.

2. For external reporting, a company must prepare either an income statement or a statement of cash flows, but not both.

3. The statement of cash flows can be prepared using cash and cash equivalents rather than just cash, as its base.

4. Cash equivalents can include both short-term and long-term investments.

5. A statement of cash flows reports the sources and uses of cash during a specific period. 6. The statement of cash flows shows the effects on profit of a company’s operating, investing, and financing activities for an accounting period.

7. Operating activities include the cash effects of transactions that create revenues and expenses.

8. The activity from the statement of financial position to be presented in the financing activities section of the statement of cash flows is based on an analysis of shareholders’ equity only.

9. The statement of cash flows explains the difference between profit, as shown on the income statement, and the net cash flows generated from operating activities.

10. Noncash investing and financing activities must be reported in the body of a statement of cash flows.

11. Noncash investing and financing transactions, such as the exchange of common shares to purchase assets, represent significant investing and financing activities and are reported in a note to the financial statements.

12. The acquisition of a building by issuing a mortgage payable would be considered an investing and financing activity that did not affect cash and would be reported in the notes to the financial statements.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

13. The statement of cash flows classifies cash receipts and payments as operating, nonoperating, and financial activities.

14. The sale of land for cash would be classified as a cash receipt from an investing activity.

15. Cash flow provided (used) by investing activities is considered the most important category on the statement of cash flows because it is considered the best measure of expected profit.

16. Under IFRS, the receipt of dividends from equity investments may be classified as a cash receipt provided (used) by investing activities.

17. Under ASPE, the payment of interest on a mortgage payable may be classified as a cash payment from financing activities.

18. The statement of cash flows is a required statement for both public and private corporations.

19. Like the other financial statements, the statement of cash flows is prepared from an adjusted trial balance.

20. Cash provided by operating activities is generally the same as the profit reported on the income statement.

21. The direct method is considered to be more informative and easier to compare with the other financial statements.

22. Under the indirect method, a loss on the sale of equipment is added to profit in calculating cash provided by operating activities.

23. Under the indirect method, an increase in accounts receivable during a period is deducted from profit in calculating cash provided by operating activities.

24. A disadvantage of the indirect method of reporting cash flows provided (used) by operating activities is that the difference between the net amount of cash flows from operating activities and profit is not emphasized.

25. Under the indirect method, an increase in accounts payable during a period is deducted from profit in calculating cash provided by operating activities.

Statement of Cash Flows

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26. Cost of goods sold + an increase in inventory + an increase in accounts payable = cash paid to suppliers during a period.

27. During the year, Income Tax Expense was $22,000 and Income Tax Payable increased by $3,000; therefore, the cash paid for income tax was $19,000.

28. In calculating cash flow provided (used) by operating activities using the direct method, each item in the income statement is adjusted from the accrual basis to the cash basis.

29. Under the direct method, an increase in inventory would be added to cost of goods sold to determine net purchases for the period.

30. Under the direct method, as an adjustment to operating expenses per the income statement, an increase in accrued liabilities would be added to operating expenses to determine cash payments for operating expenses.

31. Under the direct method, as an adjustment to operating expenses per the income statement, a decrease in prepaid expenses would be added to operating expenses to determine cash payments for operating expenses.

32. Investing activities affect non-current asset accounts.

33. In the investing activities section of the statement of cash flows, all the cash payments for purchase of non-current assets should be totalled and reported as one number.

34. A loss on sale of equipment is included in the investing activities on the statement of cash flows.

35. In preparing a statement of cash flows, an increase in the Common Shares account during a period would be classified as an investing activity.

36. In preparing a statement of cash flows, the issue of debt should be reported separately from the retirement of debt.

37. Preparing the financing activities section of the statement of cash flows requires the analysis of non-current liability and equity accounts, as well as any short-term loans incurred for lending purposes rather than trade.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

38. If accumulated other comprehensive income increases or decreases during the year, the change must be reported in the financing activities section.

39. On the statement of cash flows of a growing company, the reader should expect to see cash provided by its financing activities, not cash used.

40. For a company using the direct method, both the operating activities and investing activities will report the same net amounts provided or used as the indirect method, but the amount reported under financing activities will be different.

41. If a company has combined cash equivalents with cash, it must disclose the components of the cash equivalents, with a reconciliation of the amounts reported on the statement of cash flows with those reported on the statement of financial position.

42. The cash current debt coverage ratio is a measure of solvency.

43. The cash total debt coverage ratio is calculated as cash provided (used) by operating activities divided by average total liabilities.

44. A high cash total debt coverage ratio could signal a long-term solvency problem.

45. Free cash flow is a solvency-based measure that helps creditors and investors understand how much discretionary cash flow a company has left from operating activities.

46. Free cash flow is calculated as cash provided (used) by operating activities less net capital expenditures and dividends paid.

Statement of Cash Flows

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ANSWERS TO TRUE-FALSE STATEMENTS Item 1. 2. 3. 4. 5. 6. 7.

Ans. T F T F T F T

Item 8. 9. 10. 11. 12. 13. 14.

Ans. F T F T T F T

Item 15. 16. 17. 18. 19. 20. 21.

Ans. F T F T F F T

Item 22. 23. 24. 25. 26. 27. 28.

Ans. T T F F F T T

Item 29. 30. 31. 32. 33. 34. 35.

Ans. T F F T F F F

Item 36. 37. 38. 39. 40. 41. 42.

Ans. T T F T F T F

Item 43. 44. 45. 46.

Ans. T F T T

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 47. The statement of cash flows (a) must be prepared on a daily basis. (b) summarizes the operating, financing, and investing activities of a company. (c) is another name for the income statement. (d) is a special section of the income statement.

48. 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 cash receipts and cash payments during a period. (d) report to Canada Revenue Agency.

49. If a company reports a loss, it (a) may still have a net increase in cash. (b) will not be able to pay cash dividends. (c) will not be able to get a loan. (d) will not be able to make capital expenditures.

50. The statement of cash flows will not report the (a) amount of cheques outstanding at the end of the period. (b) sources of cash in the current period. (c) uses of cash in the current period. (d) change in the cash balance for the current period.

51. The acquisition of land by issuing common shares is (a) a cash transaction and would be reported in the body of a statement of cash flows. (b) a noncash transaction that is not reported in the body of a statement of cash flows. (c) a noncash transaction but would be reported in the body of a statement of cash flows. (d) only reported if the statement of cash flows is prepared using the direct method.

52. The order of presentation of activities on the statement of cash flows is (a) operating, investing, and financing. (b) operating, financing, and investing. (c) financing, operating, and investing. (d) financing, investing, and operating.

53. Financing activities involve (a) lending money. (b) acquiring investments. (c) issuing debt. (d) acquiring long-lived assets.

Statement of Cash Flows

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54. Investing activities include (a) repayment of debts. (b) obtaining cash from creditors. (c) obtaining capital from investors. (d) collecting the principal on loans receivable.

55. Generally, the first category shown on the statement of cash flows is cash flows provided (used) by (a) operating activities. (b) investing activities. (c) financing activities. (d) significant noncash activities.

56. 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 provided (used) by financing activities. (b) cash flows provided (used) by investing activities. (c) cash flows provided (used) by operating activities. (d) usually different from year to year.

57. Under IFRS, cash receipts from interest and dividends are classified as (a) operating activities. (b) investing activities. (c) either operating or investing activities. (d) either financing or investing activities.

58. Significant noncash transactions would not include (a) conversion of preferred shares into common shares. (b) asset acquisition through issue of a note payable. (c) loans to other companies. (d) exchange of equipment.

59. In preparing a statement of cash flows, preferred shares issued in exchange for land would be reported in the (a) financing activities section. (b) investing activities section. (c) operating activities section. (d) notes to the financial statements.

60. In preparing a statement of cash flows, the conversion of bonds into common shares will be reported in the (a) financing activities section. (b) notes to the financial statements. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

61. Which one of the following transactions does not affect cash during a period? (a) write-off of an uncollectible account receivable (b) collection of an account receivable (c) sale of common shares (d) repayment of a bank loan

62. The statement of cash flows (a) is prepared instead of an income statement under ASPE. (b) is used to assess a company's ability to generate cash and the needs of the company in using the cash flows. (c) is prepared from a comparative income statement. (d) reports earnings per share figures on a cash basis in the body of the statement.

63. Which one of the following items is not generally used in preparing a statement of cash flows? (a) adjusted trial balance (b) comparative statements of financial position (c) current income statement (d) additional information

64. In preparing the operating activities section of the statement of cash flows, most companies in Canada prefer to (a) use the direct method. (b) use the indirect method. (c) present both the indirect and direct methods in their financial reports. (d) prepare the operating activities section on the accrual basis.

65. 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 retained earnings. (c) a comparative statement of financial position. (d) a comparative income statement.

66. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Assume the indirect method is used. Ingles Corp. experienced a decrease in accounts receivable: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Statement of Cash Flows

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67. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Assume the indirect method is used. increase in merchandise inventory: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

68. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Assume the indirect method is used. payment of interest on a long-term bank loan: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

69. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Assume the indirect method is used. receipt of dividends on trading investments: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

70. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Assume the indirect method is used. decrease in income tax payable: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

71. Cash flows provided (used) by operating activities, prepared using the indirect method, would include (a) receipts from the sale of investments. (b) profit. (c) payments for dividends. (d) receipts from the issue of preferred shares.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(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.

73. Accounts receivable arising from sales to customers amounted to $35,000 and $40,000 at the beginning and end of the year, respectively. Profit reported on the income statement for the year was $120,000. Ignoring the effect of any other adjustments, the cash flow provided (used) by operating activities, prepared using the indirect method, is (a) $120,000. (b) $125,000. (c) $155,000. (d) $115,000.

74. 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.

75. In calculating cash flows provided (used) by 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.

76. In calculating cash flows provided (used) by 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.

77. Guenther Corporation reported profit of $50,000 for the year. During the year, accounts receivable increased by $8,000, accounts payable decreased by $4,000 and depreciation expense of $6,000 was recorded. Using the indirect method, cash provided by operating activities for the year is (a) $56,000. (b) $54,000. (c) $50,000. (d) $44,000.

78. Monster Cookie Ltd. reported a loss of $12,000 for the year. During the year, accounts receivable decreased $5,000, merchandise inventory increased $4,000, accounts payable Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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increased by $13,000, and depreciation expense of $7,000 was recorded. Using the indirect method, operating activities (a) used net cash of $33,000. (b) used net cash of $23,000. (c) provided net cash of $9,000. (d) provided net cash of $7,000.

79. Starting with profit and adjusting it for items that affected reported profit but not cash is called the (a) direct method. (b) indirect method. (c) working capital method. (d) cost-benefit method.

80. 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.

81. Using the indirect method, depreciation expense for the period (a) is deducted from profit. (b) is ignored. (c) causes cash to decrease. (d) is added to profit.

82. Using the indirect method, which of the following would be subtracted from profit? (a) depreciation expense (b) increase in accounts receivable (c) increase in accounts payable (d) decrease in prepaid expenses

83. Using the indirect method, which of the following would be added to profit? (a) increase in accounts receivable (b) increase in prepaid expenses (c) depreciation expense (d) decrease in accounts payable

84. Using the indirect method, which of the following would not be an adjustment to profit? (a) depreciation expense (b) an increase in prepaid insurance (c) an increase in inventories (d) an increase in Land

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

85. In calculating cash flows provided (used) by operating activities using the indirect method, a loss on the sale of equipment will appear as a(n) (a) subtraction from profit. (b) addition to profit. (c) addition to cash flow from investing activities. (d) subtraction from cash flow from investing activities.

86. Using the indirect method, which of the following adjustments to convert profit to net cash provided by operating activities is correct? Add to Profit Deduct from Profit (a) Accounts Receivable increase decrease (b) Prepaid Expenses increase decrease (c) Merchandise Inventory decrease increase (d) Income Tax Payable decrease increase

87. Using the indirect method, which of the following adjustments to convert profit to net cash provided by operating activities is incorrect? Add to Profit Deduct from Profit (a) Accounts Receivable decrease increase (b) Prepaid Expenses increase decrease (c) Merchandise Inventory decrease increase (d) Accounts Payable increase decrease

88. Using the indirect method, 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) loss on Sale of Equipment (d) amortization of Bond Discount

89. Using the indirect method, 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.

90. Profit reported for the current year was $200,000. Depreciation expense was $35,000. During the year, Accounts Receivable and Merchandise Inventory increased $18,000 and $26,000, respectively. Prepaid Expenses and Accounts Payable decreased $4,000 and $9,000, respectively. There was also a loss on the sale of equipment of $6,000. Using the indirect method, how much cash was provided by operating activities? (a) $182,000 (b) $192,000 (c) $210,000 (d) $244,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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91. Profit reported for the current year was $222,000. Depreciation expense was $35,000. Accounts Receivable and Inventories increased $4,000 and $7,000, respectively. Prepaid Expenses and Accounts Payable decreased $3,000 and $9,000, respectively. Using the indirect method, how much cash was provided by operating activities? (a) $170,000 (b) $180,000 (c) $240,000 (d) $258,000

92. Profit reported for the current year was $100,000. Depreciation expense was $25,000. Accounts Receivable and Inventories decreased $5,000 and $15,000, respectively. Prepaid Expenses and Accounts Payable increased, respectively, by $500 and $4,000. Using the indirect method, how much cash was provided by operating activities? (a) $101,500 (b) $123,500 (c) $140,500 (d) $148,500

93. On a statement of cash flows using the indirect method, depreciation expense will (a) be added to profit in the operating activities section. (b) be deducted from profit in the operating activities section. (c) appear a cash receipt in the investing activities section. (d) be ignored.

94. The indirect and direct methods of preparing the statement of cash flows are identical except for the (a) significant noncash activity section. (b) operating activities section. (c) investing activities section. (d) financing activities section.

95. Using the indirect method, which of the following would not be needed to determine net cash provided by operating activities? (a) depreciation expense (b) change in accounts receivable (c) payment of cash dividends (d) change in prepaid expenses

96. The income statement showed bond interest expense of $11,520 while the statement of financial position showed that the carrying amount of the bonds payable had increased by $1,520. Assuming no other transactions affected bonds during the period, the cash paid for bond interest was (a) $13,040. (b) $11,520. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

97. During the year, Yeung Inc. reported an $8,000 increase in Merchandise Inventory and a $7,000 increase in Accounts Payable. Cost of goods sold for the year was $140,000. What were the cash payments made to suppliers during the year? (a) $155,000 (b) $141,000 (c) $139,000 (d) $125,000

98. During the year, Cost of Goods Sold was $65,000, Merchandise Inventory decreased by $4,000, and Accounts Payable decreased by $2,000. What were the cash payments for merchandise during the year? (a) $63,000 (b) $65,000 (c) $67,000 (d) $71,000

99. During the year, Alfa Limited reported credit sales of $850,000. Beginning Accounts Receivable was $60,000 and ending Accounts Receivable was $140,000. What were the cash collections from customers during the year? (a) $930,000 (b) $850,000 (c) $770,000 (d) $710,000

100. During the year, Beta Corp. reported $420,000 in cash sales and $2,800,000 in credit sales. Beginning Accounts Receivable was $470,000 and ending Accounts Receivable was $540,000. What was the total cash collected from all customers during the year? (a) $2,680,000 (b) $2,870,000 (c) $2,730,000 (d) $3,150,000

101. The following information relates to Jatema Corporation: Prepaid insurance, December 31, 2015 ..................... $125,000 Prepaid insurance, December 31, 2016 ..................... 145,000 Insurance expense for 2016 ....................................... 480,000 What was the amount of cash paid for insurance during 2016? (a) $625,000 (b) $500,000 (c) $480,000 (d) $460,000

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102. Cash receipts from customers are greater than sales revenues when there is a(n) (a) increase in accounts receivable. (b) decrease in accounts receivable. (c) increase in cost of goods sold. (d) decrease in cost of goods sold.

103. During the year, Marigold Corp. reported an increase in Merchandise Inventory of $25,000. Cost of Goods Sold for the year was $150,000, and there was an $8,000 decrease in Accounts Payable. What were the cash payments to suppliers during the year? (a) $117,000 (b) $133,000 (c) $167,000 (d) $183,000

104. Which of the following items does not appear in the operating activities section of the statement of cash flows prepared under the direct method? (a) cash payments to suppliers (b) cash collections from customers (c) depreciation expense (d) cash payments for interest

105. During the year, Oak Inc. reported other operating expenses of $85,000. The Prepaid Expenses decreased $7,000 during the year, and Accrued Liabilities increased by $13,000. What were Oak's cash payments for operating expenses for the year? (a) $105,000 (b) $ 91,000 (c) $ 79,000 (d) $ 65,000

106. During the year, Beech Corp. reported Income Tax Expense of $49,000. There was a $6,000 decrease in federal income tax payable and a $4,000 increase in provincial income tax payable during the year. What were Beech's cash payments for income tax for the year? (a) $59,000 (b) $51,000 (c) $47,000 (d) $39,000

107. Which of the following would not appear in the operating activities section of a statement of cash flows prepared using 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

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

End of Year Beginning of Year Merchandise Inventory $26,000 $42,000 Accounts Payable 33,000 18,000 If cost of goods sold for the year is $137,000, the amount of cash paid to suppliers is (a) $168,000. (b) $138,000. (c) $136,000. (d) $106,000.

109. On the statement of cash flows, the operating activities section prepared using the direct method would include (a) receipts from the issue of common shares. (b) receipts from the sale of investments. (c) payments for the acquisition of investments. (d) cash receipts from sales activities.

110. During the year, Salaries Payable decreased by $9,000. If Salary Expense was $155,000 for the year, the cash paid to employees was (a) $173,000. (b) $164,000. (c) $155,000. (d) $146,000.

111. In which section would the purchase of land for cash be classified on the statement of cash flows? (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

112. If a company has both a receipt and payment of cash related to the acquisition of equipment for $15,000 cash and the sale of machinery for $10,000 cash, the (a) two cash effects can be netted and presented as one item in investing activities. (b) cash receipt from the sale and cash payment for the acquisition should be reported separately in investing activities. (c) two cash effects can be netted and presented as one item in financing activities. (d) cash receipt and cash payment should be reported separately in financing activities.

113. When equipment is sold for cash, the amount received is reflected as a cash (a) receipt in the operating activities section. (b) receipt in the financing activities section. (c) receipt in the investing activities section. (d) payment in the operating activities section.

114. If a gain of $30,000 is incurred in selling (for cash) office equipment that cost $120,000 and Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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had accumulated depreciation of $40,000, the total amount reported in investing activities is (a) $90,000. (b) $110,000. (c) $130,000. (d) $150,000.

115. If a loss of $20,000 is incurred in selling (for cash) office equipment that cost $90,000 and had accumulated depreciation of $22,500, then the actual cash proceeds must have been (a) $47,500. (b) $67,500. (c) $70,000. (d) $87,500.

116. Land costing $65,000 was sold for $125,000 cash. The gain on the sale was reported on the income statement as an operating expense. On the statement of cash flows, what amount should be reported as an investing activity from the sale of the land? (a) $5,000 (b) $60,000 (c) $65,000 (d) $125,000

Use the following information for questions 117–120. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows.

117. Declaration and issue of a stock dividend: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

118. Retirement of non-current debt (incurred for lending purposes) with cash: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

119. Issue of preferred shares for cash: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

120. Repurchase of Ingles’ own common shares on the open market: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

121. Which of the following items affecting retained earnings during a period could be reported in the financing activities section of the statement of cash flows? (a) cash dividends paid only (b) profit for the period only (c) both cash dividends paid and profit for the period (d) neither cash dividends paid nor profit for the period

122. 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 number of shares issued in a stock split. (d) how the retirement of debt was accomplished.

123. If $200,000 of new bonds are issued during the year and $120,000 of old bonds are retired during the year, the financing activities section of the statement of cash flows will show (a) a net increase in cash of $80,000. (b) a net decrease in cash of $80,000. (c) an increase in cash of $200,000 and a decrease in cash of $120,000. (d) a net gain on retirement of bonds of $80,000.

124. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Issue of common shares in exchange for equipment: (a) operating activities section (b) investing activities section (c) financing activities section (d) does not represent a cash flow

125. Ingles Corp., a private company reporting under ASPE, engaged in the following transactions. For each transaction, indicate where, if at all, it would be classified on the statement of cash flows. Purchase of 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

126. Which of the following statements concerning the statement of cash flows is true? (a) The statement of cash flows is usually more accurate when using the indirect method. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) If the direct method is used, gains and losses on sale of equipment are not shown. (c) The statement of cash flows reports earnings per share. (d) The statement of cash flows is an optional financial statement for external reporting purposes.

127. Of the items below, the one that appears before the others on the statement of cash flows is (a) noncash investing and financing activities. (b) net increase (decrease) in cash. (c) cash at the end of the period. (d) cash at the beginning of the period. 128. Kate’s Fashions Ltd. produces and sells high fashion merchandise. For the year ended June 30, 2016, the company reported $85,000 cash provided by operating activities, $18,000 by investing activities, and $49,000 by financing activities. Kate’s Fashions paid $22,000 in dividends and spent $35,000 for new equipment. Its free cash flow for 2016 was (a) $95,000. (b) $63,000. (c) $50,000. (d) $28,000.

129. The cash current debt coverage ratio demonstrates (a) the company’s ability to repay all its liabilities from cash generated from all sources without having to liquidate assets. (b) the company’s ability to repay its short-term liabilities from cash generated from operating activities. (c) how fast the company collects cash. (d) the company’s ability to meet interest payments.

130. Free cash flow is a measure of (a) solvency. (b) profitability. (c) liquidity. (d) creativity.

131. The cash current debt coverage ratio is a measure of (a) comparability. (b) liquidity. (c) profitability. (d) solvency.

132. In assessing solvency, it is better if the cash total debt coverage and debt to total assets ratios are (a) high and low, respectively. (b) low and high, respectively. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59.

Ans. b c a a b a c d a c c c d

Item 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

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

Item 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

Ans. d c b a d c b a d b c d b

Item 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98.

Ans. c b a d b c d a b c c b a

Item 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111.

Ans. c d b b d c d b c d d b b

Item 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124.

Ans. b c b a d d c c c a c c d

Item Ans. 125. d 126. b 127. b 128. d 129. b 130. a 131. b 132. a

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 133 Selected transactions of Darwinder Inc., a private company reporting under ASPE, are listed below: 1. Common shares are sold for cash. 2. Bonds payable are purchased on the open market for cash at a premium. 3. Interest on a short-term note receivable is collected. 4. Merchandise is sold to customers for cash. 5. Inventory is purchased on account. 6. Equipment is purchased by signing a 3-year, 5% note payable. 7. Cash dividends on common shares are declared and paid. 8. One hundred Belton Inc. common shares are purchased for cash, as a trading investment. 9. Land is sold for cash at the carrying amount. 10. Recorded an increase in the fair value of the trading investment. Instructions Indicate in which section each of the above transactions would be reported (a) operating activity, (b) investing activity, (c) financing activity, or (d) in the notes as a noncash investing and financing activity. Solution 133 (10 min.) 1. (c) Financing activity 2.

(a) Operating activity (Note 1)

(a) Operating activity

(d) Noncash activity

(b) Operating activity

(b) Investing activity

10. (d) Operating activity Note 1. If Darwinder were reporting under IFRS, the interest received may be classified as either an operating or an investing activity. Note 2. If Darwinder were reporting under IFRS, the dividends paid may be classified as either an operating or a financing activity.

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Ex. 134 Selected transactions of Yang Corp., a public company reporting under IFRS, are listed below: 1. Collected an account receivable. 2. Declared and paid dividends on common shares. 3. Sold long-term investments for cash. 4. Issued common shares in exchange for new equipment. 5. Repaid a five-year note payable. 6. Paid employee salaries. 7. Converted bonds payable to common shares. 8. Acquired a long-term investment with cash. 9. Sold buildings and equipment for cash. 10. Sold merchandise to customers. Instructions Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a noncash investing and financing activity. Solution 134 (10 min.) 1. (a) Operating activity 2.

(b) Investing activity

(d) Noncash activity

(a) Operating activity

(d) Noncash activity

(b) Investing activity

10. (a) Operating activity

Ex. 135 (a) Identify how significant noncash activities are presented in the financial statements. (b) Give three examples of significant noncash transactions. Solution 135 (5 min.) (a) Significant noncash transactions are not included in the body of the statement of cash flows, but are presented in a separate note to the financial statements.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) 1. 2. 3. 4.

Issue of common shares to purchase assets Conversion of bonds or preferred shares into common shares Issue of notes or bank loans payable to purchase assets Noncash exchanges of property, plant, and equipment

Ex. 136 Assume the indirect method is used to calculate the operating activities section of the statement of cash flows. For each item listed below, indicate the effect on profit in arriving at cash flows provided (used) by operating activities by choosing one of the following code letters: Cash flows provided (used) by operating activities Add to profit Deduct from profit

Code A D

Increase in accounts receivable

____

Increase in inventory

____

Decrease in prepaid expenses

____

Decrease in accounts payable

____

Decrease in accrued liabilities

____

Increase in income tax payable

____

Depreciation expense

____

Unrealized loss on trading investments

____

Gain on disposal of equipment

____

10. Patent amortization expense

____

Solution 136 (10 min.) 1. D 2.

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10. A

Ex. 137 Using the indirect method, calculate the amount of cash flows provided (used) by operating activities from the following data: Profit .......................................................................... $392,000 Beginning accounts receivable ................................... 54,000 Ending accounts receivable ....................................... 43,000 Beginning prepaid expenses ...................................... 8,000 Ending prepaid expenses ........................................... 2,000 Beginning accounts payable....................................... 27,000 Ending accounts payable ........................................... 17,000 Depreciation expense ................................................ 46,000 Solution 137 (15 min.) Profit ................................................................................. + Decrease in accounts receivable ................................... + Decrease in prepaid expenses ....................................... – Decrease in accounts payable ....................................... + Depreciation expense .................................................... Cash flows provided (used) by operating activities ............

$392,000 11,000 6,000 (10,000) 46,000 $445,000

Ex. 138 Tabele Limited reported a profit of $545,000 for the year ended December 31, 2015. Depreciation expense recorded on buildings and equipment was $182,000 for the year. Balances of the current assets and current liabilities accounts at the beginning and end of the year are as follows:

Cash Accounts receivable Inventories Prepaid expenses Accounts payable Income tax payable

End of Year $120,000 16,500 42,000 8,500 26,000 1,200

Beginning of Year $108,000 22,500 47,000 4,000 30,000 900

Instructions Using the indirect method, prepare the operating activities section of the statement of cash flows.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Solution 138 (15 min.) TABELE LIMITED Statement of Cash Flows (partial) Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Profit ...................................................................................................................... $545,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ..................................................................................... 182,000 Decrease in accounts receivable ..................................................................... 6,000 Decrease in inventories ................................................................................... 5,000 Increase in prepaid expenses.......................................................................... (4,500) Decrease in accounts payable ........................................................................ (4,000) Increase in income tax payable ....................................................................... 300 Net cash provided by operating activities ........................................................ $729,800

Ex. 139 Downwind Limited prepared the following information for the operating activities section of the statement of cash flows using the indirect method for the year ended December 31, 2016: Profit ...................................................................................................................... $250,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense, $40,000 ..................................................................... ______ Increase in accounts receivable, $65,000 ..................................................... ______ Decrease in inventory, $12,500 ..................................................................... ______ Share of profit from an investment in associate, $5,250 ................................ ______ Increase in accounts payable, $7,500 ........................................................... ______ Decrease in interest receivable, $3,500 ........................................................ ______ Increase in prepaid expenses, $5,000 ........................................................... ______ Decrease in income tax payable, $1,250 ....................................................... ______ Gain on sale of land, $4,000 ......................................................................... ______ Net cash provided (used) by operating activities .................................... ______ Instructions Fill in the missing blanks, indicating how each item should be reported in the operating activities section of the statement of cash flows. Solution 139 (15 min.) Profit ...................................................................................................................... Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ..................................................................................... Increase in accounts receivable ...................................................................... Decrease in inventory ..................................................................................... Share of profit from an investment in associate ............................................... Increase in accounts payable .......................................................................... Decrease in interest receivable ....................................................................... Increase in prepaid expenses..........................................................................

$250,000 40,000 (65,000) 12,500 (5,250) 7,500 3,500 (5,000)

Statement of Cash Flows

Decrease in income tax payable ..................................................................... Gain on sale of land ........................................................................................ Net cash provided by operating activities .................................................

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(1,250) (4,000) $233,000

Ex. 140 Presented below are Maginot Inc.’s operating activities section, prepared using the indirect method, of their 2016 statement of cash flows, and the current assets and liabilities sections of the statement of financial position for 2015. The company is using its overdraft facility at June 30, 2016. MAGINOT INC. Statement of Cash Flows (partial) Year Ended June 30, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Profit ............................................................................................. $34,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................................................. 8,500 Loss on sale of investments ................................................... 4,200 Decrease in accounts receivable ............................................ 8,500 Increase in merchandise inventory ......................................... (4,750) Decrease in prepaid expenses ............................................... 600 Decrease in accounts payable................................................ (3,250) Increase in accrued expenses ................................................ 1,200 Net cash provided by operating activities ......................... $49,000 Assets 2016 Cash .................................................................................................... Accounts receivable ............................................................................. Merchandise inventory ......................................................................... Prepaid expenses ................................................................................ Total assets Liabilities Bank overdraft...................................................................................... Accounts payable................................................................................. Accrued expenses payable .................................................................. Total liabilities

2015 $ 8,000 18,500 41,500 1,200 $69,200

$ 0 12,300 5,500 $17,800

Instructions Complete the current assets and current liabilities sections of the 2016 statement of financial position.

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Solution 140 (20 min.) MAGINOT INC. Comparative Statements of Financial Position June 30 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2016 2015 Cash ................................................................................. $ –– $ 8,000 Accounts receivable .......................................................... 10,000 18,500 Merchandise inventory ...................................................... 46,250 41,500 Prepaid expenses ............................................................. 600 1,200 $56,850 $69,200 Liabilities Bank overdraft (plug to balance) ....................................... Accounts payable.............................................................. Accrued expenses payable ............................................... ($56,850 – $38,550) ..........................................................

$ 2,550 9,050 6,700 $18,300

$ — 12,300 5,500 $17,800

Ex. 141 Assume the indirect method is used to calculate the operating activities section of the statement of cash flows. For each item listed below, indicate the reporting of the transactions and events by major categories on the statement. Use the following code letters to indicate the appropriate category under which the item would appear: Code Operating Activities OA Add to profit + Deduct from profit – Investing Activities IA Financing Activities FA

Common shares are issued for cash.

Category _____

Merchandise inventory increased during the period.

_____

Depreciation expense is recorded for the period.

_____

Building is purchased for cash.

_____

Bonds payable are purchased and retired at their carrying value.

_____

Accounts payable decreased during the period.

_____

Prepaid expenses decreased during the period.

_____

Common shares are reacquired for cash.

_____

Land is sold for cash at an amount equal to carrying amount.

_____

Statement of Cash Flows

10. Cash dividends are paid.

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_____

Solution 141 (10 min.) Category FA

Common shares are issued for cash.

Merchandise inventory increased during the period.

OA–

Depreciation expense is recorded for the period.

OA+

Building is purchased for cash.

Bonds payable are purchased and retired at their carrying value.

Accounts payable decreased during the period.

OA–

Prepaid expenses decreased during the period.

OA+

Common shares are reacquired for cash.

Land is sold for cash at an amount equal to carrying amount.

10. Cash dividends are paid.

Ex. 142 Use the following information to perform the calculations below. Clearly label the amount of each answer as positive or negative and show all your calculations: Profit Depreciation expense Beginning accounts receivable Ending accounts receivable Beginning inventory Ending inventory Beginning prepaid expenses Ending prepaid expenses

$475,000 92,000 38,000 41,500 23,000 26,000 3,700 3,100

Beginning accounts payable Ending accounts payable Purchase of equipment Issue of long-term debt Issue of shares for cash Issue of shares for land Repurchase of issued shares Sale of long-term investment at cost

Instructions (a) Calculate the amount of cash flows provided (used) by operating activities, using the indirect method. (b) Calculate the amount of cash flows provided (used) by investing activities. (c) Calculate the amount of cash flows provided (used) by financing activities. (d) Calculate the net change in cash. (e) Identify any significant noncash investing or financing activities.

$ 24,000 41,000 525,000 145,000 80,000 140,000 93,500 28,000

______________ ______________ ______________ ______________ ______________

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Solution 142 (20 min.) (a) Operating activities Profit ............................................................................................. Depreciation expense ................................................................... Increase in accounts receivable .................................................... Increase in inventory ..................................................................... Decrease in prepaid expenses ...................................................... Increase in accounts payable ........................................................ Cash flows provided (used) by operating activities ........................

$475,000 92,000 (3,500) (3,000) 600 17,000 $578,100

(b) Investing activities Purchase of equipment ................................................................. $(525,000) Sale of long-term investment ......................................................... 28,000 Cash flows provided (used) by investing activities ......................... $(497,000) (c) Financing activities Issue of long-term debt.................................................................. Issue of shares for cash ................................................................ Repurchase of issued shares ........................................................ Cash flows provided (used) by financing activities.........................

$145,000 80,000 (93,500) $131,500

(d) Net change in cash Increase from operating activities .................................................. $578,100 Decrease from investing activities ................................................. (497,000) Increase from financing activities .................................................. 131,500 Net increase in cash...................................................................... $212,600 (e) Issue of shares for land .................................................................

$140,000

Ex. 143 Comparative statements of financial position for Campbell Inc. appear below: CAMPBELL INC. Comparative Statements of Financial Position ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Dec. 31, 2016 Dec. 31, 2015 Cash ................................................................................. $ 29,000 $10,000 Accounts receivable .......................................................... 28,000 19,000 Prepaid expenses ............................................................. 9,000 12,000 Merchandise inventory ...................................................... 37,000 27,000 Long-term investments...................................................... 35,000 53,000 Equipment......................................................................... 75,000 48,000 Accumulated depreciation—equipment ............................. (26,000) (22,000) Total assets................................................................ $187,000 $174,000 Liabilities and Shareholders' Equity Accounts payable.............................................................. $ 21,000 Mortgage payable ............................................................. 37,000

$ 9,000 45,000

Statement of Cash Flows

Common shares................................................................ Retained earnings ............................................................. Total liabilities and shareholders' equity .....................

40,000 89,000 $187,000

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23,000 97,000 $174,000

Additional information regarding fiscal 2016: 1. Profit for the year was $27,000. 2. Cash dividends of $13,000 were declared and paid during the year. 3. Long-term investments with a carrying amount of $53,000 were sold for $48,000 cash. Instructions Using the indirect method, prepare a statement of cash flows for the year ended December 31, 2016. Solution 143 (25–30 min.) CAMPBELL INC. Statement of Cash Flows Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Profit .................................................................................................... $27,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................................................. $ 4,000 Loss on sale of long-term investment in bonds ....................... 5,000 Increase in accounts receivable ............................................. (9,000) Decrease in prepaid expenses ............................................... 3,000 Increase in inventory .............................................................. (10,000) Increase in accounts payable ................................................. 12,000 5,000 Net cash provided by operating activities ......................... 32,000 Investing activities Sale of long-term investments ....................................................... Purchase of equipment ................................................................. Net cash used by investing activities ...................................... Financing activities Issue of common shares ................................................................... Repayment of mortgage notes payable ............................................. Payment of cash dividends ............................................................... Net cash used by financing activities ...................................... Net increase in cash ............................................................................ Cash, January 1 ................................................................................... Cash, December 31 .............................................................................

$18,000 (27,000) (9,000)

$ 17,000 (8,000) (13,000) (4,000) 19,000 10,000 $29,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Ex. 144 Comparative statements of financial position for Shamu Corporation appear below: SHAMU CORPORATION Comparative Statements of Financial Position ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Dec 31, 2016 Dec 31, 2015 Cash ................................................................................. $ 39,000 $ 31,000 Accounts receivable .......................................................... 73,000 60,000 Prepaid insurance ............................................................. 19,000 17,000 Land.................................................................................. 18,000 40,000 Equipment......................................................................... 70,000 60,000 Accumulated depreciation—equipment ............................. (20,000) (13,000) Total assets................................................................ $199,000 $195,000 Liabilities and Shareholders' Equity Accounts payable.............................................................. Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total liabilities and shareholders' equity .....................

$ 11,000 27,000 140,000 21,000 $199,000

6,000 19,000 115,000 55,000 $195,000

Additional information regarding fiscal 2016 1. A loss of $25,000 was reported for the year. 2. Cash dividends were declared and paid. 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. The bonds were originally issued at face value. $12,000 worth of bonds were retired during the year at their carrying amount. 6. Equipment was exchanged for common shares. The fair value of the shares at the time of the exchange was $25,000. Instructions Using the indirect method, prepare a statement of cash flows for the year ended December 31, 2016. Solution 144 (30 min.) SHAMU CORPORATION Statement of Cash Flows Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Loss .............................................................................................. $(25,000) Adjustments to reconcile net loss to net cash provided Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Statement of Cash Flows

by operating activities: Depreciation expense (a) ....................................................... Loss on sale of land ............................................................... Increase in accounts receivable ............................................. Increase in prepaid expenses ................................................. Increase in accounts payable ................................................. Net cash used by operating activities...............................

$ 17,000 10,000 (13,000) (2,000) 5,000

Investing activities Proceeds from the sale of land (b) ................................................ Proceeds from the sale of equipment ............................................ Net cash provided by investing activities .........................

$12,000 5,000

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17,000 (8,000)

17,000

Financing activities Retirement of bonds payable......................................................... $(12,000) Issue of bonds payable (c) ............................................................ 20,000 Payment of dividends (d)............................................................... (9,000) Net cash used by financing activities ............................... (1,000) Increase in cash ................................................................................... 8,000 Cash, January 1 ................................................................................... 31,000 Cash, December 31 ............................................................................. $ 39,000 Noncash investing and financing activities Purchase of equipment through issue of common shares ...........

$25,000

(a) Accumulated depreciation, Dec 31, 2015 ...................................... Accumulated depreciation, Dec 31, 2016 ...................................... 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

(c) Bonds payable, Dec 31, 2015 ....................................................... Bonds payable, Dec 31, 2016 ....................................................... Increase ........................................................................................ Add retirement of bonds ................................................................ New bonds issued .........................................................................

$19,000 27,000 8,000 12,000 $20,000

(d) Retained earnings, Dec 31, 2015 .................................................. Less loss for year .......................................................................... Less retained earnings, Dec 31, 2016 ........................................... Dividends declared........................................................................

$55,000 (25,000) (21,000) $ 9,000

Ex. 145 The following information is available for Bounty Bay Corporation for the year ended December 31, 2016:

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Collection of principal on long-term loan to a supplier ................... $25,000 Purchase of equipment for cash .................................................... 12,000 Proceeds from the sale of long-term investment at carrying amount 28,000 Issue of common shares for cash.................................................. 23,500 Depreciation expense ................................................................... 19,000 Redemption of bonds payable at their carrying amount ................. 33,000 Payment of cash dividends ........................................................... 14,250 Profit ............................................................................................. 51,750 Purchase of land by issuing mortgage payable ............................. 35,000 In addition, the following information is available from the comparative statements of financial position for Chaplin Comics at the end of 2016 and 2015: Dec 31,2016 Cash .......................................................................... $ 95,900 Accounts receivable ................................................... 24,500 Prepaid insurance ...................................................... 13,500 Total current assets.................................................... $133,900 Accounts payable ....................................................... Salaries payable......................................................... Total current liabilities ................................................

Dec 31, 2015 $16,000 21,250 9,000 $46,250

$36,250 5,100 $41,350

$33,500 8,200 $41,700

Instructions Using the indirect method, prepare a statement of cash flows for the year ended December 31, 2016. Solution 145 (30 min.) CHAPLIN COMICS CORPORATION Statement of Cash Flows Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Profit ............................................................................................. $51,750 Adjustments to reconcile profit to net cash provided by operating activities ........................................................................ Depreciation .................................................................................. $19,000 Increase in accounts receivable .................................................... (3,250) Increase in prepaid insurance ....................................................... (4,500) Increase in accounts payable ........................................................ 2,750 Decrease in salaries payable ........................................................ (3,100) 10,900 Net cash provided by operating activities ............................... 62,650 Investing activities Collection of long-term loan ........................................................... Proceeds from the sale of investment ........................................... Purchase of equipment ................................................................. Net cash provided by investing activities ................................

$ 25,000 28,000 (12,000) 41,000

Statement of Cash Flows

Financing activities Issue of common shares ............................................................... Redemption of bonds .................................................................... Payment of dividends .................................................................... Net cash used by financing activities ...................................... Increase in cash ................................................................................... Cash, January 1 ................................................................................... Cash, December 31 ............................................................................. Noncash investing and financing activities Purchase of land by issuing mortgage payable .............................

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$23,500 (33,000) (14,250) (23,750) 79,900 16,000 $95,900

$35,000

Ex. 146 Condensed financial data of Primavera Corporation appear below. The company uses the indirect method to prepare the operating activities section of its statement of cash flows. PRIMAVERA CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2015 2014 Cash ................................................................................. $ 34,000 $ 18,000 Accounts receivable .......................................................... A 32,000 Merchandise inventory ...................................................... B 70,000 Prepaid expenses ............................................................. 2,500 C Long-term investments...................................................... D 10,000 Property, plant, and equipment ......................................... 224,000 200,000 Accumulated depreciation ................................................. (50,000) (40,000) Total assets................................................................ $ E $292,000 Liabilities and Shareholders' Equity Accounts payable.............................................................. Accrued expenses payable ............................................... Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total liabilities and shareholders’ equity .....................

$ F 10,000 130,000 50,000 136,000 $364,000

$ 34,000 12,000 100,000 75,000 G $292,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Interest expense............................................................................ Loss on sale of property, plant, and equipment ............................. Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

9,000 J

408,000 92,000 17,000 K

PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Profit ............................................................................................................... $75,000 Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ............................................................................... 15,000 Loss on sale of property, plant, and equipment ........................................ L Increase in accounts receivable ............................................................... (16,500) Increase in merchandise inventory ........................................................... (20,000) Increase in prepaid expenses ................................................................... (500) Increase in accounts payable ................................................................... 4,000 Decrease in accrued expenses ................................................................ _____M Net cash provided by operating activities ........................................... _____N Investing activities Purchase of investments ................................................................................. Purchase of property, plant, and equipment .................................................... Net cash used by investing activities .................................................

(5,000) _____P _____Q

Financing activities Reacquisition of common shares .................................................................... Issue of bonds ................................................................................................. Payment of cash dividends ............................................................................. Net cash used by financing activities .................................................

R S _____T _____U

Net increase in cash .............................................................................................. Cash, January 1 ..................................................................................................... Cash, December 31 ...............................................................................................

16,000 18,000 $ V

Additional information regarding fiscal 2015: 1. New property, plant, and equipment costing $33,000 was purchased for cash. 2. Old property, plant, and equipment costing $9,000 was scrapped when the carrying amount was $4,000. 3. A cash dividend of $10,000 was declared and paid during the year. 4. The bonds were originally issued at face value. Instructions Solve for the missing amounts (note the letter O is not used).

Statement of Cash Flows

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Solution 146 (45 min.) PRIMAVERA CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ................................................................................. Accounts receivable .......................................................... Merchandise inventory ...................................................... Prepaid expenses ............................................................. Long-term investments...................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total assets................................................................

2015 $ 34,000 48,500 90,000 2,500 15,000 224,000 (50,000) $364,000

2014 $ 18,000 32,000 70,000 2,000 10,000 200,000 (40,000) $292,000

Liabilities and Shareholders' Equity Accounts payable.............................................................. Accrued expenses payable ............................................... Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total liabilities and shareholders’ equity .....................

$ 38,000 10,000 130,000 50,000 136,000 $364,000

$ 34,000 12,000 100,000 75,000 71,000 $292,000

PRIMAVERA CORPORATION Income Statement Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales .................................................................................................... $500,000 Expenses Cost of goods sold ........................................................................ $290,000 Operating expenses (excluding depreciation) ................................ 90,000 Depreciation expense ................................................................... 15,000 Interest expense............................................................................ 9,000 Loss on sale of property, plant, and equipment ............................. 4,000 408,000 Profit before income tax ....................................................................... 92,000 Income tax expense ............................................................................. 17,000 Profit .................................................................................................... $ 75,000

$75,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Adjustments to reconcile profit to net cash provided by operating activities: Depreciation expense ................................................................... $ 15,000 Loss on sale of property, plant, and equipment ............................. 4,000 Increase in accounts receivable .................................................... (16,500) Increase in merchandise inventory ................................................ (20,000) Increase in prepaid expenses........................................................ (500) Increase in accounts payable ........................................................ 4,000 Decrease in accrued expenses ..................................................... (2,000) Net cash provided by operating activities ...............................

(16,000) 59,000

Investing activities Purchase of long-term investments ............................................... Purchase of property, plant, and equipment .................................. Net cash used by investing activities ........................................

(38,000)

$ (5,000) (33,000)

Financing activities Reacquisition of common shares .................................................. $(25,000) Issue of bonds ............................................................................... 30,000 Payment of cash dividends ........................................................... (10,000) Net cash used by financing activities ........................................

(5,000)

Net increase in cash ............................................................................ Cash, January 1 ................................................................................... Cash, December 31 .............................................................................

16,000 18,000 $34,000

Summary A = $48,500 B = $90,000 C = $2,000 D = $15,000 E = $364,000 F = $38,000 G = $71,000 H = $90,000 I = $15,000 J = $4,000 K = $75,000

L = $4,000 M = $(2,000) N = $59,000 P = $(33,000) Q = $(38,000) R = $(25,000) S = $30,000 T = $(10,000) U = $(5,000) V = $34,000

Ex. 147 Greenbriar Sales Inc. reported total operating expenses of $320,000 in 2016, which included depreciation expense of $75,000. Also, during 2016, prepaid expenses increased by $17,000 and accrued expenses decreased by $16,500. Instructions Using the direct method, calculate the amount of cash payments for operating expenses in 2016 Solution 147 (5–8 min.) Operating expenses .......................................................... Less: Depreciation expense ..............................................

$320,000 (75,000)

Statement of Cash Flows

Add: Increase in prepaid expenses ................................... Add: Decrease in accrued liabilities................................... Cash payments for operating expenses ............................

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17,000 16,500 $278,500

Ex. 148 For all instances below, assume the direct method of preparing the operating activities section of the statement of cash flows is used. (a) Sales = $640,280; accounts receivable increased by $23,450. Calculate cash receipts from sales. (b) Cost of goods sold = $1,640,000; inventory decreased by $52,000; accounts payable decreased by $28,500. Calculate cash payments for purchases. (c) The income statement shows $10,450 for income tax expense. The statement of financial position shows an increase in income tax payable of $2,525. Calculate the cash paid for income tax. (d) Operating expenses total $102,500; depreciation expense = $37,200; prepaid expenses increased by $16,300; accrued liabilities decreased by $4,900. Calculate cash payments for operating expenses. Solution 148 (10 min.) (a) $616,830 (640,280 – 23,450) (b) $1,616,500 (1,640,000 – 52,000 + 28,500) (c) $7,925 (10,450 – 2,525) (d) $86,500 (102,500 – 37,200 + 16,300 + 4,900)

Ex. 149 For all instances below, assume the direct method of preparing the operating activities section of the statement of cash flows is used. (a) Sales = $1,025,000; accounts receivable decreased by $162,000. Calculate cash receipts from sales. (b) Cost of goods sold = $444,000; inventory increased by $12,000; accounts payable increased by $32,750. Calculate cash payments for purchases. (c) The income statement shows $32,900 for income tax expense. The statement of financial position shows a decrease in income tax payable of $2,250. Calculate the cash paid for income tax. (d) Operating expenses total $272,000; depreciation expense = $41,200; prepaid expenses decreased by $15,750; accrued liabilities increased by $6,000. Calculate cash payments for operating expenses. Solution 149 (10 min.) (a) $1,187,000 (1,025,000 + 162,000) (b) $432,250 (444,000 + 12,000 – 32,750) (c) $35,150 (32,900 + 2,250)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(d) $209,050 (272,000 – 41,200 – 15,750 – 6,000)

Ex. 150 The general ledger of Mandeep Limited provides the following information: End of Year Beginning of Year Accounts Receivable ............................ $ 71,000 $ 103,000 Merchandise Inventory ......................... 343,000 262,000 Accounts Payable ................................ 45,000 66,000 The company's net sales for the year were $3,700,000 and cost of goods sold was $2,650,000. Instructions Assuming the company uses the direct method of preparing the operating activities section of its statement of cash flows, calculate the following: (a) Cash receipts from customers. (b) Cash payments to suppliers. Solution 150 (8–12 min.) (a) Cash receipts from customers Sales + decrease in Accounts Receivable $3,700,000 + $32,000 = $3,732,000 (b) Cash payments to suppliers Cost of Goods Sold + increase in Merchandise Inventory + decrease in Accounts Payable $2,650,000 + $81,000 + 21,000 = $2,752,000

Ex. 151 The income statement of Packer Inc. for the year ended December 31, 2016, reported the following condensed information: Revenue from fees ................................... Operating expenses ................................. Profit from operations ............................... Income tax expense ................................. Profit ........................................................

$585,000 340,000 245,000 61,250 $183,750

Packer's statement of financial position contained the following comparative data at December 31:

Accounts receivable ................................. Accounts payable ..................................... Income taxes payable ..............................

2016 $52,500 34,000 5,500

2015 $45,000 41,000 3,000

The corporation has no depreciable assets. Accounts payable pertain to operating expenses. Instructions

Statement of Cash Flows

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Using the direct method, prepare the operating activities of the statement of cash flows for the year ended December 31, 2016. Solution 151 (15 min.) PACKER INC. Statement of Cash Flows (partial) Year Ending December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers ($585,000 – $7,500) ............. $577,500 Cash payments: For operating expenses ($340,000 + $7,000) ................ $347,000 For income taxes ($61,250 – $2,500) ............................ 58,750 405,750 Net cash provided by operating activities ...................... $171,750

Ex. 152 The income statement of Northumberland Corporation is shown below: NORTHUMBERLAND CORPORATION Income Statement Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ........................................................................................... $8,500,000 Cost of goods sold ...................................................................... 5,200,000 Gross profit ................................................................................. 3,300,000 Operating expenses .................................................................... $1,250,000 Depreciation expense ................................................................. 140,000 1,390,000 Profit ........................................................................................... $1,910,000 Additional information: 1. Accounts receivable increased $420,000 during the year. 2. Inventory increased $250,000 during the year. 3. Prepaid expenses increased $215,000 during the year. 4. Accounts payable to merchandise suppliers increased $290,000 during the year. 5. Accrued expenses payable increased $160,000 during the year. Instructions Using the direct method, prepare the operating activities section of the statement of cash flows for the year ended December 31, 2016. Solution 152 (15–20 min.) NORTHUMBERLAND CORPORATION Statement of Cash Flows (partial) Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash flows provided (used) by operating activities Cash receipts from customers ............................................... $8,080,000 (1)

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Cash payments: To suppliers...................................................................$5,160,000 (2) For operating expenses ................................................. 1,305,000 (3) 6,465,000 Net cash provided by operating activities ................ $1,615,000 (1) Sales .................................................................................... Deduct: Increase in accounts receivable .............................. Cash receipts from customers ..............................................

$8,500,000 420,000 $8,080,000

(2) Cost of goods sold ............................................................... Add: Increase in inventory .................................................... Purchases ............................................................................ Deduct: Increase in accounts payable .................................. Cash payments to suppliers .................................................

$5,200,000 250,000 5,450,000 290,000 $5,160,000

(3) Operating expenses ............................................................. Add: Increase in prepaid expenses ...................................... Deduct: Increase in accrued expenses payable ................... Cash payments for operating expenses ...............................

$1,250,000 215,000 (160,000) $1,305,000

Ex. 153 Condensed financial data of Primavera Corporation appear below. The company uses the direct method to prepare the operating activities section of its statement of cash flows. PRIMAVERA CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ................................................................................. Accounts receivable .......................................................... Merchandise inventory ...................................................... Prepaid expenses ............................................................. Investments ...................................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total assets................................................................

2015 $ 34,000 A B 2,500 D 224,000 (50,000) $ E

2014 $ 18,000 32,000 70,000 C 10,000 200,000 (40,000) $292,000

Liabilities and Shareholders' Equity Accounts payable.............................................................. Accrued expenses payable ............................................... Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total ...........................................................................

F 10,000 130,000 50,000 136,000 $364,000

$ 34,000 12,000 100,000 75,000 71,000 $292,000

Statement of Cash Flows

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PRIMAVERA CORPORATION Income Statement Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ................................................................................. $500,000 Expenses Cost of goods sold ..................................................... $290,000 Operating expenses (excluding depreciation) ............. G Depreciation expense ................................................ H Interest expense......................................................... 9,000 Loss on sale of property, plant, and equipment .......... _______I 408,000 Profit before income tax .................................................... 92,000 Income tax expense .......................................................... 17,000 Profit ................................................................................. $ J

PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers........................................... $483,500 Cash payments To suppliers ............................................................... $306,000 For operating expenses.............................................. K For income tax ........................................................... 17,000 For interest expense .................................................. 9,000 L Net cash provided by operating activities ............ M Investing activities Purchase of long-term investments ............................ Purchase of property, plant, and equipment ............... Net cash used by investing activities ...................

$(5,000) (33,000)

Financing activities Reacquisition of common shares ............................... Issue of bonds ............................................................ Payment of cash dividends ........................................ Net cash used by financing activities ...................

$(25,000) 30,000 (10,000)

Net increase in cash ......................................................... Cash, January 1 ................................................................ Cash, December 31 ..........................................................

(38,000)

(5,000) 16,000 18,000 $34,000

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5. 6.

Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Accrued expenses pertain to operating expenses. The bonds were originally issued at face value.

Instructions Solve for the missing amounts (note the letter O is not used). Solution 153 (45 min.) PRIMAVERA CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ................................................................................. Accounts receivable .......................................................... Merchandise inventory ...................................................... Prepaid expenses ............................................................. Investments ...................................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total ............................................................................

2015 $ 34,000 48,500 90,000 2,500 15,000 224,000 (50,000) $364,000

2014 $ 18,000 32,000 70,000 2,000 10,000 200,000 (40,000) $292,000

Liabilities and Shareholders' Equity Accounts payable.............................................................. Accrued expenses payable ............................................... Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total ............................................................................

$ 38,000 10,000 130,000 50,000 136,000 $364,000

$ 34,000 12,000 100,000 75,000 71,000 $292,000

PRIMAVERA CORPORATION Income Statement Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ................................................................................. $500,000 Expenses Cost of goods sold ..................................................... $290,000 Operating expenses (excluding depreciation)............. 90,000 Depreciation expense ................................................ 15,000 Interest expense......................................................... 9,000 Loss on sale of property, plant, and equipment .......... 4,000 408,000 Profit before income tax .................................................... 92,000 Income tax expense .......................................................... 17,000 Profit ................................................................................. $ 75,000

Statement of Cash Flows

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PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers ($500,000 – $16,500) ........... $483,500 Cash payments To suppliers ($290,000 + $20,000 – $4,000) ................. $306,000 For operating expenses ($90,000 + $2,000 + $500) ...... 92,500 For income tax .............................................................. 17,000 For interest expense...................................................... 9,000 (424,500) Net cash provided by operating activities ................ 59,000 Investing activities Purchase of long-term investments ...................................... Purchase of property, plant, and equipment ......................... Net cash used by investing activities .............................

$ (5,000) (33,000)

Financing activities Reacquisition of common shares ......................................... $(25,000) Issue of bonds ...................................................................... 30,000 Payment of cash dividends .................................................. (10,000) Net cash used by financing activities ............................. Net increase in cash ................................................................... Cash, January 1 .......................................................................... Cash, December 31 ....................................................................

(38,000)

(5,000) 16,000 18,000 $ 34,000

Summary A = $48,500 B = $90,000 C = $2,000 D = $15,000 E = $364,000 F = $38,000 G = $90,000 H = $15,000 I = $4,000 J = $75,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

K = $92,500 L = $(424,500) M = $59,000

Ex. 154 Presented below is the comparative trial balance and additional information for The IN Crowd Inc., which has a calendar year end. Credit balances are shown in brackets. 2015 2014 Cash .................................................................................... $ 9,900 $ (5,000) Accounts Receivable ............................................................ 24,100 20,000 Merchandise Inventory ......................................................... 5,000 7,000 Prepaid Expenses ................................................................ 1,000 500 Equipment ............................................................................ 42,000 35,000 Accumulated Depreciation ................................................... (10,000) (7,000) Accounts Payable ................................................................ (17,000) (10,000) Salaries Payable .................................................................. (3,000) 0 Income Tax Payable ............................................................ (1,000) 0 Bank Loan Payable .............................................................. (10,000) (12,000) Common Shares .................................................................. (5,000) (4,000) Retained Earnings................................................................ (24,500) (14,900) Dividends ............................................................................. 5,000 5,000 Revenue .............................................................................. (177,000) (145,000) Cost of Goods Sold .............................................................. 58,000 43,000 Salaries Expense ................................................................. 69,000 55,000 Operating Expenses............................................................. 26,000 26,500 Depreciation Expense .......................................................... 5,000 2,500 Interest Expense .................................................................. 500 600 Income Tax Expense ........................................................... 3,000 2,800 Gain on Disposal of Equipment ............................................ (1,000) 0 Additional information regarding fiscal 2015: 1. New equipment costing $10,000 was purchased for cash. 2. Old equipment costing $3,000 was sold for $2,000 cash when the carrying amount was $1,000. 3. A cash dividend of $5,000 was paid during the year. 4. Accounts payable pertain to merchandise purchases. Instructions Using the direct method, prepare a statement of cash flows for the year ended December 31, 2015.

Statement of Cash Flows

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Solution 154 (35 min.) THE IN CROWD INC. Statement of Cash Flows Year Ended December 31, 2015 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers [$177,000 – ($24,100 – $20,000)] $172,900 Cash payments To suppliers ($58,000 + ($5,000 – $7,000) – ($17,000 – $10,000)) .................................................. $49,000 For operating expenses ($26,000 + ($1,000 – $500) ..... 26,500 For salaries ($69,000 – $3,000)..................................... 66,000 For income tax ($3,000 – $1,000) .................................. 2,000 For interest expense...................................................... 500 144,000 Net cash provided by operating activities ................ 28,900 Investing activities Proceeds from sale of equipment ......................................... Purchase of equipment ........................................................ Net cash used by investing activities ............................. Financing activities Issue of common shares ...................................................... Repayment of bank loan ...................................................... Payment of cash dividends ................................................. Net cash used by financing activities ............................. Net increase in cash ................................................................... Cash, January 1 .......................................................................... Cash, December 31 ....................................................................

$ 2,000 (10,000) (8,000)

$1,000 (2,000) (5,000) (6,000) 14,900 (5,000) $ 9,900

Ex. 155 The financial statements of Morse Limited appear below: MORSE LIMITED Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2016 2015 Cash ........................................................................................... $ 59,000 $ 23,000 Accounts receivable .................................................................... 31,000 34,000 Merchandise inventory ................................................................ 20,000 15,000 Property, plant, and equipment ................................................... 50,000 78,000 Accumulated depreciation ........................................................... (20,000) (24,000) Total ..................................................................................... $140,000 $126,000 Liabilities and Shareholders' Equity Accounts payable........................................................................ $ 15,000

$ 23,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Income tax payable ..................................................................... 13,000 Mortgage payable ....................................................................... 9,000 Common shares.......................................................................... 39,000 Retained earnings ....................................................................... 64,000 Total ..................................................................................... $140,000

8,000 33,000 24,000 38,000 $126,000

MORSE LIMITED Income Statement Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ...................................................................................................................... $380,000 Cost of goods sold ................................................................................................. 290,000 Gross profit ............................................................................................................ 90,000 Operating expenses ............................................................................................... 36,000 Interest expense .................................................................................................... 4,000 Profit before income tax ......................................................................................... 50,000 Income tax expense ............................................................................................... 10,000 Profit ...................................................................................................................... $ 40,000 Additional information regarding fiscal 2016: 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. Depreciation expense is included in operating expenses. 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. Instructions Using the direct method, prepare a statement of cash flows for the year ended December 31, 2016. Solution 155 (30 min.) MORSE LIMITED Statement of Cash Flows Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers ($380,000 + $3,000) ............. $383,000 Cash payments: To suppliers................................................................... $303,000 (1) For operating expenses ................................................. 24,000 (2) For interest expense...................................................... 4,000 For income tax ($10,000 – $5,000) ................................ 5,000 336,000 Net cash provided by operating activities ................ 47,000 Investing activities Sale of equipment ................................................................

$12,000

Statement of Cash Flows

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Net cash provided by investing activities .......................

12,000

Financing activities Repayment of mortgage ....................................................... $(24,000) Issue of common shares ...................................................... 15,000 Payment of cash dividend .................................................... (14,000) Net cash used by financing activities ............................. Net increase in cash ................................................................... Cash, January 1 .......................................................................... Cash, December 31 ....................................................................

(23,000) 36,000 23,000 $ 59,000

(1) Cost of goods sold ............................................................... $290,000 Add: Increase in inventory ................................................... 5,000 Purchases ............................................................................ 295,000 Add: Decrease in accounts payable .................................... 8,000 Cash payments to suppliers ................................................. $303,000 (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.

Ex. 156 Condensed financial data of McKillop Corporation appear below: MCKILLOP CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2016 Cash ........................................................................................... $ 74,700 Accounts receivable .................................................................... 104,000 Merchandise inventory ................................................................ 100,000 Prepaid expenses ....................................................................... 32,000 Long-term investments................................................................ 81,000 Property, plant, and equipment ................................................... 235,000 Accumulated depreciation ........................................................... (65,000) Total ..................................................................................... $561,700

2015 $ 35,000 67,000 112,000 36,000 66,000 175,000 (60,000) $431,000

Liabilities and Shareholders' Equity Accounts payable........................................................................ $ 93,000 Accrued expenses payable ......................................................... 29,000 Bonds payable ............................................................................ 135,000 Common shares.......................................................................... 240,000 Retained earnings ....................................................................... 64,700

$ 75,000 24,000 160,000 91,000 81,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Total ..................................................................................... $561,700

$431,000

MCKILLOP CORPORATION Income Statement Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ........................................................................................... $500,000 Expenses Cost of goods sold ............................................................... $295,000 Operating expenses ............................................................. 65,000 Depreciation expense .......................................................... 17,000 Interest expense................................................................... 18,000 Loss on sale of equipment ................................................... 3,000 398,000 Profit before income tax .............................................................. 102,000 Income tax expense .................................................................... 15,300 Profit ........................................................................................... $ 86,700 Additional information regarding fiscal 2016: 1. New equipment costing $85,000 was purchased for cash. 2. Old equipment costing $25,000 was sold for $10,000 cash when the carrying amount was $13,000. 3. Bonds were originally issued at face value. Bonds with a face value of $25,000 were converted into $25,000 of common shares during the year. 4. Cash dividends were declared and paid during the year. 5. Accounts payable pertain to merchandise purchases. Instructions Using the direct method, prepare a statement of cash flows for the year ended December 31, 2016. Solution 156 (25–30 min.) MCKILLOP CORPORATION Statement of Cash Flows Year Ended December 31, 2016 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers ($500,000 – $37,000) .................. $463,000 Cash payments: To suppliers................................................................... $265,000 (1) For operating expenses ................................................. 56,000 (2) For income tax .............................................................. 15,300 For interest .................................................................... 18,000 354,300 Net cash provided by operating activities ................ 108,700 Investing activities Purchase of long-term investments ...................................... $(15,000) Purchase of equipment ........................................................ (85,000) Sale of equipment ................................................................ 10,000

Statement of Cash Flows

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Net cash used by investing activities ......................

(90,000)

Financing activities Issue of common shares ...................................................... $124,000 Payment of cash dividends .................................................. (103,000) (3) Net cash provided by financing activities ................ Net increase in cash ................................................................... Cash, January 1 .......................................................................... Cash, December 31 ....................................................................

21,000 39,700 35,000 $ 74,700

Noncash investing and financing activities Conversion of bonds payable into common shares ............

$25,000

(1) Cost of goods sold ............................................................... $295,000 Deduct: Decrease in merchandise inventory ....................... (12,000) Purchases ............................................................................ 283,000 Deduct: Increase in accounts payable ................................. (18,000) Cash payments to suppliers ................................................. $265,000 (2) Operating expenses ............................................................. Deduct: Decrease in prepaid expenses ............................... Deduct: Increase in accrued expenses payable .................. Cash payments for operating expenses ...............................

$65,000 (4,000) (5,000) $56,000

(3) Retained earnings, Dec 31, 2015 ......................................... $ 81,000 Add: Profit for 2016 .............................................................. 86,700 Less: Retained earnings, Dec 31, 2016................................ (64,700) Dividends declared............................................................... $ 103,000

Ex. 157 A summary of the statement of cash flows for Seattle Corner Store, Inc. appears below: SEATTLE CORNER STORE, INC. Statements of Cash Flows Years Ended December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 2016 2015 Net cash provided by operating activities .................................... $125,000 $160,000 Net cash used by investing activities ........................................... (40,000) (30,000) Net cash used by financing activities ......................................... (15,000) (5,000) Net increase (decrease) in cash .................................................. 70,000 125,000 Cash, January 1 .......................................................................... 135,000 10,000 Cash, December 31 .................................................................... $205,000 $135,000 Additional information: Current liabilities ......................................................................... $110,000 Non-current liabilities................................................................... 150,000 $260,000

$ 75,000 125,000 $200,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) Calculate the following ratios for 2016: 1. Cash current debt coverage. 2. Cash total debt coverage. (b) Explain the purpose of each ratio calculated in (a). Solution 157 (15 min.) (a) Cash provided by operating activities 1. Cash current debt coverage = ———————————————–— Average current liabilities $125,000 ——————————–— = 1.4 times ($110,000 + $75,000) ÷ 2

Cash total debt coverage =

Cash provided by operating activities ————————————————– Average total liabilities $125,000 ———————————— = 0.5 times ($260,000 + $200,000) ÷ 2

(b) 1. Cash current debt coverage: This liquidity ratio measures the ability of the company’s operating activities to generate enough cash flow to cover its current liabilities. 2.

Cash total debt coverage: This ratio is a cash-based measure of solvency. The higher the ratio, the more solvent the company should be.

Ex. 158 Merlin Marketing Ltd. produces the following information from their latest financial statements: Profit .................................................................................... $ 21,000 Dividends paid ..................................................................... 5,000 Average total assets............................................................. 210,000 Current assets ...................................................................... 150,000 Current liabilities................................................................... 100,000 Cash provided by operating activities ................................... 19,000 Net capital expenditures ....................................................... 10,000 Net sales .............................................................................. 150,000 Total liabilities ...................................................................... 105,000 Total assets.......................................................................... 175,000 Cash used in investing activities........................................... 12,000 Instructions (a) Calculate the free cash flow. (b) Explain the importance of the free cash flow calculation.

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Solution 158 (10 min.) (a) Free cash flow = Cash provided by operating activities – Net capital expenditures – Dividends = $19,000 – $10,000 – $5,000 = $4,000 (b) Free cash flow is a measure of solvency that helps external stakeholders understand how much discretionary cash flow Merlin Marketing has left after paying for net capital expenditures and paying dividends. It indicates the company’s potential to finance new investments or expansion, reduce debt, or even pay more dividends in future.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MATCHING QUESTIONS SET 1 159. 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 indirect method (ASPE). A. B. C. D. E. F. G.

Added to profit Deducted from profit Cash payment—investing activity Cash receipt—investing activity Cash payment—financing activity Cash receipt—financing activity Significant noncash investing and financing activity

____

1. Increase in accounts payable during a period

____

2. Declaration and payment of a cash dividend.

____

3. Gain on sale of land.

____

4. Increase in accounts receivable during a period.

____

5. Redemption of bonds for cash.

____

6. Proceeds from sale of equipment at carrying amount.

____

7. Issue of common shares for cash.

____

8. Purchase of a building for cash.

____

9. Acquisition of land in exchange for common shares.

____ 10. Decrease in merchandise inventory during a period.

Statement of Cash Flows

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ANSWERS TO MATCHING SET 1 1.

10. A

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MATCHING QUESTIONS SET 2 160. 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 payment—investing activity Cash receipt—investing activity Cash payment—financing activity Cash receipt—financing activity Significant noncash investing and financing activity Is not shown

____ 1. Increase in accounts payable during a period. ____ 2. Purchase of a long-term investment. ____ 3. Decrease in accounts receivable during a period. ____ 4. Depreciation expense. ____ 5. Conversion of bonds payable into common shares. ____ 6. Increase in merchandise inventory during a period. ____ 7. Sale of equipment for cash at carrying amount. ____ 8. Issue of preferred shares for cash. ____ 9. Purchase of land for cash. ____ 10. Loss on sale of equipment.

Statement of Cash Flows

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ANSWERS TO MATCHING SET 2 1.

10. J

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

SHORT-ANSWER ESSAY QUESTIONS S-A E 161 Forest Mountain Trading Corporation's most recent financial statements showed a dismal performance. There was a loss of $10,000 and the statement of cash flows showed a net cash decrease in all categories—operating, investing, and financing activities. The company president, Mr. Forest, called all the managers together and asked them to do all they could to make sure the next quarter's performance was better. Sam Sidhu, 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. Gloria Renton, the controller, immediately suspended payments on all accounts payable except those on which interest would accrue. She also instituted aggressive collection procedures for accounts receivable. Instructions (a) Were Sam Sidhu’s actions ethical? Explain. (b) Were Gloria Renton's actions ethical? Explain. (c) Were Mr. Forest’s actions ethical? Explain. Solution 161 (a) There is no clear-cut answer as to whether Sam Sidhu's actions were ethical or not. Both points of view 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 jobs 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. (b) Gloria Renton's actions all appear to be ethical. (c) Mr. Forest 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.

S-A E 162 (a) 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? (b) Explain how the accrual basis of accounting affects the operating activities section of the statement of cash flows. Solution 162 (a) The information used to prepare the statement of cash flows usually comes from three sources, which are: (1) a comparative statement of financial position, (2) a current income Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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statement, and (3) additional information. (b) The accrual basis of accounting requires that revenues be recorded when earned and that expenses be recorded in the same period the revenue was generated. 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 noncash revenues and noncash expenses do not affect the cash balance. Therefore, the noncash revenues and noncash expenses must be eliminated to determine the net cash provided by operating activities.

S-A E 163 Standard setters recommend using the direct method for preparing a statement of cash flows, yet the indirect method is still widely used in Canada, even by corporations reporting under IFRS. Why do you think this is? Solution 163 Standard setters recommend the direct method since it is considered to be more informative for users, and is easier to compare with other financial statements. It does not contain references to noncash items and changes to current asset and liability accounts (as the indirect method does). However, the indirect method, which has been used for many years, continues to be in wide use because it is easier to prepare and reveals less company information to competitors. Proponents of the indirect method (who are thus opponents of the direct method) maintain that the costs of modifying accounting systems to obtain the data required for the direct method outweigh the benefits, i.e., it would not be cost-beneficial.

S-A E 164 You are having coffee with Maxwell Smart, the CEO of Smart Shoe Technology Inc. Your conversation turns to the company's recent financial statements. Mr. Smart feels that he understands the basics of the financial statements but is puzzled by the need for an income statement and a statement of cash flows. In particular he wonders about the operating activities in the statement of cash flows. He asks you to explain to him why both are needed and the difference between them. Instructions In point form, list the items you would include in your response to Mr. Smart. Solution 164 • The income statement uses accrual accounting to measure the profitability of the business. • The statement of cash flows focuses on the receipt, payment and change in cash for the period. • The operating activities on the statement of cash flows are similar to the income statement but they are focused on cash rather than accrual accounting. • Both cash flow and profit are important to users of the financial statements. The income statement helps assess and predict profitability while the statement of cash flows allows a user to assess and predict future cash flows.

S-A E 165 When preparing a statement of cash flows using the indirect method, why is depreciation added

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

back to profit in the operating activities section? Solution 165 The indirect method begins with profit based on accrual accounting, which includes depreciation expense. However, depreciation expense does not represent a cash payment and thus, to convert accrual-based profit to cash-based profit, it must be added back to profit to “cancel” the expense. As a result, depreciation will not be included in the calculation of cash flows provided (used) by operating activities

S-A E 166 How is it possible for a company to record a loss for a given year, yet produce a positive cash flow provided (used) by operating activities? Solution 166 A loss means that accrual-based expenses exceeded accrual-based revenues for the period. However, if you eliminate the effect of noncash expenses such as depreciation by adding them back, it is possible to produce a positive net cash flow from operations. Increasing payables (not paying all expenses incurred this period) and decreasing receivables (collecting more receivables than sales) would also cause cash flow to be higher than accrual-based profit or loss.

S-A E 167 The operating activities section of the statement of cash flows can be calculated using the indirect or direct method. Describe how the two methods differ, yet arrive at the same information about the cash flows provided (used) by operating activities. Solution 167 The indirect 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) noncash 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, noncash expenses such as depreciation expense are added back to profit. 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 calculated by adjusting each individual revenue and expense 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 difference between these major classes is the net cash provided (used) by operating activities. The same adjustments are made in both methods, regardless of whether profit is adjusted or individual revenues and expenses are adjusted. Therefore, both methods arrive at the same result.

S-A E 168 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?

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Solution 168 Sales revenue (from the income statement) is an accrual-based figure that includes both cash and credit sales for the period. The statement of cash flows reports cash collections only, regardless of whether the sales arose in the current period or whether the credit sales have or have not been collected. An adjustment based on the change in accounts receivable accomplishes this conversion.

S-A E 169 Your fellow student, Majinder, is having a lot of trouble with ratios. “Why do we need to calculate all these ratios?” he exclaims. “We already calculated the current ratio, the working capital, and the debt to total assets ratio. Now we’re expected to learn the cash current debt coverage (CCDC) and the cash total debt coverage (CTDC). Aargh! I’m just getting more confused. Please help me!” Instructions Enlighten Majinder on the CCDC and the CTDC, including how to calculate them and what their importance is. Solution 169 Majinder, the CCDC is a liquidity ratio, so it gives us an idea of the ability of a company to pay their obligations due in the next year, or the short term. I agree it’s a little more complicated, because we need to look at both the statement of cash flows and the comparative statements of financial position, whereas the other ratios you mention just require data from the current statement of financial position. To calculate the CCDC, we find the net cash provided by operating activities and divide that by the average current liabilities. A disadvantage of the current ratio (which is also a liquidity ratio), although it is easy to calculate, is that it uses year end balances, which include accrual-based numbers, that may not be representative of the company’s financial position during the year. The CCDC improves on this problem somewhat, as the numerator uses cash-based numbers, and although the denominator still includes accrual-based numbers, at least it takes the average, which may be more representative. A high value, as with the current ratio, suggests good liquidity. As well, the CCDC provides a useful supplement to the current ratio. On the other hand, the CTDC is a solvency ratio, so it gives us an idea of the ability of the company to survive over the long term, and be able to pay all its liabilities. It uses the same numerator as the CCDC, but uses average total liabilities for the denominator, so obviously would always be a smaller number than the CCDC (unless the company has no non-current liabilities, which is not very likely). Again, a high CTDC suggest good solvency and that the company can meet its obligations in the long term. It also provides a useful supplement to the debt to total assets ratio.

CHAPTER 14 PERFORMANCE MEASUREMENT SUMMARY OF QUESTION TYPES BY STUDY OBJECTIVES AND LEVEL OF DIFFICULTY Item

SO LOD

Item

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

1 1 1 1 1 1 1 1 1 2

E E E M E M E M M M

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67.

1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

E M E M M E M M M M E M E E M E M M

68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

140. 141. 142. 143. 144. 145.

1 1 1 1 2 2

E M M M E E

146. 147. 148. 149. 150. 151.

166.

4-6 E,M

167.

168. 169.

1 M 2,3 H

170. 171.

Note:

E = Easy

LOD Item SO LOD Item True-False Statements 2 M 21. 3 M 31. 2 E 22. 3 M 32. 2 M 23. 3 M 33. 2 E 24. 3 M 34. 2 3 M 25. M 35. 2 M 26. 4 E 36. 2 M 27. 4 E 37. 3 E 28. 4 M 38. 3 E 29. 4 E 39. 3 M 30. 4 E 40. Multiple Choice Questions 2 E 86. 4 E 104. 2 M 87. 4 M 105. 3 E 88. 4 M 106. 3 E 89. 4 M 107. 3 E 90. 4 M 108. 3 M 91. 4 M 109. 3 E 92. 4 M 110. 3 E 93. 4 M 111. 3 H 94. 4 M 112. 3 M 95. 4 M 113. 3 M 96. 4 M 114. 3 E 97. 4 M 115. 4 E 98. 4 E 116. 4 M 99. 4 H 117. 4 M 100. 4 H 118. 4 E 101. 4 E 119. 4 M 102. 4 E 120. 4 E 103. 4 H 121. Exercises 2 M 152. 4 E 158. 2 M 153. 4 M 159. 2 M 154. 4 M 160. 2,3 M 155. 4 M 161. 2,3 M 156. 4 E 162. 3 M 157. 4,5 M 163. Matching 4-6 E,M Short-Answer Essay 4,5,6 M 172. 7 M 6, 7 M 173. 7 M

M = Medium

LOD

Item

SO LOD

4 4 4 5 5 5 5 5 5 6

M E E E M M M M M E

41. 42. 43. 44. 45. 46. 47. 48. 49.

6 6 6 6 6 6 6 7 7

M H H M M M M E E

4 4 4 4 5 5 5 5 5 6 6 6 6 6 6 6 6 6

E E M M E E E E M H H E E E M M E E

122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139.

6 6 6 6 6 6 6 6 6 6 6 6 6 6 6 7 7 7

E E E E M M M M H H M H M M M M E E

4,5,6 4,5,6 4,6 5,6 5,6 6

M H H M M M

164. 165.

6 6

M M

H = Hard

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SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type 1. 2. 3. 4.

TF TF TF TF

5. 6. 7. 8.

TF TF TF TF

9. 50. 51. 52.

10. 11. 12. 13.

TF TF TF TF

14. 15. 16. 17.

TF TF TF TF

59. 60. 61. 62.

18. 19. 20. 21.

TF TF TF TF

22. 23. 24. 25.

TF TF TF TF

70. 71. 72. 73.

26. 27. 28. 29. 30. 31. 32. 33.

TF TF TF TF TF TF TF TF

80. 81. 82. 83. 84. 85. 86. 87.

MC MC MC MC MC MC MC MC

88. 89. 90. 91. 92. 93. 94. 95.

34. 35. 36.

TF 37. TF 38. TF 39.

TF 108. TF 109. TF 110.

40. 41. 42. 43. 44. 45. 46. 47.

TF TF TF TF TF TF TF TF

MC MC MC MC MC MC MC MC

48. 49.

TF 137. TF 138.

113. 114. 115. 116. 117. 118. 119. 120.

121. 122. 123. 124. 125. 126. 127. 128.

MC 139. MC 171.

Note: TF = True-False MC = Multiple Choice

Study Objective 1 TF 53. MC 57. MC MC 54. MC 58. MC MC 55. MC 140. Ex MC 56. MC 141. Ex Study Objective 2 MC 63. MC 67. MC MC 64. MC 68. MC MC 65. MC 69. MC MC 66. MC 144. Ex Study Objective 3 MC 74. MC 78. MC MC 75. MC 79. MC MC 76. MC 149. Ex MC 77. MC 150. Ex Study Objective 4 MC 96. MC 105. MC MC 97. MC 106. MC MC 98. MC 107. MC MC 99. MC 152. Ex MC 100. MC 153. Ex MC 101. MC 154. Ex MC 102. MC 155. Ex MC 103. MC 156. Ex Study Objective 5 MC 111. MC 158. Ex MC 112. MC 159. Ex MC 157. Ex 161. Ex Study Objective 6 MC 129. MC 158. Ex MC 130. MC 159. Ex MC 131. MC 160. Ex MC 132. MC 161. Ex MC 133. MC 162. Ex MC 134. MC 163. Ex MC 135. MC 164. Ex MC 136. MC 165. Ex Study Objective 7 MC 172. SAE SAE 173. SAE Ma = Matching Ex = Exercise

Item

Type

142. 143. 168.

Ex Ex SAE

145. 146. 147. 148.

Ex Ex Ex Ex

151. 169.

Ex SAE

157. 158. 159. 160. 166. 167. 170.

Ex Ex Ex Ex Ma Ma SAE

162. 166. 167.

Ex Ma Ma

166. 167. 170. 171.

Ma Ma SAE SAE

Item

Type

149. 150. 169.

Ex Ex SAE

170.

SAE

SAE = Short-Answer Essay

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CHAPTER STUDY OBJECTIVES 1.

Understand the concept of sustainable income and indicate how discontinued items are presented. Sustainable income is the level of profit likely to be obtained in the future. It excludes irregular revenues and expenses that may be included in profit. Discontinued items are presented separately from continuing operations on the statement of financial position, income statement, and statement of cash flows, net of income tax to highlight their infrequent nature.

Explain and apply horizontal analysis. Horizontal analysis is a technique for evaluating a series of data, such as line items in a company’s financial statements, by expressing them as percentage increases or decreases over two or more years (or periods of time). The horizontal percentage of a base-period amount is calculated by dividing the amount in a specific year (period) by a base-year (period) amount. This percentage calculation normally covers multiple years (periods). The horizontal percentage change for the period is calculated by dividing the dollar amount of the change between two years (or periods) by the prior-year (period) amount. This percentage calculation normally covers two years (or periods) only.

Explain and apply vertical analysis. Vertical analysis is a technique for evaluating data within one year (or period) by expressing each item in a financial statement as a percentage of a relevant total (base amount) in that same financial statement. For example, the vertical percentage of a base amount can be determined by expressing each item on the income statement as a percentage of revenue (or net sales) or each item on the statement of financial position as a percentage of total assets by dividing the financial statement amount under analysis by the base amount for that particular financial statement.

Identify and calculate ratios that are used to analyze liquidity. Liquidity ratios include working capital, the current ratio, cash current debt coverage, receivables turnover and average collection period, and inventory turnover and days in inventory. The formula, what it measures, and desired result of each ratio are presented in Illustration 14-12.

Identify and calculate ratios that are used to analyze solvency. Solvency ratios include debt to total assets, times interest earned, cash total debt coverage, and free cash flow. The formula, what it measures, and desired result of each ratio are presented in Illustration 14-13.

Identify and calculate ratios that are used to analyze profitability. Profitability ratios include gross profit margin, profit margin, asset turnover, return on assets, return on common shareholders’ equity, earnings per share, price-earnings, payout, and dividend yield. The formula, what it measures, and desired result of each ratio are presented in Illustration 14-15.

Understand the limitations of financial analysis. The usefulness of financial analysis can be limited by (1) the use of alternative accounting policies, (2) professional judgment affecting the quality of the information, (3) the existence of a large amount of other

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comprehensive income, (4) diversification within a company or industry, (5) significant inflation, and (6) variable economic factors.

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TRUE-FALSE STATEMENTS 1. Sustainable income is the most likely level of profit to be obtained in the future.

2. One objective of the income statement is to separate the results of continuing operations from those of discontinued operations.

3. When there is a disposal of a component of an entity, the income statement should report both profit from continuing operations and profit (loss) from discontinued operations.

4. A component of an entity represents a separate major line of business.

5. Assets or liabilities of discontinued items are always reported as non-current.

6. Identifying discontinued items is important if a potential investor is going to use reported profit to estimate a company’s value.

7. The gain (loss) on disposal of a discontinued operation is not reported on the income statement.

8. Assets and liabilities of a discontinued operation are reported on the statement of financial position at fair value.

9. Earnings per share must be reported separately for continuing operations and discontinued operations.

10. Comparisons of company data with industry averages provide information about a company's relative position within the industry.

11. Horizontal analysis is also called trend analysis.

12. Horizontal analysis can be carried out on statement of financial position data but not on income statement data.

13. Horizontal analysis is a technique for evaluating a financial statement item in the current year with other items in the current year.

14. In horizontal analysis, the base year is the most current year being examined. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

15. If a company has sales of $100 in 2015 (the base period) and $560 in 2016 (the analysis period), the percentage of the base period is 460%.

16. If a company has sales of $220 in 2015 and $560 in 2016, the percentage increase in sales from 2015 to 2016 is 155%.

17. In horizontal analysis, if an item has a negative amount in the base year, and a positive amount in the following year, the percentage change will exceed 100%.

18. Vertical analysis is a technique for evaluating a series of financial statement data over a period of time to determine the increase (decrease) that has taken place.

19. Vertical analysis expresses each item in a financial statement as a percent of a base amount.

20. When preparing a vertical analysis on an income statement, net sales are represented by 100%.

21. On an income statement analyzed vertically, each item is expressed as a percentage of profit.

22. On a statement of financial position analyzed vertically, total assets are represented by 100%.

23. In the vertical analysis of a statement of financial position, the base for current liabilities is total liabilities.

24. Vertical analysis makes it easier to compare different companies.

25. Using vertical analysis on the income statement, a company's profit as a percentage of net sales is 15%; therefore, the cost of goods sold as a percentage of net sales must be 85%.

26. The first step in any comprehensive analysis is to perform a horizontal and vertical analysis.

27. Liquidity ratios measure the ability of the company to survive over a long period of time.

28. The current ratio should not be interpreted on its own without also looking at the receivables turnover and inventory turnover ratios. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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29. The receivables turnover ratio is useful in assessing the profitability of receivables.

30. The inventory turnover ratio measures the number of times, on average, the inventory was sold during the period.

31. The inventory turnover ratio is a measure of liquidity that focuses on efficient use of inventory.

32. The cash current debt coverage ratio may be a better indicator of liquidity than the current ratio.

33. An assessment of liquidity can be done based on only one ratio, such as the current ratio or the receivables ratio.

34. A solvency ratio measures the profit or operating success of a company for a given period of time.

35. From a creditor's point of view, the higher the debt to total assets ratio, the lower the risk that the company may be unable to pay its obligations.

36. Earnings before interest and tax (EBIT) is a proxy for the amount available to cover interest payments.

37. An accrual-based equivalent to the debt to total assets ratio is the cash total debt coverage ratio.

38. Free cash flow is the cash available after a company pays dividends.

39. Even if a company has a low debt to total assets ratio, it may have difficulty paying interest on debt if it also has a low times interest earned ratio.

40. Profitability ratios are frequently used as a basis for evaluating management's operating effectiveness. 41. Both the profit margin ratio and the asset turnover ratio affect a company’s return on assets. 42. Leveraging and return on common shareholders’ equity are closely related. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

43. The return on common shareholders’ equity is affected by both the return on assets and debt to total assets ratios.

44. Comparisons of earnings per share with other companies and the industry averages are usually not very meaningful. 45. The price-earnings ratio reflects investors’ expectations about the future profitability of the company. 46. An investor interested in purchasing a company’s shares for their income potential would be more interested in the company’s dividend yield and payout ratios than its price-earnings ratio.

47. Dividend yield measures profit generated by each share, based on the market price per share.

48. Many firms today are so diversified that they cannot be classified by industry.

49. Factors that may limit the usefulness of financial analysis include alternative accounting policies, professional judgement, other comprehensive income, diversification, inflation, and economic factors.

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ANSWERS TO TRUE-FALSE STATEMENTS Item Ans. 1. T 2. T 3. T 4. T 5. F 6. T 7. F

Item 8. 9. 10. 11. 12. 13. 14.

Ans. F T T T F F F

Item 15. 16. 17. 18. 19. 20. 21.

Ans. F T T F T T F

Item 22. 23. 24. 25. 26. 27. 28.

Ans. T F T F T F T

Item 29. 30. 31. 32. 33. 34. 35.

Ans. F T T T F F F

Item 36. 37. 38. 39. 40. 41. 42.

Ans. T F F T T T T

Item 43. 44. 45. 46. 47. 48. 49.

Ans. T T T T F T T

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

MULTIPLE CHOICE QUESTIONS 50. Sustainable income differs from actual profit by the amount of (a) irregular revenues, expenses, gains and losses. (b) dividends declared. (c) changes in accounting policies. (d) comprehensive income.

51. An income statement would not include (a) assets held for sale of a discontinued operation. (b) a loss on disposal of a component of an entity. (c) an operating loss on discontinued operations. (d) an unusually large bad debt expense.

52. Which of the following income statement figures would probably be the best indicator of a company’s future performance? (a) total revenues (b) gross profit (c) profit (d) profit from continuing operations

53. The discontinued operations section of the income statement refers to (a) discontinuance of a product line. (b) the profit or loss on products that have been completed and sold. (c) sale of obsolete equipment and discontinued inventory items. (d) the disposal of a major line of business or major geographical area of operations.

54. Assets that are held for sale as discontinued operations (a) are separately identified on the statement of comprehensive income. (b) are removed from the statement of financial position and are disclosed in the notes instead. (c) are not separately identified on the statement of financial position until they are sold. (d) are segregated and reported on the statement of financial position at the lower of their carrying amount and fair value.

55. Which of the following items appears on the income statement before profit from continuing operations? (a) loss from discontinued operations (net of income tax) (b) profit from discontinued operations (net of income tax) (c) income tax expense (d) gain on sale of discontinued operations (net of income tax) 56. Wilson Corporation reports that this years’ profit is $750,000, but this amount includes depreciation of $60,000 and an irregular gain of $150,000. Based on this year’s results what is the company’s sustainable income? (a) $750,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) $600,000 (c) $690,000 (d) 540,000

57. A component of an entity, for the purpose of discontinued operations, represents all of the following except (a) a major line of business. (b) major geographical area of operations. (c) a clearly distinguishable component from the rest of the company. (d) a major line of business held for future use.

58. Assets and liabilities of a discontinued operation that are held for sale are reported (a) separately on statement of financial position. (b) at higher of their carrying amount or fair value. (c) at lower of fair value or cost. (d) separately on the statement of comprehensive income.

59. Comparisons of financial data made within a company are called (a) intracompany comparisons. (b) interior comparisons. (c) intercompany comparisons. (d) intramural comparisons.

60. Horizontal analysis is also called (a) percentage analysis. (b) trend analysis. (c) vertical analysis. (d) economic analysis.

61. In horizontal analysis, the percentage of a base-period amount is calculated by (a) dividing the analysis period amount by the base period amount. (b) dividing the dollar amount of the change since the base period by the base period amount. (c) dividing the item under analysis by net sales. (d) dividing the item under analysis by total assets.

62. Under which of the following cases would a percentage change not be calculated? (a) The trend of the amounts is decreasing but all amounts are positive. (b) There is no amount in the base year. (c) The trend of the amounts is decreasing but all amounts are negative. (d) The trend of the amounts is increasing but all amounts are negative.

63. 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. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) to determine the amount and/or percentage increase or decrease that has taken place.

64. Horizontal analysis of comparative financial statements includes the (a) development of vertically analyzed 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 the current period’s financial statement as a percentage of a base amount.

65. 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.

66. A horizontal analysis is being conducted with year one as the base year. If year one equals $800, year two equals $840, and year three equals $896, the percentage of the base period for year three is (a) 89%. (b) 100%. (c) 105%. (d) 112%. 67. Assume the following sales data for a company: 2016 ....................................... $1,450,000 2015 ....................................... 1,250,000 2014 ....................................... 875,000 2013 ....................................... 730,000 What is the percentage increase in sales from 2015 to 2016? (a) 14% (b) 97% (c) 16% (d) 50%

68. In horizontal analysis, each item is expressed as a percentage of the (a) retained earnings amount. (b) total assets amount. (c) profit amount. (d) base year amount.

69. If, over a three-year period, sales increased by 30%, and cost of goods sold increased by 45%, (a) the sales trend is unfavourable, but the cost of goods sold trend is favourable. (b) the sales trend is favourable, but the cost of goods sold trend is unfavourable. (c) both trends are favourable. (d) both trends are unfavourable. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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70. All of the following statements about vertical analysis are true except (a) vertical analysis is also called common size analysis. (b) amounts on the income statement are expressed as a percentage of net sales. (c) vertical analysis shows the relative size of each item in the statement of financial position. (d) vertical analysis is also called trend analysis.

71. On financial statements that include vertical analysis, which of the following is set at 100%? (a) total liabilities (b) profit (c) total assets (d) cost of goods sold

72. In vertical analysis of an income statement, the 100% figure is (a) profit. (b) cost of goods sold. (c) gross profit. (d) net sales.

73. All of the following statements about vertical analysis are true except (a) vertical analysis makes it easier to for intercompany comparisons. (b) vertical analysis is seldom performed on the income statement. (c) vertical analysis makes it easier to compare companies of different sizes. (d) vertical analysis is seldom performed on the cash flow statement.

74. Vertical analysis is a technique that expresses each item in a financial statement (a) in dollars and cents. (b) as a percentage of the item in the previous year. (c) as a percentage of a base amount. (d) starting with the highest value down to the lowest value.

75. In vertical analysis (a) a base amount is required. (b) a base amount is optional. (c) the same base is used across all financial statements being analyzed. (d) the results of the horizontal analysis are necessary inputs for vertical analysis.

76. Horizontal analysis showed a 25% increase in accounts receivable in 2016 over 2015. Vertical analysis showed accounts receivable declining from 7.5% to 6.8% over the same period. Given this information, what conclusion(s) may be reached? (a) The dollar amount of accounts receivable increased. (b) The dollar amount of accounts receivable decreased. (c) It cannot be determined if the dollar amount of accounts receivable increased or decreased. (d) This result is impossible. An error has been made in the calculations.

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77. In performing a 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.

Use the following information for questions 78–79. Accounts receivable ............... $ 2,500 Cost of goods sold ................. 200,000 Profit ...................................... 50,000 Net sales ................................ 450,000 Sales ...................................... 500,000 Total assets............................ 250,000 Total current assets................ 25,000

78. In performing a vertical analysis, the percentage for accounts receivable is (a) 0.5%. (b) 1.0%. (c) 5.0%. (d) 10.0%.

79. In performing a vertical analysis, the percentage for cost of goods sold is (a) 4.4%. (b) 40.0%. (c) 44.4%. (d) 400.0%.

80. Short-term creditors are usually most interested in assessing (a) solvency. (b) liquidity. (c) marketability. (d) profitability.

81. A common measure of liquidity is (a) return on assets. (b) receivables turnover. (c) profit margin. (d) debt to total assets.

82. 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.

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(a) liquidity ratio. (b) profitability ratio. (c) solvency ratio. (d) cash flow ratio.

84. A company with $60,000 in current assets and $40,000 in current liabilities pays a $1,000 current liability. As a result of this transaction, the current ratio and working capital will (a) both decrease. (b) both increase. (c) increase and remain the same, respectively. (d) remain the same and decrease, respectively.

85. The receivables turnover and inventory turnover ratios are used to analyze (a) solvency. (b) profitability. (c) liquidity. (d) leverage.

86. A high receivables turnover ratio may indicate that (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.

87. Summer Fashions had a balance in the Accounts Receivable account of $660,000 at the beginning of the year and a balance of $720,000 at the end of the year. Net credit sales during the year were $5,350,000. The average collection period of the receivables was (a) 45 days. (b) 47 days. (c) 49 days. (d) 93 days.

88. Jasper Electrical reported net credit sales of $4,500,000 and cost of goods sold of $2,700,000 for the year. The Accounts Receivable balances at the beginning and end of the year were $450,000 and $480,000, respectively. The receivables turnover ratio was (a) 5.8 times. (b) 9.4 times. (c) 9.7 times. (d) 10.0 times.

Use the following information for questions 89–90. Winnipeg Washing Machines reported net credit sales of $12,000,000 and cost of goods sold of $9,000,000 for the year. The average inventory for the year was $2,000,000. 89. The inventory turnover ratio for the year was (a) 4.5 times. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) 5.3 times. (c) 6.0 times. (d) 22.0 times.

90. The days in inventory during the year was (a) 17 days. (b) 61 days. (c) 69 days. (d) 81 days.

91. Which one of the following would not be considered a liquidity ratio? (a) current ratio (b) inventory turnover ratio (c) cash current debt coverage ratio (d) return on assets ratio

92. A weakness of the current ratio is (a) the difficulty of the calculation. (b) that it doesn't take into account the composition of the current assets. (c) that it is rarely used by sophisticated analysts. (d) that it can be expressed as a percentage, as a rate, or as a proportion.

93. A supplier to a company would be most interested in the (a) asset turnover ratio. (b) profit margin ratio. (c) current ratio. (d) free cash flow.

94. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company? (a) current ratio (b) dividend yield (c) asset turnover (d) receivables turnover

95. Some of the ratios that are used to determine a company's short-term debt paying ability are (a) asset turnover, times interest earned, current ratio, and receivables turnover. (b) times interest earned, inventory turnover, current ratio, and receivables turnover. (c) times interest earned, current ratio, and inventory turnover. (d) current ratio, receivables turnover, and inventory turnover.

96. Best Baskets Limited (BBL) had a current ratio of 0.8:1 before borrowing $50,000 from the bank with a short-term note payable. What effect did the borrowing transaction have on BBL’s current ratio? (a) The ratio remained unchanged. (b) The ratio decreased. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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97. A liquidity ratio measures the (a) profit or operating success of a company over a period of time. (b) ability of the company to survive over a long period of time. (c) short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. (d) ability of a company to raise capital.

98. If a company has a current ratio of 1.3:1, what effects will the borrowing of cash by shortterm debt and collection of accounts receivable have on the ratio? (a) (b) (c) (d)

Short-term Borrowing Increase Increase Decrease Decrease

Collection of Receivables No effect Increase No effect Decrease

99. A company has a receivables turnover ratio of 12. The average gross accounts receivable during the period is $360,000. What is the amount of net credit sales for the period? (a) $ 432,000 (b) $3,000,000 (c) $4,320,000 (d) Cannot be determined from the information given.

100. If the average collection period is 45 days, what is the receivables turnover? (a) 8.1 times (b) 12.0 times (c) 18.0 times (d) 20.0 times

101. A general rule to use in assessing the average collection period is that it (a) should not exceed 30 days. (b) can be any length as long as the customer eventually pays his account. (c) should not greatly exceed the discount period. (d) should not greatly exceed the credit period.

102. The inventory turnover ratio is calculated by dividing (a) cost of goods sold by ending inventory. (b) cost of goods sold by beginning inventory. (c) cost of goods sold by average inventory. (d) average inventory by cost of goods sold.

103. A company has average inventory on hand of $40,000 and its average days in inventory is 26.4 days. What is the cost of goods sold? Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(a) $1,056,000 (b) $ 553,030 (c) $ 486,667 (d) $ 480,000

104. A successful grocery store would probably have (a) a low inventory turnover. (b) a high inventory turnover. (c) zero profit margin. (d) low volume.

Use the following information to answer questions 105–107. Green Thumb Garden Supplies reported the following information for 2015 and 2016. 2016

2015

Assets Cash ........................................................ Accounts receivable ................................. Merchandise inventory ............................. Property, plant, and equipment ................ Total assets..............................................

$ 50,000 $ 45,000 35,000 25,000 25,000 20,000 240,000 210,000 $350,000 $300,000

Liabilities and Shareholders’ Equity Current liabilities....................................... Non-current liabilities ................................ Shareholders’ equity—common ............... Total liabilities and shareholders’ equity ...

$ 65,000 $ 60,000 110,000 90,000 175,000 150,000 $350,000 $300,000

Income statement for 2016 Sales ........................................................ Cost of goods sold ................................... Gross profit .............................................. Operating expenses ................................. Profit before income tax ........................... Income tax expense ................................. Profit ........................................................

$95,000 45,000 50,000 15,000 35,000 5,000 $30,000

105. What is the current ratio for 2016? (a) 2.0:1 (b) 1.7:1 (c) 1.6:1 (d) 0.6:1

106. What is the receivables turnover ratio for 2016? (a) 2.7 times (b) 2.0 times (c) 3.2 times (d) 3.8 times Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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107. What is the inventory turnover ratio for 2016? (a) 2.3 times (b) 2.0 times (c) 1.8 times (d) 0.5 times

108. A common measure of long-term solvency is the (a) cash total debt coverage ratio. (b) current ratio. (c) asset turnover ratio. (d) inventory turnover ratio.

109. Which of the following solvency positions would a company consider most favourable? (a) a high debt to total assets ratio and a low times interest earned ratio (b) a low debt to total assets ratio and a high times interest earned ratio (c) a high debt to total assets ratio and a high times interest earned ratio (d) a low debt to total assets ratio and a low times interest earned ratio

110. Long-term creditors are usually most interested in evaluating (a) liquidity. (b) marketability. (c) profitability. (d) solvency.

111. Gifford Limited reported the following on its income statement: Profit before income tax ......... Income tax expense ............... Profit ......................................

$600,000 180,000 $420,000

Interest expense was $60,000. Gifford's times interest earned was (a) 11 times. (b) 10 times. (c) 7 times. (d) 3 times.

112. Free cash flow is calculated as (a) profit minus net capital expenditures minus dividends paid. (b) profit minus dividends paid. (c) net cash provided (used) by operating activities minus net capital expenditures minus dividends paid. (d) net cash provided (used) by investing activities minus net capital expenditures minus dividends paid.

113. The return on assets ratio is affected by the (a) profit margin and debt to total assets ratios. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) profit margin and asset turnover ratios. (c) times interest earned and debt to total assets ratios. (d) profit margin and free cash flow. 114. The return on common shareholders’ equity ratio is affected by the (a) gross profit margin and profit margin ratio. (b) profit margin and free cash flow. (c) times interest earned and debt to total assets ratios. (d) return on assets and debt to total assets ratios.

115. Shareholders are most interested in evaluating (a) liquidity. (b) solvency. (c) profitability. (d) marketability.

116. Assuming the number of units sold does not change, if a company wants to increase its profit margin it can do any of the following except (a) raise the selling price. (b) decrease the percentage markup on cost. (c) reduce its cost of goods sold. (d) reduce its operating expenses.

117. A common measure of profitability is the (a) current ratio. (b) cash current debt coverage ratio. (c) return on common shareholders’ equity ratio. (d) debt to total assets ratio.

118. All of the following profitability ratios relate more to the needs of investors than corporations except for (a) earnings per share. (b) payout ratio. (c) profit margin. (d) dividend yield.

119. Which of the following is false about the dividend yield ratio? (a) High growth companies tend to have lower dividend yield ratios. (b) It measures the rate of return a shareholder earned from dividends during the year. (c) A low dividend yield, by itself, is neither bad nor good. (d) Dividend yield ratio = Market price per share ÷ Dividends per share.

120. Asset turnover ratio is calculated as (a) net sales divided by profit. (b) average total assets divided by profit. (c) net sales divided by average total assets. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) average total assets divided by net sales.

121. Asset turnover measures (a) how often a company replaces its assets. (b) how efficiently a company uses its assets to generate sales. (c) the portion of the assets that have been financed by creditors. (d) the overall rate of return on assets.

122. Profit margin is calculated by dividing (a) sales by cost of goods sold. (b) gross profit by net sales. (c) profit by shareholders' equity. (d) profit by net sales.

Use the following information for questions 123–126. During 2016, Pattar Corp. reported after-tax profit of $450,000 and paid $75,000 in common dividends. The weighted average number of common shares issued in 2016 was 150,000. There are no preferred shares issued. At year end, Pattar's common shares are selling for $60 per share on the Toronto Stock Exchange. 123. Pattar’s earnings per share for 2016 is (a) $25.00. (b) $20.00. (c) $3.00. (d) $2.50. 124. Pattar’s price-earnings ratio is (a) 120 times. (b) 24 times. (c) 20 times. (d) 3 times.

125. Pattar's payout ratio for 2016 is (a) $0.50. (b) 0.8%. (c) 6.0%. (d) 16.7%. 126. Pattar’s dividend yield for 2016 is (a) $0.50. (b) 0.8%. (c) 6.0%. (d) 16.7%.

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127. A company that is highly leveraged is one that (a) has a high earnings per share. (b) contains debt financing. (c) contains equity financing. (d) has a high current ratio.

128. Consider the following information: Beginning number of shares..................... Ending number of shares ......................... Dividend per share ................................... Market price per share ............................. Profit ........................................................

140,000 160,000 $1.20 $80.00 $930,000

The dividend yield is (a) 1.5%. (b) 6.2%. (c) 8.6%. (d) 50.0%.

129. Which of the following ratios are known as market measures of profitability? (a) payout and dividend yield (b) return on assets and debt to total assets (c) earnings per share and price-earnings (d) price-earnings and dividend yield

130. Net sales are $2,700,000, beginning total assets are $750,000, and the asset turnover is 3.0. What is the ending total assets? (a) $600,000 (b) $900,000 (c) $1,050,000 (d) $1,125,000

Use the following information to answer questions 131–136. Green Thumb Garden Supplies reported the following information for 2015 and 2016: 2016

2015

$ 50,000 $ 45,000 35,000 25,000 25,000 20,000 240,000 210,000 $350,000 $300,000

$ 65,000 $ 60,000 110,000 90,000 175,000 150,000 $350,000 $300,000

Performance Measurement

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$95,000 45,000 50,000 15,000 35,000 5,000 $30,000

Share data for 2016 Weighted average number of common shares Market price per common share ............... Dividends per share .................................

6,000 $40 $0.90

131. What is the return on assets for 2016? (a) 27.1% (b) 10.0% (c) 9.2% (d) 8.6%

132. What is the profit margin for 2016? (a) 8.6% (b) 10.0% (c) 17.1% (d) 31.6% 133. What is the return on common shareholders’ equity for 2016? (a) 4.5% (b) 17.1% (c) 18.5% (d) 20.0%

134. What are the earnings per share for 2016? (a) $15.83 (b) $ 5.00 (c) $ 2.50 (d) $ 0.90

135. What is the price-earnings ratio? (a) 44.4 times (b) 16.0 times (c) 8.0 times (d) 2.5 times

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(b) 4.4% (c) 9.0% (d) 12.5%

137. If a company is very diversified (a) it makes it easier to classify the company by industry. (b) it would not be necessary to provide any segmented information. (c) it can limit the usefulness of financial analysis. (d) any problems with a subsidiary would be apparent when examining the consolidated statements.

138. Factors than can limit the usefulness of financial analysis do not include (a) professional judgement. (b) alternative accounting policies. (c) diversification. (d) accrual accounting.

139. The use of alternative accounting policies (a) is not a problem in ratio analysis because the footnotes disclose the method used. (b) may be a problem in ratio analysis even if disclosed. (c) is not a problem in ratio analysis since eventually all methods will lead to the same end. (d) is only a problem in ratio analysis with respect to inventory.

Performance Measurement

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62.

Ans. a a d d d c b d a a b a b

Item 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75.

Ans. d c b d c d b d c d d c a

Item Ans. Item 76. a 89. 77. b 90. 78. b 91. 79. c 92. 80. b 93. 81. b 94. 82. b 95. 83. a 96. 84. c 97. 85. c 98. 86. a 99. 87. b 100. 88. c 101.

Ans. a d d b c b d c c c c a d

Item 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114.

Ans. c b b b c b a b d a c b d

Item 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127.

Ans. c b c c d c b d c c d b b

Item 128. 129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139.

Ans. a d c c d c b c a c d b

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

EXERCISES Ex. 140 Soft Fabric Inc. reported the following information from its income statement for 2016: Gain on disposal of discontinued division, net of tax of $30,000 .................................................. $ 70,000 Gain on sale of equipment ................................................ 250,000 Income tax expense .......................................................... 405,000 Interest expense ............................................................... 205,000 Profit from operations ........................................................ 1,350,000 Instructions Calculate Soft Fab’s sustainable income. Solution 140 (5 min.) Profit from operations ........................................................ $1,350,000 Add: Gain on sale of equipment................................... 250,000 Deduct: Interest expense .................................................. (205,000) Income tax expense ............................................ (405,000) Sustainable income ........................................................... $990,000

Ex. 141 Indicate whether the following items would be included when calculating sustainable income: Items Loss attributable to labour strike Gain on sale of equipment Operating loss from fertilizer division, which was sold Loss from sale of marketable securities Gain on sale of fertilizer division

Included

Excluded

Included X X

Excluded

Solution 141 (5 min.) Items Loss attributable to labour strike Gain on sale of equipment Operating loss from fertilizer division, which was sold Loss from sale of marketable securities Gain on sale of fertilizer division

X X X

Ex. 142 For the year ended December 31, 2016, Master Moving Corp. reports pretax profit from continuing operations of $520,000. Other items relating to 2016 are: 1. $160,000 profit from discontinued operations, net of income tax. 2. Dividends of $35,000 were declared. 3. Retained earnings, January 1, 2016, were $980,000. Its income tax rate is 30%. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

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Instructions (a) Calculate the profit for 2016. (b) Calculate the sustainable income for 2016. (c) Calculate the retained earnings at December 31, 2016. Solution 142 (10 min.) (a) Profit before taxes from continuing operations .............................. Less: Income tax at 30% ............................................................... Profit from continuing operations ................................................... Profit from discontinued operations, net of income tax .................. Profit .............................................................................................

$520,000 156,000 364,000 160,000 $524,000

Dividends declared do not impact the calculation of profit for 2016. (b) Sustainable earnings = profit from continuing operations ..............

$364,000

(c) Retained earnings, beginning ........................................................ $980,000 Add: Profit ..................................................................................... 524,000 Less: Dividends ............................................................................. (35,000) Retained earnings, ending ............................................................ $1,469,000

Ex. 143 Listed below are some selected items that may appear on a corporate income statement. Indicate the order in which these items would appear on the income statement. (The first one should be assigned the number “1”, the second “2”, etc.) ____

Cost of goods sold

____

Profit

____

Profit before income tax

____

Discontinued operations

____

Revenue

____

Profit from continuing operations

____

Operating expenses

____

Income tax expense

Solution 143 (5 min.) __2__ Cost of goods sold __8__ Profit __4__ Profit before income tax __7__ Discontinued operations Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

__1__ Revenue __6__ Profit from continuing operations __3__ Operating expenses __5__ Income tax expense

Ex. 144 Comparative information taken from Water Works Corporation’s financial statements is shown below: 2016 2015 (a) Cash .......................................................................... $(60,000) $(80,000) (b) Accounts receivable ................................................... 135,000 175,000 (c) Merchandise inventory ............................................... 195,000 115,000 (d) Notes receivable ........................................................ 30,000 -0Instructions Using horizontal analysis, calculate the percentage change from 2015 to 2016. Solution 144 (8 min.) (a) $(20,000) ÷ $(80,000) = 25% decrease. (b) $(40,000) ÷ $175,000 = 22.8% decrease. (c) $80,000 ÷ $115,000 = 69.6% increase. (d) Base year is zero. Not possible to calculate.

Ex. 145 Sports Pick Corporation reported profit of $1,750,000 in 2013. Using 2013 as the base year, profit decreased by 60% in 2014 and increased by 130% in 2015. Instructions Calculate the profit reported by Sports Pick Corporation for 2014 and 2015. Solution 145 (2–3 min.) 2014: $1,750,000 × (100% – 60%) = $700,000 2015: $1,750,000 × 130% = $2,275,000

Ex. 146 The following items were taken from the financial statements of McGonigal Inc. over a four-year period: Item 2016 2015 2014 2013 Net sales $650,000 $580,000 $530,000 $500,000 Cost of goods sold 520,000 440,000 380,000 340,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

Gross profit

$130,000

$140,000

$150,000

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$160,000

Instructions Using horizontal analysis and 2013 as the base year, calculate the horizontal percentages of a base-period for net sales, cost of goods sold, and gross profit. Explain whether the trends are favourable or unfavourable for each item. Solution 146 (8–12 min.) Item 2016 Net sales 130% Cost of goods sold 153% Gross profit 81%

2015 116% 129% 88%

2014 106% 112% 94%

2013 100% 100% 100%

The trend in net sales is increasing and favourable. The cost of goods sold trend is increasing and unfavourable, since it is growing more rapidly than sales. This is resulting in an unfavourable and decreasing trend in gross profit.

Ex. 147 The following items were taken from the financial statements of Nesci Ltd. over a three-year period: Item 2016 2015 2014 Net sales $460,000 $420,000 $395,000 Cost of goods sold 230,000 220,000 205,000 Gross profit $230,000 $200,000 $190,000 Instructions Using horizontal analysis and 2014 as the base year, calculate the horizontal percentages of a base-period for net sales, cost of goods sold, and gross profit. Explain whether the trends are favourable or unfavourable for each item. Solution 147 (8–12 min.) Item 2016 Net sales 116% Cost of goods sold 112% Gross profit 121%

2015 106% 107% 105%

2014 100% 100% 100%

The trend in net sales is increasing and favourable. The cost of goods sold trend is increasing which could be unfavourable, but the sales are increasing each year at a faster pace than cost of goods sold. This is apparent by examining the gross profit percentages, which show a favourable, increasing trend.

Ex. 148 The following items were taken from the financial statements of Cukor Corp. over a three-year period: Item 2016 2015 2014 Net sales $338,520 $322,400 $310,000 Cost of goods sold 182,104 175,100 170,000 Gross profit $156,416 $147,300 $140,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Instructions Using horizontal analysis, calculate the following for each of the above items: (a) The amount and percentage change from 2015 to 2016. (b) The amount and percentage change from 2014 to 2015. Solution 148 (8–12 min.) Item Net sales Cost of goods sold Gross profit

2015-2016 $ Percent $16,120 5.0 7,004 4.0 $ 9,116 6.2

2014-2015 $ Percent $12,400 4.0 5,100 3.0 $7,300 5.2

Ex. 149 The comparative statements of financial position of Dolphin Corporation appear below: DOLPHIN CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets .................................................................................................. 2016 2015 Current assets...................................................................................... $ 390 $280 Property, plant, and equipment ............................................................ 660 520 Total assets .................................................................................... $1,050 $800 Liabilities and shareholders' equity Current liabilities .................................................................................. Non-current liabilities............................................................................ Common shares................................................................................... Retained earnings ................................................................................ Total liabilities and shareholders' equity .........................................

$ 200 250 340 260 $1,050

$120 160 320 200 $800

Instructions (a) Using horizontal analysis, prepare a comparative statement of financial position, expressing the 2016 amounts as percentages of the 2015 amounts. (b) Prepare a comparative statement of financial position using vertical analysis. Solution 149 (20 min.) (a) DOLPHIN CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2016 2015 Current assets...................................................................................... 139% 100% Property, plant, and equipment ............................................................ 127% 100% Total assets .................................................................................... 131% 100% Liabilities and shareholders' equity Current liabilities ..................................................................................

167%

100%

Performance Measurement

Non-current liabilities............................................................................ Common shares................................................................................... Retained earnings ................................................................................ Total liabilities and shareholders' equity ........................................

156% 106% 130% 131%

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100% 100% 100% 100%

(b) DOLPHIN CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2016 Percent 2015 Percent Current assets................................................. $ 390 37% $280 35% Property, plant, and equipment ....................... 660 63% 520 65% Total assets.............................................. $1,050 100% $800 100% Liabilities and shareholders' equity Current liabilities ............................................. Non-current liabilities....................................... Common shares.............................................. Retained earnings ........................................... Total liabilities and shareholders' equity ...

$ 200 250 340 260 $1,050

19% 24% 32% 25% 100%

$120 160 320 200 $800

15% 20% 40% 25% 100%

Ex. 150 Using the following selected items from the comparative statements of financial position of Pong Limited, illustrate horizontal and vertical analyses by calculating the percentages of a baseamount. December 31, 2016 December 31, 2015 Accounts receivable ........................... $ 520,000 $ 450,000 Merchandise inventory ....................... 680,000 650,000 Total assets ....................................... 4,400,000 4,000,000 Solution 150 (8–10 min.)

Accounts receivable Merchandise inventory Total assets

HORIZONTAL ANALYSIS December 31, 2016 December 31, 2015 116% 100% 105% 100% 110% 100%

Accounts receivable Merchandise inventory Total assets

VERTICAL ANALYSIS December 31, 2016 December 31, 2015 12% 11% 15% 16% 100% 100%

Ex 151 Condensed data from the latest comparative income statement of Maduse Corp. follow: 2016 2015 Net sales .................................................................. $620,000 $500,000 Cost of goods sold ................................................... 340,000 210,000 Gross profit .............................................................. 280,000 290,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Operating expenses ................................................. 108,000 Profit before income tax ........................................... 172,000 Income tax expense ................................................. 51,600 Profit ........................................................................ $ 120,400

120,000 170,000 51,000 $ 119,000

Instructions (a) Prepare a vertical analysis for each year. (b) Comment on the results. Solution 151 (15 min.) (a) Net sales .................................................................. Cost of goods sold ................................................... Gross profit .............................................................. Operating expenses ................................................. Profit before income tax ........................................... Income tax expense ................................................. Profit ........................................................................

2016 100% 55% 45% 17% 28% 8% 19%

2015 100% 42% 58% 24% 34% 10% 24%

(b) Although the dollar amounts of sales and gross profit have increased from 2015 to 2016, the vertical analysis shows that the cost of goods sold as a percent of sales has increased, thus the gross profit percentage has actually declined. Operating expenses as a percent of sales have decreased (good), but, again, although profit before and after income tax has increased in absolute dollars, they have decreased as a percent of sales. This is all due to the 13% reduction in gross profit from 2015 to 2016.

Ex. 152 Selected information from the comparative financial statements of Danton Doors Inc. for the year ended December 31 appears below: 2016 2015 Accounts receivable ................................................. $ 260,000 $200,000 Cost of goods sold ................................................... 700,000 530,000 Current liabilities ...................................................... 210,000 110,000 Depreciation expense .............................................. 70,000 31,000 Income tax expense ................................................. 50,000 29,000 Interest expense ...................................................... 45,000 25,000 Merchandise inventory ............................................. 240,000 160,000 Net cash provided by operating activities ................. 220,000 135,000 Net credit sales ........................................................ 1,250,000 700,000 Non-current liabilities................................................ 450,000 300,000 Profit ........................................................................ 170,000 85,000 Total assets ............................................................. 1,000,000 800,000 Instructions Calculate the following ratios for 2016: (a) Inventory turnover (b) Receivables turnover (c) Cash current debt coverage Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

Solution 152 (12 min.) (a) Inventory turnover

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$700,000 ———————————— = 3.5 times ($240,000 + $160,000) ÷ 2

(b) Receivables turnover $1,250,000 ———————————— = 5.4 times ($260,000 + $200,000) ÷ 2 (c) Cash current debt coverage $220,000 = 1.4 times ($210,000 + $110,000)  2

Ex. 153 Selected data for Younge Yoga Shoppe appear below: Net sales .................................................................. Cost of goods sold ................................................... Merchandise inventory at end of year ...................... Accounts receivable at end of year ..........................

2016 $745,000 375,000 50,000 35,000

2015 $660,000 250,000 40,000 25,000

Instructions Calculate the following ratios for 2016: (a) Inventory turnover (b) Days in inventory (c) Receivables turnover (d) Average collection period Solution 153 (6–10 min.) (a) Inventory turnover

= Cost of goods sold ÷ Average inventory = $375,000 ÷ [($50,000 + $40,000) ÷ 2] = 8.3 times = $375,000 ÷ $45,000 = 8.3 times

(b) Days in inventory

= 365 days ÷ inventory turnover = 365 ÷ 8.3 = 44 days

(c)

= Net sales ÷ Average accounts receivable = $745,000 ÷ [($35,000 + $25,000) ÷ 2] = $745,000 ÷ $30,000 = 24.8 times

Receivables turnover

(d) Average collection period

= 365 days ÷ receivables turnover = 365 ÷ 24.8 = 15 days

Ex. 154 Omar Corporation reported the following comparative current assets and current liabilities: Dec. 31, 2016

Dec. 31, 2015

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Current assets Cash ................................................................. Trading investments .......................................... Accounts receivable .......................................... Merchandise inventory ...................................... Prepaid expenses ............................................. Total current assets .................................... Current liabilities Accounts payable .............................................. Salaries payable................................................ Income tax payable ........................................... Total current liabilities .................................

$ 30,000 40,000 65,000 120,000 35,000 $290,000

$ 25,000 15,000 95,000 90,000 20,000 $245,000

$125,000 35,000 25,000 $185,000

$115,000 30,000 10,000 $155,000

During 2016, credit sales and cost of goods sold were $480,000 and $288,000, respectively. Net cash provided by operating activities for 2016 was $94,000. Instructions Calculate the following ratios for 2016: (a) Current ratio (b) Cash current debt coverage ratio (c) Receivables turnover (d) Inventory turnover Solution 154 (10–15 min.) (a) Current ratio = Current Assets ÷ Current Liabilities = $290,000 ÷ $185,000 = 1.6:1 (b) Cash current debt coverage ratio = Cash provided by operating activities ÷ Average current liabilities = $94,000 ÷ $170,000 = 0.6 times (c) Receivables turnover = =

Net credit sales ÷ Average gross accounts receivable $480,000 ÷ $80,000 = 6.0 times

(d) Inventory turnover

Cost of goods sold ÷ Average inventory $288,000 ÷ $105,000 = 2.7 times

= =

Ex. 155 State the effect of the following transactions on the current ratio. Use increase, decrease, or no effect for your answer. Assume the current ratio is greater than 1:1. (a) Collection of an account receivable. ______________ (b) Sale of additional shares for cash. ______________ (c) Payment of an account payable. ______________ (d) Purchase of equipment for cash. ______________ (e) Purchase of Inventory for cash. ______________ (f) Purchase of short-term investments for cash. ______________ Solution 155 (8 min.) Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

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(a) no effect (b) increase (c) increase (d) decrease (e) no effect (f) no effect

Ex. 156 The following data are taken from the financial statements of Stevenson Corporation: 2016 2015 Average gross accounts receivable.......................... $ 650,000 $ 700,000 Net sales on account................................................ 7,475,000 5,600,000 Terms for all sales are 2/10, n/30. Instructions (a) Calculate 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? Solution 156 (8–10 min.) (a) Receivables turnover

Average collection period

2016 $7,475,000 ————— $650,000

2015 $5,600,000 ————— $700,000

11.5 times

8 times

365 days ———— 11.5

365 days ———— 8

32 days

46 days

(b) The receivables are turning over much faster in 2016 than they did in 2015. There was a problem in 2015 since the normal credit period is 30 days, and the average collection period was more than 50% longer. The company showed vast improvement in the management of their receivables in 2016.

Ex. 157 Presented below are liquidity and solvency ratios for Carmelo Industries, along with industry averages: Ratio 2016 2015 Industry Average Cash current debt coverage ................... 0.4 0.6 0.8 Cash total debt coverage........................ 0.03 0.07 0.1 Current ratio ........................................... 0.7:1 0.8:1 1.4:1 Debt to total assets................................. 55% 48% 35% Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Inventory turnover .................................. Receivables turnover .............................. Times interest earned .........................

7.0 6.2 2.0

11.0 8.1 4.8

15.2 10.4 8.5

Instructions Analyze the company's liquidity and solvency using the information presented. Present a conclusion on the liquidity and solvency, supported by your analysis. Solution 157 (15 min.) The company's current ratio has decreased and is well below the industry average. This indicates that the company's liquidity is deteriorating. This is consistent with the decreases in inventory turnover and receivables turnover, which are both cause for concern. In terms of solvency, the company appears to be in a poor position. Its debt to total assets has increased somewhat and is now well above the industry average. Both times interest earned and cash total debt coverage have decreased and are well below the industry average.

Ex. 158 The financial statements of Belleville Corporation appear below: BELLEVILLE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2016 2015 Cash $ 35,250 $ 40,000 Trading investments 15,000 60,000 Accounts receivable 50,000 30,000 Merchandise inventory 60,000 70,000 Property, plant, and equipment 260,000 300,000 Total assets $420,250 $500,000 Liabilities and shareholders' equity Accounts payable Short-term bank loan payable Bonds payable Common shares Retained earnings Total liabilities and shareholders' equity

$ 20,000 $ 30,000 40,000 90,000 80,000 160,000 170,000 145,000 110,250 75,000 $400,250 $500,000

BELLEVILLE CORPORATION Income Statement Year Ended December 31, 2016 ————————————————————————————————————————— Net sales .............................................................................................. $400,000 Cost of goods sold ............................................................................... 190,000 Gross profit .......................................................................................... 210,000 Expenses Operating expenses ...................................................................... $85,000 Interest expense............................................................................ 18,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

Total expenses ......................................................................... Profit before income tax ....................................................................... Income tax expense ............................................................................. Profit ....................................................................................................

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103,000 107,000 26,750 $ 80,250

Additional information for 2016: 1. 2. 3. 4.

Cash dividends of $45,000 were declared and paid. Average number of common shares was 60,000 shares. Market value of common shares on December 31 was $20 per share. Net cash provided by operating activities was $62,000.

Instructions Using the financial statements and the additional information, calculate the following ratios for 2016: (a) Current ratio (b) Return on common shareholders' equity (c) Price-earnings ratio (d) Receivables turnover (e) Times interest earned (f) Profit margin (g) Days in inventory (h) Payout ratio (i) Return on assets (j) Cash current debt coverage ratio (k) Dividend yield Solution 158 (25 min.) (a) Current ratio

$160,250 ————–— = 2.7 to 1 $60,000

(b) Return on common shareholders' equity

$80,250 ———— —————––——— = 32.1% ($280,250 + $220,000) ÷ 2

(d) Receivables turnover

(e) Times interest earned

$80,250 EPS = ———––— = $1.34; 60,000 $20 ——— = 14.9 $1.34 $400,000 ——————————––— = 10 times ($50,000 + $30,000) ÷ 2 $80,250 + $26,750 + $18,000 ————————————––— = 6.9 $18,000 $80,250

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(f) Profit margin

———–––— = 20.1% $400,000

(g) Days in inventory

$190,000 –––––––––––––––––––– = 2.9 ($60,000 + $70,000) ÷ 2

Inventory turnover = 2.9

365 days ————– = 126 2.9

(h) Payout ratio

$45,000 ———––— = 56.1% $80,250

(i)

Return on assets

$80,250 ——————————––—— = 17.4% ($420,250 + $500,000) ÷ 2

(j)

Cash current debt coverage ratio

(k) Dividend yield

$62,000 –––––––––––––––––––––– = 0.7 times ($60,000 + $120,000) ÷ 2 ($45,000 ÷ 60,000) —————————– = 3.8% $20

Ex. 159 The following ratios have been calculated for Rosco and Ramsey Limited for 2016: Current ratio ............................................................. 2.1:1 Debt to total assets ratio .......................................... 25% Profit margin ............................................................ 25% Receivables turnover ratio ....................................... 2.4 times Times interest earned .............................................. 23 times Financial statement information for 2016 for Rosco and Ramsey Limited with missing information follows: ROSCO AND RAMSEY LIMITED Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2016 2015 Cash ........................................................................................... $ 25,000 $ 35,000 Trading investments .................................................................... 15,000 15,000 Accounts receivable .................................................................... ? (6) 35,000 Merchandise inventory ................................................................ 30,000 20,000 Property, plant, and equipment ................................................... 200,000 160,000 Total assets $ ? (8) $265,000 Liabilities and shareholders' equity Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

Accounts payable........................................................................ Short-term bank loan payable ..................................................... Bonds payable ............................................................................ Common shares.......................................................................... Retained earnings ....................................................................... Accumulated other comprehensive income ................................. Total liabilities and shareholders' equity ...............................

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? (7) $ 25,000 15,000 10,000 ? (9) 20,000 139,500 125,000 33,625 35,000 50,000 50,000 $ ? (10) $265,000

ROSCO AND RAMSEY LIMITED Income Statement Year Ended December 31, 2016 ——————————————————————————————————————–— Net sales ..................................................................................... $75,000 Cost of goods sold ...................................................................... 29,000 Gross profit ................................................................................. 46,000 Expenses Depreciation expense .......................................................... $ ? (5) Operating expenses ............................................................. 7,500 Interest expense................................................................... 250 Total expenses .............................................................. ? (4) Profit before income tax .............................................................. ? (2) Income tax expense .................................................................... ? (3) Profit ...................................................................................... ? (1) Instructions Using the above ratios and information from Rosco and Ramsey Limited’s financial statements, fill in the missing information on the financial statements. Follow the sequence indicated. Show calculations that support your answers. Solution 159 (35–40 min.) ROSCO AND RAMSEY LIMITED Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2016 2015 Cash $ 25,000 $ 35,000 Trading investments 15,000 15,000 Accounts receivable 27,500 (6) 35,000 Merchandise inventory 30,000 20,000 Property, plant, and equipment 200,000 160,000 Total assets $297,500 (8) $265,000 Liabilities and shareholders' equity Accounts payable Short-term bank loan payable Bonds payable Common shares Retained earnings Accumulated other comprehensive income Total liabilities and shareholders' equity

$ 33,750 (7) 15,000 25,625 (9) 139,500 33,625 50,000 $297,500 (10)

$ 25,000 10,000 20,000 125,000 35,000 50,000 $265,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ROSCO AND RAMSEY LIMITED Income Statement Year Ended December 31, 2016 ———————————————————————————————————————— Net sales ..................................................................................... $75,000 Cost of goods sold ...................................................................... 29,000 Gross profit ................................................................................. 46,000 Expenses Depreciation expense .......................................................... $6,750 (5) Operating expenses ............................................................. 7,500 Interest expense................................................................... 250 Total expenses .............................................................. 14,500 (4) Profit before income tax .............................................................. 31,500 (3) Income tax expense .................................................................... 12,750 (2) Profit ........................................................................................... $18,750 (1) (1)

Profit = $18,750 ($75,000 × 25%)

(2)

Income tax = $12,750 Use Times Interest Earned ratio to determine income tax Let X = Income tax $18,750-250 – X 250 = 23 times; X = $12,750

(3)

Profit before income tax = $31,500 ($12,750 + $18,750)

(4)

Total expenses = $14,500 ($46,000 – $31,500)

(5)

Depreciation expense = $6,750

(6)

Accounts receivable = $27,500 Let X = Average receivables $75,000 ————– = 2.4 times; 2.4X = $75,000; X = $31,250 X

[$14,500 – ($7,500 + $250)]

Let Y = Accounts receivable at December 31, 2016 $35,000 + Y —————–— = $31,250; $35,000 + Y = $62,500; Y = $27,500 2 (7)

Short-term bank loan payable = $15,000 Let X = Current liabilities $25,000 + $15,000 + $27,500 + 30,000 ————————————–————— = 2.0 X 2.0X = $97,500; X = $ 48,750; $48,750 – $15,000 = $33,750.

(8)

Total assets = $297,500 ($25,000 + $15,000 + $27,500 + $30,000 + $200,000)

(9)

Let X = Total debt

Performance Measurement

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X ———–— = 25%; X = $74,375; $74,375 – ($33,750 + $15,000) = $25,625 $297,500 (10) Total liabilities and shareholders' equity = $297,500; same as total assets—see (8) above.

Ex. 160 Walla Walla Corporation has only common shares issued. The company’s average gross profit margin is 40%. The information shown below was taken from Walla Walla’s latest financial statements: Average common shareholders' equity ............................. $4,000,000 Average gross accounts receivable................................... 625,000 Beginning inventory .......................................................... 300,000 Ending inventory ............................................................... ? Inventory purchased ......................................................... 3,050,000 Profit ................................................................................. 280,000 Sales (all on credit) ........................................................... 5,000,000 Instructions Calculate the following ratios: (a) Receivables turnover and average collection period (b) Inventory turnover and days in inventory (c) Return on common shareholders' equity Solution 160 (12 min.) (a) Receivables turnover

Credit sales = ———————————––––—— Average gross accounts receivable = $5,000,000 ÷ $625,000 = 8.0 times

Average collection period

365 days = —————————— Receivables turnover 365 ÷ 8.0 times = 46 days

(b) Inventory turnover = Cost of goods sold ÷ Average inventory First calculate ending inventory: Beginning Inventory ........................ $ 300,000 + Inventory purchased .................... 3,050,000 – Cost of Goods Sold...................... *(3,000,000) Ending Inventory............................. $ 350,000 *Since the gross profit margin is 40%, the cost of goods sold ratio is 60%. 60% × $5,000,000 (net sales) = $3,000,000 Ending Inventory = $350,000 (per above) Average Inventory = ($300,000 + $350,000) ÷ 2 = $325,000 Inventory Turnover = $3,000,000 ÷ $325,000 = 9.2 times Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Days in Inventory = 365 days ÷ 9.2 times = 40 days (c) Return on common shareholders' equity

Profit ————————————————— Average common shareholders' equity

$280,000 ÷ $4,000,000 = 7.0%

Ex. 161 The statement of financial position for Jakubo Corporation at the end of the current year includes the following: Mortgage payable, 6% .................................................. $2,250,000 $5 noncumulative preferred shares ............................... 1,050,000 Common shares (400,000 shares issued) ..................... 4,000,000 Profit before income tax was $1,850,000, and income tax expense for the current year was $550,000. Cash dividends paid on common shares were $200,000 and $100,000 was paid on preferred shares. The common shares were selling for $85.00 per share at the end of the year. There were no ownership changes during the year. Instructions Calculate the following ratios: (a) times interest earned (b) earnings per share (c) price-earnings ratio (d) dividend yield Solution 161 (10 min.) (a) Times interest earned

Profit before income tax and interest expense ———————————————————— Interest expense

$1,850,000 + $135,000 ———————–––—— = 14.7 times $135,000

Profit – Preferred dividends ———————————————— Average number of common shares

$1,300,000 – $100,000 —————————––– = $3.00 400,000 shares

Price-earnings ratio

Market price per share —————————–– Earnings per share

(d) Dividend per share

($200,000 ÷ 400,000) = $0.50

(b) Earnings per share

(c)

Dividend per share

$85.00 ———– = 28.3 times $3.00

$0.50

Performance Measurement

Dividend yield

—————————— Market price per share

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= ————— = 0.6% $85.00

Ex. 162 The condensed income statement for Anchorage Limited for the year ended December 31, 2016 appears below: Cost of goods sold ............................................................ $360,000 Expenses .......................................................................... *260,000 Gross profit ....................................................................... 440,000 Profit ................................................................................. 180,000 Sales ................................................................................. $800,000 *Includes $45,000 of interest expense and $50,000 of income tax expense Additional information: 1. Average number of common shares in 2016 was 55,000 shares. 2. The market price of Anchorage’s shares was $40 per share at the end of 2016. 3. Total cash dividends of $36,000 were paid, $6,000 of which were paid to preferred shareholders. Instructions Calculate the following ratios for 2016: (a) Earnings per share (b) Price-earnings ratio (c) Times interest earned Solution 162 (8 min.) (a) Earnings per share $180,000 – $6,000 ——————–—— 55,000

$174,000 ———–— = $3.16 55,000

(b) Price-earnings ratio $40.00 ——–— = 12.7 $3.16 (c) Times interest earned $180,000 + $50,000 + $45,000 ———————————––—— = 6.1 times $45,000

Ex. 163 Selected data from McAllister Corp. are presented below: Average assets ............................................................. $7,200,000 Average common shareholders' equity ......................... 4,500,000 Cost of goods sold ........................................................ 3,600,000 Net cash provided by operating activities ...................... 820,000 Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

Net sales ....................................................................... Profit ............................................................................. Total assets ..................................................................

6,000,000 950,000 7,400,000

Instructions Calculate all of the profitability ratios that can be determined from the above information. Solution 163 (10–15 min.) With the information provided, the profitability ratios that can be calculated are as follows:

Return on common shareholders' equity

Profit = ————————————————— Average common shareholders' equity = $950,000 ÷ $4,500,000 = 21.1%

Return on assets

= Profit ÷ Average assets = $950,000 ÷ $7,200,000 = 13.2%

Profit margin

Asset turnover

Gross profit margin

= Profit ÷ Net sales = $950,000 ÷ $6,000,000 = 15.8% = Net sales ÷ Average assets = $6,000,000 ÷ $7,200,000 = 0.8 times

Gross Profit ———––—— Net Sales

= ($6,000,000 – $3,600,000) ÷ $6,000,000 = 40%

Ex. 164 The following information was taken from the financial statements of Hicks Corporation: 2016 2015 Gross profit ................................................................................. $900,000 $350,000 Profit ........................................................................................... 140,000 162,500 Profit before income tax .............................................................. 230,000 221,000 Profit margin ............................................................................... 8% 20% Instructions (a) Calculate the net sales for each year. (b) Calculate the cost of goods sold in dollars and as a percentage of net sales for each year. Solution 164 (12–15 min.) (a) To calculate net sales, divide profit by the profit margin: 2016 2015 Net Sales $140,000 ÷ 8% = $1,750,000 $162,500 ÷ 20% = $812,500 (b)

Using the net sales information from (a) and the gross profit given, it is possible to calculate the cost of goods sold.

Performance Measurement

Net sales Less: Gross profit Cost of goods sold % of net sales

2016 $1,750,000 900,000 $ 850,000 49%

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2015 $812,500 350,000 $462,500 57%

Ex. 165 The following are data from the latest financial statements of Pound Limited: ($ in thousands) Average common shareholder's equity ............................. $32,000 Average issue price of common shares............................. $100 Average total liabilities ...................................................... $38,000 Average total shareholders’ equity .................................... $36,000 Cash dividends paid .......................................................... $400 Gross profit ....................................................................... $12,000 Payout ratio....................................................................... 20% Preferred dividends paid ................................................... $80 Price-earnings ratio ........................................................... 18 Profit margin ..................................................................... 8% Instructions Using the above information, calculate the following: (a) Profit (b) Return on common shareholders' equity (c) Asset turnover (d) Return on assets (e) Gross profit margin (f) Earnings per share (g) Market price per share Solution 165 (20 min.) (a) Profit = Cash dividends ÷ payout ratio = $400 ÷ 0.20 = $2,000

(b) Return on common shareholders' equity

= =

Profit – preferred dividends ————————————————— Average common shareholders' equity ($2,000 – $80) ÷ $32,000 = 6.0%

(c) Asset turnover = Net sales ÷ average total assets = $25,000 ÷ $74,000 = 0.3 times Net sales = Profit ÷ profit margin = $2,000 ÷ 0.08 = $25,000 Average total assets = Average total liabilities + average total shareholders' equity = $38,000 + $36,000 = $74,000 (d) Return on assets = Profit ÷ average total assets = $2,000 ÷ $74,000 = 2.7% (e) Gross profit margin = gross profit ÷ net sales = $12,000 ÷ $25,000 = 48% Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

(f) Earnings per share =

Profit – preferred dividends ———————————————–= ($2,000 – $80) ÷ 320 = $6.00 Average number of common shares

Average number of common shares =

Average common shareholders' equity ————————————————— Average issue price $32,000 ÷ $100 = 320

(g) Market price per share = Earnings per share × Price-earnings ratio = $6.00 × 18 = $108.00

Performance Measurement

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MATCHING QUESTIONS SET 1 166. 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.

L = Liquidity ratio

Code: P = Profitability ratio

S = Solvency ratio

____ 1. Receivables turnover ____ 2. Cash current debt coverage ____ 3. Inventory turnover ____ 4. Debt to total assets ____ 5. Free cash flow ____ 6. Times interest earned ____ 7. Return on assets ____ 8. Earnings per share ____ 9. Payout ratio ____ 10. Dividend yield

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MATCHING SET 1 1.

10. P

Performance Measurement

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MATCHING QUESTIONS SET 2 167. Match the ratios with the appropriate ratio calculation by entering the appropriate letter in the space provided. A. B. C. D. E.

Current ratio Dividend yield Profit margin Asset turnover Price-earnings ratio

F. G. H. I. J.

Times interest earned Inventory turnover Average collection period Days in inventory Payout ratio

Cost of goods sold ____ 1. ————————— Average inventory Current assets ____ 2. ———————— Current liabilities 365 days ____ 3. —————————— Receivables turnover 365 days ____ 4. ———————— Inventory turnover Profit before income tax and interest expense ____ 5. ——————————————————————— Interest expense Profit ____ 6. —————— Net sales Cash dividends ____ 7. ——————— Profit Net sales ____ 8. ——————— Average assets Market price per share ____ 9. —————————— Earnings per share Dividend per share ____ 10. —————————— Market price per share Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

ANSWERS TO MATCHING SET 2 1.

10. B

Performance Measurement

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SHORT-ANSWER ESSAY QUESTIONS S-A E 168 Define the term discontinued operations. Why is it better to report discontinued operations separately in the financial statements? Solution 168 The term discontinued operations refers to the disposal, or availability for sale, of a component of an entity. A component of an entity represents a major line of business or major geographic area of a company. The results from discontinued operations are reported separately so that users of the financial statements can estimate the company’s sustainable income, which would be used to predict future earnings. This would be difficult to do if the results from continuing operations were mixed in with the results from discontinued operations.

S-A E 169 Horizontal and vertical analyses are analytical tools frequently used to analyze 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 competitors. Solution 169 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 shareholders' 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 earnings. This would show which companies have taken on a large amount of debt and which companies have reinvested profit.

S-A E 170 Fast Express specializes in the overnight transportation of medical equipment and laboratory specimens. 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 is $2.1 million. Last year's profit was $1.8 million. • The current ratio has changed to 2:1 from last year's 1.5:1. • The debt to 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 in the Atlantic region. Instructions Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Test Bank for Financial Accounting: Tools for Business Decision-Making, 6th Canadian Edition

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. Solution 170 Fast Express released its financial statements today, disclosing a 17% increase in profit, 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 in the Atlantic region. The purchase of the vans, however, caused the debt to total assets ratio to increase. It now has $4 of debt for every $5 in assets, while last year there were only $3 of debt to $5 in assets.

S-A E 171 The use of alternative accounting policies can hamper comparability in financial statement analysis. Explain how different depreciation methods used by different companies can affect the comparability of certain profitability ratios. Solution 171 Any of the profitability ratios that involve profit will be affected by the method of depreciation chosen. The use of an accelerated method, such as double-diminishing balance, will result in higher depreciation charges in the early years and lower depreciation charges in the later years. These costs will differ from the depreciation costs that would have been incurred if the straightline method had been used. Therefore, because of the different costs, profit will also be different. Thus, the choice of depreciation method affects profit, which in turn affects the ratios. It is important to recognize that these differences are timing differences only. They affect yearby-year comparisons, but not comparisons over the total life of the asset.

S-A E 172 You and a fellow classmate from your commerce class, Sidney Short, have recently started work at High Five Marketing Inc. Sidney majored in marketing and is working with one of the production teams. You are with the finance and accounting department. During one of your regular coffee breaks together Sidney asks about the use of estimates when determining the company's profit. He says that he knows future revenues and expenses are estimates but doesn't understand why events that have already occurred cannot be measured accurately. He says he remembers from his introductory accounting course that there are accounting rules that cover how things must be accounted for, so he wants to know how profit that is in accordance with GAAP can be anything other than exact. Instructions Prepare the explanation you would give Sidney. Include two examples of where estimates are made. Solution 172 Many estimates are required in preparing financial information. For example, estimates are used in determining the allowance for uncollectible receivables. Although the sales have occurred, not all of the customers have paid their bills by the time the financial statements are prepared. Since bad debts are a necessary expense of doing business, the accountant must estimate the amount of the outstanding receivables that will not be collected. This expense must be recorded in the same period as the revenue. Copyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Performance Measurement

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Another example involves the cost of long-lived assets. For instance, office furniture and equipment will last for several years. Each of those years should bear a portion of the cost of the furniture and equipment because each year will benefit from it. But it is impossible to know in advance exactly how long each item will last, or what residual value an item will have at the end of its useful life. So again, the accountant must rely on estimates of the life of the assets as well as the residual values.

S-A E 173 It has been reported that companies in financial difficulty tend to change accounting policies more frequently than those not in financial difficulty. Is it ethical behaviour? Solution 173 Management must use professional judgement in choosing the most appropriate accounting policy for the circumstances. A voluntary change in accounting policy is only allowed when management can show that the new accounting policy results in a more reliable and relevant presentation of events or transactions in the financial statements. If the reason for the change in policy is strictly to improve appearances, the behaviour would neither be permissible nor ethical. But, because the standard is subjective, management’s initial choices may be justifiable while being biased in favour of a presentation that furthers certain company objectives.