TEST BANK FOR Financial Accounting Tools for Business Decision Making, 7th Canadian Edition 7 Editio by StudyGuide

Part 1 CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 13. 2 E K F AN 25. 4 M K F AN 2. 1 E C F AN 14. 2 E K F AN 26. 4 M K F AN 3. 1 E C F AN 15. 2 M K F AN 27. 4 E K F AN K F AN F AN F AN 4. 1 E 16. 2 E K 28. 4 M K 5. 1 E K F AN 17. 3 E K F AN 29. 4 E K F AN 6. 1 E K F AN 18. 3 E K F AN 30. 4 M C F AN 7. 1 M C F AN 19. 3 M K F AN 31. 4 E C F AN 8. 1 M C F AN 20. 3 E K F AN 32. 4 E K F AN 9. 1 M C F AN 21. 3 M K F AN 33. 4 M C F AN 10. 1 M C F AN 22. 3 E C F AN 34. 4 E K F AN 11. 1 M C F AN 23. 4 M K F AN 12. 2 E K F AN 24. 4 E K F AN Multiple Choice Questions 35. 1 E K F AN 58. 3 E C F AN 81. 4 E C F AN 36. 1 E K F AN 59. 3 E C F AN 82. 4 E K F AN 37. 1 M K F AN 60. 3 M C F AN 83. 4 E C F AN 38. 1 M K F AN 61. 3 M K F AN 84. 4 H AP F AN 39. 1 E K F AN 62. 3 M K F AN 85. 4 M AP F AN 40. 1 E K F AN 63. 3 M C F AN 86. 4 M AP F AN 41. 1 E K F AN 64. 3 E K F AN 87. 4 M AP F AN 42. 1 E K F AN 65. 3 E C F AN 88. 4 M K F AN 43. 1 E K F AN 66. 3 E C F AN 89. 4 M C F AN 44. 1 E C F AN 67. 3 E K F AN 90. 4 M K F AN 45. 1 M C F AN 68. 3 E K F AN 91. 4 E K F AN 46. 2 M K F AN 69. 3 E K F AN 92. 4 M K F AN 47. 2 M K F AN 70. 3 E K F AN 93. 4 M C F AN 48. 2 M K F AN 71. 3 M C F AN 94. 4 M K F AN 49. 2 E K F AN 72. 4 M K F AN 95. 4 E K F AN 50. 2 E K F AN 73. 4 M C F AN 96. 4 E C F AN 51. 2 E C F AN 74. 4 E K F AN 97. 4 E K F AN 52. 2 E K F AN 75. 4 E C F AN 98. 4 E C F AN 53. 2 M K F AN 76. 4 M K F AN 99. 4 E C F AN 54. 2 E C F AN 77. 4 H C F AN 100. 4 H C F AN 55. 2 M K F AN 78. 4 E K F AN 101. 4 M C F AN 56. 3 E K F AN 79. 4 M C F AN 102. 4 M C F AN 57. 3 M C F AN 80. 4 E C F AN LOD: Bloom’s: CPA: AACSB:

E = Easy M = Medium H = Hard AN = Analysis AP = Application C = Comprehension F = Financial Reporting CM = Communication AN = Analytic E = Ethics

K = Knowledge

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

K = Knowledge

The Purpose and Use of Financial Statements

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Learning Objective 1 1. TF 6. TF 11. TF 39. MC 44. MC 2. TF 7. TF 35. MC 40. MC 45. MC 3. TF 8. TF 36. MC 41. MC 135. SAE 4. TF 9. TF 37. MC 42. MC 136. SAE 5. TF 10. TF 38. MC 43. MC 129. Ma Learning Objective 2 12. TF 15. TF 47. MC 50. MC 53. MC 13. TF 16. TF 48. MC 51. MC 54. MC 14. TF 46. MC 49. MC 52. MC 55. MC Learning Objective 3 17. TF 21. TF 58. MC 62. MC 66. MC 18. TF 22. TF 59. MC 63. MC 67. MC 19. TF 56. MC 60. MC 64. MC 68. MC 20. TF 57. MC 61. MC 65. MC 69. MC Learning Objective 4 23. TF 33. TF 80. MC 90. MC 100. MC 24. TF 34. TF 81. MC 91. MC 101. MC 25. TF 72. MC 82. MC 92. MC 102. MC 26. TF 73. MC 83. MC 93. MC 109. Ex 27. TF 74. MC 84. MC 94. MC 110. Ex 28. TF 75. MC 85. MC 95. MC 111. Ex 29. TF 76. MC 86. MC 96. MC 112. Ex 30. TF 77. MC 87. MC 97. MC 113. Ex 31. TF 78. MC 88. MC 98. MC 114. Ex 32. TF 79. MC 89. MC 99. MC 115. Ex Note:

TF = True-False MC = Multiple Choice

Ma = Matching Ex = Exercise

Item

Type

Item

Type

130. 131. 132. 138.

SAE SAE SAE CP

103. 104. 129.

Ex Ex Ma

139. 140.

CP CP

70. 71. 105. 106.

MC MC Ex Ex

107. 108. 129.

Ex Ex Ma

116. 118. 119. 120. 121. 122. 123. 124. 125. 126.

Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex

127. 128. 129. 133. 134. 135. 136. 137. 141. 142.

Ex Ex Ma SAE SAE SAE SAE SAE CP CP

CP = CPA Questions SAE = Short-Answer Essay

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

CHAPTER LEARNING OBJECTIVES 1.

Identify the uses and users of accounting information. The purpose of accounting is to provide useful information for decision-making. There are two types of decision makers who use accounting information: internal users and external users. The primary internal users are managers, who work for the business and need internal accounting information to manage and run its operations. The primary external users are investors and 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 lending money or granting credit to a business. Other external users include non-management employees, customers, regulators, and taxing authorities.

Describe the primary forms of business organization. There are three types of business organizations: 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, which means their shares trade on a stock exchange, or private, which means their shares are closely held and do not trade on a stock exchange. Generally accepted accounting principles are a common set of guidelines that are used to record and report economic events. These can differ depending on the form of business organization. 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 use ASPE.

Explain the three main types of business activity. Financing activities involve collecting the necessary funds (through the issue of equity or the assumption of debt) to support the business. Repayments of debt, the declaration and payment of dividends, and share repurchases are also financing activities. Investing activities primarily involve purchasing the long-term assets (such as property, plant, and equipment) that are needed to run the business, but also include the disposition of these items. Operating activities involve putting the resources of the business into action to generate net income. These involve the day-today activities of the business as it earns revenues and incurs expenses doing so.

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 including those related to the issue of shares, generation of net income, and the distribution of dividends. 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 the management discussion and analysis (MD&A), and other nonfinancial and financial information.

The Purpose and Use of Financial Statements

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

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

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

7. Accounting provides financial comparisons of operating alternatives, projections of income from new sales campaigns, analyses of sales costs, and forecasts of cash needs for external users. Feedback: Accounting provides financial comparisons of operating alternatives, projections of income from new sales campaigns, analyses of sales costs, and forecasts of cash needs for internal users.

8. Companies present summarized financial information in the form of financial statements for both internal and external use.

9. Anyone who works for a company but does not necessarily have access to accounting information to assist them in managing and operating the company is still considered to be an internal user. Feedback: Anyone who works for a company but does not necessarily have access to accounting information to assist them in managing and operating the company is considered to be an external user.

10. Potential employees who use annual reports to learn about the company and evaluate job prospects are regarded as external users.

11. As labour unions represent employees they are also regarded as internal users. Feedback: Labour unions who represent employees are regarded as external users.

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

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

13. A proprietor has unlimited liability.

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

15. The users of private company financial statements do not have access to financial information beyond that available to the users of public company financial statements.

16. A proprietorship is usually operated by the owner.

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

18. Assets are resources owned by a business that provide current services or benefits to the business. 19. Economic resources that are owned by a business are called shareholders’ equity.

20. Payments to shareholders are called dividends.

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

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

23. Net income for the period is determined by subtracting total expenses and dividends declared from revenues.

24. Net income is another term for revenue.

25. The issue of shares and distribution of dividends are used in determining net income.

26. Financial statement users are interested in net income because it may be a predictor of future net income.

The Purpose and Use of Financial Statements

27. The statement of cash flows shows how cash was used during the period.

28. Claims of creditors and shareholders on the assets of a business are called liabilities. 29. Shareholder’s equity consists of at least two parts: share capital and retained earnings.

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

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

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

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

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

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

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

Ans. T F F T T F

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

Ans. F T F T F F

Item 13. 14. 15. 16. 17. 18.

Ans. T T F T T F

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

Ans. F T F T F F

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

Ans. F T T F T F

Item 31. 32. 33. 34.

Ans. F F F T

The Purpose and Use of Financial Statements

MULTIPLE CHOICE QUESTIONS 35. The world’s economic systems depend on financial reporting that is (a) highly transparent. (b) accurate. (c) reliable. (d) all of the above

36. 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

37. 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) purchasing clerk (d) receptionist of the employees’ labour union

38. 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

39. 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 40. Which of the following uses accounting information to determine whether a company’s net income 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, Seventh Canadian Edition

41. 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

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

43. 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 sales manager of a company

44. 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) How many employees can the company hire this year? (d) How does the company compare in profitability with competitors?

45. Which of the following statements regarding external users is true? (a) Shareholders and creditors are the only people who need accounting information. (b) Canada Revenue Agency is the primary external user of financial information. (c) External users of accounting information include the managers who plan, organize, and run a business. (d) The information needs and questions of external users vary considerably.

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

47. 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.

The Purpose and Use of Financial Statements

48. 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.

49. Which form of business would have its shares listed on a stock exchange? (a) proprietorship (b) partnership (c) private corporation (d) public corporation

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

51. 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.

52. 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.

53. 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, limited liability

54. 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.

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

55. 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.

56. 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.

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

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

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

60. If a company borrows funds and subsequently ceases operations, (a) shareholders have immediate claim on the assets of the corporation. (b) shareholders have no claim on the assets of the corporation. (c) shareholders have to pay all debt first before claiming the assets of the corporation. (d) shareholders have only a residual claim on the assets of the corporation.

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

The Purpose and Use of Financial Statements

62. Allocating and recording the cost of using property, plant & equipment over their useful lives is called (a) allocation expense. (b) depreciation expense. (c) a general expense. (d) amortization expense.

63. Which of the following would be create a cash inflow? (a) issue common shares (b) cash dividends paid (c) repurchase common shares (d) purchase of equipment

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

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

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

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

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

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

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

70. Liabilities of a company are owed to (a) debtors. (b) owners. (c) creditors. (d) shareholders.

71. Which of the following is true regarding the statement of cash flows? (a) Financing activities for corporations include lending money and buying shares. (b) Investing activities involve collecting the necessary funds to operate the business. (c) The purchase of equipment is an example of a financing activity. (d) Revenues are increases in economic resources that result from a business’s operating activities.

72. Dividends declared 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.

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

74. 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.

75. Net income results when (a) Assets > Liabilities. (b) Assets < Liabilities. (c) Revenues > Expenses. (d) Revenues < Expenses.

The Purpose and Use of Financial Statements

76. Retained earnings at the end of the period is equal to (a) retained earnings at the beginning of the period plus net income minus liabilities. (b) retained earnings at the beginning of the period plus net income minus dividends declared. (c) net income for the period. (d) assets plus liabilities. 77. 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.

78. An income statement (a) summarizes the changes in retained earnings 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) reports the revenues and expenses for a specific period of time.

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

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

81. 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

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

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

83. 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 84–85. Plumbers-on-the-Go Ltd. started the year with total assets of $120,000 and total liabilities of $75,000. During the year, the business recorded $82,000 in service revenues, $45,000 in expenses, and paid dividends of $2,500. 84. Shareholders’ equity at the end of the year was (a) $79,500. (b) $45,000. (c) $82,000. (d) $77,000. Feedback: Opening shareholders’ equity: $120,000 – $75,000 = $45,000; Closing shareholders’ equity: $45,000 + $82,000 – $45,000 – $2,500 = $79,500.

85. The net income reported for the year was (a) $34,500. (b) $37,000. (c) $45,000. (d) $82,000. Feedback: $82,000 – $45,000 = $37,000 86. If total liabilities increased by $18,000 and shareholders’ equity increased by $21,000 during a period of time, then total assets must change by what amount and direction (increase or decrease) during that same period? (a) $18,000 increase (b) $21,000 increase (c) $39,000 decrease (d) $39,000 increase Feedback: $18,000 + $21,000 = $39,000 increase 87. If total liabilities decreased by $134,000 during a period of time and shareholders’ equity increased by $103,000 during the same period, then the amount and direction (increase or decrease) of the period’s change in total assets is a(n) (a) $134,000 increase. (b) $103,000 increase. (c) $31,000 decrease. (d) $31,000 increase. Feedback: ($134,000) + $103,000 = ($31,000) decrease

The Purpose and Use of Financial Statements

88. 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.

89. 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 90. 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.

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

92. 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. 93. Shareholders’ equity is usually comprised of (a) common shares and dividends declared. (b) common shares and retained earnings. (c) dividends declared and retained earnings. (d) net income and retained earnings.

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

95. Retained earnings are

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

(a) the shareholders’ claim on total assets. (b) equal to cash. (c) equal to revenues. (d) the amount of net income kept in the corporation for future use.

96. 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

97. 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.

98. The statement of changes in equity is dependent on the results from (a) the statement of cash flows. (b) the statement of financial position. (c) the income statement. (d) a company's share capital.

99. 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.

100. 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 net income.

101. Which one of the following statements is false? (a) The basic accounting equation does not subdivide liabilities into two categories: claims of creditors and claims of the Canada Revenue Agency.

The Purpose and Use of Financial Statements

(b) The accounting equation can be expressed as: Assets – Shareholders’ Equity = Liabilities. (c) The accounting equation can be expressed as: Assets + Liabilities = Shareholders’ Equity. (d) If the assets owned by a business total $100,000 and liabilities total $52,000, shareholders’ equity must total $48,000.

102. Which of the following is false regarding financial statements? (a) 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. (b) The statement of financial position reports assets and claims against those assets at a specific point in time. (c) The statement of changes in equity covers a different time period than that covered by the income statement. (d) Creditors use the statement of financial position as another source of information to determine the likelihood they will be repaid.

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

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46.

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

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

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

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

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

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

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

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

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

Item 95. 96. 97. 98. 99. 100. 101. 102.

Ans. d d c c b c c c

The Purpose and Use of Financial Statements

EXERCISES Ex. 103 For each of the following identify which combination of characteristics reflect a proprietorship, partnership or corporation and why. 1. economic resources and skills are shared; unlimited liability; income from the company is reported as self-employment income. 2. indefinite life; owner(s) not personally liable for debt of the business. 3. business organization simple to set up; income from the company is reported as selfemployment income; unlimited liability. 4. separate legal entity; business organization complex to set up. 5. control over the business; definite life. Solution 103 1. Partnerships are often formed because one person does not have enough economic resources to start or expand the business, or because partners bring unique skills or other resources to the partnership. Each partner generally has unlimited liability for all debts of the partnership, even if one of the other partners created the debt. The income of the partnership is reported as self-employment income and taxed on each partner’s personal income tax return. 2.

Since a corporation is a separate legal entity, its life is indefinite. Shareholders are not responsible for corporate debts unless they have provided a personal guarantee to the lender for them. Most shareholders enjoy limited liability since their risk of loss is limited to the amount they have invested in the company’s shares.

The proprietorship form of business organization is simple to set up and gives the owner control over the business. The business income is reported as self-employment income and taxed on the owner’s personal income tax return. The owner receives any income, suffers any losses, and is personally liable (responsible) for all debts of the business. This is known as unlimited liability.

A corporation is a business organized as a separate legal entity owned by shareholders and is the most complex form of business to establish.

The proprietorship form of business organization gives the owner control over the business. The life of the proprietorship is limited to the life of the owner.

Ex. 104 For each of the below statements, indicate whether it is true or false for a private corporation, public corporation, both, or neither: Private Corp. Public Corp. 1. 2. 3. 4.

Both

Neither

Issues “closely held” shares Shares listed on a stock exchange May follow ASPE when preparing internal use financial statements Seldom distribute financial statements publicly

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5. 6. 7. 8.

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

Required to report on a quarterly basis Can choose to follow IFRS or ASPE Required to follow IFRS Business formed as a corporation

Solution 104 1.

Issues “closely held” shares

Shares listed on a stock exchange

May follow ASPE when preparing internal use financial statements

Seldom distribute financial statements publicly

Required to report on a quarterly basis

Can choose to follow IFRS or ASPE

Required to follow IFRS

Business formed as a corporation

Private Corp. Public Corp. True

Both

Neither

True

True True True True True True

Ex. 105 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 105 (6 min.) 1. Operating 2.

Financing

Operating

Investing

Operating

Financing

The Purpose and Use of Financial Statements

Operating

Investing

10. Financing

Ex. 106 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 106 (5 min.) O 1. F

Ex. 107 For each of the following transactions, identify how they would be classified on the cash flow statement and whether it is a cash outflow (O) or cash inflow (I). If none are applicable indicate an “X” under the N/A (not applicable) column.

Operating

Investing

Financing

N/A

Cash paid for employee salaries Cash dividends declared Repurchased shares Cash paid for new equipment Issued bonds Recorded depreciation expense Cash received from customers Paid interest expense on bonds payable Cash paid for the purchase of ABC company shares

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

Purchased land in exchange for common shares Solution 107 Cash paid for employee salaries

Operating O

Investing

Cash dividends declared

N/A

Repurchased shares

Cash paid for new building

Issued bonds

Cash received for sale of computer equipment

Cash received from customers

Paid interest expense on bonds payable*

Cash paid for the purchase of ABC company shares Purchased land in exchange for common shares

Financing

O O X

*Interest paid on borrowed funds can be classified as operating or financing under IFRS.

Ex. 108 Use the following information to prepare the statement of cash flows for PowerPlus Limited for the year ended October 31, 2018: Collected cash from customers .................................. $100,500 Repaid long-term debt ................................................ 25,000 Cash dividends paid ................................................... 5,000 Purchased inventory for cash ..................................... 35,000 Purchased computer equipment for cash .................. 20,000 Cash, November 1, 2017 ........................................... 16,300 Cash, October 31, 2018 ............................................. 31,800 Solution 108 POWERPLUS LIMITED Statement of Cash Flows Year Ended October 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash collected from customers ..................................................... $100,500 Cash paid for inventory ................................................................. (35,000) Net cash provided by operating activities ...................................... $65,500 Investing activities Cash paid for new computer equipment ........................................ (20,000) Financing activities

The Purpose and Use of Financial Statements

Repayment on long-term debt ....................................................... $(25,000) Cash dividends paid ...................................................................... (5,000) Net cash provided by financing activities ....................................... Net increase (decrease) in cash ........................................................... Cash, November 1 ............................................................................... Cash, October 31 .................................................................................

(30,000) 15,500 16,300 $31,800

Ex. 109 The following questions are unrelated: 1. You know that net income is $62,000, opening retained earnings $80,000, dividends declared $25,000, common shares $15,000, current assets $37,000 and total liabilities are $45,000. What is the amount of total assets? 2. Cash provided by operating activities is $38,000, cash used in investing activities is $26,000 and cash used in financing activities is $4,500. The ending cash balance is $18,700. What is the beginning cash balance? Solution 109 (10 min.) 1. Opening retained earnings ............................................................ Add: Net income............................................................................ Less: dividends declared ............................................................... Ending retained earnings ..............................................................

$80,000 62,000 (25,000) $117,000

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

$117,000 15,000 45,000 $177,000

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

$177,000

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

$38,000 (26,000) (4,500) 7,500 __ X $18,700

Solving for X, cash beginning is $18,700 – $7,500 = $11,200.

Ex. 110 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, 2018: Accounts payable .......................................................................... $10,000 Accounts receivable ...................................................................... 14,000 Cash ............................................................................................. 10,000 Common shares ............................................................................ 28,000 Dividends paid .............................................................................. 6,000 Income tax expense ...................................................................... 4,500 Equipment ..................................................................................... 30,000

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Supplies ........................................................................................ Supplies expense .......................................................................... Rent expense ................................................................................ Retained earnings, October 1........................................................ Salaries expense........................................................................... Service revenue ............................................................................ Utilities expense ............................................................................

2,800 3,500 3,000 15,000 7,000 28,500 700

Solution 110 (30 min.) NORMAN RAE LTD. Income Statement Month Ended October 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Revenues Service revenue ............................................................................ $28,500 Expenses Salaries expense........................................................................... $7,000 Supplies expense .......................................................................... 3,500 Rent expense ................................................................................ 3,000 Utilities expense ............................................................................ _ 700 Total expenses ....................................................................... 14,200 Income before income tax .................................................................... 14,300 Income tax expense ............................................................................. 4,500 Net income........................................................................................... $ 9,800

NORMAN RAE LTD. Statement of Changes in Equity Month Ended October 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Common Shares Retained Earnings Total Equity Balances, October 1 $28,000 $15,000 $43,000 Net income 9,800 9,800 Dividends declared ______ (6,000) (6,000) Balances, October 31 $28,000 $18,800 $46,800

NORMAN RAE LTD. Statement of Financial Position October 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $10,000 Accounts receivable ............................................................................. 14,000 Supplies ............................................................................................... 2,800 Equipment............................................................................................ 30,000 Total assets................................................................................... $56,800 Liabilities and Shareholders’ Equity Liabilities Accounts payable ..........................................................................

$10,000

The Purpose and Use of Financial Statements

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

$28,000 18,800 46,800 $56,800

Ex. 111 Use the following information to calculate for the year ended December 31, 2018: (a) net income, (b) ending retained earnings, and (c) total assets. Accounts payable ....................................................... Accounts receivable ................................................... Bank loan payable...................................................... Cash .......................................................................... Common shares ......................................................... Dividends declared..................................................... Income tax expense ................................................... 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 111 (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. 112 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 Geelin Industries Ltd. for the month ended August 31, 2018: Accounts payable ....................................................... $ 9,375 Accounts receivable ................................................... 5,500 Bank loan payable...................................................... 13,750 Cash .......................................................................... 58,750 Common shares ......................................................... 94,375 Dividends declared..................................................... 6,250 Income tax expense ................................................... 17,375 Insurance expense ..................................................... 2,125 Building ...................................................................... 125,000 Retained earnings (beginning) ................................... 40,625 Revenues ................................................................... 78,750

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Salaries expense........................................................ Supplies .....................................................................

20,625 1,250

Solution 112 (30 min.) GEELIN INDUSTRIES LTD. Income Statement Month Ended August 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Revenues Service revenue ............................................................................ $78,750 Expenses Salaries expense........................................................................... $20,625 Insurance expense ........................................................................ _ 2,125 Total expenses ....................................................................... 22,750 Income before income tax .................................................................... 56,000 Income tax expense ............................................................................. 17,375 Net income........................................................................................... $ 38,625

GEELIN INDUSTRIES LTD. Statement of Changes in Equity Month Ended August 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Common Shares Retained Earnings Total Equity Balances, July 1 Net income Dividends declared Balances, July 31

$94,375 ______ $94,375

$40,625 38,625 (6,250) $73,000

$135,000 38,625 (6,250) $167,375

GEELIN INDUSTRIES LTD. Statement of Financial Position August 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $ 58,750 Accounts receivable ............................................................................. 5,500 Supplies ............................................................................................... 1,250 Building ............................................................................................... 125,000 Total assets................................................................................... $190,500 Liabilities and Shareholders’ Equity Liabilities Accounts payable .......................................................................... Bank loan payable......................................................................... Total liabilities ........................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity ...................................

$ 9,375 13,750 $ 23,125 $94,375 73,000

167,375 $190,500

The Purpose and Use of Financial Statements

Ex. 113 Listed below in alphabetical order is accounting information for Hawthorne Corp. at December 31, 2018. Prepare a statement of financial position in good format. Accounts payable ....................................................... $ 23,750 Accounts receivable ................................................... 40,000 Building ...................................................................... 125,000 Cash .......................................................................... 52,500 Common shares ......................................................... 200,000 Land ........................................................................... 75,000 Equipment .................................................................. 50,000 Retained earnings ...................................................... 118,750 Solution 113 (10 min.) HAWTHORNE CORP Statement of Financial Position December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $ 52,500 Accounts receivable ............................................................................. 40,000 Land..................................................................................................... 75,000 Building ................................................................................................ 125,000 Equipment............................................................................................ 50,000 Total assets .................................................................................... $342,500 Liabilities and Shareholders’ Equity Liabilities Accounts payable ........................................................................... Shareholders’ equity Common shares ............................................................................. Retained earnings .......................................................................... Total liabilities and shareholders’ equity .................................

$ 23,750

$200,000 118,750

318,750 $342,500

Ex. 114 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. ____

Supplies

11. ____ Dividends Declared

6. ____

Salaries Expense

12. ____ Notes Payable

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

Solution 114 (5 min.) 1. IS 2.

SFP

SCE and SFP

SFP

10. IS 11. SCE 12. SFP

Ex. 115 Grayson Inc. was reviewing its business activities at the end of its fiscal year (November 30, 2018) 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 net income 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, 2018. Solution 115 (10 min.) GRAYSON INC. Statement of Changes in Equity Year Ended November 30, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Common Shares Retained Earnings Total Equity Balances, Dec 1, 2017 Net income Dividends declared Balances, Nov 30, 2018

$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)

The Purpose and Use of Financial Statements

Ex. 116 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 ......................................................... ? Equipment .................................................................. 18,700 Land ........................................................................... 33,000 Retained earnings ...................................................... 43,200 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, 2018. Solution 116 (10 min.) GOODFOOD RESTAURANT LTD. Statement of Financial Position September 3, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash .................................................................................................... $ 33,200 Accounts receivable ............................................................................. 1,600 Supplies ............................................................................................... 4,600 Land..................................................................................................... 33,000 Building ................................................................................................ 68,000 Equipment............................................................................................ 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

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

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

Ex. 117 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) Service Revenue (g) Cash (c) Land (h) Supplies Expense (d) Salaries Expense (i) Supplies (e) Notes Payable (j) Utilities Expense Solution 117 (5 min.) (a), (c), (e), (f), (g), (i)

Ex. 118 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 declared................................... Revenue .................................................. Expenses, including income tax expense .

Corporation Z

$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 118 (30 min.) Corporation X ($50,000) Beginning shareholders’ equity ($400,000 – $250,000) ................................... Common shares issued ($170,000 + $70,000 – $150,000 – $40,000) ............ Net income for year ($195,000 – $155,000) .................................................... Less: dividends declared ................................................................................. 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................................................................................... Net income for year ($183,000 – $45,000 – $79,000) .................................... [Revenues = $172,000 ($113,000 + $59,000)] .........................................

$ 45,000 79,000 59,000 183,000

The Purpose and Use of Financial Statements

Less: dividends declared ................................................................................. Ending shareholders’ equity ($195,000 – $95,000) ......................................... Corporation Z ($85,000) Beginning shareholders’ equity ($199,000 – $168,000) ................................... Common shares issued................................................................................... Net income for year ($187,000 – $185,000) .................................................... Less: dividends declared ($111,000 – $26,000) .............................................. Ending shareholders’ equity ($195,000 – $169,000) .......................................

83,000 $100,000

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

Ex. 119 Calculate the missing items. Assets $80,000 (b) $84,000

= = = =

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

+ + + +

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

Solution 119 (5 min.) (a) $48,000 (b) $118,000 (c) $19,000

Ex. 120 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 120 (5 min.) (b), (c), (d), (f), (g)

Ex. 121 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

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_____

2. Equipment

____

8. Retained earnings

_____

3. Accounts payable

____

9. Service revenue

_____

4. Common shares

____ 10. Bank loan payable

_____

5. Insurance expense

____ 11.

Dividends declared

_____

6. Cash

____ 12.

Unearned revenue

Solution 121 (5 min.) 1. SE 2.

10. L 11. SE 12. L

Ex. 122 Classify each of these items as an asset (A), liability (L), or shareholders’ equity (SE). _____ 1. Accounts receivable _____ 6. Cash _____ 2. Salaries payable _____ 7. Mortgage payable _____ 3. Common shares _____ 8. Land _____ 4. Supplies _____ 9. Dividends declared _____ 5. Retained earnings _____ 10. Supplies expense Solution 122 (5 min.) 1. A 2.

The Purpose and Use of Financial Statements

10. SE

Ex. 123 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. 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? 2. 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? 3. 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 123 (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. 124 Rug Repairs Ltd. has the following statement of financial position items: Accounts Payable Accounts Receivable

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

Bank Loan Payable Cash Common Shares Equipment Retained Earnings Unearned Revenue Vehicles Instructions Identify which items are (a) Assets (b) Liabilities (c) Shareholders’ Equity Solution 124 (5 min.) (a) Assets—Accounts Receivable; Cash; Equipment; Vehicles (b) Liabilities—Accounts Payable; Bank Loan Payable; Unearned Revenue (c) Shareholders’ Equity—Common Shares; Retained Earnings

Ex. 125 On June 1, Archipelego Ltd. prepared a statement of financial position that shows the following: Assets (no cash) ........................................................................... $350,000 Liabilities ....................................................................................... 210,000 Shareholders’ Equity ..................................................................... 140,000 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 – $360,000 $________

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

Case B

350,000

________

Case C

325,000

________

Solution 125 (5 min.) Cash Received for the Assets Case A $360,000

Balances Immediately After Sale Assets – Liabilities = Shareholders’ Equity $360,000 $210,000 $150,000

Case B

350,000

210,000

140,000

Case C

325,000

210,000

115,000

The Purpose and Use of Financial Statements

Ex. 126 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 126 (5 min.) (a) $262,000 ($360,000 – $98,000 = $262,000). (b)

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

(c)

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

Ex. 127 Use the following information to prepare the statement of cash flows for Santorini Corporation for the year ended December 31, 2018: Cash received from customers ................................... $37,500 Cash dividends paid ................................................... 4,500 Cash paid to suppliers ................................................ 15,000 Cash paid for new equipment ..................................... 45,000 Cash received from lenders ....................................... 10,500 Cash, January 1, 2018 ............................................... 37,500 Cash, December 31, 2018 ......................................... 21,000 Solution 127 (10 min.) SANTORINI CORPORATION Statement of Cash Flows Year Ended December 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash received from customers ...................................................... $37,500 Cash paid to suppliers ................................................................... (15,000) Net cash provided by operating activities ...................................... $22,500 Investing activities Cash paid for new equipment ........................................................ (45,000) Financing activities Cash received from lenders .......................................................... $ 10,500 Cash dividends paid ...................................................................... (4,500) Net cash provided by financing activities ....................................... 6,000 Net increase (decrease) in cash ........................................................... (16,500) Cash, January 1 ................................................................................... 37,500 Cash, December 31 ............................................................................. $21,000

Ex 128 Cooper Corporation’s shareholders’ equity equals one-fifth of the company’s total assets. The company’s liabilities are $345,000. What is the amount of the company’s shareholders’ equity?

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Solution 128 $31,250 (X = 1/5X + $345,000) where X = total assets Solving for X: X – 1/5X = $345,000 4/5X = $345,000 X = $345,000 × 5/4 X = $431,250 Shareholder’s equity = (1/5) × $431,250 = $86,250 Proof: $86,250 + $345,000 = $431,250

The Purpose and Use of Financial Statements

MATCHING 129. 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

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ANSWERS TO MATCHING 1.

(a)

(b)

(h)

(c)

(g)

(i)

(f)

(d)

(j)

10. (e)

The Purpose and Use of Financial Statements

SHORT-ANSWER ESSAY QUESTIONS S-A E 130 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 130 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. How many employees can we afford to hire 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 net income? 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 131 Private corporations have a choice between using IFRS or ASPE. (a) Explain why a private corporation might choose to adopt ASPE rather than IFRS. (b) Explain why a private corporation might choose to adopt IFRS rather than ASPE. Solution 131 (a) A private corporation might adopt ASPE rather than IFRS: 1. because it’s users have different needs than those required of publicly traded corporations 2. to reduce the complexity of financial reporting 3. to reduce the cost of financial reporting (b) A private corporation might adopt IFRS rather than ASPE because: 1. it is considering accessing public debt or equity markets in the future 2. it wants to be able to compare its financial results with competitors that use IFRS 3. it has foreign subsidiaries that are required to use IFRS and it wants a common set of accounting standards across the company.

S-A E 132 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:

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DAVIDSON CORPORATION Statement of Financial Position September 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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?” 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 132 (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 the company’s true financial position. It should then be as follows: DAVIDSON CORPORATION Statement of Financial Position September 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Cash ($80,000 – $45,000) ..................................................................................... $ 35,000 Accounts receivable ............................................................................................... 22,000

The Purpose and Use of Financial Statements

Equipment ($160,000 – $90,000) ........................................................................... Total assets.....................................................................................................

70,000 $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 133 Identify the types of transactions that affect shareholders’ equity under ASPE and IFRS, and how they affect it? Solution 133 Under ASPE, shareholders’ equity generally consists 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 declared. In addition to share capital and retained earnings, shareholders’ equity may also include accumulated other comprehensive income under IFRS. While retained earnings accumulates net income over time, accumulated other comprehensive income accumulates other comprehensive income (complex items similar to revenues and expenses not used in determining net income) over time.

S-A E 134 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 134 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 135

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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 135 (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 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 136 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 136 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

The Purpose and Use of Financial Statements

will be able to repay its debts.

S-A E 137 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, 2018 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 net income of $1,075 and she put $1,000 into the company, she is surprised to see her cash account only has $925 in it. 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 net income 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, 2018 ————————————————————————————————————————— Revenues Service revenue .............................................................................................. $2,500 Gratuities………………………………………………………………... ................. _ 75 Total revenues…………………………………………………….. ................. 2,575 Operating expenses ............................................................................................... 1,200 Income before income tax ...................................................................................... 1,375 Income tax expense ............................................................................................... _ 300 Net income............................................................................................................. $1,075

BRUNET BEAUTICIAN LTD. Statement of Changes in Equity Month Ended September 30, 2018 ————————————————————————————————————————— Common Shares Retained Earnings Total Equity Balances, Sep 1 $ 0 $ 0 $ 0 Issued common shares 1,000 1,000 Net income 1,075 1,075 Balances, Sep 30 $1,000 $1,075 $2,075

BRUNET BEAUTICIAN LTD. Statement of Financial Position September 30, 2018 —————————————————————————————————————————— Assets Cash .................................................................................................... $ 925

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Accounts receivable ............................................................................. Total assets................................................................................... Liabilities and Shareholders’ Equity Liabilities Accounts payable ........................................................................... Income tax payable ........................................................................ Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................. Retained earnings .......................................................................... Total liabilities and shareholders’ equity ................................

1,500 $2,425

$ 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. Solution 137 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

The Purpose and Use of Financial Statements

your business and will help to explain the cash balance that appears on your statement of financial position.

Sincerely, (signature)

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OBJECTIVE FORMAT QUESTIONS 138. Identify all of the following that are true with regards to ethics and accounting: (a) Accountants and other professionals have extensive rules of professional conduct which guide their behavior; therefore, information prepared by accountants is always ethically compiled. (b) Ethical practices when compiling accounting information are critical as both internal and external decision makers rely on accounting information to make decisions. (c) Information reported by public corporations is used by government, unions, investors and potential employees. The impact of unethical practices by a public corporation, therefore, could be much larger than the impact of unethical practices by a proprietorship. (d) Ethical practices are most important when compiling external accounting information. (e) Most individuals in businesses act in a legal and responsible manner. (f) Since proprietorships and partnerships have no shareholders, ethics are not a big concern. Solution 138 Statements (b), (c), and (e) are correct; (a), (d), and (f) are incorrect. (a) Accountants do have a professional code of conduct, which guides their behavior but this does not guarantee that the information is ethically compiled. (d) Ethical information is important regardless of if it is internal or external. Internal users of information also need information that is ethically compiled and reported. (f) Ethics are a concern for all forms of business organization. The owners are a business, regardless of business organization, are responsible to their stakeholders including employees, the government, society and customers.

139. Identify all of the following statements that are true: (a) For proprietorships, there is a clear legal distinction between the business as an economic unit and the owner. (b) The reporting entity concept represents the idea that an owner’s personal records and business records must be kept separate. (c) A proprietorship is distinct from a partnership in that a proprietorship’s income is reported as self-employment income for tax purposes. (d) Partnerships are typically used to organize professional service businesses, such as the practices of lawyers, doctors, architects, engineers, and accountants. (e) Exposure to personal liability risk is a factor that must be considered when choosing the organizational form of a new business. (f) The main advantages of incorporation include definite life, ease of transferring ownership when selling shares, and unlimited liability. (g) In Canada, private corporations must use IFRS for financial reporting. (h) Because proprietorships and partnerships are privately owned, they generally follow ASPE for external financial reporting purposes. Solution 139

The Purpose and Use of Financial Statements

Statements (b), (d), (e), and (h) are correct; (a), (c), (f) and (g) are incorrect. (a) For partnerships and proprietorships, there is no legal distinction between the business and its owners. Owners have indefinite liability for the business. (c) Both proprietorship and partnership income are reported as self-employment earnings for tax purposes. (f) The main advantages of incorporation include indefinite life, ease of transferring ownership when selling shares, and limited liability. (g) In Canada, private corporations may use APSE or IFRS, either is acceptable. Public corporations, on the other hand, must use IFRS.

140. Choose the most likely type(s) of business organization being described: Proprietorship, Partnership, or Corporation (a) The business must use international financial reporting standards (IFRS) for financial reporting. (b) Shares are listed on a public stock exchange. (c) The business life is definite. (d) The business is a separate legal entity owned by shareholders and is the most complex form of business to establish. (e) A business is similar to a proprietorship except that there is more than one owner. (f) There exists for the business a formalized written agreement that outlines the formation of the business organization, owners’ contributions, how net income and losses are shared, provisions for withdrawals of assets, dispute resolution, and liquidation. (g) There is no legal distinction between the business as an economic unit and the owner(s). (h) The business finds it easier to raise external capital (cash) compared with other forms of business organization. (i) This form of business organization includes both public and private forms. (j) The owner(s) of this company have unlimited liability for all debts. Solution 140 (a) Corporation. Public corporations must use IFRS when reporting financial information. Private corporations have the choice of IFRS or APSE. Proprietorships and partnerships generally follow APSE for external financial reporting purposes. (b) Corporation. Only public corporations have shares listed on a public stock exchange. (c) Proprietorship and partnership. A proprietorship or partnership is dissolved with the withdrawal, death or incapacity of its owner(s). A corporation, on the other hand, is a separate legal entity from its owners, and will continue on regardless of who owns its

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shares. (d) Corporation. A corporation is formed as a separate legal entity from its owners. The legal and reporting requirements for corporations are more complicated than proprietorships or partnerships. (e) Partnership. Partnerships are similar to proprietorships except they have two or more partners and are formalized through a partnership agreement. (f) Partnership and corporation. The owners of a partnership normally develop a partnership agreement that outlines ownership interests and how specific actions will be undertaken, such as how the partnership will be dissolved or how disputes are settled. (g) Proprietorship and partnership. For both a proprietorship and partnership, the owner(s) is responsible for all liabilities of the business and income is reported as self-employment earnings for tax purposes. (h) Corporation. The advantages of indefinite life, ease of transferring ownership when selling shares, and limited liability help increase the attractiveness of the company to investors. (i)

Corporation. Private corporations issue shares, but they do not make them available to the general public nor are they traded on public stock exchanges. Public corporation’s shares are traded on the public stock exchange.

(j)

Proprietorship and partnership. For both a proprietorship and partnership, the owner(s) is responsible for all liabilities of the business.

141. Choose on which financial statement(s) the item would be included: (1) income statement, (2) statement of changes in equity, (3) statement of financial position and/or (4) statement of cash flows. (1), (2), (3), or (4) (a)Common shares issued during the year (b)Revenues (c)Accounts payable (d)Depreciation expense (e)Land (f)Unearned revenue (g)Income tax expense (h)Retained earnings (i)Dividends declared and paid Solution141 The items are shown on the financial statements as follows: (a) Common shares issued

(2), (4)

The Purpose and Use of Financial Statements

(b) Revenues

(d) Depreciation expense

(e) Land

(f)

Unearned revenue

(g) Income tax expense

(h) Retained earnings

(i)

Dividends declared and paid

The ending balance of common shares is shown on the statement of financial position, but new issuances are only shown on the statement of cash flows and statement of changes in equity. (1) Revenues are only reported on the income statement. (3) Accounts payable is a short-term liability, which is reported on the statement of financial position. (1) All expenses are only reported on the income statement. (3) Land is a long-lived asset, which is reported on the statement of financial position. (3) Unearned revenue is a liability. It is money that the company has received for a service it has not yet performed or products that have not yet been provided. Liabilities are reported on the statement of financial position. (1) All expenses are only reported on the income statement. (2), (3) Retained earnings are shown on both the statement of changes in equity and the statement of financial position. The statement of changes in equity shows the detailed breakdown of how retained earnings is determined, while the statement of financial position only shows its ending balance. (2), (4) Dividends are not an expense. They are a distribution of income to shareholders. They are shown on the statement of changes in equity as well as the statement of cash flows.

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142. The following incomplete financial statements are for JTC Enterprises Inc.: JTC ENTERPRISES INC. Income Statement Year Ended December 31, 2018 ————————————————————————————————————————— Revenues............................................................................................................... $1,250,000 Expenses: Salaries expense .......................................................................................... 680,000 Administrative expenses ............................................................................... 250,000 Interest expense ........................................................................................... 45,000 Rent expense................................................................................................ 18,000 Total expenses ......................................................................................... a Net income............................................................................................................. b

JTC ENTERPRISES INC. Statement of Changes in Equity Year Ended December 31, 2018 Total shareholders’ equity, beginning of year ......................................................... $ 811,000 Common shares, beginning of year........................................................................ c Issue of shares....................................................................................................... 250,000 Common shares, end of year ................................................................................. 475,000 Retained earnings, beginning of year ..................................................................... d Net income............................................................................................................. e Dividends declared ................................................................................................ 58,000 Retained earnings, end of year .............................................................................. 785,000 Total shareholders’ equity, end of year .................................................................. f

JTC ENTERPRISES INC. Statement of Financial Position December 31, 2018 Total assets ........................................................................................................... g Total liabilities ........................................................................................................ 1,785,000 Total shareholders’ equity ...................................................................................... h Total liabilities and shareholders’ equity ................................................................. i Instructions Complete the missing data in these financial statements by choosing the following corresponding number for each missing item. Note: some values will be used more than once and some values will not be used. 1. $257,000 2. $1,260,000 3. $725,000 4. $225,000 5. $993,000 6. $528,000 7. $470,000 8. $3,791,000

The Purpose and Use of Financial Statements

9. $586,000 10. $2,006,000 11. $3,045,000 (a) Total expenses (b) Net income (c) Common shares, beginning of year (d) Retained earnings, beginning of year (e) Net income (f) Total shareholders’ equity, end of year (g) Total assets (h) Total shareholders’ equity (i) Total liabilities and shareholders’ equity Solution 142 The answers are as follows: (a) (b) (c) (d) (e) (f) (g) (h) (i)

Total expenses Net income Common shares, beginning of year Retained earnings, beginning of year Net income Total shareholders’ equity, end of year Total assets Total shareholders’ equity Total liabilities and shareholders’ equity

5. 1. 4. 9. 1. 2. 11. 2. 11.

$993,000 $257,000 $225,000 $586,000 $257,000 $1,260,000 $3,045,000 $1,260,000 $3,045,000

The following shows the completed financial statements for JTC Enterprises Inc.: JTC ENTERPRISES INC. Income Statement Year Ended December 31, 2018 ————————————————————————————————————————— Revenues............................................................................................................... $1,250,000 Expenses: Salaries expense .......................................................................................... 680,000 Administrative expenses ............................................................................... 250,000 Interest expense ........................................................................................... 45,000 Rent expense................................................................................................ 18,000 Total expenses ......................................................................................... 993,000 Net income............................................................................................................. $ 257,000

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Common shares, end of year ................................................................................. 475,000 Retained earnings, beginning of year ..................................................................... 586,000 Net income............................................................................................................. 257,000 Dividends declared ................................................................................................ 58,000 Retained earnings, end of year .............................................................................. 785,000 Total shareholders’ equity, end of year .................................................................. $1,260,000

CHAPTER 2 A FURTHER LOOK AT FINANCIAL STATEMENTS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 15. 2 M C F AN 29. 3 M C F AN 2. 1 E K F AN 16. 2 E C F AN 30. 3 M K F AN 3. 1 E C F AN 17. 2 E C F AN 31. 3 E C F AN 4. 1 M K F AN 18. 2 M K F AN 32. 3 M K F AN 5. 1 M K F AN 19. 2 E K F AN 33. 3 E K F AN 6. 1 M K F AN 20. 2 M C F AN 34. 3 M C F AN 7. 1 M K F AN 21. 2 E K F AN 35. 3 M C F AN 8. 1 M K F AN 22. 2 M C F AN 36. 3 E K F AN 9. 1 M K F AN 23. 2 M K F AN 37. 3 E K F AN 10. 2 E K F AN 24. 3 M K F AN 38. 3 M K F AN 11. 2 E K F AN 25. 3 M C F AN 39. 3 M K F AN 12. 2 M K F AN 26. 3 M K F AN 40. 3 E K F AN 13. 2 E C F AN 27. 3 E K F AN 41. 3 E K F AN 14. 2 M K F AN 28. 3 E C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting C = Communication AACSB: AN = Analytic

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

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Multiple Choice Questions 42. 1 M C F AN 72. 2 H C F AN 102. 2 M C F AN 43. 1 M C F AN 73. 2 M C F AN 103. 3 M C F AN 44. 1 H C F AN 74. 2 E K F AN 104. 3 M C F AN 45. 1 E K F AN 75. 2 M K F AN 105. 3 H C F AN 46. 1 M K F AN 76. 2 M K F AN 106. 3 M C F AN 47. 1 E K F AN 77. 2 E K F AN 107. 3 M C F AN 48. 1 E C F AN 78. 2 E K F AN 108. 3 M C F AN 49. 1 M K F AN 79. 2 E K F AN 109. 3 E K F AN 50. 1 E K F AN 80. 2 E K F AN 110. 3 E K F AN 51. 1 M C F AN 81. 2 M K F AN 111. 3 M K F AN 52. 1 E K F AN 82. 2 E K F AN 112. 3 M K F AN 53. 1 E K F AN 83. 2 M C F AN 113. 3 M K F AN 54. 1 E K F AN 84. 2 E K F AN 114. 3 E K F AN 55. 1 E K F AN 85. 2 M K F AN 115. 3 E K F AN 56. 1 E K F AN 86. 2 M K F AN 116. 3 E K F AN 57. 1 M K F AN 87. 2 E AP F AN 117. 3 M K F AN 58. 1 M K F AN 88. 2 E AP F AN 118. 3 H K F AN 59. 1 M AP F AN 89. 2 M AP F AN 119. 3 E K F AN 60. 1 M AP F AN 90. 2 M AP F AN 120. 3 E K F AN 61. 1 M AP F AN 91. 2 M AP F AN 121. 3 E K F AN 62. 1 M AP F AN 92. 2 E K F AN 122. 3 E K F AN 63. 1 H AP F AN 93. 2 M K F AN 123. 3 E K F AN 64. 1 M AP F AN 94. 2 E K F AN 124. 3 M C F AN 65. 1 M AP F AN 95. 2 H C F AN 125. 3 E K F AN 66. 1 E AP F AN 96. 2 H C F AN 126. 3 H K F AN 67. 1 H AP F AN 97. 2 M AP F AN 127. 3 E K F AN 68. 1 M AP F AN 98. 2 M C F AN 128. 3 E K F AN 69. 1 M AP F AN 99. 2 M C F AN 129. 3 E K F AN 70. 2 M C F AN 100. 2 H C F AN 71. 2 M C F AN 101. 2 M C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting C = Communication AACSB: AN = Analytic

A Further Look at Financial Statements

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K = Knowledge

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

SUMMARY OF LEARNING 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. 42. 43. 44. 45. 46.

TF TF MC MC MC MC MC

47. 48. 49. 50. 51. 52. 53.

10. 11. 12. 13. 14. 15. 16. 17. 18. 19.

TF TF TF TF TF TF TF TF TF TF

20. 21. 22. 23. 70. 71. 72. 73. 74. 75.

TF TF TF TF MC MC MC MC MC MC

76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

24. 25. 26. 27. 29. 30. 31. 32.

TF TF TF TF TF TF TF TF

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

TF TF TF TF TF TF TF TF

41. 103. 104. 105. 106. 107. 108. 109.

Note:

TF = True/False Ex = Exercise

Type Item Type Item Learning Objective 1 MC 54. MC 61. MC 55. MC 62. MC 56. MC 63. MC 57. MC 64. MC 58. MC 65. MC 59. MC 66. MC 60. MC 67. Learning Objective 2 MC 86. MC 96. MC 87. MC 97. MC 88. MC 98. MC 89. MC 99. MC 90. MC 100. MC 91. MC 101. MC 92. MC 102. MC 93. MC 136. MC 94. MC 137. MC 95. MC 138. Learning Objective 3 TF 110. MC 118. MC 111. MC 119. MC 112. MC 120. MC 113. MC 121. MC 114. MC 122. MC 115. MC 123. MC 116. MC 124. MC 117. MC 125.

MC = Multiple Choice SAE = Short-Answer Essay

Type

Item

Type Item Type

MC MC MC MC MC MC MC

68. 69. 130. 131. 132. 133. 134.

MC MC Ex Ex Ex Ex Ex

135. 136. 137. 153. 154. 159.

Ex Ex Ex Ma SAE CP

MC MC MC MC MC MC MC Ex Ex Ex

139. 140. 141. 142. 143. 144. 145. 146. 147. 153.

Ex Ex Ex Ex Ex Ex Ex Ex Ex Ma

154. 155. 160. 161. 162.

SAE SAE CP CP CP

MC MC MC MC MC MC MC MC

126. 127. 128. 129. 148. 149. 150. 151.

MC MC MC MC Ex Ex Ex Ex

152. 153. 156. 157. 158. 163.

Ex Ma SAE SAE SAE CP

Ma = Matching CP = CPA

A Further Look at Financial Statements

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CHAPTER LEARNING 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 long-term 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 basic 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, Seventh Canadian Edition

TRUE-FALSE STATEMENTS 1. Long-term investments appear in the property, plant, and equipment section of the statement of financial position.

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

3. A liability is normally classified as a current liability if it is to be paid within the coming year.

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

5. 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).

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

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

8. 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.

9. 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.

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

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

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

13. Analysis of financial statements is enhanced with the use of comparative data.

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14. Solvency ratios measure the entity’s ability to survive over a long period.

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

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

17. The most liquid resource is inventory.

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

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

20. 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.

21. The price-earnings ratio is a measure of liquidity. 22. The higher the price-earnings ratio, the higher are investors’ expectations of the company’s future profitability.

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

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

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

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

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

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28. Enhancing qualitative characteristics include timeliness and comparability.

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

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

31. 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.

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

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

34. Information has verifiability if the information is comparable.

35. 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.

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

37. Two measurement principles are historical cost and current value.

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

39. 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.

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

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

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

Ans. F T T T F F

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

Ans. F F T F T F

Item 13. 14. 15. 16. 17. 18.

Ans. T T T F F F

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

Ans. T F F T T T

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

Ans. T F T T T T

Item 31. 32. 33. 34. 35. 36.

Ans. T F T F F F

Item 37. 38. 39. 40. 41.

Ans. T T T T T

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MULTIPLE CHOICE QUESTIONS 42. On a statement of financial position (a) Cash and Office Supplies are both classified as current assets. (b) Inventories and Prepaid Expenses are classified as long-term investments. (c) Land and Buildings are classified as long-term investments. (d) Depreciation Expense is classified as property, plant and equipment. 43. Shareholders’ equity (a) is divided into at least two parts: share capital and retained earnings. (b) consists of two parts: common and preferred shares. (c) reflects two parts: dividends declared and share capital. (d) reflects retained earnings only.

44. All property, plant and equipment (a) including land have estimated useful lives over which they are expected to generate revenue. (b) are depreciated over their estimated useful lives including land. (c) with finite lives including land are depreciated. (d) including land contributes to the generation of revenue.

45. 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.

46. 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.

47. 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

48. 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.

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(d) cannot be classified on the statement of financial position because it lacks physical substance.

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

50. The difference between cost and accumulated depreciation is referred to as (a) net depreciation. (b) book amount. (c) current value. (d) cost value.

51. Trademarks would appear in which section of the statement of financial position? (a) Shareholders’ equity (b) Investments (c) Intangible assets (d) Current assets

52. 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.

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

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

55. 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.

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56. 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.

57. 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.

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

Use the following information to answer questions 59–63. HONEST RON’S FURNITURE OUTLET LTD. Statement of Financial Position December 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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

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

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Solution: $30,000 + $10,000 = $40,000

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

61. The dollar amount of current assets is (a) $ 26,000. (b) $ 40,000. (c) $ 25,000. (d) $196,000. Solution: $5,000 + $20,000 + $1,000+170,000 = $196,000

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

63. 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 64–69.

Cash Prepaid insurance Accounts receivable Inventory Land Building Less: Accumulated depreciation Trademark Less: Accum. Amort. Total assets

FRANKLIN LTD. Statement of Financial Position December 31, 2018 $ 65,000 Accounts payable 15,000 Salaries payable 95,000 Bonds payable 120,000 Total liabilities 165,000 $235,000 Common shares Retained earnings 70,500 164,500 Total shareholders’ equity $ 125,000 37,500 87,500 Total liabilities and $712,000 shareholders’ equity

$ 66,000 25,000 225,000 316,000 250,000 146,000 396,000

$712,000

64. The total dollar amount of assets to be classified as current assets is

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(a) $295,000. (b) $235,000. (c) $175,000. (d) $160,000. Solution: $65,000 + $15,000 + $95,000+120,000 = $295,000

65. The total dollar amount of assets to be classified as net property, plant, and equipment is (a) $329,500. (b) $164,500. (c) $252,000. (d) $235,000. Solution: $165,000 + $235,000 – 70,500 = $329,500

66. The total dollar amount of assets to be classified as investments is (a) $ 0. (b) $ 165,000. (c) $ 525,000. (d) $400,000.

67. The total amount in the contra asset accounts is (a) $ 37,500. (b) $ 108,000. (c) $70,500. (d) $252,000. Solution: $70,500 – $37,500 = $108,000

68. Non-current liabilities total (a) $712,000. (b) $316,000. (c) $225,000. (d) $ 25,000. Solution: Bonds payable $225,000

69. Net income retained for use in the business is (a) $712,000. (b) $396,000. (c) $316,000. (d) $146,000.

70. Working capital is (a) the difference between total assets and current liabilities. (b) the excess of current assets over current liabilities. (c) the difference between current assets and total liabilities. (d) the excess of total assets over total liabilities.

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71. The current ratio (a) is calculated by dividing total assets by total liabilities. (b) takes into account the composition of current assets. (c) takes into account the composition of current assets and current liabilities. (d) is calculated by dividing current assets by current liabilities.

72. Which of the following statements is true? (a) A current ratio of 1.2 to 1 indicates that a company’s current assets are less than its current liabilities. (b) All companies, regardless of size, should have a current ratio of at least 2:1. (c) The current ratio is a more dependable indicator of liquidity than working capital. (d) The use of the current ratio does not make it possible to compare companies of different sizes.

73. Basic earnings per share (a) is calculated by dividing income available to common shareholders for the period by the dollar value in the common shares account. (b) is the only ratio that must be presented in the financial statements for publicly traded companies. (c) is frequently compared across companies in the same industry. (d) is the only ratio that must be presented in the financial statements for both publicly traded companies and privately held companies.

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

75. Basic 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) income available to common shareholders by weighted average shareholders’ equity. (d) income available to common shareholders by the weighted average number of common shares.

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

77. The relationship between current assets and current liabilities is important in evaluating a company’s (a) profitability.

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(b) liquidity. (c) current value. (d) solvency.

78. The most important information needed to determine if companies can pay their current obligations is the (a) net income for this year. (b) projected net income for next year. (c) relationship between current assets and current liabilities. (d) relationship between current and non-current liabilities.

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

80. 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.

81. 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.

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

83. 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.

84. A liquidity ratio measures the (a) net income or operating success of a company over a period of time. (b) ability of a company to survive over a long period of time.

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(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.

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

86. 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 87–91. Current assets.................... Current liabilities ................ Average assets .................. Total assets ....................... Net income.........................

$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

87. What is the total amount of working capital? (a) $4,000 (b) $8,000 (c) $10,000 (d) $14,000 Solution: $18,000 - $8,000 = $10,000

88. What is the current ratio? (a) 2.3:1 (b) 2.0:1 (c) 0.6:1 (d) 0.4:1 Solution: $18,000 / $8,000 = 2.3:1

89. What is the basic earnings per share? (a) $0.44 (b) $0.69 (c) $1.92 (d) $1.54

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Solution: $18,000 / 26,000 = $0.69

90. What is the price-earnings ratio? (a) 9.1 times (b) 5.8 times (c) 2.1 times (d) 1.7 times Solution: $4 / $0.69 = 5.8 times

91. What is the debt to total assets? (a) 12.5% (b) 20.0% (c) 75.0% (d) 16.7% Solution: $10,000 / $60,000 = 16.7%

92. 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.

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

94. 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

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

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

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(d) marketability and solvency.

97. The current assets of Brothers Corporation are $615,000. The current liabilities are $512,500. The current ratio expressed as a ratio is (a) 120% (b) 1.2:1 (c) 0.8:1 (d) 80% Solution: $615,000 / $512,500 = 1.2:1

98. 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.

99. 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) basic earnings per share.

Use the following information for questions 100–101. Anson Corporation had $325,000 in current assets and $145,000 in current liabilities before borrowing $100,000 from the bank for a 6-month period. 100. What effect did the borrowing transaction have on the amount of Anson’s working capital? (a) No effect (b) $100,000 increase (c) $145,000 increase (d) $100,000 decrease Solution: $325,000 – $145,000 = $180,000 versus ($325,000 – ($145,000 + $100,000)) = $80,000: $180,000 – $80,000 = $100,000 decrease 101. What effect did the borrowing transaction have on Anson’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. Solution: $325,000 / $145,000 = 2.2:1 versus $325,000 / ($145,000 + $100,000) = 1.3:1; ratio decreased

102. Marvel Inc. has $180,000 in current assets and $150,000 in current liabilities. When the

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company pays $35,000 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. Solution: $180,000 / $150,000 = 1.2:1 versus ($180,000-35,000) / ($145,000 - $35,000) = 1.3:1; ratio increased slightly

103. The key components of the conceptual framework include (a) the objective of financial reporting, qualitative characteristics, the going concern assumption, elements of financial statements and the measurement of those elements. (b) the objective of financial reporting, qualitative characteristics, the going concern assumption, and elements of financial statements. (c) the objective of financial reporting, qualitative characteristics, the going concern assumption, and measurement of the elements of financial statements. (d) the objective of financial reporting, qualitative characteristics and the going concern assumption.

104. The two fundamental qualitative characteristics are (a) relevance and timeliness. (b) faithful representation and relevance. (c) comparability and relevance. (d) understandability and relevance.

105. Information (a) is relevant if it will make a difference in a user’s decision(s). (b) has predictive value if it helps users confirm or correct their previous predictions. (c) has confirmatory value if it helps users make predictions about the future. (d) is not relevant if it will make a difference in a user’s decision(s).

106. The cost constraint ensures that (a) the value of information provided is greater than the cost of providing it. (b) that information costs less than budget. (c) the value of information provided is less than the cost of providing it. (d) that information costs more than budget.

107. Which of the following statements is false? (a) The going concern assumption states that the business will continue in operation for the foreseeable future. (b) If a company is not a going concern, the classification of its assets and liabilities does not matter. (c) The going concern assumption underlies the preparation of financial statements. (d) The going concern assumption does not create a foundation for the accounting process.

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108. Which of the following statements is true? (a) Two recognition principles are the current value basis of accounting and the going concern assumption. (b) The current value basis of accounting states that all assets and liabilities can be reported at current value. (c) Current values may not always be representationally faithful. (d) Current value is fair value in use.

109. 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.

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

111. 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.

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

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

114. 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.

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(d) be used by a lot of different organizations.

115. 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.

116. 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.

117. Which of the following is not an enhancing qualitative characteristic? (a) verifiability (b) faithful representation (c) comparability (d) timeliness

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

119. 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

120. 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 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.

121. 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 net income.

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122. 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.

123. 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.

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

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

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

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

128. The qualitative characteristic that says the value of information should exceed the cost of preparing it is called (a) relevance. (b) understandability.

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

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56.

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

Item 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71.

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

Item 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86.

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

Item Ans. 87. c 88. a 89. b 90. b 91. d 92. c 93. d 94. d 95. d 96. b 97. b 98. b 99. c 100. d 101. c

Item 102. 103. 104. 105. 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116.

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

Item 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129.

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

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EXERCISES Ex. 130 Companies group similar types of assets and similar types of liabilities together. In the table below, the standard classifications on a statement of financial position are identified:

Assets

Liabilities and Shareholders’ Equity

Retained earnings

Non-current liabilities

Goodwill

Current liabilities

Long-term investments

Shareholders’ equity

Share capital

Intangible assets

Property, plant, and equipment

Current assets

Instructions Rearrange the table to reflect the general order in which the standard classifications should be presented on a statement of financial position. Solution 130

Assets

Liabilities and Shareholders’ Equity

Current assets

Current liabilities

Long-term investments

Non-current liabilities

Property, plant, and equipment

Shareholders’ equity

Intangible assets

Share capital

Goodwill

Retained earnings

Ex. 131 The following descriptors relate to the order in which items on the statement of financial position may be presented:

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(a) (b) (c) (d) (c) (f)

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Order of liquidity No general prescribed order Order of permanency Reverse order of liquidity Largest to smallest Smallest to largest

Instructions Assuming a firm uses the standard order used by North American companies (excluding real estate companies), match the key letter of the correct term above with the descriptive statement below. Please note: the above descriptors may be used more than once when assigned to the items below: _____ 1. Current assets _____ 2. Property, plant & equipment _____ 3. Non-current liabilities _____ 4. Current liabilities _____ 5. Qualitative enhancing characteristics Solution 131 __a__ 1. Current assets __c__ 2. Property, plant & equipment __b__ 3. Non-current liabilities __a__ 4. Current liabilities __b__ 5. Qualitative enhancing characteristics

Ex. 132 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, 2018 Assets Current assets Accounts receivable (net of accounts payable of $2,000)..................... Prepaid insurance ................................................................................ Goodwill ............................................................................................... Property, plant and equipment ............................................................. Less: Accounted depreciation .............................................................. Other assets (non-current) ................................................................... Total assets ......................................................................................... Liabilities Bank loan payable (due in 6 months) ................................................... Long-term debt..................................................................................... Total liabilities ......................................................................................

$12,000 1,500 1,200 14,700 $4,300 1,100 1,720

4,920 $19,620

$9,500 6,700 16,200

Shareholders’ equity

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Retained earnings ................................................................................ Less: Dividends declared ..................................................................... Common shares................................................................................... Total.....................................................................................................

$2,460 150 1,110

3,420 $19,620

Solution 132 (15 min.) 4. The date is not properly identified in the heading—it should be December 31, 2018, 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.

Goodwill should not be a current asset. Goodwill is a type of intangible asset, shown separately. Current assets should be $15,500.

Other (non-current) assets should not be included with property, plant and equipment subtotal. The subtotal should be $3,200.

Accounted depreciation should be accumulated depreciation.

A heading “Liabilities and Shareholders’ Equity” should replace the “Liabilities” heading.

Liabilities should be classified as current and non-current.

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.

Common shares should be listed first under the shareholders’ equity heading.

10. Dividends declared should not be shown on the statement of financial position—only the ending 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, 2018 Assets Current assets Accounts receivable ...................................................................... Prepaid insurance ......................................................................... Total current assets ............................................................................. Property, plant and equipment ............................................................. Less: Accumulated depreciation .......................................................... Goodwill ............................................................................................... Other assets (non-current) ................................................................... Total assets .........................................................................................

$14,000 1,500 15,500 $4,300 1,100

3,200 1,200 1,720 $21,620

Liabilities and Shareholders’ Equity Liabilities

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Current liabilities Accounts payable .......................................................................... Bank loan payable (due in 6 months) ............................................ Total current liabilities .......................................................................... Non-current liabilities Long-term debt .............................................................................. Total liabilities ......................................................................................

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

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

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

Ex. 133 The following information is available for Jordi Ltd. At December 31, 2018: Accounts payable ....................................................... $14,500 Accounts receivable ................................................... 2,500 Accumulated amortization, patents ............................ 3,500 Accumulated depreciation, equipment........................ 3,000 Retained earnings ...................................................... 6,400 Cash .......................................................................... 41,900 Common shares ......................................................... 40,000 Equipment .................................................................. 3,500 Land ........................................................................... 15,000 Long-term investments ............................................... 500 Bank loan payable (due in 5 years) ............................ 4,200 Patents....................................................................... 5,500 Short-term (held for trading) investments ................... 2,700 Instructions Use the above information to prepare a classified statement of financial position at December 31, 2018. Solution 133 (20 min.) JORDI LTD. Statement of Financial Position December 31, 2018 Assets Current assets Cash ............................................................................................. Short-term (trading) investments ................................................... Accounts receivable ...................................................................... Total current assets ............................................................................. Long-term Investments ........................................................................ Property, plant, and equipment Land .............................................................................................. Equipment ..................................................................................... Less Accumulated depreciation, equipment ..................................

$41,900 2,700 2,500 $47,100 500 15,000 $3,500 3,000

500

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Intangible assets Patents.......................................................................................... Less: Accumulated amortization, patents ...................................... Total assets ......................................................................................... 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 ...............................................

$5,500 3,500

2,000 $65,100

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

Ex. 134 The following accounts were taken from a company’s statement of financial position: Account Classification Cash Inventory Held for 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) 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 134 Account Cash Inventory Held for Trading Investments Building Accounts Payable Trademarks

Classification CA CA CA NCA CL NCA

A Further Look at Financial Statements

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

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NCA CA NCL CL NCL CA NCA NCA NCA

Ex. 135 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 135 (4) Order of Liquidity Current assets 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. 136 The following items are taken from the financial statements of La Brea Ltd. For the fiscal year ended December 31, 2018. Note they are in alphabetical order. Accounts payable ....................................................... $ 15,500 Accounts receivable ................................................... 18,000 Accumulated depreciation—buildings......................... 30,500 Advertising expense ................................................... 21,000 Cash .......................................................................... 15,000 Common shares (10,000 shares) ............................... 90,000 Depreciation expense ................................................ 12,000

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

Dividends declared..................................................... Income tax expense ................................................... Insurance expense ..................................................... Bank loan payable...................................................... Prepaid insurance ...................................................... Rent expense ............................................................. Retained earnings, January 1, 2018 .......................... Salaries expense........................................................ Salaries payable......................................................... Service revenue ......................................................... Supplies ..................................................................... Supplies expense ....................................................... Buildings ....................................................................

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 net income for the year. (b) Calculate the balance of Retained Earnings that would appear on the statement of financial position at December 31, 2018. (c) Prepare a classified statement of financial position for La Brea Ltd. At December 31, 2018, assuming the bank loan payable is a non-current liability. (d) Calculate the current ratio, debt to total assets, and basic earnings per share. Assets at the beginning of 2018 totalled $183,000. No additional shares were issued or redeemed during the year. Solution 136 (20 min.) (4) Net income is $143,000 – $21,000 – $12,000 – $3,000 – $22,000 – 32,000 – $6,000 – $10,000 = $37,000 (b)

Retained earnings, January 1 ................................... Add: Net income ....................................................... Less: Dividends declared ......................................... Retained earnings, December 31 .............................

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

(c) LA BREA LTD. Statement of Financial Position December 31, 2018 Assets Current assets Cash ............................................................................................. Accounts receivable ...................................................................... Supplies ........................................................................................ Prepaid insurance ......................................................................... Total current assets ................................................................ Property, plant and equipment Buildings ....................................................................................... Less: Accumulated depreciation—buildings .................................. Total assets ............................................................................

$ 15,000 18,000 4,000 6,000 43,000 $210,000 30,500

179,500 $222,500

Liabilities and Shareholders’ Equity

A Further Look at Financial Statements

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)

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$ 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% Basic earnings per share: $37,000 ÷ 10,000 = $3.70

Ex. 137 The following items are taken from the financial statements of Pelle Ltd. For the year ended December 31, 2018: Accounts payable ....................................................... $31,300 Accounts receivable ................................................... 10,000 Accumulated depreciation—equipment ...................... 8,400 Bank loan payable...................................................... 34,500 Cash .......................................................................... 38,500 Common shares (4,375 shares issued) ...................... 43,750 Depreciation expense ................................................ 8,400 Dividends declared..................................................... 525 Equipment .................................................................. 82,000 Goodwill ..................................................................... 12,300 Income tax expense ................................................... 1,750 Interest expense......................................................... 6,125 Market price per common share ................................. $5.25 Rent Expense ............................................................ 21,000 Retained earnings, beginning ..................................... 28,000 Salaries expense........................................................ 14,350 Sales revenue ............................................................ 56,875 Supplies ..................................................................... 7,875 Instructions (a) Prepare an income statement and a classified statement of financial position for Pelle for 2018. (b) Calculate the following ratios: 1. Current ratio 2. Debt to total assets 3. Basic earnings per share 4. Price-earnings ratio Solution 137 (25 min.) (a)

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

PELLE LTD. Income Statement Year Ended December 31, 2018 Sales revenue ...................................................................................... Operating expenses Rent expense ................................................................................ Salaries expense........................................................................... Depreciation expense ................................................................... Interest expense............................................................................ Income before income tax .................................................................... Income tax expense ............................................................................. Net income...........................................................................................

$56,875 $21,000 14,350 8,400 6,125

49,875 7,000 1,750 $ 5,250

PELLE LTD. Statement of Financial Position December 31, 2018 Assets Current assets Cash ............................................................................................. Accounts receivable ...................................................................... Supplies ........................................................................................ Total current assets ................................................................ Property, plant, and equipment Equipment ..................................................................................... Less: Accumulated depreciation—equipment................................ Goodwill ............................................................................................... Total assets ............................................................................ Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................... Non-current liabilities Bank loan payable......................................................................... Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity .................................

$38,500 10,000 7,875 56,375 $82,000 8,400

73,600 12,300 $142,275

$31,300 34,500 65,800 $43,750 32,725*

76,475 $142,275

*Retained earnings = $32,725 ($28,000 + $5,250 – $525) (b) 1. 2. 3. 4.

Current ratio: $56,375 ÷ $31,300 = 1.8:1 Debt to total assets: $65,800 ÷ $142,275 = 46.2% Basic earnings per share: $5,250 ÷ 4,375 = $1.20 Price-earnings ratio: $5.25 ÷ $1.20 = 37.7 times

Ex. 138 The following data have been selected from the annual report of Komark Corporation: Market price per share $60

A Further Look at Financial Statements

Price-Earnings ratio Total Assets Current Liabilities Shareholders’ Equity Current ratio Weighted average number of shares

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20 times $450,000 $180,000 $200,000 1.5:1 100,000

Instructions Calculate the following: (a) Basic earnings per share (b) Net income (c) Debt to Total Assets ratio (d) Current assets (e) Working capital Solution 138 (a) Price-earnings = Market price per share ÷ Basic earnings per share 20 = $60.00 ÷ Basic EPS Basic EPS = $3.00 (b) Basic earnings per share = Net income ÷ Weighted average number of shares $3.00 = Net income ÷ 100,000 Net income = $300,000 (c) Assets = Liabilities + Shareholders’ Equity $450,000 = $180,000 + Non-Current Liabilities + $200,000 Non-Current Liabilities = $70,000 Debt to Total Assets = Total Liabilities ÷ Total Assets = ($180,000 + $70,000) ÷ $450,000 = 55.6% (d) Current ratio = Current assets ÷ Current liabilities 1.5 = Current assets ÷ $180,000 Current assets = $270,000 (e) Working capital = Current assets – Current liabilities = $270,000-180,000 = $90,000

Ex. 139 Presented below is information on XBRL Ltd.: 2018 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

2017 $ 12,000 0 7,000 30,000 75,000

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

Current liabilities................................................................... Dividends declared............................................................... Long-term assets ................................................................. Price-earnings ratio .............................................................. Retained earnings ................................................................ Total liabilities ...................................................................... Weighted average number of shares issued ........................

60,000 11,000 125,000 12 60,000 110,000 1,000

45,000 15,000 110,000 14 40,000 95,000 1,000

Instructions Calculate the following for 2018: (a) Basic earnings per share (b) Market price per common share (c) Working capital (d) Current ratio (e) Debt to total assets Solution 139 (15–20 min.) (a) Basic earnings per share Calculate net income Retained earnings 2017 ............................................. Less: Dividends declared............................................ Subtotal ................................................. Net income ................................................. Retained earnings 2018 ............................................. Solving for X, Net income = $31,000

$40,000 11,000 29,000 X $60,000

Basic earnings per share = Net income ÷ 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. 140 The following data are taken from the financial statements of Kamloops Inc.: Accounts payable ....................................................... $28,000 Accounts receivable ................................................... 56,000 Cash .......................................................................... 54,000 Dividends declared..................................................... 10,000 Market price per share ............................................... 12.75 Other current liabilities................................................ 17,000

A Further Look at Financial Statements

Net income ................................................................. Wages payable .......................................................... Weighted average number of common shares ...........

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44,000 5,000 10,000

Instructions Calculate the following ratios: (a) Current ratio (b) Working capital (c) Basic earnings per share (d) Price-earnings ratio Solution 140 (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 (c) Basic earnings per share = Net income ÷ Weighted average number of common shares = $44,000 ÷ 10,000 = $4.40 (d) Price-earnings ratio = Market price ÷ Basic earnings per share = $12.75 ÷ $4.40 = 2.9

Ex. 141 The following data are taken from the financial statements of Sannot Inc.: Current assets ............................................................ $225,000 Current liabilities......................................................... 140,625 Dividends declared..................................................... 6,000 Market price per share ............................................... 9 Net sales .................................................................... 230,000 Net income ................................................................. 48,000 Total liabilities ............................................................ 153,125 Total assets................................................................ 218,750 Weighted average number of common shares ........... 8,000 Instructions Calculate the following ratios: (a) Current ratio (b) Working capital (c) Basic earnings per share (d) Price-earnings ratio (e) Debt to total assets Solution 141 (15 min.) (a) Current ratio = Current assets ÷ Current liabilities = $225,000 ÷ $140,625 = 1.6:1 (b) Working capital = Current assets – Current liabilities = $225,000 – $140,625 = $84,375 (c) Basic earnings per share = Net income ÷ Weighted average number of common shares

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

= $48,000 ÷ 8,000 = $6.00 (d) Price-earnings ratio = Market price per share ÷ Basic earnings per share = $9 ÷ $6.00 = 1.5 (e) Debt to total assets = Total debt ÷ Total assets = $153,125 ÷ $218,750 = 70%

Ex. 142 The following selected data are taken from the financial statements of Lincoln Inc. The data are in alphabetical order. Accounts payable ....................................................... $ 52,000 Accounts receivable ................................................... 84,500 Average assets .......................................................... 520,000 Cash .......................................................................... 147,200 Market price/share ..................................................... 65.00 Net sales .................................................................... 590,000 Other current liabilities................................................ 22,500 Net income ................................................................. 174,000 Salaries payable......................................................... 19,600 Shareholders’ equity .................................................. 310,900 Total assets................................................................ 500,000 Weighted average number of common shares ........... 4,000 Instructions Calculate the following ratios: (a) Current ratio (b) Working capital (c) Basic earnings per share (d) Price-earnings ratio (e) Debt to total assets Solution 142 (10 min.) (a) Current ratio = Current assets ÷ Current liabilities = $231,700 ÷ $94,100 = 2.5:1 Current assets: $84,500 + $147,500 = $231,700 Current liabilities: $52,000 + $22,500 + $19,600 = $94,100 (b) Working capital

= Current assets – Current liabilities = $231,700 – $94,100 = $137,600

(c) Basic earnings per share = Net income ÷ Weighted avg. number of common shares = $174,000 ÷ 4,000 = $43.50 (d) Price-earnings ratio

= Market price per share ÷ Basic earnings per share = $65.00 ÷ $43.50= 1.5

(e) Debt to total assets = Total liabilities ÷ Total assets = $189,100 ÷ $500,000 = 37.8% (Total liabilities = Total assets – Shareholders’ equity = $500,000 – $310,900 = $189,100)

A Further Look at Financial Statements

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Ex. 143 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.

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

Solution 143 (5 min.) P 1. Basic earnings per share S

2. Debt to total assets

3. Price-earnings ratio

4. Current ratio

Ex. 144 The following information is available from the 2018 financial statements of Ying Corp. and Yang Inc. (amounts in millions, except share price) Ying Yang Beginning total assets ................................................ $22,233 $43,069 Current assets ............................................................ 15,225 36,981 Current liabilities......................................................... 9,958 18,688 Ending total assets ..................................................... 28,715 47,015 Net income ................................................................. 735 1,652 Sales .......................................................................... 31,812 41,415 Share price................................................................. $90 $130 Total liabilities ............................................................ 20,170 39,028 Weighted average number of common shares ........... 25 44 Instructions (a) For each company, calculate the following ratios: 1. Current ratio 2. Debt to total assets 3. Basic earnings per share 4. Price-earnings ratio (b) Based on your calculations, discuss the relative liquidity, solvency, and profitability of the two companies. Solution 144 (15 min.) (a)

Ying

Yang.

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1. 2. 3. 4.

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

Current ratio 1.5:1 ($15,225 ÷ $9,958) Debt to total assets 70.2% ($20,170 ÷ $28,715) Basic earnings per share $29.40 ($735 ÷ 25) Price-earnings ratio 3.1 ($90 ÷ $29.40)

2.0:1 ($36,981 ÷ $18,688) 83.0% ($39,028 ÷ $47,015) $37.55 ($1,652 ÷ 44) 3.6 ($130 ÷ $37.55)

(b) Based on the current ratio, Yang is more liquid than Ying since its current ratio (2.0:1) is 27% higher than Ying’s ratio (1.5:1). However, Ying would be considered more solvent than Yang since its debt to total assets (70.2%) is lower than Yang’s debt to total assets ratio (83.0%). A lower debt to total assets ratio indicates a company is more solvent and better able to survive over a long period of time. Yang has a higher basic earnings per share and price-earnings ratio than Ying. Yang’s basic earnings per share ($37.55) is 27.7% higher than Ying’s basic earnings per share ($29.40); as well, Yang’s price-earnings ratio (3.6) is 11.4% higher than Ying’s ratio (3:1).

Ex. 145 Selected information from the comparative financial statements of National Falls Inc. for the year ended December 31 appears below: 2018 2017 Accounts receivable ................................................... $ 142,000 $ 182,000 Bank loan payable...................................................... 490,000 390,000 Cash .......................................................................... 27,000 17,000 Cost of goods sold ..................................................... 970,000 900,000 Current liabilities......................................................... 125,000 95,000 Income tax expense ................................................... 80,000 60,000 Interest expense ........................................................ 40,000 15,000 Inventory .................................................................... 136,000 154,000 Net income ................................................................. 220,000 155,000 Total assets................................................................ 1,350,000 950,000 Total revenues ........................................................... 2,100,000 1,100,000 Weighted average number of common shares ........... 15,000 7,000 Instructions Calculate the following ratios for 2018: (a). Current ratio. (b) Working capital. (c) Debt to total assets. (d) Basic earnings per share. Solution 145 (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

A Further Look at Financial Statements

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(c) Debt to total assets is 46%. $125,000 + $490,000 ———————–——– = 46% $1,350,000 (d). Basic earnings per share is $15. $220,000 ——–—— = $15 15,000

Ex. 146 Channing Corporation reported the following current assets and current liabilities: Dec. 31, 2018 Dec. 31, 2017 Current assets Cash .......................................................................... $ 40,000 $ 30,000 Short-term investments .............................................. 40,000 10,000 Accounts receivable ................................................... 55,000 95,000 Inventory .................................................................... 110,000 90,000 Prepaid insurance ...................................................... 35,000 20,000 Total current assets ............................................. $280,000 $245,000 Current liabilities Accounts payable ....................................................... $120,000 $110,000 Salaries payable......................................................... 40,000 30,000 Income tax payable .................................................... 20,000 15,000 Total current liabilities .......................................... $180,000 $155,000 Instructions (a) Calculate the following ratios for 2018: 1. Current ratio. 2. Working capital. (b) Explain the purpose of each ratio. Solution 146 (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. 147

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

Selected data from Lift-Off Ltd. are presented below: Net sales .................................................................... $3,425,000 Net income ................................................................. 315,000 Share price................................................................. 14.45 Weighted average number of common shares ........... 185,000 Instructions (a) Based on the above information, calculate two profitability ratios. (b) Explain the purpose of each ratio. Solution 147 (10–15 min.) (a) With the information provided, the profitability ratios that can be calculated are as follows: 1. Basic earnings per share = Net income ÷ Weighted average number of shares = $315,000 ÷ 185,000 = $1.70 2. Price-earnings = Market price per share ÷ Basic earnings per share = $14.45 ÷ $1.70 = 8.50 (b) The purpose of each ratio: 1. Basic earnings per share measures the net income for each common share. 2. The price-earnings ratio measures the ratio of the market price of each common share to its basic earnings per share. It reflects the investors’ assessment of the company’s future net income expectations.

Ex. 148 Insert the characteristics listed below that are associated with relevance and faithful representation: Confirmatory value Materiality Completeness Free from errors Neutral Predictive value

1. 2. 3.

RELEVANCE _________________________ _________________________ _________________________

Solution 148 (5 min.) RELEVANCE 1. Confirmatory value

1. 2. 3.

FAITHFUL REPRESENTATION ______________________ ______________________ ______________________

FAITHFUL REPRESENTATION Free from errors

Predictive value

Completeness

Materiality

Neutral

Ex. 149 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

A Further Look at Financial Statements

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Predictive value Relevance Faithful representation Timeliness 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 149 (5 min.) 1. (b) 2.

(f)

(g)

(d)

(e)

(a)

Ex. 150 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 current 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 150 (5 min.) (a) Timeliness (b) Comparability (consistency) (c) No violation (d) No violation (materiality)

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

Ex. 151 Identify whether the following statements are true or false. _____ 1. The conceptual framework of accounting guides decisions about what to present in financial statements, alternative ways of reporting economic events, and inappropriate ways of communication this information. _____ 2. The users identified in the conceptual framework are all external users and, and as such, do not have access to the same financial information as internal users do. _____ 3. The conceptual framework is fundamentally similar for publicly traded companies in Canada reporting under IFRS and private companies reporting under ASPE. _____ 4. Two major economies, the United States and China, have yet to adopt IFRS. _____ 5. All countries use the same conceptual framework or set of accounting standards. Solution 151 __F__ 1. The conceptual framework of accounting guides decisions about what to present in financial statements, alternative ways of reporting economic events, and inappropriate ways of communication this information. __T__ 2. The users identified in the conceptual framework are all external users and, as such, do not have access to the same financial information as internal users do. __T__ 3. The conceptual framework is fundamentally similar for publicly traded companies in Canada reporting under IFRS and private companies reporting under ASPE. __F__ 4. Two major economies, the United Kingdom and China, have yet to adopt IFRS. __F__ 5. All countries use the same conceptual framework or set of accounting standards.

Ex. 152 Identify which qualitative characteristic is being violated in each of the situations below: (a) Valeem Industries has its financial statements audited on an as needed basis, usually every other year. (b) Over & Out Communications Inc. did not issue its 2015 financial statements until the end of F2016. (c) On the statement of financial position, Faithfully Yours reported the cost of machinery equipment used in the manufacturing of the company product in the inventory account. (d) Oriole Enterprises is the only company in the industry who uses straight-line method of depreciation. (e) The Controller for Paws Inc. prepares the financial statements with as few classifications and descriptions to make it easier on the reader. Solution 152 (a) Verifiability (b) Timeliness (c) Faithful representation (d) Comparability

A Further Look at Financial Statements

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(e) Understandability

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

MATCHING QUESTIONS 153. 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

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

Working capital Current ratio Basic 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 basic earnings per share

____

An omission or statement that could influence the decisions of users

____

Obligations that result from past transactions

____

Non-current assets that do not have physical substance

____

Income available to common shareholders divided by the weighted average number of common shares

____

Different companies using the same accounting principles

____

10.

Measures of the short-term ability of the company to pay its maturing obligations

____

11.

The excess of current assets over current liabilities

____

12.

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

SHORT-ANSWER ESSAY QUESTIONS S-A E 154 Give the definition of current assets, current liabilities and the current ratio. Solution 154 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 155 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. • Net income this year was $2.1 million. Last year, net income 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 155 Fast Express released its financial statements today, disclosing a 17% increase in net income, 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 156 Comparability is an enhancing qualitative characteristic that makes accounting information useful for decision-making purposes. Briefly explain how comparability affects financial reporting and if comparability would be easier when accounting policies are used consistently. Solution 156 Comparability results when a specific company, and similar companies, use the same accounting principles and methods, so that users can identify and understand similarities and differences among items on the financial reports. Using the same accounting policies from year to year would

A Further Look at Financial Statements

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make comparability easier as meaningful trends could be identified company to company.

S-A E 157 Marberry Inc. has hired a new controller who has prepared the company’s annual financial statements. The company president, who has been in business for over 25 years, has reviewed the statements and comments that there are little to no classifications and that some of the descriptions are not ones that have been used in the past and appear complicated. Instructions Have any of the qualitative characteristics of useful financial information been violated? If so, which one and why. Solution 157 To be useful for decision-making, information should be understandable which means that users with a reasonable knowledge of business can interpret the information and comprehend its meaning. The fact that the president, who we can assume is this type of user given his 25 years of business experience, is having difficulty with the financial statements indicates that the understandability enhancing characteristic has been violated.

S-A E 158 Identify and describe the three characteristics information must have in order to provide a faithful representation of economic reality. Solution 158 In order to achieve faithful representation, information must be complete, neutral and free from 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 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.

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

OBJECTIVE FORMAT QUESTIONS 159. The following balances were taken from the statement of financial position for Guardian Ltd. at December 31, 2018:

Accounts payable Total current assets Current portion of bank loan payable Land Buildings Accumulated depreciation, buildings Mortgage payable Total long term investments Interest payable Net equipment Unearned revenue Bank loan payable Current portion of mortgage payable Accumulated depreciation, equipment Common shares Goodwill Salaries payable Retained earnings

$24,500 28,500 30,500 58,000 475,000 95,000 113,700 47,850 17,500 37,680 1,500 91,500 22,800 9,420 125,000 12,500 6,500 ?

Indicate all of the following statements that are correct. (a) Total assets for Guardian Ltd. at Dec. 31 2018 are $556,994. (b) Total retained earnings cannot be determined from the information given. (c) Total current liabilities are $103,300. (d) Total retained earnings are $131,030. (e) Total property, plant and equipment is $468,144. (f) Total non-current liabilities are $205,200. (g) Total liabilities and shareholder’s equity is $564,030. (h) The current liabilities are $101,800. Solution 159 Statements (c), (d), and (f) are correct; (a), (b), (e), (g), and (h) are incorrect. The following is a completed statement of financial position for Guardian Ltd., which indicates the correct values.

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Guardian Ltd. Statement of Financial Position December 31, 2018 Assets Current assets Total current assets Long term investments Property, plant, and equipment Land Buildings $475,000 Less: Accumulated depreciation 95,000 Equipment $ 47,100 Less: Accumulated depreciation 9,420 Total property, plant, and equipment Goodwill Total assets Liabilities and Shareholders' Equity Current liabilities Accounts payable Salaries payable Interest payable Unearned revenue Current portion of bank loan Current portion of mortgage payable Total current liabilities Non-current liabilities Bank loan payable Mortgage payable Total liabilities Shareholders' equity Common shares Retained earnings Total shareholders’ equity Total liabilities and shareholders' equity

$ 28,500 47,850 $ 58,000 380,000 37,680 475,680 12,500 $564,530

$ 24,500 6,500 17,500 1,500 30,500 22,800 $103,300 $ 91,500 113,700

205,200 308,500

$125,000 131,030 256,030 $564,530

160. Choose whether the item is describing liquidity, profitability or leverage ratios: (a) Total liabilities divided by total assets (b) The difference between current assets and current liabilities (c) The market price per share divided by basic earnings per share (d) Measures a company’s operating success for a specific period of time (e) Current assets divided by current liabilities (f) Measures a company’s ability to survive over the long term by having enough assets to settle its liabilities as they fall due (g) Measures a company’s short-term ability to pay its maturing obligations (h) Income available to common shareholders divided by the weighted average number of common shares

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(i)

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

Uses net income from the income statement.

Solution 160 (a) Solvency. This describing the debt to total assets ratio, which is a solvency ratio and measures long-term debt-paying ability. (b) Liquidity. This is describing working capital which is a liquidity ratio and measures a company’s ability to pay its current obligations. (c) Profitability. This is describing the price-earnings ratio which is a profitability ratio that measures the ratio of the stock market price of each common share to its basic earnings per share. (d) Profitability. Profitability ratios such as price-earnings and basic earnings per share measure a company’s earnings for a specific period of time. (e) Liquidity. This is describing the current ratio which is a measure of a company’s liquidity. (f) Solvency. Solvency ratios such as debt to total assets measure a company’s long-term debt-paying ability. (g) Liquidity. Liquidity ratios such as working capital and the current ratio measure a company’s short-term debt-paying ability. (h) Profitability. This is describing the basic earnings per share ratio which measures the income earned on each common share. (i)

Profitability. Net income from the income statement is used to calculate profitability ratios such as basic earnings per share and price-earning.

161. The following was reported for Grand Enterprises Corporation for the last two years: 2018 Current assets Total assets Current liabilities Total liabilities Net income Weighted average number of common shares Market price per share Industry average price earnings ratio

$58,000 358,000 62,000 88,000 108,000 55,000 $18.25 13.50

2017 $45,000 321,000 40,000 101,000 92,000 45,000 $15.17 times

Based on the above information, indicate all of the following statements that are correct: (a) The price-earnings ratio for 2018 is 4.2 times lower than the industry average.

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The company’s overall liquidity has improved. The current ratio for 2017 is 1.125. The company’s ability to pay long-term debt obligations has improved in 2018. The basic earnings per share is $1.96 for 2018. The current ratio for 2018 indicates the company may not be able to cover its long-term debt obligations. (g) Investors will likely consider that Grand Enterprises’ stock is overpriced given its priceearnings ratio for 2018. (b) (c) (d) (e) (f)

Solution 161 (a) and (e) are correct. The price-earnings ratio for 2018 is 4.2 times (13.5 – 9.3 times = 4.2 times) lower. 1. Basic earnings per share = Net income ÷ Weighted average number of shares = $108,000 ÷ 55,000 = $1.96 2. Price-earnings = Market price per share ÷ Basic earnings per share = $18.25 ÷ $1.96 = 9.31 times (c) is correct. Current ratio 2018 Current ratio 2017

= Current assets ÷ current liabilities = $58,000 ÷ $62,000 = .935 = Current assets ÷ current liabilities = $45,000 ÷ $40,000 = 1.125

(d) is correct. Debt to total assets ratio has improved from 31.5% to 24.6% Debt to total assets 2018 = Total liabilities ÷ Total assets = $88,000 ÷ $358,000 = 24.6% Debt to total assets 2017 = Total liabilities ÷ Total assets = $101,000 ÷ $321,000 = 31.5%

(b), (f), and (g) are incorrect. (b) The overall liquidity has declined. – Refer to current ratio in part (c) above. (f) The current ratio for 2018 indicates the company may not be able to cover its short-term debt obligations. - Refer to current ratio for 2018 in part (c) above which has fallen below 1. (g) Investors will likely consider that Grand Enterprises’ shares are under priced given that the price-earnings ratio for 2018 as it is below the industry average. For 2018 the priceearnings ratio is 9.31 (18.25/1.96) which is lower than the industry average of 13.5 times.

162. The following data has been provided for Luna Industries Ltd.:

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

Using the above information, identify all of the following statements that are correct. (a) Total current liabilities are $810,000 (b) Luna’s working capital is negative. (c) The market price per common share cannot be determined from the information given. (d) Total assets are $1,250,000. (e) Net income is $650,000. (f) Total current liabilities are $250,000. (g) The market price per common shares is $195. (h) Total assets are $188,180. Solution 162 (d), (e), (f), and (g) are correct; (a), (b), (c), and (h) are incorrect. (a) Total liabilities are $250,000. 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 $450,000 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = = $250,000 1.8 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 =

(b) Luna’s working capital is positive Working capital = Current assets less current liabilities = $450,000 - $250,000 [taken from (a) above] = $200,000 (c) The market price per share can be determined from the prices earnings ratio and the basic earnings per share. 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 𝑝𝑟𝑖𝑐𝑒 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑟𝑎𝑡𝑖𝑜 × 𝑏𝑎𝑠𝑖𝑐 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 15 × $13 = $195 (h) Total assets are $1,250,000: 𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝐷𝑒𝑏𝑡 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 $485,000 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = = $1,250,000 0.388 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 =

163. Choose the qualitative characteristic of financial information being described and whether it is a fundamental (F) or enhancing (E) characteristic. Note: a characteristic may be used more than once.

A Further Look at Financial Statements

(a) Accounting information represents economic reality.

(b) Users can identify and understand similarities in, and differences among, items. (c) Accounting information influences a user’s decision.

(d) Different knowledgeable and independent users can reach consensus that the accounting information is faithfully represented. (e) Accounting information has three characteristics: complete (nothing important was omitted), neutral (not biased toward one position or another), and free from error (it provides an accurate description and no errors were made in the process used to determine it). (f) Accounting information is made available to decision makers before it loses its ability to influence decisions. (g) Accounting information is classified, characterized, and presented clearly and concisely.

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Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability

Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, or Understandability

Solution163 (a) Faithful representation (F). For accounting information to be useful, it should report the economic substance of an event. If the substance of the transaction is different from its legal form, the transaction should be accounted for based on its economic reality. For example, if a company knew they were not going to be able to collect an accounts receivable from a customer because the customer went out of business, excluding this loss in their determination of income would not be a faithful representation of the economic reality. (b) Comparability (E). Comparability means that users can compare results from the same company from one period to the next or compare results across different companies. (c) Relevance (F). Accounting information is relevant when it impacts a user’s decision. For example, if a manager is deciding whether to purchase a new machine, the cost of the new machine is relevant but the cost of old machine that is being replaced is not. The purchase of the old machine was a historical event that will not change whether or not they decide to purchase the new machine.

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

(d) Verifiability (E). Accounting results are verifiable when those results can be reproduced. Accounting information is verifiable if the same data and assumptions are provided to an independent accountant and they produce the same result. Auditors provide a key role in ensuring accounting information if verifiable. (e) Faithful representation (F). A transaction is faithfully represented if information regarding the transaction is complete, accurate and not misleading to users. (f) Timeliness (E). Financial information should be provided to users in time to make decisions. For instance, stock exchange regulators require annual financial statements to be made available to users within 90 days of a company’s year end. (g) Understandability (E). Users with a reasonable knowledge of business should be able to interpret financial information and comprehend its meaning

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CHAPTER 3 THE ACCOUNTING INFORMATION SYSTEM SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 14. 2 E K F AN 27. 3 E K F AN 2. 1 E C F AN 15. 2 E K F AN 28. 3 E K F AN 3. 1 M C F AN 16. 2 E K F AN 29. 4 M K F AN 4. 1 M C F AN 17. 2 E C F AN 30. 4 E C F AN 5. 2 E K F AN 18. 2 M C F AN 31. 4 E K F AN F AN F AN F AN 6. 2 E K 19. 2 E K 32. 4 M C 7. 2 E C F AN 20. 2 E C F AN 33. 4 E K F AN 8. 2 M C F AN 21. 3 E K F AN 34. 5 E C F AN 9. 2 E K F AN 22. 3 E K F AN 35. 5 E K F AN 10. 2 E C F AN 23. 3 E K F AN 36. 5 M C F AN 11. 2 E C F AN 24. 3 E K F AN 37. 5 M C F AN 12. 2 E C F AN 25. 3 E K F AN 13. 2 E K F AN 26. 3 E K F AN LOD: E = Easy M = Medium Bloom’s: C = Comprehension K = Knowledge CPA: F = Financial Reporting AACSB: AN = Analytic

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

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Multiple Choice Questions 38. 1 M C F AN 73. 2 M C F AN 108. 3 M C F AN 39. 1 M C F AN 74. 2 M C F AN 109. 3 M C F AN 40. 1 M C F AN 75. 2 M C F AN 110. 4 M C F AN 41. 1 M C F AN 76. 2 M C F AN 111. 4 M C F AN F AN F AN 112. 4 M F AN 42. 1 E C 77. 2 M C K 1 F AN 2 F AN 4 K F AN 43. M C 78. E C 113. E F AN F AN 114. 4 E C F AN 44. 1 M C 79. 2 E C F AN C F AN 115. 4 M C F AN 45. 1 E C 80. 2 E F AN C F AN 116. 4 M C F AN 46. 1 M C 81. 2 E 47. 1 E C F AN 82. 2 E C F AN 117. 4 E C F AN 48. 1 E K F AN 83. 2 E C F AN 118. 4 E C F AN 49. 1 E C F AN 84. 2 E K F AN 119. 4 E K F AN 50. 1 E C F AN 85. 2 M C F AN 120. 4 M K F AN 51. 1 E C F AN 86. 2 M C F AN 121. 4 E K F AN 52. 1 E C F AN 87. 2 E C F AN 122. 4 M K F AN 53. 1 E C F AN 88. 2 M C F AN 123. 4 E K F AN 54. 1 M C F AN 89. 2 E C F AN 124. 4 E K F AN 55. 1 M C F AN 90. 3 M C F AN 125. 4 M K F AN 56. 1 E C F AN 91. 3 E K F AN 126. 4 M K F AN 57. 1 E C F AN 92. 3 E K F AN 127. 4 E K F AN 58. 1 M C F AN 93. 3 E K F AN 128. 4 E C F AN 59. 2 M C F AN 94. 3 E K F AN 129. 5 M C F AN 60. 2 E K F AN 95. 3 E K F AN 130. 5 M C F AN 61. 2 E K F AN 96. 3 M K F AN 131. 5 M C F AN 62. 2 E K F AN 97. 3 M C F AN 132. 5 M C F AN 63. 2 E K F AN 98. 3 E K F AN 133. 5 E K F AN 64. 2 E K F AN 99. 3 E K F AN 134. 5 M C F AN 65. 2 E K F AN 100. 3 E K F AN 135. 5 M K F AN 66. 2 E C F AN 101. 3 M K F AN 136. 5 M K F AN 67. 2 E C F AN 102. 3 E K F AN 137. 5 M C F AN 68. 2 M C F AN 103. 3 E K F AN 138. 5 M C F AN 69. 2 E C F AN 104. 3 M C F AN 139. 5 E C F AN 70. 2 H K F AN 105. 3 M C F AN 140. 5 H C F AN 71. 2 E K F AN 106. 3 E C F AN 141. 5 M C F AN 72. 2 M C F AN 107. 3 E C F AN 142. 5 M C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: C = Comprehension K = Knowledge CPA: F = Financial Reporting AACSB: AN = Analytic

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C = Comprehension

K = Knowledge

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

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type Item

Type

Item

1. 2. 3. 4. 38.

TF TF TF TF MC

39. 40. 41. 42. 43.

MC MC MC MC MC

45. 46. 47. 48. 49.

5. 6. 7. 8. 9. 10. 11. 12. 13.

TF TF TF TF TF TF TF TF TF

14. 15. 16. 17. 18. 19. 20. 59. 60.

TF TF TF TF TF TF TF MC MC

61. 62. 63. 64. 65. 66. 67. 68. 69.

21. 22. 23. 24. 25. 26.

TF TF TF TF TF TF

27. 28. 90. 91. 92. 93.

TF TF MC MC MC MC

94. 95. 96. 97. 98. 99.

29. 30. 31. 32.

TF TF TF TF

33. 110. 111. 112.

TF MC MC MC

113. 114. 115. 116.

34. 35. 36. 37. 129.

TF TF TF TF MC

130. 131. 132. 133. 134.

MC MC MC MC MC

135. 136. 137. 138. 139.

Note:

TF = True/False Ex = Exercise

Type Item Type Item Learning Objective 1 MC 50. MC 55. MC 51. MC 56. MC 52. MC 57. MC 53. MC 58. MC 54. MC 143. Learning Objective 2 MC 70. MC 79. MC 71. MC 80. MC 72. MC 81. MC 73. MC 82. MC 74. MC 83. MC 75. MC 84. MC 76. MC 85. MC 77. MC 86. MC 78. MC 87. Learning Objective 3 MC 100. MC 106. MC 101. MC 107. MC 102. MC 108. MC 103. MC 109. MC 104. MC 155. MC 105. MC 157. Learning Objective 4 MC 117. MC 121. MC 118. MC 122. MC 119. MC 123. MC 120. MC 124. Learning Objective 5 MC 140. MC 162. MC 141. MC 163. MC 142. MC 164. MC 160. Ex 165. MC 161. Ex 166.

MC = Multiple Choice SAE = Short-Answer Essay

Type

Item

Type Item Type

MC MC MC MC Ex

144. 145. 146. 147. 172.

Ex 178. Ex Ex Ex SAE

MC MC MC MC MC MC MC MC MC

88. 89. 147. 148. 149. 150. 151. 152. 153.

MC MC Ex Ex Ex Ex Ex Ex Ex

154. 155. 156. 171. 172. 173. 174. 179.

Ex Ex Ex Ma SAE SAE SAE CP

MC MC MC MC Ex Ex

158. 159. 160. 161. 171. 175.

Ex 180. Ex 181. Ex Ex Ma SAE

CP CP

MC MC MC MC

125. 126. 127. 128.

MC MC MC MC

156. 160. 162. 171.

Ex Ex Ex Ma

Ex Ex Ex Ex Ex

167. 168. 169. 170. 171.

Ex Ex Ex Ex Ma

176. 177. 182.

SAE SAE CP

Ma = Matching CP = CPA

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CHAPTER LEARNING 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.

Explain how accounts, debits, and credits are used to record transactions. The terms debit and credit mean the same thing as left and right, respectively. Assets, dividends declared, 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 in the general journal. 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 to the general ledger. 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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Test Bank for Financial Accounting: Tools for Business Decision -Making, Seventh Canadian Edition

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. 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.

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

7. A debit increases an account and a credit decreases an account. 8. If a revenue account is credited, this must increase shareholders’ equity.

9. The normal balance of a liability account is a debit.

10. A credit means that an account has been increased.

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

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

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

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

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

16. The normal balance of the Dividends Declared account is a debit.

17. Assets are decreased with a credit.

18. An expense account is a subdivision of the retained earnings account and decreases shareholders’ equity. 19. Revenues are a subdivision of shareholders’ equity.

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

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

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

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

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

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

26. Entering transactions into the journal is called posting.

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

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

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

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

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

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

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

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

34. A trial balance can still balance even if an entry is posted to the wrong account.

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

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

37. 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.

Ans. T F F F F T F

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

Ans. T F F T T F T

Item 15. 16. 17. 18. 19. 20. 21.

Ans. F T T T T F F

Item 22. 23. 24. 25. 26. 27. 28.

Ans. T T T F F F T

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

Ans. F T T F T T T

Item 36. 37.

Ans. F T

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

MULTIPLE CHOICE QUESTIONS 38. If total assets are increased, there must be a corresponding (a) increase in liabilities only. (b) increase in shareholders’ equity only. (c) increase in liabilities and decrease in shareholders’ equity. (d) increase in liabilities and/or increase in shareholders’ equity.

39. An increase in the Dividends Declared account will result in (a) an increase in the Retained Earnings account. (b) an increase in expenses. (c) a decrease in the Retained Earnings account. (d) a decrease in expenses.

40. Prepaid expenses are recorded as (a) expenses on the income statement. (b) assets on the statement of financial position. (c) revenues on the income statement. (d) liabilities on the statement of financial position.

41. The payment of an account payable (a) decreases total assets. (b) increases total assets. (c) has no effect on total assets. (d) increases total liabilities. 42. Shareholders’ equity is increased by (a) dividends declared. (b) revenues. (c) expenses. (d) liabilities.

43. If total liabilities increased by $22,500, then (a) assets must have increased by $22,500. (b) only shareholders’ equity must have increased by $22,500. (c) assets must have increased by $22,500, or shareholders’ equity must have decreased by $22,500. (d) assets and shareholders’ equity must have both decreased by $22,500.

44. Collection of an $800 accounts receivable (a) increases an asset $800; decreases a liability $800. (b) decreases a liability $800; increases shareholders’ equity $800. (c) decreases an asset $800; decreases a liability $800.

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(d) has no effect on total assets.

45. 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.

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

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

48. 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.

49. 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.

50. 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.

51. 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.

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

52. 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.

53. 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.

54. 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.

55. 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.

56. Which of the following items has no effect on retained earnings? (a) expenses (b) dividends declared (c) revenues (d) hiring a new employee

57. 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.

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

59. Debit and credit can be interpreted to mean

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(a) “bad” and “good,” respectively. (b) increase and decrease, respectively. (c) decrease and increase, respectively. (d) either an increase or decrease depending on the account.

60. 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.

61. 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.

62. 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.

63. 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.

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

65. 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.

66. A credit to an asset account indicates a(n) (a) error.

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

(b) credit was made to a liability account. (c) decrease in the asset. (d) increase in the asset.

67. 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.

68. 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.

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

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

71. 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.

72. 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.

73. Which of the following correctly identifies the normal balances of accounts? (a) Assets Debit Liabilities Credit

The Accounting Information System

Common Shares Revenues Expenses (b) Assets Liabilities Common Shares Revenues Expenses (c) Assets Liabilities Common Shares Revenues Expenses (d) Assets Liabilities Common Shares Revenues Expenses

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Credit Debit Credit Debit Credit Credit Credit Credit Credit Debit Debit Credit Debit Debit Credit Credit Credit Debit

74. An accountant has debited an asset account for $5,000 and credited a revenue account for $10,000. What can be done to complete the recording of the transaction? (a) Nothing further can be done. (b) Credit a shareholders’ equity account for $5,000. (c) Debit another asset account for $5,000. (d) Credit another asset account for $5,000.

75. An accountant has debited an asset account for $2,000 and credited an expense account for $4,000. Which of the following would be the correct way to complete the recording of the transaction? (a) Credit an asset account for $4,000. (b) Credit a liability account for $2,000. (c) Credit a shareholders’ equity account for $2,000. (d) Debit a shareholders’ equity account for $2,000.

76. Which pair of accounts follows the rules of debit and credit in the same manner? (a) Accounts 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

77. 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.

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

78. 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.

79. 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.

80. 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.

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

82. 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 Declared 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

83. 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. 84. Which account below is not a subdivision of shareholders’ equity? (a) Dividends Declared (b) Revenues (c) Expenses (d) Liabilities

85. When a corporation pays a dividend, the

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(a) Cash account will be increased with a debit. (b) Dividends Declared account will be increased with a credit. (c) Retained Earnings account will be directly increased with a debit. (d) Dividends Declared account will be increased with a debit.

86. The Dividends Declared 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.

87. 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 net income.

88. 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.

89. 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.

90. Which of the following is NOT true regarding the general journal? (a) It discloses the complete effect of a transaction. (b) It provides a chronological record of transactions. (c) It helps to prevent and locate errors. (d) Transactions are posted to the general journal.

91. 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.

92. In recording accounting transactions, evidence that a transaction has taken place is obtained

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

from (a) source documents. (b) the bank. (c) the public relations department. (d) the chart of accounts.

93. The first step in the recording process is to (a) prepare financial statements. (b) analyze the transaction in terms of its effect on the accounts. (c) post to a journal. (d) post to the ledger.

94. 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.

95. 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.

96. 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.

97. A simple journal entry affects (a) one account. (b) two accounts. (c) two or more accounts. (d) three accounts.

98. 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.

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(d) a chronological record of transactions.

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

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

101. 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.

102. 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.

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

104. Which of the following journal entries is recorded correctly in the basic format (ignoring explanations)? (a) Salaries Expense ................................................................. 600 Cash.............................................................................. 1,350 Advertising Expense ............................................................ 750 (b) Salaries Expense ................................................................. Advertising Expense ............................................................ Cash ....................................................................................

600 750

(c) Salaries Expense ................................................................. Advertising Expense ............................................................ Cash..............................................................................

600 750

1,350

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(d)

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

Cash.............................................................................. Salaries Expense ................................................................. Advertising Expense ............................................................

1,350 600 750

105. 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.

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

107. 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.

108. 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.

109. A $50,000 machine is purchased by paying $35,000 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 Accounts Receivable. (d) credit to Machinery.

110. 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.

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111. 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.

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

113. 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.

114. Which of the following accounts probably would be listed before the others in a chart of accounts? (a) Buildings (b) Insurance Expense (c) Dividends Declared (d) Service Revenue

115. All transactions (a) are entered in the general ledger and then transferred to the general journal. (b) are non-economic events that are recorded. (c) are recorded and reported. (d) are entered in the general journal and posted to the general ledger.

116. Unearned revenues are classified as (a) assets on the statement of financial position. (b) liaiblities on the statement of financial position. (c) shareholders’ equity on the statement of financial position. (d) revenue on the income statement.

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

118. Which of the following is an asset?

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

(a) Service Revenue (b) Bank Loan Payable (c) Supplies Expense (d) Prepaid Rent

119. 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.

120. 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.

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

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

123. The procedure of transferring journal entries to the ledger accounts is called (a) journalizing. (b) analyzing. (c) reporting. (d) posting.

124. A chart of accounts (a) is a chart created in Excel. (b) indicates the amount of net income or loss for the period. (c) lists the accounts in the ledger. (d) shows the balance of each account in the general ledger.

125. Which of the following guidelines should be applied when choosing an account name to be included in the chart of accounts?

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(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.

126. 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.

127. 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. 128. Crystal Credit recently started work with Carcrashian 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.

129. Jane Doe has prepared the trial balance for Braven Corp. Total debits are $25,678 while total credits are $30,034. Which of the following errors has Jane likely made? (a) a journal entry is posted twice (b) a transposition error (c) a correct journal entry is not posted (d) posted a debit as a credit

130. A trial balance is prepared (a) on a monthly basis only. (b) on a quarterly basis only. (c) on an annual basis only. (d) at the end of an accounting period which could be monthly, quarterly or annually.

131. A trial balance will not balance when (a) a one-sided entry is posted. (b) a journal entry is posted twice. (c) a correct journal entry is not posted. (d) incorrect accounts are used in journalizing or posting.

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

132. The trial balance will not balance when (a) a transaction is not journalized. (b) a correction journal entry is not posted. (c) a debit and a credit amount are unequal in a journal entry. (d) a journal entry is posted twice. 133. 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.

134. 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.

135. 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.

136. 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.

137. A trial balance usually (a) lists all the debit balances first, then all the credit balances. (b) lists all the credit balances first, then all the debit balances. (c) lists all the accounts in alphabetical order. (d) lists all the accounts and balances in financial statement order.

138. 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

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139. 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.

140. 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.

141. Which of the following errors, each considered individually, would cause the trial balance to be out of balance? (a) A payment of $229 to a creditor was posted as a debit to Accounts Payable and a debit of $229 to Cash. (b) Cash received from a customer on account was posted as a debit of $400 to Cash and a credit of $400 to Accounts Payable. (c) A payment of $75 for supplies was posted as a debit of $57 to Supplies and a credit of $57 to Cash. (d) A transaction was not posted.

142. 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) net income 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, Seventh Canadian Edition

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52.

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

Item 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67.

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

Item 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82.

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

Item Ans. Item Ans. b d 83. 98. d c 84. 99. d d 85. 100. c b 86. 101. a b 87. 102. a d 88. 103. c c 89. 104. d a 90. 105. b c 91. 106. a b 92. 107. b d 93. 108. c a 94. 109. a c 95. 110. c d 96. 111. c a 97. 112.

Item 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127.

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

Item 128. 129. 130. 131. 132. 133. 134. 135. 136. 137. 138. 139. 140. 141. 142.

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

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EXERCISES Ex. 143 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 declared 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 143 (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. 144 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

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

1. 2. 3. 4.

Received cash for services provided. 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 declared were paid. 9. Obtained a loan from the bank. 10. Billed customers for services performed.

_______ _______ _______

______ ______ ______

_______ _______ _______

_______ _______

______ ______

_______ _______

_______

______

_______

_______ _______ _______ _______

______ ______ ______ ______

_______ _______ _______ _______

Solution 144 (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 declared were paid.

–

Obtained a loan from the bank.

10. Billed customers for services performed.

Liabilities

Shareholders’ Equity +

+ –

–

– + +

Ex. 145 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.

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3. Purchased courier bags for $1,200 cash. 4. Received a bill from Campus News for $300 for advertising in the campus newspaper. 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

Shareholders’ Equity Retained Earnings + Revenue – Expenses - Dividends Declared

Common Shares

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

—————————————————————————————————————————— Solution 145 (20 min.) Trans1.

Assets Accounts Cash +Receivable + +$25,000

–$3,000

–$1,200

Courier Bicycles +Bags =

Liabilities Accounts Payable

+$5,000

+$2,000

Common Shares +$25,000

Shareholders’ Equity Retained Earnings + Revenue – Expenses- Dividends Declared

+$1,200

+$300

+$1,600

–$300

+$1,600 –$300 +$100

–$300

–$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, Seventh Canadian Edition

Ex. 146 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 $25,000 cash. 2. Purchased supplies on credit for $1,500. 3. Billed customers $2,500 for services provided. 4. Paid for supplies purchased in transaction 2. 5. Paid dividends of $400 cash to shareholders. 6. Received half of the money from customers billed in transaction 3. 7. Received and paid utility bill for $75. Trans-

Assets Accounts +Receivable +

Liabilities Accounts Payable

Common Shares

Shareholders’ Equity Retained Earnings + Revenue - Expenses - Dividends Declared

Cash Supplies = + 1. 2. 3. 4. 5. 6. 7. —————————————————————————————————————————————————————————— Totals ——————————————————————————————————————————————————————————

Solution 146 (15 min.) Trans1.

Cash +$25,000

Assets Accounts +Receivable +

Supplies

+$1,500

Liabilities Accounts Payable

–$1,500

–$400

+$1,250

Shareholders’ Equity Retained Earnings + Revenue – Expenses- Dividends Declared

+$1,500

+$2,500

Common Shares +$25,000

+$2,500 –$1,500 - $400

–$1,250

7. –$75 -$75 —————————————————————————————————————————————————————————— Totals $24,275 $1,250 $1,500 $0 $25,000 $2,500 -$75 -$400 ——————————————————————————————————————————————————————————

$15,250

Ex. 147 For each of the following: (a) Identify what type of account it is (Asset, Liability, Shareholders’ Equity, Revenue, or Expense); and

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(b) its normal balance (debit or credit). 1. 2. 3. 4. 5. 6. 7. 8. 9.

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

Solution 147 (10 min.)

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

(b) Normal Balance Dr.

Mortgage 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. 148 For each item below, indicate whether the account will be debited or credited: 1. Decrease in Accounts Payable 2. Increase in Dividends Declared 3. Increase in Common Shares 4. Increase in Unearned Revenue 5. Decrease in Mortgage Payable 6. Increase in Prepaid Insurance 7. Decrease in Salaries Expense 8. Decrease in Supplies 9. Increase in Revenues 10. Decrease in Accounts Receivable Solution 148 (5 min.)

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

Decrease in Accounts Payable

Dr.

Increase in Dividends Declared

Dr.

Increase in Common Shares

Cr.

Increase in Unearned Revenue

Cr.

Decrease in Mortgage 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. 149 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 Declared 5. Decrease in Inventory 6. Increase in Salaries Payable 7. Increase in Supplies 8. Increase in Salaries Expense 9. Increase in Accounts Receivable Solution 149 (5 min.) 1. Decrease in Prepaid Rent

Cr.

Decrease in Revenues

Dr.

Decrease in Unearned Revenues

Dr.

Decrease in Dividends Declared

Cr.

Decrease in Inventory

Cr.

Increase in Salaries Payable

Cr.

Increase in Supplies

Dr.

Increase in Salaries Expense

Dr.

The Accounting Information System

Increase in Accounts Receivable

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Dr.

Ex. 150 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 Supplies 6. Increase in Dividends Declared 7. Increase in Service Revenue 8. Decrease in Accounts Receivable 9. Increase in Rent Expense 10. Decrease in Equipment Solution 150 (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 Supplies

Cr.

Increase in Dividends Declared

Dr.

Increase in Service Revenue

Cr.

Decrease in Accounts Receivable

Cr.

Increase in Rent Expense

Dr.

10. Decrease in Equipment

Cr.

Ex. 151 For the accounts listed below, indicate if the normal balance of the account is a debit or credit: Normal Balance Accounts Debit or Credit 1. Service Revenue ________________ 2. Rent Expense ________________ 3. Accounts Receivable ________________ 4. Accounts Payable ________________ 5. Common Shares ________________

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

6. Supplies 7. Insurance Expense 8. Dividends Declared 9. Buildings 10. Bank Loan Payable

________________ ________________ ________________ ________________ ________________

Solution 151 (5 min.) Normal Balance Debit or Credit Credit

Accounts Service Revenue

Rent Expense

Debit

Accounts Receivable

Debit

Accounts Payable

Credit

Common Shares

Credit

Supplies

Debit

Insurance Expense

Debit

Dividends Declared

Debit

Buildings

Debit

10. Bank Loan Payable

Credit

Ex. 152 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 Declared 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 152 (5 min.) 1. (a) 2.

(b)

(c)

The Accounting Information System

(b)

(a)

(c)

(a)

(c)

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10. (a)

Ex. 153 Eight transactions are recorded in the following T accounts: Cash Accounts Receivable 1. 35,000 2. 3,500 5. 27,500 7. 7. 22,500 3. 1,950 4. 2,225 6. 8,000 8. 4,500

Supplies 1,950

Common Shares 1.

35,000

Accounts Payable 8,000 2.

10,000

Salaries Expense 2,225

Equipment 13,500

Service Revenue 5.

22,500

27,500

Dividends Declared 4,500

Indicate for each debit and each credit: (a) whether an Asset, Liability, Common Shares, Dividends Declared, 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.

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

—————————————————————————————————————————— 3. —————————————————————————————————————————— 4. —————————————————————————————————————————— 5. —————————————————————————————————————————— 6. —————————————————————————————————————————— 7. —————————————————————————————————————————— 8.

Solution 153 (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 Declared + Asset –

Ex. 154 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.

Accounts Payable Accounts Receivable Common Shares

5. 6. 7.

Service Revenue Insurance Expense Bank Loan Payable

The Accounting Information System

Dividends Declared

Solution 154 (15 min.) 1. (a) Liability Account (b) Debit decreases, credit increases (c) Normal balance – credit

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Equipment

(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. 155 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 155 (15 min.) (a) List of accounts: Cash (A) Food/Groceries Expense (E) Entertainment Expense (E) Car Maintenance Expense (E) Miscellaneous Expense (E)

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

Car (A) Bank Loan Payable (L) 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. 156 The chart of accounts used by Kopy Kat 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

Cash Accounts Receivable Supplies Prepaid Insurance Equipment Accounts Payable

280 300 350 370 400 510

Unearned Revenue Common Shares Retained Earnings Dividends Declared Service Revenue Advertising Expense

The Accounting Information System

250 Bank Loan Payable

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530 Rent Expense Number(s) of account(s) debited

Number(s) of account(s) credited

Shareholders invested $75,000 cash to start the corporation. —————————————————————————————————————————— 2. Purchased three photocopy machines for $120,000, paying $60,000 cash and signing a 5-year, 3% bank loan for the remainder. —————————————————————————————————————————— 3. Purchased $3,000 paper supplies on credit. —————————————————————————————————————————— 4. Cash photocopy revenue received was $15,000. —————————————————————————————————————————— 5. Paid $250 cash for radio advertising. —————————————————————————————————————————— 6. Paid $800 on account for paper supplies purchased in transaction 3. —————————————————————————————————————————— 7. Paid a $200 cash dividend to shareholders. —————————————————————————————————————————— 8. Paid $1,500 cash for rent for the current month. —————————————————————————————————————————— 9. Received $1,200 cash advance from a customer for future copying. —————————————————————————————————————————— 10. Billed a customer for $750 for photocopy work done. —————————————————————————————————————————— 11. Paid $1,800 for a one-year insurance policy. —————————————————————————————————————————— 12. Hired four employees to begin work in one month. Weekly salary is $600 per week. Solution 156 (15 min.) Number(s) of account(s) debited

Number(s) of account(s) credited

Shareholders invested $75,000 cash to start the corporation. 100 300 —————————————————————————————————————————— 2. Purchased three photocopy machines for $120,000, paying $60,000 cash and signing a 5-year, 3% bank loan for the remainder. 180 100, 250 —————————————————————————————————————————— 3. Purchased $3,000 paper supplies on credit. 150 220 —————————————————————————————————————————— 4. Cash photocopy revenue received was $15,000. 100 400 ——————————————————————————————————————————

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

5. Paid $250 cash for radio advertising. 510 100 —————————————————————————————————————————— 6. Paid $800 on account for paper supplies purchased in transaction 3. 220 100 —————————————————————————————————————————— 7. Paid a $200 cash dividend to shareholders. 370 100 —————————————————————————————————————————— 8. Paid $1,500 cash for rent for the current month. 530 100 —————————————————————————————————————————— 9. Received $1,200 cash advance from a customer for future copying. 100 280 —————————————————————————————————————————— 10. Billed a customer for $750 for photocopy work done. 120 400 —————————————————————————————————————————— 11. Paid $1,800 for a one-year insurance policy. 170 100 —————————————————————————————————————————— 12. Hired four employees to begin work in one month. Weekly salary is $600 per week. no entry no entry

Ex. 157 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 157 (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. 158 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.

The Accounting Information System

2. 3. 4. 5. 6. 7. 8.

Purchased equipment for $90,000, paying $30,000 in cash and signing a bank loan for the balance. Paid $1,200 for a one-year insurance policy. Recorded $25,000 for services provided on account. 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 158 (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

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50,000

30,000 60,000

1,200

25,000

6,500

15,000

4,000

2,000

Ex. 159 The August transactions for AllenKey Limited are presented below: 1. Cash of $100,000 was invested in AllenKey Limited in exchange for 50,000 common shares. 2. Purchased equipment costing $25,000 in exchange for a $15,000 bank loan and paid $10,000 cash for the remainder. 3. Purchased land costing $50,000 for cash. 4. Paid $2,400 cash for a one-year insurance policy. 5. Received $3,500 cash for services to be performed in September. 6. Received $5,000 for services previously performed on account. 7. Paid employee salaries for $13,500. 8. Declared and paid dividends of $500. Instructions

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

Prepare the journal entry for each transaction. Solution 159 1. Cash ............................................................................................. Common Shares ....................................................................

100,000

Equipment ..................................................................................... Bank Loan Payable ................................................................ Cash.......................................................................................

25,000

Land .............................................................................................. Cash.......................................................................................

50,000

Prepaid Insurance ......................................................................... Cash.......................................................................................

2,400

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

3,500

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

5,000

Salaries Expense .......................................................................... Cash.......................................................................................

13,500

Dividends Declared ....................................................................... Cash.......................................................................................

500

100,000

15,000 10,000

50,000

2,400

3,500

5,000

13,500

500

Ex. 160 A tabular analysis of the transactions made during December 2018 by Sacha Enterprises Ltd. is shown below. Each increase and decrease in shareholders’ equity is explained.

Assets = Accounts Cash + Receivable + Supplies + Inventory = Nov.30 Bal. $11,000 1. +10,000 2. 3. 4.

–5,000 –950 +2,500

5. 6. 7.

–1,000 –500 –800

8. 9.

+1,250 –1,900

10.

-1,040

11.

$2,800

$200

$9,000

+15,000

Accounts Payable $2,900

Shareholders’ Equity Common Retained Earnings + Shares + Revenues – Expenses – $20,000 +10,000

$5,600

$5,500

Dividends Declared $0 Common Shares

+10,000

+950 +4,800

+7,300

Service Revenue

–1,000 –800

–500 Dividend Supplies Expense

–1,250 –1,900 -1,040 +1,500

-1,500

Salaries Expense Advertising Expense Repair & Maintenance expense

The Accounting Information System

12.

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–960

-960

Income Tax Expense

Instructions (a) For each transaction, record the appropriate journal entry. (b) Using T Accounts, calculate the ending balance for each account. Note that the opening balance for Expenses is comprised of the following: Salaries Expense of $3,800, Depreciation Expense of $1,000, and Supplies Expense of $700. (c) Prepare a trial balance as at December 31, 2018. Solution 160 (a) 1.

10.

11.

12.

Cash ........................................................................ Common Shares ...............................................

10,000

Inventory .................................................................. Cash ................................................................. Accounts Payable .............................................

15,000

Supplies ................................................................... Cash .................................................................

950

Cash ........................................................................ Accounts Receivable ............................................... Service Revenue ...............................................

2500 4,800

Accounts Payable .................................................... Cash .................................................................

1,000

Dividends Declared .................................................. Cash .................................................................

500

Supplies Expense .................................................... Cash .................................................................

800

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

1,250

Salaries Expense ..................................................... Cash .................................................................

1,900

Advertising Expense ................................................ Cash .................................................................

1,040

Repair and Maintenance Expense ........................... Accounts Payable .............................................

1,500

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

960

10,000

5,000 10,000

950

7,300

1,000

500

800

1,250

1,900

1,040

1,500

960

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

(b)

Dec 31 Bal

Cash 11,000 10,000 (2) 2,500 (3) (5) (6) (7) 1,250 (9) (10) (12) 12,600

Nov 30 Bal (3) Dec 31 Bal

Supplies 200 950 1,150

Nov 30 Bal (1) (4)

(8)

(5)

5,000 950 1,000 500 800 1,900 1,040 960

Accounts Receivable____________ Nov 30 Bal 2,800 (4) 4,800 (8) 1,250 Dec 31 Bal 6,350

Nov 30 Bal (2) Dec 31 Bal

Inventory 9,000 15,000 24,000

Accounts Payable Nov 30 Bal 2,900 1,000 (2) 10,000 (11) 1,500 Dec 31 Bal 13,400

Common Shares Nov 30 Bal (1) Dec 31 Bal

Service Revenue Nov 30 Bal (4) Dec 31 Bal

Dividends Declared 20,000 10,000 30,000

5,600 7,300 12,900

Repair and Maintenance Expense Nov 30 Bal 1,000 (11) 1,500 Dec 31 Bal 2,500

(6) Dec 31 Bal

500 500

Salaries Expense Nov 30 Bal 3,800 (9) 1,900 Dec 31 Bal 5,700

Suppies Expense Nov 30 Bal 700 (7) 800 Dec 31 Bal 1,500

The Accounting Information System

Advertising Expense (10) 1,040 Dec 31 Bal 1,040

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Income Tax Expense (12) 960 Dec 31 Bal 960

(c) SACHA ENTERPRISES LTD. Trial Balance December 31, 2018 Cash .................................................................................................... Accounts receivable ............................................................................ Supplies ............................................................................................... Inventory .............................................................................................. Accounts payable ................................................................................ Common shares .................................................................................. Dividends declared .............................................................................. Service revenue................................................................................... Salaries expense ................................................................................. Depreciation expense .......................................................................... Supplies expense................................................................................. Advertising expense ............................................................................. Income tax expense ............................................................................

Debit $12,600 6,350 1,150 24,000

Credit

$13,400 30,000 500 12,900 5,700 2,500 1,500 1,040 960 $56,300

_ $56,300

Ex. 161 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, 2018: 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 supplies. 4. Purchased equipment for $12,000, paying $7,000 in cash and signing a 30-day bank loan payable for the balance. 5. Purchased $200 of supplies on account. 6. Real estate commission fees billed to clients totalled $9,700. 7. Paid $700 cash for the current month's rent. 8. Paid $100 cash on account for 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. Instructions (a) Record the transactions for September 2018. You may omit explanations. (b) Prepare a trial balance.

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

Solution 161 (15 min.) (a) 1. Cash ............................................................................................. Common Shares ....................................................................

50,000 50,000

No entry (not a transaction)

Supplies ........................................................................................ Cash.......................................................................................

400

Equipment ..................................................................................... Cash....................................................................................... Bank Loan Payable ................................................................

12,000

Supplies. ....................................................................................... Accounts Payable...................................................................

200

Accounts Receivable ..................................................................... Fees Earned...........................................................................

9,700

Rent Expense ............................................................................... Cash.......................................................................................

700

Accounts Payable ......................................................................... Cash.......................................................................................

100

Advertising Expense ..................................................................... Accounts Payable...................................................................

500

10. Salaries Expense .......................................................................... Cash.......................................................................................

3,500

11. Dividends Declared ....................................................................... 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, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $44,300 Accounts receivable ............................................................................. 4,700 Supplies ............................................................................................... 600 Equipment............................................................................................ 12,000 Accounts payable................................................................................. $ 600 Bank loan payable ............................................................................... 7,000

The Accounting Information System

Common shares................................................................................... Dividends declared .............................................................................. Fees earned......................................................................................... Rent expense....................................................................................... Advertising expense............................................................................. Salaries expense ................................................................................. Totals ..........................................................................................

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50,000 1,000 9,700 700 500 3,500 $67,300

$67,300

Ex. 162 The transactions of Finkel Brothers 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, 2018. General Journal —————————————————————————————————————————— Date Account Titles and Explanation Debit Credit 2018 Sep 1 Cash ................................................................................ 20,000 Common Shares ....................................................... 20,000 (Shareholders invested cash in business) 4

Vehicles ........................................................................... 40,000 Cash ......................................................................... Bank Loan Payable................................................... (Paid cash and issued 2-year, 9% bank loan for balance)

15,000 25,000

Rent Expense .................................................................. Cash ......................................................................... (Paid September rent)

1,200 1,200

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

500

Cash ................................................................................ Service Revenue ...................................................... (Received cash for delivery services)

3,200

Salaries Expense............................................................. Cash ......................................................................... (Paid salaries for current period)

750

Utilities Expense .............................................................. Accounts Payable ..................................................... (Received a bill for September utilities)

125

Dividends Declared ......................................................... Cash ......................................................................... (Paid dividends)

800

500

3,200

750

125

800

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

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Accounts Receivable ....................................................... 1,450 Service Revenue ...................................................... 1,450 (Billed customer for delivery service) —————————————————————————————————————————— Solution 162 (25 min.) General Ledger

9/30 Bal.

Cash 20,000 9/4 3,200 9/8 9/15 9/20 9/30 4,950

9/15 9/30 Bal.

Prepaid Insurance 500 500

9/1 9/18

Accounts Payable 9/25 9/30 Bal.

Common Shares 9/1 9/30 Bal.

Service Revenue 9/18 9/30 9/30 Bal.

9/20 9/30 Bal.

Salaries Expense 750 750

15,000 1,200 500 750 800

9/30

Accounts Receivable 1,450

9/30 Bal.

1,450

9/4 9/30 Bal.

Vehicles 40,000 40,000

125 125

Bank Loan Payable 9/4 9/30 Bal.

20,000 20,000

9/30 9/30 Bal.

Dividends Declared 800 800

9/8

Rent Expense 1,200

9/30 Bal.

1,200

9/25 9/30 Bal.

Utilities Expense 125 125

3,200 1,450 4,650

25,000 25,000

FINKEL BROTHERS LIMITED Trial Balance September 30, 2018 ——————————————————————————————————————————

The Accounting Information System

Cash .................................................................................................... Accounts receivable ............................................................................. Prepaid insurance ................................................................................ Vehicles ............................................................................................... Accounts payable................................................................................. Bank loan payable ............................................................................... Common shares................................................................................... Dividends declared .............................................................................. Service revenue ................................................................................... Rent expense....................................................................................... Salaries expense ................................................................................. Utilities expense .................................................................................. Totals ..........................................................................................

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Debit $ 4,950 1,450 500 40,000

Credit

$ 125 25,000 20,000 800 4,650 1,200 750 125 $49,775

0000000 $49,775

Ex. 163 Although the trial balance of Howcome Limited shown below is in balance, upon further investigation a number of errors were discovered HOWCOME LIMITED Trial Balance July 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 3,200 Accounts receivable ............................................................................. 13,200 Supplies ............................................................................................... 1,200 Equipment............................................................................................ 16,600 Accounts payable................................................................................. $19,500 Common shares................................................................................... 3,000 Dividends declared .............................................................................. 3,000 Service revenue ................................................................................... 29,500 Salaries expense ................................................................................. 7,600 Repair and maintenance expense ........................................................ 3,200 Income tax expense ............................................................................. 4,000 Totals .......................................................................................... $52,000 $52,000 An examination of the ledger and journal reveals the following: 1. Each of the above listed accounts has a normal balance. 2. Cash of $240 received from a customer on account was debited to Cash as $420 and credited to Accounts Receivable as $420. 3. Dividends of $450 paid to shareholders were posted as a credit to Dividends Declared of $450 and a credit to Cash of $450. 4. Salaries Expense was posted as $7,600 rather than the correct amount of $6,668 to the general ledger. 5. The purchase of equipment on account for $900 was recorded as a debit to Repair and Maintenance Expense and a credit to Accounts Payable. 6. Services were performed on account for a customer for $820. Accounts Receivable was debited $820 and Service Revenue was credited $82.

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

A payment on account for $340 was credited to Cash for $340 and credited to Accounts Payable for $430.

Instructions Prepare a correct trial balance. Solution 163 (25 min.) HOWCOME LIMITED Trial Balance July 31, 2018 —————————————————————————————————————————— Debit Credit Cash [$3,200 – $180 (2)] ..................................................................... $ 3,020 Accounts receivable [$13,200 + $180 (2)] ............................................ 13,380 Supplies ............................................................................................... 1,200 Equipment [$16,600 + $900 (5)] ........................................................... 17,500 Accounts payable [$19,500 – $430– $340 (7)] ..................................... $ 18,730 Common shares................................................................................... 3,000 Dividends declared [$3,000 + $450 + $450 (3)] .................................... 3,900 Service revenue [$29,500 + $738 (6)] .................................................. 30,238 Salaries expense (4) ............................................................................ 6,668 Repair and maintenance expense [$3,200 – $900 (5)] ......................... 2,300 Income tax expense ............................................................................. 4,000 000 000 Totals .......................................................................................... $51,968 $51,968

Ex. 164 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 164 (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.

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Ex. 165 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 $550 was journalized and posted as a debit to Cash $550 and a credit to Service Revenue $550. 2. A $1.500 purchase of supplies on account was recorded as a debit of $1,500 to Equipment and a credit of $1,500 to Accounts Payable. 3. A purchase of equipment for $6,000 on account was not recorded. 4. A $720 receipt on account was recorded as a $270 debit to Cash and a $720 credit to Accounts Receivable. Solution 165 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 $450 higher than the credit column.

Ex. 166 Archer Corporation is a financial planning service. The account balances at December 31, 2018 are shown below, in alphabetical order: Accounts Payable ............................................................. $ 4,000 Accounts Receivable......................................................... 18,000 Bank Loan Payable ........................................................... 95,000 Building ............................................................................. 120,000 Cash ................................................................................. 18,500 Common Shares ............................................................... 149,700 Equipment......................................................................... 26,200 Inventory ........................................................................... 8,100 Land.................................................................................. 59,600 Retained Earnings ............................................................ 30,000 Supplies ............................................................................ 800 Vehicles ............................................................................ 27,500 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 166 (10 min.) ARCHER CORPORATION

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

Trial Balance December 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 18,500 Accounts receivable ............................................................................. 18,000 Inventory .............................................................................................. 8,100 Supplies ............................................................................................... 800 Equipment............................................................................................ 26,200 Vehicles ............................................................................................... 27,500 Building ................................................................................................ 120,000 Land..................................................................................................... 59,600 Accounts payable................................................................................. $ 4,000 Bank loan payable ............................................................................... 95,000 Common shares................................................................................... 149,700 Retained earnings ............................................................................... 0000000 30,000 Totals .......................................................................................... $278,700 $278,700

Ex. 167 The ledger accounts of the Fitness Guru Limited at October 31, 2018 are shown below, in alphabetical order: Accounts Payable ............................................................. $ 9,200 Accounts Receivable......................................................... 3,050 Bank Loan Payable ........................................................... 29,000 Building ............................................................................. 64,500 Cash ................................................................................. 11,800 Common Shares ............................................................... 57,100 Dividends Declared ........................................................... 4,500 Equipment......................................................................... 51,900 Fees Earned ..................................................................... 6,000 Office Expense.................................................................. 3,500 Rent .................................................................................. 3,500 Retained Earnings ............................................................ 43,700 Supplies ............................................................................ 2,250 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 167 (10 min.) FITNESS GURU LIMITED Trial Balance October 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 11,800 Accounts receivable ............................................................................. 3,050 Supplies ............................................................................................... 2,250

The Accounting Information System

Equipment............................................................................................ Building ................................................................................................ Accounts payable................................................................................. Bank loan payable ............................................................................... Common shares................................................................................... Dividends declared .............................................................................. Retained earnings ................................................................................ Fees earned......................................................................................... Rent ..................................................................................................... Office expense ..................................................................................... Totals ..........................................................................................

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51,900 64,500 $ 9,200 29,000 57,100 4,500 43,700 6,000 3,500 3,500 0 000000 $145,000 $145,000

Ex. 168 The adjusted trial balance at October 31, 2018 is presented below for Carnegie & Hurst Limited: CARNEGIE & HURST LIMITED Trial Balance October 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 5,200 Accounts receivable ............................................................................. 70,100 Prepaid insurance ................................................................................ 19,100 Supplies ............................................................................................... 2,150 Equipment............................................................................................ 34,000 Accumulated depreciation—equipment ................................................ $ 1,700 Building ................................................................................................ 81,785 Accumulated depreciation—building .................................................... 8,179 Accounts payable................................................................................. 39,200 Unearned revenue ............................................................................... 42,600 Bank loan payable ............................................................................... 37,100 Common shares................................................................................... 69,500 Retained earnings ................................................................................ 13,700 Service revenue ................................................................................... 113,300 Salaries expense ................................................................................. 58,099 Rent expense....................................................................................... 25,200 Insurance expense............................................................................... 13,100 Utilities expense ................................................................................... 6,650 Supplies expense................................................................................. 4,500 Depreciation expense .......................................................................... 3,745 Interest expense .................................................................................. 1,500 Income tax expense ............................................................................. 150 Totals .......................................................................................... $325,279 $325,279 Instructions Prepare an income statement, statement of changes in equity, and statement of financial position for the year ended October 31, 2018. Solution 168

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

CARNEGIE & HURST LIMITED Income Statement Year Ended October 31, 2018 Revenues Service revenue ............................................................................................ Expenses Salaries expense .................................................................. $58,099 Rent expense........................................................................ 25,200 Insurance expense................................................................ 13,100 Utilities expense .................................................................... 6,650 Supplies expense.................................................................. 4,500 Depreciation expense ........................................................... 3,745 Interest expense ................................................................... 1,500 Total expenses .................................................................................... Income before income tax ...................................................................................... Income tax expense ............................................................................................... Net income.............................................................................................................

CARNEGIE & HURST LIMITED Statement of Changes in Equity Year Ended October 31, 2018 Common Retained Shares Earnings Balance, November 1, 2017 $69,500 $13,700 Net income 000000 356 Balance, October 31, 2018 $69,500 $14,056

$113,300

112,794 506 150 $ 356

Total Equity $83,200 356 $83,556

CARNEGIE & HURST LIMITED Statement of Financial Position October 31, 2018 Assets Current assets Cash ................................................................................................ Accounts receivable ........................................................................ Prepaid insurance ........................................................................... Supplies ......................................................................................... Total current assets .................................................................... Property, plant and equipment Equipment .................................................. $34,000 Less: Accumulated depreciation ................. 1,700 Building ...................................................... $81,785 Less: Accumulated depreciation ................. 8,179 Total property, plant and equipment ............................................ Total assets .........................................................................................

$ 5,200 70,100 19,100 2,150 $ 96,550

$32,300 73,606 105,906 $202,456

Liabilities and Shareholders’ Equity

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Current liabilities Accounts payable ............................................................................ Unearned revenue ........................................................................... Total current liabilities ................................................................. Non-current liabilities Bank loan payable ........................................................................... Total liabilities ............................................................................. Shareholders’ equity Common shares .............................................................................. Retained earnings ........................................................................... Total liabilities and shareholders’ equity ......................................

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$39,200 42,600 $ 81,800 37,100 118,900

$69,500 14,056

83,556 $202,456

Ex. 169 The following trial balance for McMurtry Ltd. does not balance at December 31, 2018: MCMURTRY LTD. Trial Balance December 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $15,400 Accounts receivable ............................................................................. 6.530 Supplies ............................................................................................... 1,800 Building ................................................................................................ 7,350 Accumulated depreciation—building .................................................... $ 2,940 Accounts payable................................................................................. 1,980 Salaries payable .................................................................................. 900 Unearned revenue ............................................................................... 200 Common shares................................................................................... 15,000 Dividends declared .............................................................................. 500 Retained earnings ................................................................................ 8,649 Service revenue ................................................................................... 8,650 Salaries expense ................................................................................. 3,700 Depreciation expense .......................................................................... 1,270 Supplies expense................................................................................. 1,100 Income tax expense ............................................................................. 669 Totals .......................................................................................... $52,819 $23,819 Additional Information: 1. A journal entry to record a $320 purchase of supplies on account was not recorded or posted. 2. A journal entry to record a customer deposit of $350 for services not yet performed was debited to Cash and credited to Service Revenue. Instructions Prepare a corrected trial balance. Journal entries are not required.

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

Solution 169 MCMURTRY LTD. Trial Balance December 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $15,400 Accounts receivable ............................................................................. 6.530 Supplies ($1,800 + $320) ..................................................................... 2,120 Equipment............................................................................................ 7,350 Accumulated depreciation—equipment ................................................ $ 2,940 Accounts payable ($1,980 + $320)....................................................... 2,300 Salaries payable .................................................................................. 900 Unearned revenue ($200 + $350) ........................................................ 550 Common shares (normal credit balance).............................................. 15,000 Dividends declared (normal debit balance) .......................................... 500 Retained earnings ................................................................................ 8,649 Service revenue ($8,650 – $350) ......................................................... 8,300 Salaries expense ................................................................................. 3,700 Depreciation expense .......................................................................... 1,270 Supplies expense................................................................................. 1,100 Income tax expense ............................................................................. 669 Totals .......................................................................................... $38,639 $38,639

Ex. 170 The trial balance shown below for Cohen’s Inc. does not balance: COHEN’S INC. Trial Balance October 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 7,710 Accounts receivable ............................................................................. 24.650 Supplies ............................................................................................... 800 Equipment............................................................................................ 36,200 Accumulated depreciation - equipment ................................................ $ 6,520 Accounts payable................................................................................. 26,020 Salaries payable .................................................................................. 900 Unearned revenue ............................................................................... 200 Retained earnings ................................................................................ 21,847 Service revenue ................................................................................... 47,221 Salaries expense ................................................................................. 16,785 Rent expense ....................................................................................... 12,000 Depreciation expense .......................................................................... 3,260 Supplies expense................................................................................. 700 Income tax expense ............................................................................. 4,442 Totals .......................................................................................... $106,547 $102,708 Upon review of the ledger accounts the following errors were identified:

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1. 2. 3. 4. 5.

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A payment on account for $234 was credited to Cash for $324 and debited to Accounts Payable for $234. Supplies expense of $200 was posted as a credit rather than a debit. Services performed on account for $810 was posted as a debit to Accounts Receivable for $810 and a credit to Service Revenue for $81. The cost of equipment is $32,600, not $36,200. A journal entry to record a $400 purchase of supplies on account was recorded as a debit to Supplies and a credit to Cash.

Instructions Prepare a corrected trial balance. Journal entries are not required. Solution 170 COHEN’S INC. Trial Balance October 31, 2018 —————————————————————————————————————————— Debit Credit Cash ($7,710 + $324 – $234 + $400)................................................... $ 8,200 Accounts receivable ............................................................................. 24,650 Supplies ............................................................................................... 800 Equipment (report $32,600 rather than $36,200).................................. 32,600 Accumulated depreciation—equipment ................................................ $ 6,520 Accounts payable ($26,020 + $400) ..................................................... 26,420 Salaries payable .................................................................................. 900 Unearned revenue ............................................................................... 200 Retained earnings ................................................................................ 21,847 Service revenue ($47,221 – $81 + $810) ............................................. 47,950 Salaries expense ................................................................................. 16,785 Rent expense ....................................................................................... 12,000 Depreciation expense .......................................................................... 3,260 Supplies expense ($700 + $200 + $200) .............................................. 1,100 Income tax expense ............................................................................. 4,442 Totals .......................................................................................... $103,837 $103,837

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

MATCHING QUESTIONS 171. 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

F. G. H. I. J.

Journal Posting Chart of accounts Trial balance Source document

____ 1. The entire group of accounts maintained by a company ____ 2. Transferring journal entries to ledger accounts ____ 3. The side which increases an account ____ 4. A list of all the accounts used by a company ____ 5. An accounting record of increases and decreases in specific assets, liabilities, and shareholders’ equity items ____ 6. Left side of an account ____ 7. Evidence that a transaction has taken place ____ 8. Shows the debit and credit effects of specific transactions ____ 9. A list of accounts and their balances at a given time ____ 10. An account with a normal credit balance

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ANSWERS TO MATCHING 1.

10. D

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

SHORT-ANSWER ESSAY QUESTIONS S-AE 172 Provide an explanation for each of the following: 1. Why are investments made by shareholders not recorded as revenue? How should they be recorded? 2. Why is interest not recorded when borrowing and signing a bank loan? 3. Why is an increase in an expense shown as a negative number in the accounting equation? 4. Why is cash received before services are performed not regarded as revenue? 5. Why are dividends declared not recorded as an expense? Solution 172 1. Investments made by shareholders are not recorded as revenue because they are not generated from the ordinary operating activities of the company. Instead they are recorded as common shares of the company. 2.

No interest is owed at the time that the bank loan is signed. Interest is recorded as it accumulates, which requires the passage of time.

Increases in expenses are shown as a negative number in the accounting equation because expenses decrease retained earnings, which in turn decreases shareholders’ equity.

Cash received before services are performed is regarded as unearned revenue which is a liability account. An obligation or liability exists until the service is performed. Revenue recognition criteria will be covered in Chapter 4.

Dividends declared 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 declared are distributions of retained earnings to shareholders. They are reported on the statement of changes in equity, separately from net income.

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 declared, 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.

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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-A E 175 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 175 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 (net income) 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 176 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 176 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

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

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 177 The following trial balance was obtained from Cloverdale Ltd.'s computer system at the end of the first month of operations, November 30, 2018. RPT TR BAL DPT ACC MGR PRIORITY 2 RUN BY R.HAMES SEQUENCE 997411 ACCOUNT BAL CASH 17700 SUPPLIES 5600 ACC PAY 7500– BANK LOAN PAY 1200– COMMON SHARES 5000– DIVIDENDS DECLARED 500 SERVICE REVENUE 15000– SALARIES EXP 3500 RENT EXP 900 OFFICE EXP 500 BAL 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. (c) Describe some of the features of a computerized accounting system. Solution 177 (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.

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(b)

CLOVERDALE LTD. Trial Balance November 30, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $17,700 Supplies ............................................................................................... 5,600 Accounts payable................................................................................. $ 7,500 Bank loan payable ............................................................................... 1,200 Common shares................................................................................... 5,000 Dividends declared .............................................................................. 500 Service revenue ................................................................................... 15,000 Salaries expense ................................................................................. 3,500 Rent expense....................................................................................... 900 Office expenses ................................................................................... 500 _______ Totals .......................................................................................... $28,700 $28,700 (c) Some of the features of a computerized accounting system include: 1. Journals are kept as files and accounts are maintained in computer databases. 2.

Posting of journal entries is usually performed simultaneously after each journal entry is prepared.

The computer is usually programmed to flag violations of the normal balance and to print out error or exception reports.

Accounts can easily be rearranged in whatever order is wanted.

The trial balance is usually balanced because the system will not let you enter an unbalanced journal entry.

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

OBJECTIVE FORMAT QUESTIONS 178. Indicate all of the following that would be recorded in the accounting records: (a) Great Escapes Corporation signed a contract to hire Michel Durand to manage their operations in Nice, France. (b) The Grey Foxes Ltd., a national baseball team located in Ontario, signed on a new player. A signing bonus of $200,000 was paid to the player at the time of signing the contract. He will begin playing in six months. (c) Show Time Industries Ltd. issued new common shares totalling $200,000. (d) Sage Wick Inc. purchased equipment on account for $5,000. (e) Hillcrest Ltd. received an offer from another company to purchase their old factory site for $1.6M. (f) Tough Corp. signed a contract with Brittle Inc. to purchase $4,000 in inventory, payable in 30 days. (g) Lucky Fabricators Ltd. presented a bid to make a $56,000 piece of customized equipment to Jill Hill Company Inc. (h) Lucky Fabricators Ltd. won the bid to make a $56,000 piece of customized equipment for Jill Hill Company Inc. The equipment was fabricated and delivered. Jill Hill will pay for the equipment in instalments over six months. Solution 178 Answers (b), (c), (d), (f), and (h) would require an accounting transaction as they all reflect an economic event that changed the company’s financial position (assets, liabilities, or shareholders’ equity) in a measurable way. (a) In this case an accounting transaction has not occurred. Signing a contract to hire an employee does not change the company’s financial position. When the employee starts work, an exchange of his service for monetary pay will necessitate a transaction to occur. (e) Since Hillcrest Ltd. has not yet accepted the offer, a transaction has not occurred. (g) No transaction has occurred. Making a bid does not impact the company’s financial position. When the company wins the bid and fabricates the equipment, an accounting transaction will then occur.

179. Select each of the following statements that are always true with regards to financial statements and the relationships between financial statements. (a) Retained earnings is reported on both the Statement of Financial Position and the Statement of Changes in Equity. (b) Dividends declared is reported on the Statement of Financial Position only. (c) The opening balance of common shares is only reported on the Statement of Changes in Equity. (d) The ending balances of common shares, retained earnings and total equity are transferred from the Statement of Changes in Equity to the Statement of Financial Position. (e) The ending balance of retained earnings is calculated on the Statement of Changes of Equity by adding the net income to the beginning retained earnings balance.

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(f) An accountant must first complete the Statement of Changes in Equity so that they are able to complete the Income Statement. (g) The following balances are shown on more than one financial statement: net income, ending retained earnings and ending common shares. (h) The order of financial statement preparation is: (1) Statement of Changes in Equity, (2) Income Statement and (3) Statement of Financial Position. Solution 179 (a), (c), (d), and (g) are correct; (b), (e), (f), and (h) are incorrect. (b) Dividends declared is reported on the Statement of Changes in Equity. (e) The ending balance of retained earnings is calculated by adding the net income to the beginning balance of retained earnings and then subtracting dividends declared, if any have been declared during the period. (f) An accountant must first complete the Income Statement before completing the Statement of Changes in Equity. The net income amount is transferred to the Statement of Changes in Equity in order to calculate the ending balance of retained earnings. (h) The correct order of financial statement preparation is (1) Income Statement, (2) Statement of Changes in Equity, and (3) Statement of Financial Position.

180. The following is a selection of journal entries that Canadian Enterprises Ltd. recorded in its first month of operations. Indicate all of the entries that were correctly recorded. (a)

(b)

(c)

(d)

(e)

June 1

June 2

June 5

June 15

June 22

Cash Common Shares Cash of $125,000 was invested in exchange for 12,500 common shares

125,000

Salaries Expense Salaries Payable Hired a new employee with a salary of $2,000 per month to be paid at the end of each month

2,000

Prepaid Insurance Cash Paid $2,700 for a one-year insurance policy

2,700

125,000

2,000

2,700

Supplies Accounts Receivable Purchased two months of supplies on account from Biggy Industries for $450

450

Cash Sales Sold $5,000 of merchandise for cash

5,000

450

5,000

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(f)

(g)

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

June 31

Salaries Expense Cash Paid salaries totalling $5000 to staff Utilities Expense Cash Received a bill from Atticus Utilities for $400 for electricity for June

5,000 5,000

400 400

Solution180 (a), (c), (e), and (f) are correct; (b), (d), and (g) are incorrect. (b) Hiring an employee does not require an accounting transaction. An accounting transaction will occur when the employee has worked and is paid. No entry should be recorded for this event. (d) When purchases are made on account, this increases accounts payable, not accounts receivable. The journal entry should be: Supplies 450 Accounts Payable 450 (g) Since they only received the bill but have not yet paid it, the transaction should be recorded as follows: Utilities Expense 450 Accounts Payable 450

181. Select each of the following statements that are true with regards to journalizing transactions. (a) The information recorded in a journal entry includes the date the transaction occurred, the debit account name(s), the credit account name(s), the amounts debited and credited, and a brief explanation of the transaction. (b) In a journal, the account to be debited is indented. (c) The amounts debited are recorded in the right column and the amounts to be credited are recorded in the left column. (d) A compound entry is one where three or more accounts are required in the journal entry. (e) Account names should be as specific as possible and may contain a description of the transaction (such as equipment purchased). (f) Debit entries are recorded first and then credit entries. (g) Companies generally maintain only one type of ledger. (h) If debits do not equal credits in a journal entry, an error must have been made. Solution 181 (a), (d), (f), and (h) are correct; (b), (c), (e), and (g) are incorrect. (b) In a journal entry, the account that is credited is indented. (c) The amounts debited are recorded in the left column, while the amounts credited are

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recorded in the right column. (e) Account names can be specific but not so specific that they describe the transaction that has taken place. All transactions related to vehicles, for instance, should be recorded the vehicle account. It would be confusing if transactions were recorded to truck purchased, car purchased, car sold or other accounts. Using a common name for all transactions related to vehicles will simplify analysis and reporting. (g) There can be multiple types of ledgers maintained by companies. For instance, companies can have subsidiary ledgers related to customers and creditors, in addition to their general ledger.

182. The following trial balance was provided for the month of July for Elevated Inc.:

The accountant for Elevated is concerned that the trial balance is not balancing. Upon further research, the accountant also compiled the following information: 1. A payment on the bank loan of $5,000 was made on July 31, but not recorded in the journal. 2. A journal entry to record service revenue on account was accidently recorded as revenue for $1,250 when it should be $2,150. 3. The equipment depreciation expense account totalling $940 was accidently excluded from the trial balance. 4. The journal entry to record the cash payment of rent totalling $1,000 for the month was recorded twice.

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

The above trial balance also does not reflect prepaid insurance that was purchased on July 31 totalling $400. The company must pay this invoice in 30 days.

Instructions Select all of the statements that are correct. (a) The correct balance for the debit and credit columns should be $62,250. (b) Dividends declared are correctly reflected on the trial balance. (c) Both the Accounts Receivable and the Service Revenue account balances need to be increased by $900. (d) The cash balance should be $3,500. (e) Unearned revenue should be credited on the trial balance. (f) The accounts payable balance should be $1,980. (g) The bank loan should have a balance of $24,870. (h) The equipment balance on the trial balance should be adjusted. Solution 182 (a), (c), (e), and (f) are correct; (b), (d), (g), and (h) are incorrect. The following is the corrected trial balance for Elevate Inc.

(b) As shown above, Dividends Declared should have a debit balance. (d) The cash balance should be $4,500. Original balance = $8,500 – $5,000 (payment of loan)

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+ $1,000 (remove double entry for rent) = $4,500. (g) The bank loan balance should be $19,870. Original Balance $24,870 – $5,000 (payment of loan) = $19,870. (h) The equipment balance is correct on the trial balance. The journal entry to record accumulated depreciation was recorded correctly. The accountant simply forgot to include the accumulated depreciation account on the trial balance.

CHAPTER 4 ACCRUAL ACCOUNTING CONCEPTS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’sCPA AACSB True-False Statements 1. 1 E K F AN 14. 2 M C F AN 27. 4 M K F AN 2. 1 E K F AN 15. 2 M C F AN 28. 4 M K F AN 3. 1 M C F AN 16. 2 M C F AN 29. 4 M C F AN 4. 1 M K F AN 17. 2 E K F AN 30. 5 E C F AN 5. 1 E K F AN 18. 2 M C F AN 31. 5 E K F AN F AN F AN F AN 6. 1 E C 19. 2 M K 32. 5 E K 7. 1 E K F AN 20. 2 M C F AN 33. 5 M K F AN 8. 1 E K F AN 21. 2 M C F AN 34. 5 M C F AN 9. 1 E K F AN 22. 3 M K F AN 35. 5 E K F AN 10. 1 M K F AN 23. 3 H AP F AN 36. 5 E C F AN 11. 1 E C F AN 24. 3 M C F AN 37. 5 E C F AN 12. 1 M K F AN 25. 4 M K F AN 13. 2 E K F AN 26. 4 E C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional and Ethical Behaviour AACSB: AN = Analytic E = Ethics

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

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Multiple Choice Questions 38. 1 M C F AN 70. 2 M AP F AN 102. 3 M C F AN 39. 1 E C F AN 71. 2 M C F AN 103. 3 H C F AN 40. 1 E C F AN 72. 2 E C F AN 104. 3 H C F AN 41. 1 E C F AN 73. 2 M AP F AN 105. 3 H AP F AN 42. 1 E AP F AN 74. 2 M AP F AN 106. 3 M AP F AN 43. 1 E C F AN 75. 2 E C F AN 107. 3 M AP F AN 44. 1 M C F AN 76. 2 E C F AN 108. 3 M AP F AN 45. 1 M C F AN 77. 2 M K F AN 109. 3 E AP F AN 46. 1 M C F AN 78. 2 M AP F AN 110. 3 M AP F AN 47. 1 M C F AN 79. 2 M AP F AN 111. 3 M AP F AN 48. 1 M C F AN 80. 2 H AP F AN 112. 3 M AP F AN 49. 1 H C F AN 81. 2 H AP F AN 113. 3 H AP F AN 50. 1 H C F AN 82. 2 M C F AN 114. 4 M C F AN 51. 1 H C F AN 83. 2 M C F AN 115. 4 M AP F AN 52. 1 M C F AN 84. 2 H C F AN 116. 4 M C F AN 53. 1 M C F AN 85. 2 H C F AN 117. 4 E K F AN 54. 1 M C F AN 86. 2 M C F AN 118. 4 E K F AN 55. 1 M C F AN 87. 2 M AP F AN 119. 4 M C F AN 56. 1 M C F AN 88. 2 H AP F AN 120. 4 M K F AN 57. 1 E C F AN 89. 2 M AP F AN 121. 4 M K F AN 58. 1 M K F AN 90. 2 E K F AN 122. 4 E K F AN 59. 2 M C F AN 91. 2 M K F AN 123. 5 M K F AN 60. 2 M C F AN 92. 2 H C F AN 124. 5 M C F AN 61. 2 M C F AN 93. 2 M C F AN 125. 5 E K F AN 62. 2 M AP F AN 94. 2 M AP F AN 126. 5 M K F AN 63. 2 M C F AN 95. 2 M K F AN 127. 5 M K F AN 64. 2 M C F AN 96. 2 M AP F AN 128. 5 M C F AN 65. 2 H C F AN 97. 2,3 H C F AN 129. 5 M C F AN 66. 2 E C F AN 98. 2,3 H C F AN 130. 5 E K F AN 67. 2 H K F AN 99. 3 M C F AN 131. 5 E K F AN 68. 2 M C F AN 100. 3 H K F AN 132. 5 E K F AN 69. 2 M K F AN 101. 3 H C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional and Ethical Behaviour AACSB: AN = Analytic E = Ethics

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LODBloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Exercises 133. 1 M AP F AN 145. 2,3 M AP F AN 157. 2,3 E AP F AN 134. 1,2,3 H AP F AN 146. 2,3 M C F AN 158. 2,3 M AP F AN 135. 1,2,3 H AP F AN 147. 2,3 H C F AN 159. 2,4 H AP F AN 136. 1,2,3 H AP F AN 148. 2,3 H K F AN 160. 2-4 M AP F AN AP F AN 149. 2,3 E F AN 161. 2-4 M AP F AN 137. 1,2,3 H C AN F AN 150. 2,3 E AP F AN 162. 3 E F AN 138. 2 H AP AP F AN 151. 2,3 E AP F AN 163. 3 M AP F AN 139. 2 M F AN AP F AN AP F AN 140. 2 M AP 152. 2,3 M 164. 4 E F AN 153. 2,3 H AP F AN 165. 4,5 M AP F AN 141. 2 H AP 142. 2,3 M C F AN 154. 2,3 E C F AN 166. 5 E AP F AN 143. 2,3 M AP F AN 155. 2,3 E AP F AN 167. 5 E AP F AN 144. 2,3 M AP F AN 156. 2,3 M AP F AN 168. 5 E AP F AN Matching 169. 1-5 E C F AN Short-Answer Essay 170. 1 M C F AN 173. 1-3 E C F AN 176. 2,3 H AN F AN 171. 1 E C F AN 174. 2 M AP F, P AN, E 177. 2,3 E C F AN 172. 1-3 H AN F AN 175. 2 M C F AN CPA Questions 178. 1 M C F AN 180. 1,2 M K F AN 182. 3-5 H AN F AN 179. 1,2 M C F AN 181. 3-5 M K F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional and Ethical Behaviour AACSB: AN = Analytic E = Ethics

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Item

Type

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

TF TF TF TF TF TF TF TF

9. 10. 11. 12. 38. 39. 40. 41.

TF TF TF TF MC MC MC MC

13. 14. 15. 16. 17. 18. 19. 20. 21. 59. 60. 61. 62. 63. 64.

TF TF TF TF TF TF TF TF TF MC MC MC MC MC MC

65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79.

MC MC MC MC MC MC MC MC MC MC MC MC MC MC MC

22. 23. 24. 97. 98. 99. 100. 101. 102.

TF TF TF MC MC MC MC MC MC

103. 104. 105. 106. 107. 108. 109. 110. 111.

MC MC MC MC MC MC MC MC MC

25. 26. 27. 28.

TF TF TF TF

29. 114. 115. 116.

TF MC MC MC

30. TF 35. TF 31. TF 36. TF 32. TF 37. TF 33. TF 123. MC 34. TF 124. MC Type: TF = True-False Ex = Exercise

Item

Type Item Type Learning Objective 1 42. MC 50. MC 43. MC 51. MC 44. MC 52. MC 45. MC 53. MC 46. MC 54. MC 47. MC 55. MC 48. MC 56. MC 49. MC 57. MC Learning Objective 2 80. MC 95. MC 81. MC 96. MC 82. MC 97. MC 83. MC 98. MC 84. MC 134. Ex 85. MC 135. Ex 86. MC 136. Ex 87. MC 137. Ex 88. MC 138. Ex 89. MC 139. Ex 90. MC 140. Ex 91. MC 141. Ex 92. MC 142. Ex 93. MC 143. Ex 94. MC 144. Ex Learning Objective 3 112. MC 145. Ex 113. MC 146. Ex 134. Ex 147. Ex 135. Ex 148. Ex 136. Ex 149. Ex 137. Ex 150. Ex 142. Ex 151. Ex 143. Ex 152. Ex 144. Ex 153. Ex Learning Objective 4 117. MC 121. MC 118. MC 122. MC 119. MC 159. Ex 120. MC 160. Ex Learning Objective 5 125. MC 130. MC 126. MC 131. MC 127. MC 132. MC 128. MC 165. Ex 129. MC 166. Ex MC = Multiple Choice SAE = Short-Answer Essay

Item

Type

Item

Type

58. 133. 134. 135. 136. 137. 169. 170.

MC Ex Ex Ex Ex Ex Ma SAE

171. 172. 173. 178. 179. 180.

SAE SAE SAE CP CP CP

145. 146. 147. 148. 149. 150. 151. 152. 153. 154. 155. 156. 157. 158. 159.

Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex Ex

160. 161. 169. 172. 173. 174. 175. 176. 177. 179. 180.

Ex Ex Ma SAE SAE SAE SAE SAE SAE CP CP

154. 155. 156. 157. 158. 160. 161. 162. 163.

Ex Ex Ex Ex Ex Ex Ex Ex Ex

169. 172. 173. 176. 177. 181. 182.

Ma SAE SAE SAE SAE CP CP

161. 164. 165. 169.

Ex Ex Ex Ma

181. 182.

CP CP

Ma = Matching CP = CPA

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CHAPTER LEARNING OBJECTIVES 1.

Explain the accrual basis of accounting and the reasons for adjusting entries. Under the accrual basis of accounting, revenues are recognized (recorded) when they are earned, while expenses are recognized (recorded) when they are incurred. This means that revenues are recognized when performance obligations have been identified and satisfied, regardless of whether cash has been received. Expenses are recognized in the period when the company incurs them in an effort to generate revenue, regardless of whether cash has been paid. This differs from the cash basis of accounting in which companies record events only in the periods in which the company receives (revenues) or pays cash (expenses). Companies make adjusting entries at the end of each accounting period. These entries ensure that companies record revenues in the period in which they are earned and that companies recognize expenses in the period in which they are incurred. There are two general types of adjusting entries: (1) prepayments, which allocate a portion of an asset’s cost or unearned revenue to the income statement, and (2) accruals, which increase expenses or revenues in the income statement and the related payable or receivable in the statement of financial position.

Prepare adjusting entries for prepayments. Prepayments involve accounts that have previously been recorded as assets (such as when cash was paid in advance for prepaid expenses) or liabilities (such as when cash was received in advance for unearned revenues). The adjusting entry for prepaid expenses results in an increase (debit) to an expense account and a decrease (credit) to an asset account or an increase (credit) to a contra asset account. The adjusting entry for unearned revenues results in a decrease (debit) to a liability (Unearned Revenue) 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 expenses and revenues that apply to the current accounting period and that have not already been recognized through transaction journal entries. Accruals involve accounts for which there has been no cash received or paid as yet. The adjusting entry for accrued expenses results in an increase (debit) to an expense account and an increase (credit) to a liability (payable) account. The adjusting entry for accrued revenues results in an increase (debit) to an asset (receivable) account and an increase (credit) to a revenue account.

Prepare an adjusted trial balance and financial statements. 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. It demonstrates that total debits equal total credits. 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 reset the balance in all temporary accounts (revenue, expense, and Dividends

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Declared accounts) to zero for the beginning of the new accounting period. To accomplish this, entries are made to close each individual revenue and expense account to a temporary account called Income Summary, which summarizes net income (or net loss). The Income Summary account is then closed to the Retained Earnings account. The Dividends Declared account is closed directly to Retained Earnings (and not via the Income Summary account, because dividends do not affect net income). A post-closing trial balance lists only permanent accounts (statement of financial position accounts) because these account balances are carried forward to the next accounting period. The purpose of the post-closing trial balance, as with other trial balances, 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 time periods.

2. An accounting transaction never affects more than one accounting time period.

3. Revenue results when there is an increase in a liability or a decrease in an asset.

4. Revenue must be recognized when (or as) the company satisfies the performance obligation, regardless of whether or not the transaction price has been determined.

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. Since some costs are not recorded, adjusting entries are necessary.

12. For a private company reporting under ASPE, adjusting entries must be prepared at least quarterly.

13. Prepaid expenses are costs that are paid for before they are used.

14. Expenses paid before being used or consumed are initially recorded as liabilities.

15. When money is received from a customer prior to the delivery of goods or the performance of a service, it is recorded as revenue.

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

16. The purchase of certain types of long-lived (non-current) assets is essentially a long-term prepayment for services.

17. The cost of any depreciable asset less accumulated depreciation reflects the carrying amount of the asset.

18. The carrying amount of a depreciable asset is always equal to its actual value because depreciation is a valuation technique.

19. Accumulated Depreciation is a liability account and its normal account balance is a credit.

20. The balances of the Depreciation Expense and the Accumulated Depreciation accounts should always be the same.

21. A contra asset account is subtracted from a related asset account in the statement of financial position and has a normal credit balance.

22. Adjusting entries never affect cash.

23. If a three-month, 6% bank loan for $5,000 is signed on October 1, the interest expense for the month of October is $25. Solution: Correct interest expense: $5,000 x.06 x 1/12 = $25

24. The adjustment for accrued salaries results from services being paid for after the services are performed.

25. The statement of financial position and income statement can be prepared from the information provided by an adjusted trial balance.

26. An adjusted trial balance must be prepared before the adjusting entries can be recorded.

27. The purpose of an adjusted trial balance is to ensure all adjusting entries have been recorded.

28. The statement of changes in equity is prepared from the Common Shares, Retained Earnings and Dividends Declared accounts on the adjusted trial balance.

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29. When preparing the statement of financial position, the balance of Retained Earnings is taken from the Adjusted Trial Balance. 30. The post-closing trial balance will contain only permanent accounts.

31. The Dividends Declared account is closed to the Income Summary account at the end of each year.

32. Financial statements are generally prepared before the closing entries are posted.

33. The Income Summary account is a permanent account.

34. When closing entries are posted, the result is a zero balance in each income statement account.

35. Closing entries are prepared before adjusting entries.

36. Closing entries result in the transfer of net income or loss into the Retained Earnings account.

37. The post-closing trial balance will have fewer accounts than the adjusted trial balance.

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

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 F T

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

Ans. T F F F T T F T

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

Ans. T F F F F T F T

Item 33. 34. 35. 36. 37.

Ans. F T F T T

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MULTIPLE CHOICE QUESTIONS 38. Adjusting entries are needed (a) to produce relevant financial information. (b) only under the cash basis of accounting. (c) to update accounts at the beginning of the accounting period. (d) for budgeting purposes.

39. Under IFRS, which of the following is generally not a guideline for recognizing revenue? (a) When (or as) the company satisfies the performance obligation. (b) The contract is identified with the client. (c) Collection is reasonably assured. (d) The transaction price is determinable.

40. Which of the following is not generally an accounting time period? (a) a week (b) a month (c) a quarter (d) a year

41. 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.

42. Under IFRS, revenue recognition criteria include recognizing revenue when (a) cash is received. (b) the company satisfies the performance obligation. (c) related expenses are recognized. (d) the revenue is recorded. 43. 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.

44. 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

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

45. 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? (a) July 7 (b) July 11 (c) June 30 (d) July 1

46. 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.

47. Under the accrual basis of accounting (a) cash must be received before revenue is recognized. (b) net income is calculated by matching cash outflows against cash inflows. (c) revenue is recognized when earned, while expenses are recognized when incurred to generate revenue. (d) the ledger accounts must be adjusted to reflect a cash basis of accounting before financial statements are prepared under generally accepted accounting principles.

48. Using accrual accounting, expenses are recorded and reported only (a) when they are incurred for the purpose of generating revenue, 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.

49. Guardian Corp. sells $6,250 of goods on account in the current year and collects $3,250 of this. It incurs $4,200 in expenses on account during the current year and pays $2,600 of them. Guardian would report what amount of net income under the cash and accrual bases of accounting, respectively? (a) $2,050 on the cash basis and $3,000 on the accrual basis (b) $3,250 on the cash basis and $4,200 on the accrual basis (c) $3,000 on the cash basis and $1,600 on the accrual basis (d) $650 on the cash basis and $2,050 on the accrual basis Solution: Cash basis: $3,250 – $2,600 = $650; Accrual basis: $6,250 − $4,200 = $2,050

50. Fang's Tune-Up Shop Ltd. 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.

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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

51. Wong's Tune-Up Shop Limited 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

52. 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.

53. 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.

54. 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 net income 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.

55. 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.

56. 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.

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

(c) is only required for accounts that do not have a normal balance. (d) is optional when financial statements are prepared.

57. Adjusting entries can be classified as (a) postponements and advances. (b) accruals and prepayments. (c) prepayments and postponements. (d) accruals and advances.

58. 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.

59. An adjusting entry to a prepaid expense (a) is not required in the future if prepaid costs are initially recorded as an asset. (b) reduces a company’s liabilities. (c) is required to recognize costs that expire with time.

60. Which of the following statements is true regarding depreciation? (a) Depreciation is a valuation concept; that is, we allocate costs to reflect the actual change in the value of the asset. (b) Depreciation allocates the cost of a long-lived asset to the accounting periods over which it is used. (c) Depreciation expense will typically will be shown on the statement of financial position. (d) Accumulated depreciation has a normal debit balance.

61. An asset purchased for $130,000 on the first day of the fiscal year with a useful life of 5 years has an annual depreciation expense of (a) $25,000. (b) $125,000. (c) $26,000. (d) $2,167. Solution: $130,000 / 5 years= $26,000

62. The adjusting entry for unearned revenues results in (a) an increase to a liability account and a decrease to a revenue account. (b) a decrease to a liability account and an increase to a revenue account. (c) neither an increase or a decrease to a liability account. (d) neither an increase or a decrease to a revenue account.

63. When a company performs a service for which payment was received in advance, a journal

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entry is recorded that will (a) increase revenue and decrease unearned revenue. (b) decrease revenue and increase unearned revenue. (c) increase cash and increase revenue. (d) increase cash and decrease unearned revenue.

64. 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 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.

65. An asset–expense relationship exists with (a) liability accounts. (b) revenue accounts. (c) prepaid expense adjusting entries. (d) accrued expense adjusting entries.

66. Unearned revenue is classified as a(n) (a) asset account. (b) revenue account. (c) equity account. (d) liability.

67. Which of the following accounts would not likely need to be adjusted at year end? (a) Supplies (b) Equipment (c) Prepaid Insurance (d) Unearned Revenue

68. 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.

69. Griffin Inc. purchased supplies costing $4,250 and debited Supplies for the full amount. At the end of the accounting period, a physical count of supplies revealed $2,100 still on hand. The appropriate adjusting journal entry to be made at the end of the period would be (a) debit Supplies Expense, $2,100; credit Supplies, $2,100. (b) debit Supplies Expense, $2,150; credit Supplies, $2,150.

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

(c) debit Supplies, $4,250; credit Supplies Expense, $4,250. (d) debit Supplies, $2,100; credit Supplies Expense, $2,100. Solution: $4,250 - $2,100 = $2,150

70. A legal firm received $2,000 cash for legal services to be rendered in the future. The full amount was credited to Unearned Revenue. If the legal services have been provided at the end of the accounting period and no adjusting entry has previously been made, this would cause (a) expenses to be overstated. (b) net income to be overstated. (c) liabilities to be understated. (d) revenues to be understated.

71. 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.

72. The Town Laundry Ltd. purchased $5,500 worth of laundry supplies on June 2 and recorded the purchase as an asset in the Supplies account. On June 30, a count 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 Supplies Expense, $3,000; credit Supplies, $3,000. (b) debit Supplies Expense, $2,500; credit Supplies, $2,500. (c) debit Supplies, $2,500; credit Supplies Expense, $2,500. (d) debit Supplies, $3,000; credit Supplies Expense, $3,000. Solution: $5,500 - $3,000 = $2,500; Dr Supplies Expense and Cr Supplies

73. On July 1, Kingston Store paid $15,000 to Location 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 Kingston Store is (a) debit Rent Expense, $15,000; credit Prepaid Rent, $15,000. (b) debit Prepaid Rent, $2,500; credit Rent Expense, $2,500. (c) debit Prepaid Rent, $7,500; credit Rent Expense, $7,500. (d) debit Rent Expense, $2,500; credit Prepaid Rent, $2,500. Solution: $15,000 / 6 months = $2,500

74. 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, assuming adjusting entries have not previously been made, 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. Solution: $12,000 / 3 = $4,000/month x 2 = $8,000

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75. 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 Sales. (c) credit Unearned Revenue and debit Sales. (d) debit Unearned Revenue and credit Accounts Receivable.

76. Accumulated Depreciation is a(n) (a) expense account. (b) shareholders’ equity account. (c) liability account. (d) contra asset account.

77. The Jasmine Corporation purchased a notebook computer for $3,600 on December 1. The useful life of the notebook computer is estimated to be 3 years. If financial statements are to be prepared on December 31, the company should make the following adjusting entry: (a) debit Depreciation Expense, $1,200; credit Accumulated Depreciation—Equipment, $1,200. (b) debit Depreciation Expense, $100; credit Accumulated Depreciation—Equipment, $100. (c) debit Accumulated Depreciation—Equipment, $1,200; credit Depreciation Expense, $1,200. (d) debit Equipment, $100; credit Accumulated Depreciation—Equipment, $100. Solution: $3,600 / 36 months = $100

78. Ray Autobody purchased a car jack for $16,000 on July 1. The estimated useful life of the car jack is 4 years. If the financial statements are prepared on December 31, Ray should make the following adjusting journal entry, assuming adjusting entries are made only annually: (a) debit Depreciation Expense, $2,000, credit Accumulated Depreciation—Equipment, $2,000. (b) debit Depreciation Expense, $1,667, credit Accumulated Depreciation—Equipment, $1,667. (c) debit Depreciation Expense, $4,000, credit Accumulated Depreciation—Equipment, $4,000. (d) debit Equipment, $2,000, credit Accumulated Depreciation—Equipment, $2,000. Solution: $16,000 / 48 months x 6 months = $2,000

79. 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 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 Revenue, $3,500; credit Rent Revenue, $3,500. (b) debit Rent Revenue, $3,500; credit Unearned Revenue, $3,500. (c) debit Unearned Revenue, $21,000; credit Rent Revenue, $21,000. (d) debit Cash, $3,500; credit Rent Revenue, $3,500. Solution: $21,000 / 6 months = $3,500

80. 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

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

(a) Supplies Expense ......................................................................... 4,200 Supplies ................................................................................. (b) Supplies Expense ......................................................................... 4,000 Supplies ................................................................................. (c) Supplies ........................................................................................ 4,200 Supplies Expense................................................................... (d) Supplies Expense ......................................................................... 4,200 Cash....................................................................................... Solution: $1,200 + $4,000 – $1,000 = $4,200; Dr Supplies Expense and Cr Supplies

4,200 4,000 4,200 4,200

81. 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 change in the beginning and ending balances of the Supplies account and the cost of supplies on hand.

82. 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) net income will be understated.

83. 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.

84. 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 net income and shareholders’ equity will be understated. (c) Assets will be overstated and net income and shareholders’ equity will be understated. (d) Assets will be overstated and net income and shareholders’ equity will be overstated.

85. 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.

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86. At December 31, 2018, before any year-end adjustments, TBS Corp.'s Insurance Expense account had a balance of $800 and its Prepaid Insurance account had a balance of $3,400. It was determined that $1,650 of the Prepaid Insurance had expired. The adjusted balance for Insurance Expense for the year would be (a) $2,450. (b) $1,650. (c) $1,975. (d) $ 800. Solution: $800 + $1650 = $2,450

87. At December 31, 2018, 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. Solution: $2,000 − $800 = $1,200

88. 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) Net income 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.

89. 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.

90. 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.

91. A new accountant working for Astro Limited records $650 depreciation expense on store equipment at year end as follows: Depreciation Expense ................................................................... 650 Cash....................................................................................... 650 The effect of this entry is to

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

(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.

92. 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. 93. 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.

94. 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.

95. If equipment with a 5-year life was purchased on July 1, 2018 for $60,000, by December 31, 2019, (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. Solution: Accumulated Depreciation: $60,000 / 60 months x 18 months = $18,000; Carrying Amount: $60,000 - $18,000 = $42,000

96. 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

97. 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.

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98. 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.

99. An adjusting entry would not include which of the following accounts? (a) Cash (b) Interest Receivable (c) Accounts Payable (d) Unearned Revenue

100. 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.

101. 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.

102. Accrued revenues (a) represent money received from customers for work to be done later. (b) are revenues that have not been earned before financial statements have been prepared. (c) reflect an increase to an asset and an increase to a revenue account. (d) reflect a decrease to an asset and an increase to a revenue account.

103. Failure to prepare an adjusting entry at the end of the period to record an accrued expense would cause (a) net income to be understated. (b) an overstatement of assets and an overstatement of liabilities. (c) an understatement of expenses and an understatement of liabilities. (d) an overstatement of expenses and an overstatement of liabilities.

104. Failure to prepare an adjusting entry at the end of a period to record accrued revenue would cause (a) net income to be overstated. (b) an understatement of assets and an understatement of revenues. (c) an understatement of revenues and an understatement of liabilities.

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

(d) an understatement of revenues and an overstatement of liabilities.

105. On September 1, Piano Keys Corp. borrowed $30,000 from their bank, and signed a 5%, 3-month bank loan. Principal and interest are due on December 1. If Piano Keys prepares monthly financial statements, the adjusting entry that it should prepare for interest on September 30 would be (a) debit Interest Expense, $125; credit Interest Payable, $125. (b) debit Interest Expense, $1,500; credit Interest Payable, $1,500. (c) debit Bank Loan Payable, $375; credit Cash, $375. (d) debit Cash, $30,000; credit Bank Loan Payable, $30,000. Solution: $30,000 x.05 x 1/12 = $125

106. 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 Interest Receivable. (d) debit to Interest Receivable and a credit to Cash.

107. D. Debit Inc. 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 D. Debit 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

108. C. Credit Inc. has billed its clients for services performed in October. In November, the company receives payments from the clients. What entry will it 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

109. 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, assuming adjusting entries have not been previously made, is (a) $9,810. (b) $ 810. (c) $ 337. (d) $ 270. Solution: $9,000 x.09 x 4/12 = $270

110. On February 1, Chopper Motorcycles Ltd. signed a 5%, twelve-month bank loan payable for $168,000 to help finance increases in inventory for the spring and summer season.

Accrual Accounting Concepts

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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 ........................................................................... 7,000 Interest Payable ..................................................................... 7,000 (b) Interest Expense ........................................................................... 8,400 Interest Payable ..................................................................... 8,700 (c) Interest Expense ........................................................................... 700 Cash....................................................................................... 700 (d) Interest Expense ........................................................................... 7,700 Interest Payable ..................................................................... 7,700 Solution: $168,000 x.05 x 11/12 = $7,700

111. 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.

112. Maggie Bakeries has a weekly payroll of $8,250 and pays its employees every Friday. None of the staff work on weekends. This year, the last day of the company’s fiscal year end is a Tuesday. What is the correct adjusting entry to accrue salaries expense? (a) Salaries Expense .......................................................................... 1,650 Salaries Payable .................................................................... 1,650 (b) Salaries Expense .......................................................................... 3,300 Cash....................................................................................... 3,300 (c) Salaries Expense .......................................................................... 3,300 Salaries Payable .................................................................... 3,300 (d) Salaries Expense .......................................................................... 8,250 Salaries Payable .................................................................... 8,250 Solution: $8,250 / 5 days = $1,650/day x 2 = $3,300

113. 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, Seventh Canadian Edition

114. Which trial balance, if any, is used to prepare financial statements? (a) Adjusted trial balance (b) Post-closing trial balance (c) Unadjusted trial balance (d) none

115. What is the order of preparation of financial statements? (a) income statement, statement of changes in equity, statement of financial position. (b) statement of changes in equity, income statement, statement of financial position. (c) statement of financial position, income statement, statement of changes in equity. (d) statement of changes in equity, statement of financial position, income statement.

116. Net income calculated on a cash basis is the equivalent (a) to the net increase/(decrease) in cash reported on the statement of cash flows. (b) of cash provided by operating activities reported on the statement of cash flows.. (c) of cash provided by financing activities reported on the statement of cash flows. (d) of cash provided by investing activities reported on the statement of cash flows.

117. 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.

118. 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.

119. 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.

120. 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.

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121. 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.

122. 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.

123. 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.

124. 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. (c) Revenues and expenses are closed to the Income Summary account. (d) Revenues, expenses, and the dividends declared account are closed to the Income Summary account.

125. 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.

126. 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.

127. 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.

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

(d) list all the statement of financial position accounts in alphabetical order for easy reference.

128. Which permanent account is affected by the closing entries? (a) Income Summary (b) Common Shares (c) Retained Earnings (d) Cash

129. 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

130. The process that begins with analyzing transactions and ends with the preparation of a post-closing trial balance is called (a) the fiscal period. (b) the accounting cycle. (c) the business cycle. (d) the accounting year.

131. The first required step in the accounting cycle is (a) preparing adjusting entries. (b) journalizing transactions. (c) analyzing transactions. (d) posting transactions.

132. 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.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51.

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

Item 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65.

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

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

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

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

Item 94. 95. 96. 97. 98. 99. 100 101. 102. 103. 104. 105. 106. 107.

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

Item Ans. Item 108. b 122. 109. d 123. 110. d 124. 111. b 125. 112. c 126. 113. d 127. 114. a 128. 115. a 129. 116. b 130. 117. b 131. 118. d 132. 119. c 120. b 121. a

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

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

EXERCISES Ex. 133 During the year ended December 31, 2018, Amber Inc. received $125,000 cash for sales from customers. The company began the year with a balance in Accounts Receivable of $18,500, all of which was received in 2018. At the end of the year, customers owed Amber Inc. $26,000 for services provided in 2018. Instructions Calculate the revenue Amber should report in 2018 using: (a) the cash basis of accounting. (b) the accrual basis of accounting. Solution 133 (a) $125,000 (b) $132,500* *Calculation: Cash received ............................................ Less: 2017 Revenue (beginning Accounts Receivable) .......................... Add: 2018 Revenue not received ...............

$125,000 (18,500) 26,000 $132,500

Ex. 134 Paisley Corporation had the following balances in 2019 and 2018: 2019 Accounts receivable $10,800 Prepaid rent 4,000 Supplies 900 Accounts payable 3,350 Unearned revenue 2,000

2018 $8,200 3,600 400 4,225 1,800

In addition, the company collected $62,500 cash from customers and paid $44,800 cash for operating costs during 2019. Instructions (a) Determine Paisley Corporation’s net income on an accrual basis for 2019. (b) Determine Paisley Corporation’s net income on a cash basis for 2019. Solution 134 (a) Accounts receivable Prepaid rent Supplies Accounts payable

+$10,800 (8,200) +4,000 (3,600) +900 (400) (3,350)

$2,600 400 500

Accrual Accounting Concepts

Unearned revenue Accrual basis net income

4,225 (2,000) 1,800

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875 (200) $4,175

(b) Cash Collected – Cash Paid = $62,500 – $44,800 = $17,700

Ex. 135 The statement of financial position for Tao Ltd. include the following as at December 31: 2019 2018 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, 2019 shows the following: Interest revenue ......................................................... $15,400 Service revenue ......................................................... 72,700 Supplies expense ....................................................... 7,700 Salaries expense........................................................ 37,000 Instructions Calculate the following for 2019: (a) Cash received for interest. (b) Cash paid for supplies. (c) Cash paid for salaries. (d) Cash received for revenue. Solution 135 (15 min.) (a) Cash received for interest = ....................................... Interest revenue ......................................................... Less: Interest receivable ............................................ Cash received ............................................................ (b) Cash paid for supplies = ............................................. Supplies expense ....................................................... Less: Supplies (2018) ................................................ Add: Supplies (2019) .................................................. Cash paid ................................................................... (c) Cash paid for salaries = ............................................. Salaries expense........................................................ Add: Salaries payable (2018) ..................................... Less: Salaries payable (2019) .................................... Cash paid ................................................................... (d) Cash received for revenue = ......................................

$ 13,200 $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

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

Service revenue ......................................................... Less: Unearned revenue (2018) ................................. Cash received ............................................................

$72,700 4,000 $68,700

Ex. 136 The 2019 income statement for Paulette Corporation showed rent expense of $9,900 and salary expense of $6,350. The related statement of financial position account balances at each year end were as follows: 2019 2018 Prepaid rent ............................................. $650 $450 Salaries payable....................................... 325 475 Instructions Calculate the following for 2019: (a) Cash paid for rent. (b) Cash paid for salaries. Solution 136 (10 min.) (a) Cash paid for rent =.................................................... Rent expense ............................................................. Less: Prepaid rent (2018) ........................................... Add: Prepaid rent (2019) ............................................ Cash paid ................................................................... (b) Cash paid for salaries = ............................................. Salaries expense........................................................ Add: Salaries payable (2018) ..................................... Less: Salaries payable (2019) .................................... Cash paid ...................................................................

$10,100 $ 9,900 450 9,450 650 $10,100 $6,500 $6,350 475 6,825 325 $6,500

Ex. 137 Ezra Inc. prepared the following condensed income statement using the cash basis of accounting: EZRA INC. Income Statement, Cash Basis Year Ended December 31, 2018 Service revenue ................................................................................... Expenses ............................................................................................. Net income...........................................................................................

$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, 2018, paid for a two-year insurance policy on the automobile amounting to $1,800. This amount is included in the expenses above.

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Service revenue does not include $50,000 of services provided on account in 2018 for which payment will be received in 2019. It does, however, include $20,000 collected in 2018 for services performed in 2017. Expenses do not include $50,000 of expenses that were incurred in 2018 but won’t be paid for until 2019.

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 net income. Solution 137 (15 min.) (a)

EZRA INC. Income Statement Year Ended December 31, 2018 —————————————————————————————————————————— Service revenue ($820,000 +$50,000 – $20,000)............................................ $850,000 Expenses ($640,000 + $9,000 – $900 + $50,000) .......................................... 698,100 Net income ...................................................................................................... $151,900 Service revenue should include the $50,000 for services performed on account, but not the $20,000 collected in 2018 for services performance in 2017. The accrual basis states that revenue is recognized in the period when the service is performed (performance obligation satisfied). 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 for the purpose of generating revenue. Expenses also should only include half of the $1,800 insurance premium since only one-half of the two-year policy applies to 2018. 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 be included as an expense in 2018. (b) The accrual basis of accounting provides a better measure of net income 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. 138 The trial balance of Chelsea Corp. at October 31, 2018, showed an insurance expense account balance of $5,475 reflecting premium costs related to the following policies: Policy 1, remaining cost of $750, 1-yr. term, effective May 1, 2017; Policy 2, original cost of $3,600, 2-yr. term, effective Aug. 1, 2018; Policy 3, original cost of $3,000, 1-yr term, effective Dec. 1, 2017 Policy 4, original cost of $2,100, 1-yr. term, effective Oct. 1, 2017.

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

Instructions (a) Evaluate and comment on each policy. (b) Determine the correct insurance expense account balance at October 31, 2018. If necessary, record an adjusting entry. Solution 138 (a) 1. Policy 1: Insurance expense has been appropriately recorded up to the end of the policy term of April 30, 2018. No adjusting entry required. 2. Policy 2: Two (Aug & Sep) months of insurance expense has been recorded but three (Aug – Oct) months have expired for the fiscal year. An adjusting entry for the October months insurance usage ($3,600 / 24 = $150) should be recorded for Oct 31, 2018. 3. Policy 3: Ten (Dec 2017 – Sep 2018) months of insurance expense has been recorded but eleven (Dec 2017 – Oct 2018) months have expired for the fiscal year. An adjusting entry for the October months insurance usage ($3,000 / 12 = $250) should be recorded for Oct 31, 2018. 4. Policy 4: Insurance expense has been appropriately recorded up to the end of the policy term of Sept 30, 2018. No adjusting entry required. (b) Oct 31 Insurance Expense................................................................. Prepaid Insurance ........................................................... To record October insurance expense for policies 2 and 3.

400 400

Ex. 139 Determine the missing information in the following table for each respective company: Pillar Corp. Jar. Corp. Tin Corp. Supplies on hand, October 31, 2018 $250 $480 $700 Supplies purchased during 2018 3,500 2,850 (c) Supplies on hand, October 31, 2019 (a) 620 300 Supplies used during the year $3,250 (b) 2,000 Solution 139 Opening Balance, Supplies on hand + Supplies purchased – Closing Balance, Supplies on hand = Supplies used during the year

Supplies on hand, October 31, 2018 +Supplies purchased during 2018 –Supplies on hand, October 31, 2019 Supplies used during the year

Pillar Corp. $250 3,500 (a) 500 $3,250

Jar. Corp. $480 2,850 620 (b) $2,710

Tin Corp. $700 (c) 1,600 300 $2,000

Ex. 140 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.

Accrual Accounting Concepts

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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 140 (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. 141 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 Equipment .................................................................. 40,000 Accumulated depreciation—Equipment...................... 6,000 Unearned revenue ..................................................... 500 Other data: 1. Four months rent had been prepaid on April 1. 2. The equipment 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 equipment 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 141 (15 min.) (a) 1. $4,000. The $12,000 balance on the adjusted trial balance reflects three months

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

remaining on the prepaid lease. This indicates that the monthly lease is $4,000. 2. The equipment 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—Equipment ..........................

600

Unearned Revenue ................................................................ Ticket Revenue ............................................................... (25  $4 = $100)

100

4,000

600

100

Ex. 142 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. Simons uses the Vehicles account to record purchase of all vehicles. (b) Prepare any adjusting journal entries that should be made on June 30. (c) Show how the delivery truck will be reflected on Simons Equipment’s statement of financial position at June 30. Solution 142 (10 min.) (a) Jun 1 Vehicles ........................................................................ 42,000 Cash ....................................................................... Bank Loan Payable ................................................ (To record purchase of delivery truck and signing of a 2-month, 6% bank loan) (b) Jun 30

Jun 30

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;

170

700

170

Accrual Accounting Concepts

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$34,000  6%  1  12 = $170) (c) Property, Plant and Equipment Vehicles ........................................................................ Less: Accumulated depreciation ....................................

$42,000 700

$41,300

Ex. 143 Presented below is the unadjusted trial balance and adjusted trial balance for Caldion Corporation on December 31, 2018. CALDION CORPORATION Trial Balances December 31, 2018 —————————————————————————————————————————— Unadjusted Adjusted Dr. Cr. Dr. Cr. Cash $ 2,200 $ 2,200 Accounts receivable 3,125 4,025 Prepaid rent 9,000 7,400 Supplies 1,800 800 Equipment 26,500 26,500 Accumulated depreciation—Vehicles $ 3,300 4,950 Accounts payable 1,900 2,300 Salaries payable 0 950 Unearned revenue 8,000 6,200 Income tax payable 0 3,295 Common shares 12,100 12,100 Retained earnings 3,450 3,450 Service revenue 43,175 45,875 Salaries expense 15,300 16,250 Depreciation expense 0 1,650 Rent expense 13,500 15,100 Supplies expense 500 1,500 Utilities expense 0 400 Income tax expense 0 0000 00 3,295 0000 00 Totals $71,925 $71,925 $79,120 $79,120 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 143 Accounts Receivable............................................................................ Service Revenue ........................................................................... (To record revenue earned but not yet collected) Rent Expense ...................................................................................... Prepaid Rent ................................................................................. (To record expiration of prepaid rent)

900 900

1,600 1,600

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

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

1,000

Depreciation Expense .......................................................................... Accumulated Depreciation—Vehicles............................................ (To record depreciation expense)

1,650

Utilities Expense .................................................................................. Accounts Payable ......................................................................... (To record accrued utilities)

400

Salaries Expense ................................................................................. Salaries Payable ........................................................................... (To record accrued salaries payable)

950

Unearned Revenue .............................................................................. Service Revenue ........................................................................... (To record revenue earned)

1,800

Income Tax Expense ........................................................................... Income Tax Payable ..................................................................... (To record accrued income tax)

3,295

1,000

1,650

400

950

1,800

3,295

Ex. 144 Prepare the required year end adjusting entries for each independent case listed below. Assume no adjustments were made during the year. Case 1 Ainsworth Corporation began the year with a $6,200 balance in the Supplies account. During the year, $2,750 worth of additional supplies were purchased. A physical count of supplies on hand at the end of the year revealed that $3,875 worth of supplies had been used during the year. Case 2 Brownstone Co. Ltd. has a calendar fiscal year. On Oct 1, the company purchased equipment for $45,000. The estimated useful life of the equipment is 9 years. Case 3 Michaela Management Ltd. is in the business of renting out several apartment buildings and prepares monthly financial statements. It has been determined that two tenants in $950 per month apartments and one tenant in the $1,400 per month apartment had not paid their December rent as of December 31. Solution 144 (10 min.) Case 1 December 31 Supplies Expense................................................................... Supplies .......................................................................... (To record office supplies used during the year)

3,875 3,875

Accrual Accounting Concepts

Case 2 December 31 Depreciation Expense ............................................................ Accumulated Depreciation—Equipment .......................... (To record depreciation expense for three months; $45,000  9 years x 3  12 months = $1,250) Case 3 December 31 Rent Receivable ..................................................................... Rent Revenue ................................................................. (To accrue rent earned but not yet received [(2 x 950) + 1,400] = $3,300)

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1,250 1,250

3,300 3,300

Ex. 145 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 145 (5 min.) 1. U 2.

Ex. 146 Before month-end adjustments are made, the February 28 trial balance of Kicker Enterprises Ltd. shows revenue of $15,000 and expenses of $8,300, excluding income tax. Adjustments are necessary for the following items: 1. Depreciation for February is $1,800. 2. Revenue earned but not yet billed is $3,200. 3. Accrued interest expense is $1,000.

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4. 5. 6.

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

Revenue collected in advance that is now earned is $3,700. Portion of prepaid insurance expired during February is $600. Assume a 50% income tax rate, calculated on income before income tax.

Instructions Calculate the correct net income to report on Kicker Enterprises Ltd.’s income statement for February. Solution 146 (5 min.) Net income before adjustments and income tax expense ($15,000 – $8,300) ........................................................................ Add: Unearned revenue.................................................................. Accrued revenue .................................................................... Subtract:

Depreciation expense ...................................................... Interest expense .............................................................. Insurance expense .......................................................... Net income after adjustments and before income tax expense ............ Income tax expense ($10,200 x 50%) .................................................. Net income...........................................................................................

$ 6,700 $3,700 3,200 $1,800 1,000 600

6,900 13,600

3,400 10,200 5,100 $ 5,100

Ex. 147 On December 31, 2018, 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 net income 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 2019. 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 Correct balances

Net income $40,000

Total Assets $120,000

Total Liabilities Shareholders’ Equity $50,000 $70,000

Accrual Accounting Concepts

Solution 147 (10 min.) Item Net Income 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

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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. 148 Sheik Corporation compiles 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 net income before the adjustments listed above (and income tax) was $16,500. Calculate the correct income 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 148 (20 min.) (a) Type of Account Adjustment Relationship 1. Unearned revenue L/R

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

Adjusting Entry

Income Effect Increase (Decrease)

Adjusting Entry Unearned Revenue Service Revenue

1,000

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

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

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) Net income 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 income before income tax...............................................

$16,500 $1,000 850 $500 650 550 200 250

1,850 18,350

2,150 $16,200

Ex. 149 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 149 (15 min.) Statement of Financial Position Acct 1. Supplies

(a) Type of Adjusting Entry Prepaid Expense

(b) Related Account Supplies Expense

Accrual Accounting Concepts

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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. 150 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 150 (5 min.) 1. AR 2.

Ex. 151 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 D. Accrued Expenses

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

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 151 (5 min.) 1. B 2.

Ex. 152 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, 2018. _____ 1. Accounts Receivable _____ 2. Prepaid Expenses _____ 3. Equipment _____ 4. Unearned Revenue _____ 5. Income Tax Payable _____ 6. Common Shares _____ 7. Retained Earnings, January 1, 2018 _____ 8. Service Revenue _____ 9. Utilities Expense Solution 152 (5 min.) 1. Yes 2.

Yes

Accrual Accounting Concepts

Yes

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Ex. 153 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 net income was lower in 2019 than 2018. MINGWEI LTD. Income Statement, Cash Basis Years Ended December 31 —————————————————————————————————————————— 2019 2018 Service revenue .......................................................................... $350,000 $365,000 Expenses Salaries expense.................................................................. 200,000 190,000 Office expense ..................................................................... 54,000 55,000 Repairs and maintenance expense ...................................... 20,000 15,000 Interest expense................................................................... 15,000 2,000 Total expenses............................................................................ 289,000 262,000 Income before income tax ........................................................... 61,000 103,000 Income tax expense .................................................................... 24,400 41,200 Net income.................................................................................. $ 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, 2018 and repaid the amount with interest on June 1, 2019. The interest rate was 6%.The journal entry to record the repayment on June 1, 2019 was: Bank Loan Payable ............................................. 200,000 Interest Expense ................................................. 12,000 Cash ............................................................. 212,000 2. A customer made a deposit of $15,000 on December 1, 2018 for services to be performed in January 2019. The journal entry made on December 1, 2018 was: Cash.................................................................... 15,000 Service Revenue .......................................... 15,000 3. A bill for $4,000 maintenance work done in December 2018 was paid on January 15, 2019. The journal entry to record the payment in 2019 was: Repairs and Maintenance Expense ..................... 4,000 Cash ............................................................. 4,000

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

Instructions Assuming that no adjusting entries were made for the above transactions, prepare revised income statements for 2018 and 2019. (Income tax is calculated at 40% of income before income tax.) Solution 153 (15 min.) MINGWEI LTD. Income Statement Year Ended December 31 —————————————————————————————————————————— 2019 2018 Sales ........................................................................................... $365,000 $350,000 Expenses Salaries expense.................................................................. 200,000 190,000 Office expense ..................................................................... 54,000 55,000 Repairs & Maintenance expense .......................................... 16,000 19,000 Interest expense................................................................... 8,000 9,000 Total expenses............................................................................ 278,000 273,000 Income before income tax ........................................................... 87,000 77,000 Income tax expense .................................................................... 34,800 30,800 Net income.................................................................................. $ 52,200 $ 46,200 Calculations: Sales 2019: $350,000 + $15,000 = $365,000 2018: $365,000 – $15,000 = $350,000 Interest expense

2019: 2018:

$15,000 – $7,000 = $8,000 $ 2,000 + $7,000 = $9,000

Adjustment June to December 2018 = $200,000 × 6% × 7 ÷ 12 = $7,000 Repairs & Maintenance expenses

Income tax

2019: 2018:

2019: $20,000 – $4,000 = $16,000 2018: $15,000 + $4,000 = $19,000

$87,000 × 40% = $34,800 $77,000 × 40% = $30,800

Ex. 154 Prepare adjusting entries for the following transactions. Omit explanations. 1. Depreciation on equipment is $925. 2. Interest incurred and owed on a loan but not paid or recorded is $340. 3. There was a beginning balance of supplies of $225 and the company purchased $380 of office supplies during the period. At the end of the year $120 of supplies were on hand. 4. Prepaid rent had a $2,650 normal balance prior to adjustment. By year end $750 had expired. 5. Accrued salaries at year end were $950.

Accrual Accounting Concepts

Solution 154 (10 min.) 1. Depreciation Expense ................................................................... Accumulated Depreciation—Equipment .................................

925

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

340

Supplies Expense ......................................................................... Supplies ................................................................................. ($225 + $380 – $120)

485

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

750

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

950

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925

340

485

750

950

Ex. 155 Prepare adjusting entries for the following transactions. 1. Interest accrued on notes receivable is $320. 2. Property taxes owing but not paid or recorded amount to $800. 3. Service revenue of $3,600 was collected in advance. By year end, $1,200 was earned. 4. Prepaid insurance had a $600 debit balance prior to adjustment. By year end, 30% was still unexpired. 5. Salaries owing at year end but not yet paid or recorded amounted to $1,025. Solution 155 (10 min.) 1. Interest Receivable ....................................................................... Interest Revenue ....................................................................

320

Property Tax Expense ................................................................... Accounts Payable...................................................................

800

Unearned Revenue ....................................................................... Service Revenue ....................................................................

1,200

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

420

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

1,025

320

800

1,200

420

1,025

Ex. 156 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

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4. 5. 6. 7.

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

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 156 (10 min.) 1. Interest Receivable ....................................................................... Interest Revenue .................................................................... 2.

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. 157 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 157 (5 min.) 1. Service Revenue 2.

Rent Expense

Service Revenue

Accrual Accounting Concepts

Accumulated Depreciation

Utilities Payable

Interest Expense

Accounts Receivable or Unearned Revenue

Interest Revenue

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Ex. 158 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 158 (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

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

Adjusting Entry Unearned Revenue ................................................................ Admissions Revenue ....................................................... ($900,000  12 = $75,000) (c) Initial Journal Entry Cash....................................................................................... Bank Loan 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)

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. 159 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, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $12,300 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 Retained earnings ................................................................................ 18,925

Accrual Accounting Concepts

Rent revenue ....................................................................................... Salaries expense ................................................................................. Total.....................................................................................................

1,150 $38,125

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6,360 _______ $38,125

An analysis of the account balances provided the following additional information: 1. A physical count of 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 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. 5. Income tax of $800 is owed. 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 159 (10 min.) (a) 1. Supplies Expense ($2,700 – $1,200)............................................. Supplies ................................................................................. (To record the amount of 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

Income Tax Expense .................................................................... Income Tax Payable ............................................................... (To record income tax)

800

275

270

700

800

(b) PLOVER CORPORATION Adjusted Trial Balance September 30, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $12,300 Supplies ($2,700 – $1,500) .................................................................. 1,200 Prepaid insurance [$5,775 – ($6,600  24)] ......................................... 5,500 Equipment ........................................................................................... 16,200

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

Accumulated depreciation—Equipment ($540 + $270) ........................ Accounts payable................................................................................. Unearned revenue ($1,200 – $700) ..................................................... Income tax payable .............................................................................. Common shares................................................................................... Retained earnings ................................................................................ Rent revenue ($6,360 + $700) ............................................................. Salaries expense ................................................................................. Supplies expense [$0 + ($2,700 – $1,200)] .......................................... Insurance expense [$0 + ($6,600  24)] ............................................... Depreciation expense [$0 + ($16,200  5  12)] ................................... Income tax expense ............................................................................. Total.....................................................................................................

$ 810 1,100 500 800 10,000 18,925 7,060 1,150 1,500 275 270 800 $39,195

$39,195

Ex. 160 Xiang Insurance Agency Ltd. prepares monthly financial statements. Presented below is an income statement prepared for the month of July 2018. XIANG INSURANCE AGENCY LTD. Income Statement Month Ended July 31, 2018 —————————————————————————————————————————— Revenues Commission revenue .................................................................... $60,000 Expenses Salaries expense........................................................................... $5,000 Advertising expense ...................................................................... 800 Rent expense ................................................................................ 4,200 Depreciation expense ................................................................... 2,800 Total expenses .............................................................................. 12,800 Income before income tax .................................................................... 47,200 Income tax expense ............................................................................. 0 Net income........................................................................................... $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 July. 2. The company sold a life insurance policy on July 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 July 31. 4. The agency purchased a used car at the beginning of July for $16,800 cash. The estimated useful life of the car is 4 years. 6. The agency pays its employees each Friday. Weekly payroll is $7,200. July 31 falls on a Tuesday. 7. Estimated income tax expense owing was $10,000.

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Instructions Prepare a corrected income statement. Solution 160 (20 min.) XIANG INSURANCE AGENCY LTD. Income Statement For Month Ended July 31, 2018 —————————————————————————————————————————— Revenues Commission revenue [$60,000 + $4,200 ($28,000 x 15%)] ........... $64,200 Expenses Salaries expense [$5,000 + $2,880 ($7,200 x 2 ÷ 5)] .................... $7,880 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 ....................................................................... 17,830 Income before income tax .................................................................... 46,370 Income tax expense ($0 + $10,000) ..................................................... 10,000 Net income........................................................................................... $36,370

Ex. 161 Presented below is the trial balance and adjusted trial balance for Sandhu Corporation on December 31, 2018. SANDHU CORPORATION Trial Balances December 31, 2018 —————————————————————————————————————————— 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 declared 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

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Depreciation expense Interest expense Income tax expense Totals

$33,660

200 120 2,000 $37,980

$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 161 (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

400

200

600

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

120

100

300

2,000

600

400

200

600

120

100

300

2,000

Ex. 162 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:

Accrual Accounting Concepts

Monday Tuesday Wednesday Thursday Friday

Date June 28 June 29 June 30 July 1 July 2

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Amount $3,000 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 162 (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. 163 Each Friday, Braleigh Ltd. pays its office personnel weekly salaries of $42,500 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 163 (5 min.) (a) Mar. 31 Salaries Expense ($42,500 x 4/5) ................................. Salaries Payable .................................................. (b) Apr. 1

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

34,000 34,000 34,000 8,500 42,500

Ex. 164 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, 2018: (a) an income statement; (b) a statement of changes in equity; and (c) a classified statement of financial position. NORFAXX SERVICES INC.

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Adjusted Trial Balance December 31, 2018 —————————————————————————————————————————— Debit Credit Cash ................................................................................................... $ 6,000 Accounts receivable ............................................................................ 3,000 Supplies .............................................................................................. 1,500 Equipment ........................................................................................... 21,000 Accumulated depreciation—Equipment ............................................... $ 4,800 Accounts payable ................................................................................ 3,850 Unearned revenue .............................................................................. 8,000 Common shares................................................................................... 12,100 Retained earnings ............................................................................... 3,300 Dividends declared ............................................................................. 1,600 Service revenue .................................................................................. 11,000 Salaries expense ................................................................................ 4,000 Supplies expense ................................................................................ 500 Depreciation expense ......................................................................... 3,000 Rent expense ...................................................................................... 2,000 Income tax expense ............................................................................ 450 $43,050 $43,050 Solution 164 (30 min.) (a) NORFAXX SERVICES INC. Income Statement Month Ended December 31, 2018 —————————————————————————————————————————— Revenues Service revenue ........................................................................... $11,000 Expenses Salaries expense .......................................................................... $4,000 Depreciation expense ................................................................... 3,000 Rent expense ............................................................................... 2,000 Supplies expense ......................................................................... 500 Total expenses ...................................................................... 9,500 Income before income tax .................................................................... 1,500 Income tax expense ($1,500 x 30%) .................................................... 450 Net income........................................................................................... $ 1,050 (b) NORFAXX SERVICES INC. Statement of Changes in Equity Month Ended December 31, 2018 —————————————————————————————————————————— Common Shares Retained Earnings Total Equity Balance, December 1 $12,100 $3,300 $15,400 Net income 1,050 1,050 Dividends declared ______ (1,600) (1,600) Balance, December 31 $12,100 $ 2,750 $14,850

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(c) NORFAXX SERVICES INC. Classified Statement of Financial Position December 31, 2018 —————————————————————————————————————————— Assets Current assets Cash ................................................................................................ $6,000 Accounts receivable......................................................................... 3,000 Supplies........................................................................................... 1,500 $10,500 Property, plant, and equipment Equipment ....................................................................................... $21,000 Less: Accumulated depreciation—Equipment .................................. 4,800 16,200 Total assets................................................................................... $26,700 Liabilities and Shareholders’ Equity Current liabilities Accounts payable .......................................................................... Unearned revenue ........................................................................ Total liabilities ......................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity .................................

$3,850 8,000 $11,850 12,100 2,750 $26,700

Ex. 165 Jacquard Industries’ adjusted trial balance for the year ending December 31, 2018 appears below. JACQUARD INDUSTRIES Adjusted Trial Balance December 31, 2018 —————————————————————————————————————————— Debit Credit Cash ................................................................................................... $ 3,700 Accounts receivable ............................................................................ 9,100 Prepaid rent ......................................................................................... 400 Supplies .............................................................................................. 600 Equipment ........................................................................................... 34,550 Accumulated depreciation—Equipment ............................................... $ 4,600 Accounts payable ................................................................................ 3,400 Unearned revenue .............................................................................. 2,250 Interest payable .................................................................................. 435 Bank loan payable (due July 1, 2020) .................................................. 21,750 Common shares................................................................................... 10,000 Retained earnings ............................................................................... 12,500 Dividends declared ............................................................................. 1,000 Service revenue .................................................................................. 60,000 Salaries expense ................................................................................. 28,850 Supplies expense ................................................................................ 16,650

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Depreciation expense ......................................................................... Rent expense ...................................................................................... Interest expense ..................................................................................

2,400 17,250 435 _______ $114,935 $114,935

Instructions Using the information from the adjusted trial balance, prepare the following: (a) an income statement; (b) a statement of changes in equity; (c) a classified statement of financial position; (d) prepare the closing journal entries (e) prepare a post-closing trial balance Solution 165 (a) JACQUARD INDUSTIRES Income Statement Year Ended December 31, 2018 —————————————————————————————————————————— Revenues Service revenue ........................................................................... $60,000 Expenses Salaries expense .......................................................................... $28,850 Rent expense ............................................................................... 17,250 Supplies expense ......................................................................... 16,650 Depreciation expense ................................................................... 2,400 Interest expense............................................................................ 435 Total expenses ...................................................................... 65,585 Net loss ................................................................................................ $(5,585) (b) JACQUARD INDUSTRIES Statement of Changes in Equity Year Ended December 31, 2018 —————————————————————————————————————————— Common Shares Retained Earnings Total Equity Balance, January 1 $10,000 $12,500 $22,500 Net loss (5,585) (5,585) Dividends declared ______ (1,000) (1,000) Balance, December 31 $10,000 $ 5,915 $15,915 (c) JACQUARD INDUSTRIES Classified Statement of Financial Position December 31, 2018 —————————————————————————————————————————— Assets Current Assets Cash ............................................................................................. $3,700 Accounts receivable ...................................................................... 9,100

Accrual Accounting Concepts

Prepaid rent ................................................................................. Supplies ........................................................................................ Total current assets....................................................................... Property, Plant, and Equipment Equipment ..................................................................................... Less: accumulated depreciation—Equipment................................ Total Property, Plant, and Equipment ............................................ Total assets ......................................................................................... Liabilities and Shareholders’ Equity Current Liabilities Accounts payable .......................................................................... Unearned revenue ........................................................................ Interest payable............................................................................. Total current liabilities ................................................................... Non-Current Liabilities Bank loan payable......................................................................... Total non-current liabilities ............................................................ Total liabilities ...................................................................................... Shareholders’ equity Common shares ............................................................................ Retained earnings ......................................................................... Total liabilities and shareholders’ equity ................................. (d) Service Revenue.................................................................................. Income Summary ...................................................................

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400 600 $13,800 $34,550 4,600 29,950 $43,750

$3,400 2,250 435 $ 6,085 $21,750 21,750 27,835 10,000 5,915 $43,750

60,000 60,000

Income Summary .......................................................................... Salaries Expense ................................................................... Rent Expense......................................................................... Supplies Expense................................................................... Depreciation Expense ............................................................ Interest Expense ....................................................................

65,585

Retained Earnings......................................................................... Income Summary ...................................................................

5,585

Retained Earnings......................................................................... Dividends Declared ................................................................

1,000

28,850 17,250 16,650 2,400 435

5,585

1,000

(e) JACQUARD INDUSTRIES Post-Closing Trial Balance December 31, 2018 Cash .................................................................................................... Accounts receivable ............................................................................. Prepaid rent ......................................................................................... Supplies ............................................................................................... Equipment............................................................................................

Debit $ 3,700 9,100 400 600 34,550

Credit

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Accumulated depreciation—Equipment ............................................... Accounts payable................................................................................. Unearned revenue ............................................................................... Interest payable ................................................................................... Bank loan payable (due July 1, 2020) .................................................. Common shares................................................................................... Retained earnings ................................................................................ $48,350

$ 4,600 3,400 2,250 435 21,750 10,000 5,915 $48,350

Ex. 166 The following is a list of accounts and their balances (all normal balances) as of July 31, 2018 for Ling Chan Inc. All adjusting entries have been prepared and posted. Note that the list is in random order. Cash ............................................................................................. Utilities expense ............................................................................ Accounts receivable ...................................................................... Prepaid insurance ......................................................................... Service revenue ............................................................................ Supplies ........................................................................................ Rent expense ................................................................................ Accumulated depreciation—Equipment......................................... Accounts payable .......................................................................... Unearned revenue ........................................................................ Common shares ............................................................................ Retained earnings ......................................................................... Dividends declared........................................................................ Equipment ..................................................................................... Salaries expense .......................................................................... Depreciation expense ...................................................................

$35,300 800 16,000 5,000 24,600 1,500 3,600 3,200 11,000 9,800 27,000 17,000 1,000 20,000 8,200 1,200

Instructions Prepare the closing journal entries required. Solution 166 (10 min.) Service Revenue ........................................................................... Income Summary ...................................................................

24,600 24,600

Income Summary .......................................................................... Utilities Expense ..................................................................... Rent Expense......................................................................... Salaries Expense ................................................................... Depreciation Expense ............................................................

13,800

Income Summary .......................................................................... Retained Earnings ..................................................................

10,800

Retained Earnings......................................................................... Dividends Declared ................................................................

1,000

800 3,600 8,200 1,200

10,800

1,000

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Ex. 167 The adjusted trial balance for Poplar Ltd. at December 31, 2018, is shown below. POPLAR LTD. Adjusted Trial Balance December 31, 2018 —————————————————————————————————————————— 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 Income tax payable .............................................................................. 11,430 Common shares .................................................................................. 24,000 Retained earnings ................................................................................ 20,600 Dividends declared .............................................................................. 6,600 Service revenue ................................................................................... 76,500 Salaries expense ................................................................................. 28,850 Supplies expense................................................................................. 2,950 Insurance expense............................................................................... 800 Depreciation expense .......................................................................... 2,400 Utilities expense ................................................................................... 3,400 Income tax expense ............................................................................. 11,430 ______ Total..................................................................................................... $165,180 $165,180 Instructions Prepare the closing journal entries required. Solution 167 (10 min.) Service Revenue ........................................................................... Income Summary ...................................................................

76,500 76,500

Income Summary .......................................................................... Salaries Expense ................................................................... Supplies Expense................................................................... Insurance Expense................................................................. Depreciation Expense ............................................................ Utilities Expense ..................................................................... Income Tax Expense ..............................................................

49,830

Income Summary .......................................................................... Retained earnings ..................................................................

26,670

Retained Earnings......................................................................... Dividends Declared ................................................................

6,600

28,850 2,950 800 2,400 3,400 11,430

26,670

6,600

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Ex. 168 The adjusted trial balance for Chung, Ltd. at December 31, 2018, is shown below: CHUNG LTD. Adjusted Trial Balance December 31, 2018 —————————————————————————————————————————— Debit Credit Cash .................................................................................................... $ 8,500 Accounts receivable ............................................................................. 3,200 Supplies ............................................................................................... 950 Prepaid insurance ................................................................................ 600 Equipment............................................................................................ 73,500 Accumulated depreciation—Equipment ............................................... $ 18,500 Accounts payable................................................................................. 4,500 Salaries payable .................................................................................. 1,650 Income tax payable .............................................................................. 630 Common shares .................................................................................. 24,000 Retained earnings ................................................................................ 36,000 Service revenue ................................................................................... 33,300 Salaries expense ................................................................................. 15,850 Supplies expense................................................................................. 9,850 Insurance expense............................................................................... 700 Depreciation expense .......................................................................... 1,900 Utilities expense ................................................................................... 2,900 Income tax expense ............................................................................. 630 _______ Total..................................................................................................... $118,580 $118,580 Instructions Prepare the closing journal entries required. Solution 168 (10 min.) Service Revenue ........................................................................... Income Summary ...................................................................

33,300 33,300

Income Summary .......................................................................... Salaries Expense ................................................................... Supplies Expense................................................................... Insurance Expense................................................................. Depreciation Expense ............................................................ Utilities Expense ..................................................................... Income Tax Expense ..............................................................

31,830

Income Summary .......................................................................... Retained Earnings ..................................................................

1,470

15,850 9,850 700 1,900 2,900 630

1,470

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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.

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 cash. ____

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 accounts.

____

6. Revenue, expense and dividends declared 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.

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ANSWERS TO MATCHING 1.

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SHORT-ANSWER ESSAY QUESTIONS S-A E 170 What is the difference between the accrual basis of accounting and the cash basis of accounting? Which approach is preferable? Solution 170 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 net income, 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.

S-A E 171 Describe the requirements under IFRS and ASPE regarding the frequency required for adjusting journal entries. Solution 171 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.

S-A E 172 Anchor Ltd., a small company in its first year of operations, is in the process of preparing company financial statements for December 31, 2018. Sam Jones, one of the managing shareholders with a limited background in accounting, has identified the following details: 1. On October 1, 2018 the company purchased new computer equipment in the amount of $9,000. The equipment has an estimated useful life of 5 years. The only entry recorded related to the equipment was a debit to Equipment and credit to Cash. 2. Anchor earned $5,000 in fees for services provided that have not yet been billed and not recorded. On March 1, 2018, Anchor received its property tax bill of $6,000 for the calendar year. The bill was due May 31, 2018. Despite Sam’s limited accounting background, on March 1, he recorded

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a debit to Property Tax Expense and credit to Property Tax Payable for January and February property taxes. On May 31, the company paid the bill and Sam recorded the expense incurred for March, April and May and the payment of the liability recorded on March 1. Instructions (a) Explain the purpose of adjusting entries to Sam. (b) Based on the above, assume that adjusting entries would be prepared annually, at the end of the accounting period. Identify the impact (understatement, overstatement, or no effect) on revenue or expenses and net income if these adjusting entries were not made. Solution 172 (a) 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. (b) 1. To ignore the adjusting entry to appropriately recognize depreciation expense for the threemonth use of the computer equipment during the period October 1 to December 31 would result in understating expenses and overstating net income by $450. 2. To ignore the adjusting entry to accrue revenue (revenue earned but not yet collected) would result in understating revenue and net income by $5,000. 3. To ignore the adjusting entry to appropriately recognize the property tax expense for the remaining portion of the year, June – December, would result in understating expenses and overstating net income by $3,500 ($6,000 / 12 x 7 months).

S-A E 173 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 173 Account balances must be adjusted before financial statements are prepared, even in a properly 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 to recognize a portion of these accounts in the income statement. Accruals are adjustments giving rise to the initial recording of a

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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 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 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 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

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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 175 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 176 Central Tennis Courts, a local tennis club, has just appointed Mr. Holland as the new Treasurer for the upcoming 2019 season. Mr. Holland, a Chartered Professional Accountant (CPA), is taking over from Miss Scarsdale who, while not an accountant, has been a long standing member of the Club. In an informal conversation with Mr. Holland, Miss Scarsdale says: “It has been a very good year for the Club. I am expecting to report a significant net income, which I’m sure will please our club members.” In addition, Miss Scarsdale mentioned the below noted items. 1. Cash of $750 was collected on October 15, 2018 for 2019 membership fees. Miss Scarsdale recorded a debit to Cash and credit to Fees Earned. 2. The courts (8 in total) were resurfaced on April 1, 2018 at a cost of $18,000. As court resurfacing is regarded as a form of equipment, Miss Scarsdale recorded a debit to Equipment and a credit to Cash. The court resurfacing has an estimated useful life of 10 years. 3. The Junior Program Director, Mrs. Crenshaw, has not yet remitted her year-end expense report but has notified Miss Scarsdale that, while she hasn’t had time to complete the expense report, the expenses are $1,500 in total. Miss Scarsdale informs Mr. Holland: “Mrs. Crenshaw is always submitting her expenses late. I’m not going to delay closing the books. I’ll leave it up to you to follow up with her. You can just record the expenses in the next season.” Instructions

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Assuming that the Club has an October 31 year end and follows ASPE, explain whether or not Miss Scarsdale has recorded the above noted items correctly, given your knowledge of adjusting journal entries and revenue and expense recognition. Identify the correction, if any, and impact on the currently proposed net income. Solution 176 1. Under ASPE, revenue recognition (recording) occurs when the sales or performance effort is substantially complete, the amount is reasonably measurable, and collection is reasonably assured. As the 2019 membership fees have not yet been earned, a liability should be recorded rather than revenue. The credit side of the entry should be to Unearned Revenue rather than Fees Earned. 2. An adjusting journal entry for depreciation should be recorded for 7 months use of the resurfaced courts calculated as follows: $18,000 x 7/120 months = $1,050 debit to Depreciation Expense and credit to Accumulated Depreciation—Equipment. 3. Miss Scarsdale should accrue the $1,500 of expenses as advised by Mrs. Crenshaw in the 2018 records. The junior program expenses have been reliably measured and should be recognized and recorded (matched) in the same period (fiscal 2018) in which the Club generated its junior program member fees. Net income would be reduced by $3,300 = ($750 + $1,050 + $1,500)

S-A E 177 Briefly distinguish between a prepayment and an accrual. Solution 177 Unlike accruals, prepayments adjust assets and liabilities that were previously recorded. They are adjusted to show the portion of the asset or liability that should be expensed (because a portion of the benefit of that asset has expired) or recorded as revenue because 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.

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OBJECTIVE FORMAT QUESTIONS 178. From the following list, identify all of the transactions where revenue would be recognized on the date specified as “today’s date”. Treat each of these items as an independent situation. (a) Today’s Date: July 4 On July 1, Celia’s Cupcakes entered a contract with Higgins Ltd. to provide cupcakes at its upcoming BBQ on July 5. The cupcakes were baked and iced today and are ready to be delivered tomorrow. The invoice has not yet been prepared. (b) Today’s Date: April 2 Muhammad’s Engineering Ltd. performed an environmental assessment for GTC Drilling on April 2, 2018. Muhammad’s has not yet received payment. (c) Today’s Date: July 5 Herd Incorporated, a Canadian cattle ranch, entered into a contract on June 3rd with the Big Bert’s Restaurant chain, located in the US, to provide 1,000 kg of AAA grade Canadian beef. The product was shipped on July 3rd and is being held at US customs while awaiting approval from the US Food and Drug Administration Agency (FDA). There is some concern as to whether the US will allow the beef into the country due to a recent bovine spongiform encephalopathy (BSE) (Mad Cow Disease) occurrence in Canada. (d) Today’s Date: November 1 Five hundred chairs sold by The Chair Company Ltd. to The Dining Room Inc. were delivered on November 2. An invoice was sent to The Dining Room on November 1. (e) Today’s Date: January 12 On January 12, Noble Inc., a law firm, signed a fixed fee contract for $4,000 with Big Industry Corp. to represent it in an upcoming law suit. Big Industry paid the full $4,000 to Noble upon signing. The law suit is expected to be settled in one month. (f) Today’s Date: April 30 On January 8, Good Homes Inc. received a partial payment of $100,000 from Sam Yang for a project to renovate his home. The total renovation cost is expected to be $400,000. As of today, Good Homes has completed one quarter of the project. (g) Today’s Date: October 31 Ghost & Goblin (G&G) Inc., a rock band, performed at the ABC Corp.’s annual Halloween bash on October 31. G&G and ABC verbally agreed to a fee of $1,000 for the gig. G&G plans to send out an invoice on November 7 to ABC. Solution 178 (b), (f), and (g) are correct. (a) In a merchandising company, revenue is recognized (recorded) when the merchandise is sold and delivered. In this case, only part of the performance obligation is satisfied (making the cupcakes). They must still be delivered to the customer prior to recognizing revenues. (c) The revenue will not be recognized in this case as the beef may not be accepted into the

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USA and delivery will not be complete. In the case of international sales, if there are concerns that goods will not be accepted into the receiving country, revenue cannot be recognized until such as time as they have been accepted. (d) The revenue will be recognized on November 2 when the merchandise is delivered. (e) The revenue is recognized (recorded) at the time the service is performed. In this case, the revenue should be recorded when the law suit is settled. When the $4,000 is received on January 12, it is recorded to Unearned Revenue, a current liability account. 179. After reviewing the following list of transactions for Bob’s Bikes Incorporated for the calendar year 2018, identify all the transactions where the correct application of accrual based accounting was used. Bob’s Bikes prepares adjusting entries monthly. (a) On January 1, Bob’s Bikes purchased prepaid insurance for $1,000 for the year ended December 31, 2018. On January 1, the accountant recorded this as a $1,000 debit to Prepaid Insurance and $1,000 credit to Cash. (b) The company quoted a customer $1,200 to build a custom bike in February, built the custom bike in March, delivered the bike in March, sent the customer an invoice in April and received payment for the bike in May. Bob’s Bikes recorded the sale in April. (c) A physical count of supplies on hand was taken on both January 1 and January 31 with the following results: • January 1, $350 • January 31, $120 Total purchases of supplies during the month were $670. The accountant recorded $900 as Supplies Expense for the month of January. (d) On January 1, Bob’s Bikes borrowed $50,000 from the bank for a two-year period. The bank loan is due at maturity but monthly interest payments of $375 are due at the end each quarter to the bank. On March 31, the accountant recorded Interest Expense of $1,125 ($375 x 3) when the first interest installment was paid. (e) The Advertising Expense account had a balance of $4,850 on December 31, 2018. The following information was also available. • Included in the $4,850 was the cost of an ad that was to be placed in the January 2019 issue of Biker Magazine. The ad cost was $450. • An invoice for promotional materials totalling $350 was received on January 3, 2019. The materials were received by Bob’s on December 28, and are included in the $4,850 balance. After considering the above, the accountant reduced Advertising Expense on December 31, 2018 by $450. (f) Bob’s Bikes paid salaries to staff on October 5 totalling $1,370 (for the pay period from Sept 16–30). On October 5, the accountant recorded a debit to Salaries Expense and a credit to Cash for this amount. Solution 179 (a), (c), and (e) are correct.

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(b) Since the bike was delivered in March, the performance obligation was completed in March. Therefore, the revenue should have been recorded in the company’s financial records in March, not April. (d) Bob’s Bikes prepares adjusting entries monthly, the accountant should accrue and record the interest monthly. The following entries should have been made to accrue each month’s interest: January 31

February 28

March 31

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

375

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

375

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

375 750

375

1125

(f) The salaries relate to the September 16 to 30 pay period. Therefore, they should be recorded as follows: September 30

October 5

Salaries Expense 1370 Salaries Payable.................. Salaries Payable ........................... Cash ....................................

1370 1370 1370

180. Which of the following statements are true with regard to accrual accounting? Identify all of the statements that are true. (a) Accrual accounting usually results in a lower net income than cash-based accounting. (b) Under accrual accounting, cash is always paid for an expense after an expense is recognized. (c) If a company uses accrual accounting, reported net income will likely be different than if they used the cash basis of accounting. (d) Accrual accounting aims to record revenues when the performance obligation is complete— generally when the service is performed or the goods are delivered. (e) Unearned Revenues and Prepaid Expenses are account names that are used only in the accrual basis of accounting. (f) A company reporting under ASPE must use accrual accounting. (g) If a company forgets to adjust unearned revenue by the amount that has been partially earned, revenues will be understated and assets will be overstated.

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(h) For decision making, it really doesn’t matter if accrual-based or cash-based accounting is used. Solution 180 (c), (d), (e), and (f) are correct. (a) Accrual-based accounting may or may not result in lower net income than cash-based accounting. The intention of accrual accounting is to record revenues and expenses in the period in which the event that earned the income occurred. Using an accrual basis of accounting will match revenues and expenses to the period the revenue was earned as opposed to when cash is paid or received, as under the cash basis. (b) Under accrual accounting, cash is not always paid after an expense is recognized. Often cash is paid at the same time an expense is recognized, as in the case of recording the payment of a monthly phone bill if the phone bill is paid in the same month the expense is incurred. Moreover, cash may be paid prior to an expense being recognized, as in the case of prepaid insurance. g)

The unearned revenues account is a liability account. If a company forgets to adjust unearned revenues for the amount that is partially earned, then liabilities will be overstated and revenues will be understated.

(h) Accrual accounting is generally better for decision making. The simplicity of the cash basis can be misleading for decision makers. When expenses are not matched to related revenues, understanding the costs of business is difficult.

181. After reviewing each of the following statements, indicate all of the statements that are true. (a) The adjusted trial balance is used as the basis of a company’s financial statements. (b) Revenue, unearned revenue, expenses and prepaid expenses will all have a zero balance after closing entries are made for a company. (c) The following are considered temporary accounts: revenues, expenses, income summary and dividends declared. (d) The post-closing trial balance is not used to prepare the financial statements as it doesn’t contain any temporary accounts. (e) Retained Earnings is part of the closing process but it is not closed itself. (f) Interest expense, rent expense and service revenues are all examples of temporary accounts. (g) Adjusting entries for prepayments do not usually affect the depreciation expense, insurance expense, and revenue accounts. (h) Closing entries are only necessary if the company is using the accrual basis of accounting.

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Solution 181 (a), (c), (d), (e), and (f) are correct. (b) Revenue and expenses will have a zero balance after the closing entries are made as they are temporary accounts. However, unearned revenue and prepaid expenses are not temporary accounts and will, therefore, not necessarily have zero balances. (g) Adjusting entries for prepayments will affect depreciation expense, insurance expense and revenues. The following are typical prepayment adjustments that are made at the end of an accounting period: Insurance Expense .................................................... Prepaid Insurance ............................................... To record expiration of prepaid insurance

XXX

Depreciation Expense ................................................ Accumulated Depreciation ................................... To record accumulated depreciation on PP&E

XXX

Unearned Revenue .................................................... Revenue .............................................................. To record the earning of prepaid revenues

XXX

(h) Closing entries are required for companies using either the accrual or cash basis of accounting. Closing entries close revenues, expenses and dividends declared accounts to zero for the next accounting cycle. This is a requirement of all accounting methods.

182. The unadjusted trial balance for Gibble Ltd. is shown below: GIBBLE LTD. Unadjusted Trial Balance December 31, 2018 Cash Accounts receivable Supplies Prepaid rent Equipment Accumulated depreciation—equipment Accounts payable Unearned revenue Bank loan payable, due 2020 Retained earnings Common shares Dividends declared Service revenue Salaries expense Rent expense Office expense Income tax expense

$ 2,200 5,800 750 1,000 44,000 $ 4,500 1,250 2,550 15,900 4,385 7,500 550 37,500 10,500 2,500 1,485 4,800

______

Accrual Accounting Concepts

$73,595

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$73,595

During 2018, the following events took place, but are not reflected in the above unadjusted trial balance: 1. Unearned revenues of $1,950 were earned. 2. Prepaid rent of $500 expired. 3. Salaries of $1,250 (for the pay period December 15–31, 2018) were incurred but will not be paid until January 5, 2019. 4. Depreciation expense of $5,000 was incurred on the equipment. Instructions Select all the items that are correct for the year ended December 31, 2018. (a) Total revenues for Gibble for the year ended as reported on its Income Statement, are $39,450. (b) The net income reported for the year will be $18,215. (c) Total current assets on Gibble’s Statement of Financial Position will be $9,250. (d) Total current liabilities on Gibble’s Statement of Financial Position will be $1,850. (e) The carrying amount of property, plant, and equipment on Gibble’s Statement of Financial Position will be $34,500. (f) After the closing entries are made, total retained earnings will be $17,800. (g) After closing, total assets will be $49,250. (h) The adjusted trial balance with have equal debit and credit balances of $79,835. Solution 182 Students may find it helpful to complete an adjusted trial balance, Income Statement and Statement of Financial Position prior to answering this question, as follows: GIBBLE LTD. Adjusted Trial Balance December 31, 2018 Cash Accounts receivable Supplies Prepaid rent ($1,000 – $500) Equipment Accumulated depreciation–equipment ($4,500 + $5,000) Accounts payable Unearned revenue ($2,550 – $1,950) Salaries payable ($0 + $1,250) Bank loan payable Retained earnings Common shares Dividends declared Service revenue ($37,500 + $1,950) Office expense Salaries expense ($10,500 + $1,250) Depreciation expense ($0 + $5,000) Rent expense ($2,500 + $500)

$ 2,200 5,800 750 500 44,000 $ 9,500 1,250 600 1,250 15,900 4,385 7,500 550 39,450 1,485 11,750 5,000 3,000

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Income tax expense

4,800 $79,835

_______ $79,835

GIBBLE LTD. Income Statement Year ended December 31, 2018 Revenues Service revenue Expenses Office expense Salaries expense Depreciation expense Rent expense Income before income tax Income tax expense Net Income

$39,450 $ 1,485 11,750 5,000 3,000

21,235 18,215 4,800 $13,415

GIBBLE LTD. Statement of Financial Position December 31, 2018 Assets Current assets Cash Accounts receivable Supplies Prepaid rent Property, plant and equipment Equipment Less: Accumulated depreciation Total assets

$ 2,200 5,800 750 500 $44,000 9,500

Liabilities and Shareholders’ Equity Liabilities Current liabilities Accounts payable $1,250 Unearned revenue 600 Salaries payable 1,250 Long term liabilities Bank loan payable Total liabilities Shareholders’ equity Common shares $ 7,500 Retained earnings 17,250 Total liabilities and shareholders’ equity

$ 9,250

34,500 $43,750

$ 3,100 15,900 19,000

24,750 $43,750

According to the above: (a), (c), (e), and (h) are correct. (b), (d), (f), and (g) are not correct.

CHAPTER 5 MERCHANDISING OPERATIONS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 15. 2 M AP F AN 29. 4 E K F AN 2. 1 E K F AN 16. 3 M K F AN 30. 5 M K F AN 3. 1 E K F AN 17. 3 M C F AN 31. 5 E AP F AN 4. 1 E K F AN 18. 3 E C F AN 32. 5 E K F AN 5. 1 E C F AN 19. 3 M AP F AN 33. 5 E K F AN F AN C F AN K F AN 6. 1 M K 20. 3 M 34. 5 E 7. 1 M K F AN 21. 4 M K F AN 35. 5 M K F AN 8. 2 M C F AN 22. 4 E K F AN *36. 6 E K F AN 9. 2 M K F AN 23. 4 E K F AN *37. 6 M C F AN 10. 2 E C F AN 24. 4 E K F AN *38. 6 E K F AN 11. 2 E C F AN 25. 4 E K F AN *39. 6 E K F AN 12. 2 E K F AN 26. 4 M K F AN *40. 6 M C F AN 13. 2 E AP F AN 27. 4 M K F AN *41. 6 M C F AN 14. 2 M C F AN 28. 4 M K F AN LOD: E = Easy M = Medium Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

*This topic is dealt with in an Appendix to the chapter.

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’sCPA AACSB Item LO LOD Bloom’sCPA AACSB Multiple Choice Questions 42. 1 M C F AN 79. 3 E K F AN 116. 4 E K F AN 43. 1 E K F AN 80. 3 E C F AN 117. 4 M K F AN 44. 1 E K F AN 81. 3 E C F AN 118. 4 E K F AN 45. 1 E K F AN 82. 3 E C F AN 119. 4 M AP F AN C F AN K F AN AP F AN 46. 1 M 83. 3 M 120. 4 M 1 C F AN 3 K F AN 5 AP F AN 47. M 84. E 121. M K F AN C F AN AP F AN 48. 1 E 85. 3 E 122. 5 M K F AN AP F AN C F AN 49. 1 M 86. 3 M 123. 5 M K F AN C F AN C F AN 50. 1 E 87. 3 E 124. 5 E 51. 1 E K F AN 88. 3 E C F AN 125. 5 M C F AN 52. 1 E K F AN 89. 3 M C F AN 126. 5 E AP F AN 53. 1 M K F AN 90. 3 E C F AN 127. 5 M AP F AN 54. 1 M K F AN 91. 3 M C F AN 128. 5 E AP F AN 55. 1 E C F AN 92. 3 E K F AN 129. 5 E K F AN 56. 1 E K F AN 93. 3 E C F AN 130. 5 E K F AN 57. 1 E C F AN 94. 3 M C F AN 131. 5 M AP F AN 58. 1 E C F AN 95. 3 E AP F AN 132. 5 M AP F AN 59. 1 M C F AN 96. 3 M AP F AN *133. 6 M C F AN 60. 1 E C F AN 97. 3 M AP F AN *134. 6 M C F AN 61. 1 E C F AN 98. 3 E C F AN *135. 6 E C F AN 62. 1,6 M C F AN 99. 3 E C F AN *136. 6 E C F AN 63. 1,6 E K F AN 100. 3 E C F AN *137. 6 E C F AN 64. 1,6 E K F AN 101. 3 E C F AN *138. 6 E C F AN 65. 2 M C F AN 102. 4 E C F AN *139. 6 E C F AN 66. 2 E K F AN 103. 4 E K F AN *140. 6 M C F AN 67. 2 M AP F AN 104. 4 E K F AN *141. 6 M C F AN 68. 2 E C F AN 105. 4 E C F AN *142. 6 E C F AN 69. 2 M C F AN 106. 4 E C F AN *143. 6 E C F AN 70. 2 M C F AN 107. 4 M C F AN *144. 6 E AP F AN 71. 2 E C F AN 108. 4 E K F AN *145. 6 M AP F AN 72. 2 M C F AN 109. 4 E K F AN *146. 6 M C F AN 73. 2 E AP F AN 110. 4 E K F AN *147. 6 M AP F AN 74. 2 E C F AN 111. 4 H C F AN *148. 6 M AP F AN 75. 2 E K F AN 112. 4 M C F AN *149. 6 M AP F AN 76. 2 H C F AN 113. 4 E K F AN *150. 6 M C F AN 77. 3 E C F AN 114. 4 E K F AN 78. 3 M K F AN 115. 4 M C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

*This topic is dealt with in an Appendix to the chapter.

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item

151. 152. 153. 154. 155. 156. 157. 158. 159. 160. 161.

2 2 2,3 2,3 2,3 2,3 2,3 2,3 2,3,6 3 3

LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB

H M E M E E H H E M E

AP AP AP AP AP AP AP AP AP AP AP

F F F F F F F F F F F

AN AN AN AN AN AN AN AN AN AN AN

*183. 1–3,5,6 E,M

184. 185. 186. 187.

1 1,2,6 1,6 4

M M E E

C C K C

F F F F

AN AN AN AN

195. 196.

2,3 4

M M

C K

F F

AN AN

Exercises 162. 4 E AP 163. 4 E C 164. 4 M AP 165. 4,5 E AP AP 166. 4,5 E AP 167. 4,5 E AP 168. 4,5 E AP 169. 4,5 M 170. 5 M AP 171. 5 M AP *172. 5,6 M AP Matching

F F F F F F F F F F F

AN AN AN AN AN AN AN AN AN AN AN

Short-Answer Essay 188 4 E C F AN 189. 4 M C F AN 190. 4 E C F AN 191. 4 M C F,E AN,C CPA Questions 197. 4 M AN F AN *198. 6 E K F AN

*173. 5,6 H *174. 6 H *175. 6 M *176. 6 E *177. 6 E *178. 6 E *179. 6 M *180. 6 E *181. 6 M *182. 6 E

AP AP AP AP AP AP AP AP AP AP

F F F F F F F F F F

192. 4,5 M 193. 5 E *194. 6 E

C C C

F,E AN,E F AN F AN

*199. 6

LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: E = Professional and Ethical Behaviour F = Financial Reporting AACSB: AN = Analytic C = Communication E = Ethics *This topic is dealt with in an Appendix to the chapter.

AN AN AN AN AN AN AN AN AN AN

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item

Type

Item

Type

Item

1. 2. 3. 4. 5.

TF TF TF TF TF

6. 7. 42. 43. 44.

TF TF MC MC MC

45. 46. 47. 48. 49.

8. 9. 10. 11. 12.

TF TF TF TF TF

13. 14. 15. 65. 66.

TF TF TF MC MC

67. 68. 69. 70. 71.

16. 17. 18. 19. 20. 77.

TF TF TF TF TF MC

78. 79. 80. 81. 82. 83.

MC MC MC MC MC MC

84. 85. 86. 87. 88. 89.

21. 22. 23. 24. 25. 26. 27.

TF TF TF TF TF TF TF

28. 29. 102. 103. 104. 105. 106.

TF TF MC MC MC MC MC

107. 108. 109. 110. 111. 112. 113.

30. 31. 32. 33. 34.

TF TF TF TF TF

35. 121. 122. 123. 124.

TF MC MC MC MC

125. 126. 127. 128. 129.

*36. *37. *38. *39. *40. *41. *133.

TF TF TF TF TF TF MC

*134. *135. *136. *137. *138. *139. *140.

MC MC MC MC MC MC MC

*141. *142. *143. *144. *145. *146. *147.

Note:

TF = True-False Ex = Exercise

Type

Item

Type

Item

Learning Objective 1 MC 50. MC 55. MC 51. MC 56. MC 52. MC 57. MC 53. MC 58. MC 54. MC 59. Learning Objective 2 MC 72. MC 151. MC 73. MC 152. MC 74. MC 153. MC 75. MC 154. MC 76. MC 155. Learning Objective 3 MC 90. MC 96. MC 91. MC 97. MC 92. MC 98. MC 93. MC 99. MC 94. MC 100. MC 95. MC 101. Learning Objective 4 MC 114. MC 162. MC 115. MC 163. MC 116. MC 164. MC 117. MC 165. MC 118. MC 166. MC 119. MC 167. MC 120. MC 168. Learning Objective 5 MC 130. MC 167. MC 131. MC 168. MC 132. MC 169. MC 165. Ex 170. MC 166. Ex 171. *Learning Objective 6 MC *148. MC *175. MC *149. MC *176. MC *150. MC *177. MC *159. Ex *178. MC *172. Ex *179. MC *173. Ex *180. MC *174. Ex *181. MC = Multiple Choice SAE = Short-Answer Essay

Type

Item

Type

Item

Type

MC MC MC MC MC

60. 61. 62. 63. 64.

MC MC MC MC MC

183. 184. 185. 186.

Ma SAE SAE SAE

Ex Ex Ex Ex Ex

156. 157. 158. 159. 183.

Ex Ex Ex Ex Ma

185. 195.

SAE CP

MC MC MC MC MC MC

153. 154. 155. 156. 157. 158.

Ex Ex Ex Ex Ex Ex

159. 160. 161. 183. 195.

Ex Ex Ex Ma CP

Ex Ex Ex Ex Ex Ex Ex

169. 187. 187. 188. 189. 190. 191.

Ex SAE SAE SAE SAE SAE SAE

192. 196. 197.

SAE CP CP

Ex Ex Ex Ex Ex

172. 173. 183. 192. 193.

Ex Ex Ma SAE SAE

Ex Ex Ex Ex Ex Ex Ex

*182. *183. *185. *186. *194. *198. *199.

Ex Ma SAE SAE SAE CP CP

Ma = Matching CP = CPA Questions

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CHAPTER LEARNING 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 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 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 income before income tax is determined in one step. Income tax expense is separated from the other expenses and reported separately after income before income tax to determine net income (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 income from operations. Step 4 adds or deducts any non-operating items to determine income before income tax. Finally, step 5 deducts income tax expense to determine net income (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 net income by net sales, measures the net income 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 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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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. Under a perpetual inventory system, the cost of goods sold is determined each time a sale occurs.

4. Inventory is usually the largest current asset for a merchandiser.

5. Cost of Goods Sold is considered an operating expense for a merchandising company.

6. Operating expenses are subtracted from revenue for a service company and from gross profit for a merchandising company.

7. Cost of goods available for sale is considered an operating expense for a merchandising company.

8. When the terms of sale are FOB shipping point, the seller is responsible for any damages to the goods during shipping.

9. Freight terms will specify the point at which ownership of the goods is transferred from the seller to the buyer.

10. Freight costs incurred on incoming merchandise are an operating expense to the buyer.

11. The terms 2/10, n/30 mean that a 2% discount is allowed on payments made over 10 days but within the credit period.

12. Discounts taken for early payment of an invoice are called sales discounts by the buyer.

13. If merchandise costing $2,500, terms 2/10 n/30, is paid within 10 days, the amount of the purchase discount is $250. Solution: $2,500 x.02 = $50.00

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14. A quantity discount is recorded separately, the same way as a purchase discount.

15. If a quantity discount of 10% is received on a purchase of $10,000, inventory would be recorded at $9,000. Solution: $10,000 x.90 = $9,000

16. The Sales Returns and Allowances account and the Sales Discounts account are both classified as expense accounts.

17. When goods are shipped FOB shipping point, freight costs are an operating expense for the seller.

18. When the terms of sale include a sales discount, it usually is advisable for the buyer to pay within the discount period.

19. 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. Solution: ($2,500 – $500) x.01 = $20.00 20. When returned merchandise is defective, the seller’s sales account is debited.

21. 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 net income.

22. Operating expenses are similar in merchandising and service companies.

23. Gross profit appears on both the single-step and multiple-step forms of the income statement. 24. Non-operating activities include revenues and expenses that are related to the company’s main operations.

25. Corporations following IFRS must classify their expenses either by nature or by function.

26. Income from operations appears on both the single-step and multiple-step forms of the

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income statement. 27. A merchandising company’s income from operations is determined by subtracting cost of goods sold from net sales.

28. Interest revenue for a merchandising company is usually reported in the non-operating activities section of the income statement.

29. Companies following ASPE may classify their expenses by nature, but not by function.

30. Gross profit margin is the same as the gross profit amount.

31. If net sales are $1,000,000 and cost of goods sold is $800,000, the gross profit margin is 20%. Solution: ($1,000,000 – $800,000) / $1,000,000 = 20%

32. The gross profit amount is generally considered to be more informative than the gross profit margin.

33. Gross profit margin is calculated by dividing cost of goods sold by net sales.

34. Profit margin indicates whether a company is controlling operating expenses relative to sales.

35. Profit margin is calculated by dividing net income by net sales.

*36. Purchase Returns and Allowances and Purchase Discounts are contra expense accounts with normal credit balances.

*37. Freight In is subtracted from the Purchases account to arrive at cost of goods purchased.

*38. A key difference between the periodic and perpetual inventory systems is the timing of the calculation of cost of goods sold.

*39. 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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*40. 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.

*41. 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.

Ans. T F T T F T F F T

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

Ans. F F F F F T F F T

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

Ans. T F T T F F T F F

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

Ans. T F F T F F T T T

Item *37. *38. *39. *40. *41.

Ans. F T T T F

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MULTIPLE CHOICE QUESTIONS 42. Gross profit equals (a) sales less operating expenses. (b) gross sales less cost of goods sold. (c) cost of goods sold less operating expenses. (d) net sales less cost of goods sold.

43. 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.

44. Gross profit equals the difference between net sales and (a) net income. (b) cost of goods sold. (c) operating expenses. (d) cost of goods sold plus operating expenses.

45. Each of the following companies is a merchandising company except a (a) wholesale parts company. (b) candy store. (c) moving company. (d) furniture store.

46. Net income will result if gross profit exceeds (a) cost of goods sold. (b) operating expenses. (c) purchases. (d) cost of goods sold plus operating expenses.

47. A merchandiser will have income 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.

48. The largest current asset for a merchandiser is usually (a) inventory. (b) prepaid expenses. (c) cash.

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(d) accounts receivable.

49. 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.

50. Generally, the revenue account for a merchandising company is called (a) Sales Revenue or Sales. (b) Investment Revenue. (c) Gross Profit. (d) Net Sales.

51. 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.

52. Net sales less cost of goods sold is called (a) gross profit. (b) cost of goods sold. (c) net income. (d) income before income taxes.

53. After gross profit is calculated, operating expenses are deducted to determine (a) gross margin. (b) net income (loss) before income tax. (c) cost of goods sold. (d) profit margin. 54. Which of the following “formulas” is incorrect? (a) Gross profit – operating expenses = income 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.

55. 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.

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56. 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.

57. 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.

58. 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.

59. 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.

60. 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.

61. 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.

62. 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.

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63. 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.

64. Under the perpetual inventory system, which of the following accounts would not be used? (a) Sales (b) Purchases (c) Cost of Goods Sold (d) Inventory

65. Given a perpetual inventory system which one of the following statements is false? (a) Freight costs incurred by the buyer are added to the Inventory account. (b) Purchases of merchandise for sale are recorded in the Inventory account. (c) A discount taken for early payment is credited to the Inventory account. (d) A return of merchandise is credited to the Purchase Returns and Allowances account.

66. The abbreviation "FOB" stands for (a) free on board. (b) freight on board. (c) free only (to) buyer. (d) freight charge on buyer.

67. On July 10, Arbour Inc. purchased $5,000 of inventory on terms of 2/10, n/30. The amount due on August 25 is (a) $5,100. (b) $5,000. (c) $4,900. (d) $4,990.

68. Under a perpetual inventory system, purchase of inventory is recorded as a debit to the (a) Supplies account. (b) Purchases account. (c) Inventory account. (d) Cost of Goods Sold account.

69. 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) Inventory. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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70. A company using a perpetual inventory system that returns goods purchased on credit would (a) debit Accounts Payable and credit Inventory. (b) debit Sales and credit Accounts Payable. (c) debit Cash and credit Accounts Payable. (d) debit Accounts Payable and credit Purchases.

71. If a purchaser using a perpetual inventory system pays freight costs, then the (a) Inventory account is increased. (b) Inventory account is not affected. (c) Freight Out account is increased. (d) Freight In account is increased.

72. 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.

73. Alliance Corporation purchased inventory with an invoice price of $22,000 and credit terms of 1/10, n/15. How much cash will Alliance pay if they pay within the discount period? (a) $22,000 (b) $21,780 (c) $22,220 (d) $18,700 Solution: $22,000 x.99 = $21,780

74. 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 Inventory of $3,360. (d) debit to Inventory of $3,500.

75. 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.

76. Sales Allowances and Sales Discounts (a) are both designed to encourage customers to pay their accounts promptly.

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(b) are both contra revenue accounts to Sales. (c) both have a normal credit balance. (d) both have a normal debit balance and are therefore regarded as expense accounts.

77. Under the perpetual inventory system, in addition to making the entry to record the sale, the seller would (a) debit Inventory and credit Cost of Goods Sold. (b) debit Cost of Goods Sold and credit Purchases. (c) debit Cost of Goods Sold and credit Inventory. (d) make no additional entry until the end of the period.

78. 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.

79. Sales Discounts is a(n) (a) contra revenue account. (b) contra asset account. (c) revenue account. (d) expense account.

80. Evidence of cash sales is usually supported by (a) purchase invoices. (b) sales invoices. (c) purchase orders. (d) cash register tapes.

81. Gross sales less sales returns and allowances less sales discounts equals (a) collectible sales. (b) net sales. (c) total sales. (d) operating sales.

82. 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.

83. A sales invoice is prepared when goods (a) are sold for cash. (b) are sold on credit. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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84. Sales Returns and Allowances is a(n) (a) asset account. (b) contra asset account. (c) expense account. (d) contra revenue account.

85. 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.

86. 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. Solution: $2,000 x.02 = $40 87. 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.

88. 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. 89. 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.

90. Management may be alerted to a quality problem with their merchandise by a sudden increase in which account?

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(a) Sales (b) Sales Returns and Allowances (c) Sales Discounts (d) Cost of Goods Sold

91. 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.

92. 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.

93. 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. (d) two sales returns can be made within 10 days of the invoice date and no returns thereafter.

94. 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.

95. Alpha Corp. sells $1,000 of merchandise on account to Beta Corp. with credit terms of 2/10, n/30. If Beta pays within the discount period, how much cash will Alpha receive? (a) $900 (b) $920 (c) $980 (d) $1,000 Solution: $1,000 x.98 = $980

96. Mindful Corporation sells merchandise on account for $5,000 to Absent Corporation with credit terms of 2/10, n/30. Absent returns $750 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) $4,900 (b) $4,250 (c) $5,000 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) $4,165 Solution: ($5,000 – $750) x.98 = $4,165

97. Raven Corp. sells merchandise on account for $4,000 to Eagle Corp., terms 2/10, n/30. Eagle returns $1,600 worth of merchandise that was damaged, along with a cheque to settle the account within the discount period. What entry does Raven make upon receipt of the cheque? (a) Cash ........................................................................................... 2,400 Accounts Receivable............................................................ 2,400 (b) Cash ........................................................................................... 2,320 Sales Returns and Allowances.................................................... 1,568 Sales Discounts .......................................................................... 64 Accounts Receivable............................................................ 4,000 (c) Cash ........................................................................................... 2,352 Sales Returns and Allowances.................................................... 1,600 Sales Discounts .......................................................................... 48 Accounts Receivable............................................................ 4,000 (d) Cash ........................................................................................... 2,320 Sales Discounts .......................................................................... 80 Sales Returns and Allowances.................................................... 1,600 Accounts Receivable............................................................ 4,000 Solution: Cash: ($4,000 – $1,600) x.98 = $2,352; Discount: ($4,000 – $1,600) x.02 = $48

98. 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. (c) debit to Cash for $1,000. (d) credit to Accounts Receivable for $980.

99. 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

100. 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

101. 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.

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(d) credit, debit, credit.

102. 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

103. 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.

104. 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.

105. Gross profit for a merchandising company equals the difference between net sales and (a) operating expenses. (b) cost of goods sold. (c) net income. (d) cost of goods sold plus operating expenses.

106. 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.

107. What is the term applied to the excess of net sales over the cost of goods sold? (a) gross sales (b) income from operations (c) net income (d) gross profit

108. 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. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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109. 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.

110. Income 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.

111. 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.

112. 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. (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.

113. A multiple-step income statement shows (a) gross profit but not income from operations. (b) neither gross profit nor income from operations. (c) both gross profit and income from operations. (d) income from operations but not gross profit.

114. 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.

115. Income from operations for a merchandising company is net sales less (a) operating expenses. (b) cost of goods sold. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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116. 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.

117. Which one of the following would appear on the income statement of both a merchandising company and a service company? (a) Gross profit (b) Net income (c) Sales revenues (d) Cost of goods sold

118. 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.

Use the following information to answer questions 119–122. Cost of goods sold ............................................................ $434,000 Income tax expense .......................................................... 67,200 Operating expenses .......................................................... 344,000 Sales ................................................................................. 1,100,000 Sales discounts ................................................................. 24,000 Sales returns and allowances ........................................... 74,000

119. The amount of net sales on the income statement would be (a) $1,002,000. (b) $1,076,000. (c) $1,026,000. (d) $1,100,000. Solution: ($1,100,000 – $24,000 – $74,000) = $1,002,000

120. Gross profit would be (a) $224,000. (b) $568,000. (c) $756,000. (d) $1,002,000. Solution: ($1,002,000 – $434,000) = $568,000 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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121. The gross profit margin would be (a) 56.7%. (b) 34.3%. (c) 43.3%. (d) 39.5%. Solution: $568,000 / $1,002,000 = 56.7%

122. The profit margin would be (a) 18.5%. (b) 15.6%. (c) 60.6%. (d) 34.3%. Solution: ($568,000 – $344,000 – $67,200) / $1,002,000 = 15.6%

123. Gross profit is (a) a measure of the overall net income of a company. (b) is expressed as a percentage of gross sales. (c) also called gross margin. (d) the same as gross profit margin.

124. The gross profit margin is calculated by dividing gross profit by (a) sales. (b) cost of goods sold. (c) net sales. (d) operating expenses. 125. 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.

126. 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%. Solution: ($500,000 – $350,000) / $500,000 = 30%

127. A company shows the following balances: Cost of goods sold ............................................................ $ 900,000

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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% Solution: ($2,000,000 – $25,000 – $225,000 – $900,000) / ($2,000,000 – $25,000 – $225,000) = 48.6%

128. Profit margin is calculated by dividing (a) net income by gross profit. (b) net income by sales. (c) net income by net sales. (d) sales by net income.

129. Profit margin is a measure of (a) liquidity. (b) profitability. (c) solvency. (d) comparability.

130. Profit margin is calculated by dividing net income by (a) sales. (b) sales revenues. (c) net sales. (d) gross sales.

Use the following financial information to answer questions 131–132. Operating expenses .......................................................... Sales returns and allowances ........................................... Sales ................................................................................. Cost of goods sold ............................................................ Income tax expense ..........................................................

$ 25,000 3,000 110,000 55,000 5,000

131. What is the gross profit margin? (a) 20.6% (b) 22.7% (c) 48.6% (d) 50.0% Solution: ($110,000 – $3,000 – $55,000) / ($110,000 – $3,000) = 48.6%

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(a) 20.6% (b) 22.7% (c) 48.6% (d) 50.0% Solution: ($110,000 – $3,000 – $55,000 – $25,000 – $5,000) / ($110,000 – $3,000) = 20.6%

*133. Under a periodic inventory system, (a) purchases of inventory are debited to the Purchases account. (b) freight incurred on merchandise purchases by the buyer should be debited to the Inventory account. (c) purchases of merchandise are usually credited to the Purchases account. (d) freight incurred on merchandise sales by the seller should be debited to the Freight In account.

*134. 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.

*135. 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.

*136. 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.

*137. Under a periodic inventory system, purchase of merchandise is debited to the (a) Inventory account. (b) Cost of Goods Sold account. (c) Purchases account. (d) Accounts Payable account.

*138. Which of the following accounts has a normal credit balance? (a) Purchases (b) Sales Returns and Allowances (c) Freight In (d) Purchase Discounts

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*139. The respective normal balances of Purchases, Purchase Discounts, and Freight In are (a) credit, credit, debit. (b) debit, credit, credit. (c) debit, credit, debit. (d) debit, debit, debit.

*140. 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.

*141. 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.

*142. 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.

*143. 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.

*144. Market Inc. shows the following account balances for last month: Freight In........................................................................... $ 3,750 Freight Out ........................................................................ 2,425 Purchases ......................................................................... 33,500 Purchase Discounts .......................................................... 1,005 Sales Returns and Allowances.......................................... 4,250 The cost of goods purchased for last month is (a) $33,820. (b) $36,245. (c) $32,495. (d) $33,500. Solution: ($33,500 + $3,750 – $1,005) = $36,245

*145. ClearEyes Inc. reported beginning inventory of $20,000. During the period, purchases were Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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$140,000; purchase returns, $4,000; and freight in $10,000. A physical count of inventory at the end of the period revealed that $30,000 was still on hand. The cost of goods available for sale was (a) $156,000. (b) $164,000. (c) $166,000. (d) $184,000. Solution: $20,000 + (140,000 – 4,000 + 10,000) = $166,000

*146. 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 *147–*149. For last month, the following data were taken from the ledger of Rockit Inc.: Beginning Inventory .......................................................... $ 43,000 Ending Inventory ............................................................... 32,400 Freight In........................................................................... 2,300 Purchases ......................................................................... 224,000 Purchase Discounts .......................................................... 1,500 Purchase Returns and Allowances.................................... 3,800

*147. What was the cost of goods purchased? (a) $220,200 (b) $218,700 (c) $221,000 (d) $216,400 Solution: $224,000 – 1,500 – 3,800 + 2,300 = $221,000

*148. What was the cost of goods sold? (a) $234,600 (b) $231,600 (c) $237,600 (d) $213,400 Solution: $43,000 + ($224,000 – 1,500 – 3,800 + 2,300) – $32,000 = $231,600

*149. What was the cost of goods available for sale? (a) $264,000 (b) $267,000 (c) $269,300 (d) $234,600 Solution: $43,000 + ($224,000 – 1,500 – 3,800 + 2,300) = $264,000 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Merchandising Operations

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*150. On the income statement, the beginning 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) income from operations. (d) gross profit.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57.

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

Item 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73.

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

Item 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89.

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

Item 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105.

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

Item Ans. d 106. d 107. c 108. c 109. d 110. b 111. d 112. c 113. a 114. d 115. c 116. b 117. b 118. a 119. b 120. a 121.

Item Ans. b 122. c 123. c 124. c 125. b 126. b 127. c 128. b 129. c 130. c 131. a 132. a *133. a *134. b *135. b *136. c *137.

Item Ans. d *138. c *139. a *140. c *141. b *142. a *143. b *144. c *145. d *146. c *147. b *148. a *149. b *150.

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EXERCISES Ex. 151 Ann-Marie Carver is a new accountant with Ornell Corporation. Ornell purchased merchandise on account for $10,000. The credit terms are 2/10, n/30. Ann-Marie has talked with the company's banker and knows that she could earn 10% on any money invested in the company's savings account. Instructions (a) Should Ann-Marie pay the invoice within the discount period or should she keep the $10,000 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 Ann-Marie forgoes the discount, it may be viewed as paying an interest rate of 2% for the use of $10,000 for 20 days. Calculate the annual rate of interest that this is equivalent to. Solution 151 (10 min.) (a) Discount of 2% on $10,000 $200.00 Interest received on $10,000 (for 20 days at 10%) $54.79 ($10,000  10%  20  365) Savings by taking the discount $145.21 Recommendation: Ann-Marie should pay the invoice within the discount period. (b)

The equivalent annual interest rate is: 2%  365  20 = 36.5%.

Ex. 152 Magnesium Inc. uses a perpetual 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 costing $600 on credit for $1,000, terms 2/10, n/45. 14 The customer of April 13 returned $300 of the goods that had a cost of $180. 23 Received payment from the customer of April 13. Instructions Prepare journal entries to record the above transactions. Solution 152 Apr 3 Inventory ............................................................................ Accounts Payable ....................................................... 6

2,000 2,000

Accounts Payable .............................................................. Inventory .....................................................................

300

Inventory ............................................................................ Cash ...........................................................................

150

300

150

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Accounts Payable ($2,000 – $300) .................................... Inventory ($1,700 x 3%) .............................................. Cash ($1,700 x 97%) ..................................................

1,700

Accounts Receivable ......................................................... Sales ...........................................................................

1,000

Cost of Goods Sold ............................................................ Inventory .....................................................................

600

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

300

Inventory ............................................................................ Cost of Goods Sold .....................................................

180

Cash ($700 x 98%) ............................................................ Sales Discounts ($700 x 2%) ............................................. Accounts Receivable ($1,000 – $300).........................

686 14

51 1,649

1,000

600

300

180

700

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 153 (15–20 min.) (a) Willem’s records Jun 4 Inventory ............................................................................ Accounts Payable ....................................................... 10

4,000 4,000

Accounts Payable .............................................................. Inventory .....................................................................

700

Accounts Payable ($4,000 – $700) .................................... Cash ...........................................................................

3,300

(b) Cate’s records Jun 4 Accounts Receivable ......................................................... Sales ...........................................................................

4,000

Cost of Goods Sold ............................................................

700

3,300

4,000 2,600

Merchandising Operations

Inventory ..................................................................... 10

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2,600

Sales Returns and Allowance ............................................ Accounts Receivable...................................................

700

Inventory ............................................................................ Cost of Goods Sold .....................................................

450

Cash .................................................................................. Accounts Receivable ($4,000 – $700).........................

3,300

700

450

3,300

Ex. 154 On July 1, Racquets Plus had an inventory of 20 tennis racquets at a cost of $125 each. Racquets Plus uses a perpetual inventory system. During the month of July, the following transactions occurred: Jul 4 Purchased 25 racquets at a cost of $125 each from the Tennis Gear Corporation, terms 2/10, n/30. 5 Paid freight of $100 on the July 4 purchase. 6 Sold 10 racquets from the July 1 inventory to Team Canada for $225 each, terms 2/10, n/30. 7 Received a credit from Tennis Gear for the return of 2 defective racquets. 8 Sold two racquets from the July 1 inventory for $550 cash. 13 Issued a credit memo to Team Canada for the return of a defective racquet. 14 Paid Tennis Gear in full. 15 Received payment from Team Canada. Instructions Record the July transactions for Racquets Plus. Solution 154 (20 min.) Jul 4 Inventory ($125 x 25) ......................................................... Accounts Payable ....................................................... 5

3,125 3,125

Inventory ............................................................................ Cash ...........................................................................

100

Accounts Receivable ($225 x 10)....................................... Sales ........................................................................... Cost of Goods Sold ($125 x 10) ......................................... Inventory .....................................................................

2,250

Accounts Payable .............................................................. Inventory .....................................................................

250

Cash. ................................................................................. Sales ........................................................................... Cost of Goods Sold ($125 x 2) ........................................... Inventory .....................................................................

550

100

2,250 1,250 1,250

250

550 250 250

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Sales Returns and Allowances .......................................... Accounts Receivable...................................................

225

Accounts Payable ($3,125 – $250) .................................... Cash ($2,875  98%) .................................................. Inventory ($2,875  2%) ..............................................

2,875

Cash ($2,025 x 98%) ......................................................... Sales Discounts ($2,025 x 2%) .......................................... Accounts Receivable ($2,250 – $225).........................

1,984.50 40.50

225

2,817.50 57.50

2,025

Ex. 155 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 155 (15–20 min.) Sep 4 Inventory ($30 x 35) ........................................................... Accounts Payable ....................................................... 6

1,050 1,050

Accounts Payable .............................................................. Inventory .....................................................................

150

Accounts Receivable ($50 x 20)......................................... Sales ...........................................................................

1,000

Cost of Goods Sold ($30 x 20) ........................................... Inventory .....................................................................

600

Accounts Payable ($1,050 – $150) .................................... Cash ($900  97%) ..................................................... 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

Merchandising Operations

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Ex. 156 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 156 (15–20 min.) Jul 6 Inventory ............................................................................ Accounts Payable ....................................................... 8

1,800 1,800

Accounts Payable .............................................................. Inventory .....................................................................

175

Inventory ............................................................................ Cash ...........................................................................

Accounts Receivable ......................................................... Sales ...........................................................................

1,800

Cost of Goods Sold ............................................................ Inventory .....................................................................

900

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

200

Inventory ............................................................................ Cost of Goods Sold .....................................................

100

Cash ($1,600 x 98%) ......................................................... Sales Discounts ($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

Ex. 157 (a) Arbour Corporation purchased merchandise on account from Lavalle Supplies for $136,000, with terms of 2/10, n/30. During the discount period, Arbour returned some merchandise and Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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paid $113,680 as payment in full. Arbour uses a perpetual inventory system. Prepare the journal entries that Arbour made to record the 1. purchase of merchandise. 2. return of merchandise. 3. payment on account. (b) Ransak Corporation sold merchandise to Belville Corporation on account for $168,000 with credit terms of?/10, n/30. The cost of the merchandise sold was $84,000. During the discount period, Belville returned $28,000 worth of merchandise and paid its account in full (minus the return and the discount) by paying $134,400 in cash. The returned goods were returned to inventory. Both companies use a perpetual inventory system. Prepare the journal entries that Ransak Corporation made to record the 1. sale of merchandise. 2. return of merchandise. 3. collection on account. Solution 157 (15–20 min.) (a) To calculate the amount due after returns but before the discount, divide $113,680 by 98% (100% – 2%) = $113,680  98% = $116,000 Subtract $116,000 from $136,000 to determine that $20,000 of merchandise was returned. 1.

Inventory ................................................................................ Accounts Payable ............................................................

136,000

Accounts Payable................................................................... Inventory .........................................................................

20,000

Accounts Payable................................................................... Inventory (116,000 x 2%)................................................. Cash ................................................................................

116,000

136,000

20,000

2,320 113,680

(b) Belville returns $28,000 of merchandise and thus owes $140,000 to Ransak. $134,400  $140,000 = 96%; 100% – 96% = 4% The missing discount percentage is 4%. $140,000  4% = $5,600 sales discount $140,000 – $5,600 = $134,400 cash received on account 1.

Accounts Receivable .............................................................. Sales ...............................................................................

168,000

Cost of Goods Sold ................................................................ Inventory .........................................................................

84,000

Sales Returns and Allowances ............................................... Accounts Receivable .......................................................

28,000

Inventory ................................................................................ Cost of Goods Sold .........................................................

14,000

Cash.......................................................................................

134,400

168,000

84,000

28,000

14,000

Merchandising Operations

Sales Discounts...................................................................... Accounts Receivable .......................................................

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5,600 140,000

Ex. 158 On June 1, Grill Master Ltd. had an inventory of 10 barbeques at a cost of $440 each. Grill Master uses a perpetual inventory system. During the month of June the following transactions occurred: Jun 3 Purchased 25 barbeques at a cost of $440 each from BBQ King Ltd., terms n/30. 5 Paid $200 freight for the barbeques purchased on June 3. 6 Sold 12 barbeques to Outdoor Grill for $760 each, terms 2/10, n/30. 7 Received credit from BBQ King for the return of two defective barbeques. 13 Issued a credit to Outdoor Grill for the return of one defective barbeque. 16 Received a credit from BBQ King for the defective barbeque returned by Outdoor Grill. 19 Purchased 10 barbeques from Backyard Barbecues at a cost of $440 each, terms 2/10, n/30. 20 Paid freight of $200 on the June 19 purchase. Instructions Prepare journal entries to record the above transactions. Solution 158 Jun 3 Inventory ($440 x 25) ......................................................... Accounts Payable ....................................................... 5

11,000 11,000

Inventory ............................................................................ Cash ...........................................................................

200

Accounts Receivable ($760 x 12)....................................... Sales ...........................................................................

9,120

Cost of Goods Sold ($440 x 12) ......................................... Inventory .....................................................................

5,280

Accounts Payable ($440 x 2) ............................................. Inventory .....................................................................

880

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

760

Inventory ............................................................................ Cost of Goods Sold .....................................................

440

Accounts Payable .............................................................. Inventory .....................................................................

440

Inventory ($440 x 10) ......................................................... Accounts Payable .......................................................

4,400

Inventory ............................................................................

200

9,120

5,280

880

760

440

4,400

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Cash ...........................................................................

200

Ex. 159 Presented below are selected transactions for Manclave Corporation during July. Jul 1 Sold merchandise to Regina Inc. for $1,000, terms 3/10, n/30. The merchandise sold cost $600. 2 Purchased merchandise from Novalle Corporation for $5,200, terms 4/10, n/30. 3 Paid freight charges of $150 on items purchased on July 2. 4 Purchased merchandise from Ollie Company Ltd. for $7,500, n/30. 10 Received payment from Regina Inc. for purchase of July 1. 11 Paid Novalle Corporation for July 2 purchase. Instructions (a) Record the above transactions for Manclave 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 Manclave Corporation, assuming a periodic inventory system is used. Solution 159 (25 min.) (a) Perpetual Jul 1 Accounts Receivable ......................................................... Sales ........................................................................

1,000

Cost of Goods Sold ............................................................ Inventory ...................................................................

600

Inventory ............................................................................ Accounts Payable ....................................................

5,200

Inventory ............................................................................ Cash .........................................................................

150

Inventory ............................................................................ Accounts Payable ....................................................

7,500

Cash ($1,000 x 97%) ......................................................... Sales Discounts ($1,000 x 3%) .......................................... Accounts Receivable ................................................

970 30

Accounts Payable .............................................................. Inventory ($5,200 x 4%) ............................................ Cash ($5,200 x 96%) ................................................

5,200

(b) Periodic Jul 1 Accounts Receivable ......................................................... Sales ........................................................................ 2

1,000

Purchases..........................................................................

600

5,200

150

7,500

1,000

208 4,992

1,000 1,000 5,200

Merchandising Operations

Accounts Payable ..................................................... 3

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5,200

Freight in............................................................................ Cash .......................................................................

150

Purchases.......................................................................... Accounts Payable .....................................................

7,500

970 30

Accounts Payable .............................................................. Purchase Discounts ($5,200 x 4%) ........................... Cash ($5,200 x 96%) ................................................

5,200

150

7,500

1,000

208 4,992

Ex. 160 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 160 (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. 161 Storm Inc. completed the following transactions in October: Credit Sales Sales Returns Date Amount Terms Date Amount Oct 3 $ 800 2/10, n/30 11 1,200 3/10, n/30 Oct 14 $ 500

Date of Collection Oct 8 16

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17 21 23

7,000 1,700 2,500

1/10, n/30 2/10, n/60 2/10, n/30

20 23 27

1,200 400 500

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 161 (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 ....................................................... Inventory ................................................................

7,000

Sales Returns and Allowances ...................................... Accounts Receivable .............................................. 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. 162 Financial information is presented here for two companies. Complete the missing amounts. Empty Corporation Full Corporation

Merchandising Operations

Cost of goods sold Gross profit Income tax expense Net sales Operating expenses Net income Income before income tax Sales Sales returns

$26,000 ? 6,500 47,000 8,000 ? 13,000 50,000 ?

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$? 38,000 9,000 62,000 ? 9,000 18,000 ? 5,000

Solution 162 (15 min.) Empty Corporation Sales returns = $3,000($50,000 – $47,000 = $3,000) Gross profit = $21,000($47,000 – $26,000 = $21,000) Net income = $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. 163 State the missing items identified by?. (a) Gross profit – Operating expenses =? (b) Sales – (? +?) = Net sales (c) Income from operations +? –? = Income before income tax (d) Net sales – Cost of goods sold =? (e) Cost of goods sold + Gross profit =? Solution 163 (5 min.) (a) Income 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. 164 The following information was taken from the adjusted trial balance of Lucifer Lighting Inc. at December 31, 2018. All accounts have normal balances. Accounts payable .............................................. $ 52,000 Accounts receivable .......................................... 18,700 Accumulated depreciation—Building ................. 44,900

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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

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, 2018. Solution 164 LUCIFER LIGHTING INC. Income Statement Year Ended December 31, 2018 ___________________________________________________________________________ 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. 165 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 Net income ...................................... ? 198,400 Income 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 165 (20 min.) (a) Company A Sales Operating expenses Net income

$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. 166 The following information is available for Shawson Ltd. for calendar 2018: Cost of goods sold ..................................................... 595,000 Income tax expense ................................................... 4,500 Interest expense......................................................... 15,000

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Interest revenue ......................................................... Operating expenses ................................................... Sales .......................................................................... Sales returns and allowances.....................................

19,000 97,000 $725,000 22,000

SHAWSON LTD. Income Statement Year Ended December 31, 2018 ___________________________________________________________________________ Sales revenue 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 Income from operations................................................................. 11,000 Other revenues and gains Interest revenue ..................................................................... $19,000 Other expenses and losses Interest expense ..................................................................... 15,000 (4,000) Income before income tax ............................................................. 15,000 Income tax expense ...................................................................... 4,500 Net income .................................................................................... $ 10,500 (b)

Gross profit margin: $108,000 ÷ $703,000 = 15.4% Profit margin: $10,500  $703,000 = 1.5%

Ex. 167 The adjusted trial balance of Sandhu Corporation at December 31, 2018 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 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

Merchandising Operations

Sales returns and allowances............................ Salaries expense............................................... Utilities expense ................................................

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55,000 45,000 18,000

Instructions (a) Use the above information to prepare a multiple-step income statement for the year ended December 31, 2018. (b) Calculate the gross profit margin and the profit margin for 2018. Solution 167 (25 min.) (a) SANDHU CORPORATION Income Statement Year Ended December 31, 2018 ___________________________________________________________________________ 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 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 Income from operations ....................................................................... 79,204 Other revenues and gains Interest revenue ............................................................................ $15,000 Other expenses and losses Interest expense............................................................................ 19,000 4,000 Income before income tax .................................................................... 75,204 Income tax expense ............................................................................. 32,000 Net income........................................................................................... $ 43,204 (b) Gross profit margin = $162,500 ÷ $509,500 = 31.9% Profit margin = $43,204 ÷ $509,500 = 8.5%

Ex. 168 The adjusted trial balance of Jayco Corporation at December 31, 2018 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

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Income tax expense .......................................... Interest expense................................................ Interest revenue ................................................ Salaries expense............................................... Sales ................................................................. Sales discounts ................................................. Sales returns and allowances............................ Utilities expense ................................................

74,280 12,500 $

15,000

248,000 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, 2018. (b) Calculate the gross profit margin and the profit margin for 2018. Solution 168 (25 min.) (a) JAYCO CORPORATION Income Statement Year Ended December 31, 2018 ___________________________________________________________________________ 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 Income from operations .................................................................... 245,100 Other revenues and gains Interest revenue ......................................................................... $ 15,000 Other expenses and losses Interest expense......................................................................... 12,500 2, 500 Income before income tax ................................................................. 247,600 Income tax expense .......................................................................... 74,280 Net income........................................................................................ $ 173,320 (b) Gross profit margin = $566,000 ÷ $1,158,000 = 48.9% Profit margin = $173,320 ÷ $1,158,000 = 15.0%

Ex. 169

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Financial information is presented here for two companies.

Sales Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit Operating expenses Income from operations Other revenue Other expenses Income before income tax Income tax Net income

Arts Inc. $960,000 24,000 (a) 920,000 632,000 288,000 (b) 59,600 (c) 3,200 63,200 (d) 50,600

Cass Inc. $ (e) 18,000 12,000 834,000 (f) 250,200 214,600 (g) 4,300 1,800 (h) 7,400 30,700

Instructions (a) Fill in the missing amounts. (b) Calculate the profit margin and the gross profit margin for each company. Solution 169 (a) Sales Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit Operating expenses Income from operations Other revenue Other expenses Income before income tax Income tax Net income

Arts Inc. $960,000 24,000 16,000 920,000 632,000 288,000 228,400 59,600 6,800 3,200 63,200 12,600 50,600

Cass Inc. $864,000 18,000 12,000 834,000 583,800 250,200 214,600 35,600 4,300 1,800 38,100 7,400 30,700

(b) Gross profit margin

Arts Inc. : ($288,000) / $920,000) = 31.3% Cass Inc.: ($250,200) / $834,000) = 30.0%

Profit margin

Arts Inc. : ($50,600) / $920,000) = 5.5% Cass Inc.: ($30,700) / $834,000) = 3.7%

Ex. 170 Selected information from Coleman Inc.’s income statements for three years is indicated below:

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2018

2017

2016

Net sales

$225,800

$220,900

$219,696

Cost of goods sold

126,765

125,489

123,775

Income from operations

1,200

(7,495)

Net income

1,050

(7,750)

840

Instructions (a) Calculate the gross profit margin for each year and comment on any trend in the percentages. (b) Calculate the profit margin for each year and comment on any trend in the percentages. Solution 170 (a) Gross profit margin

2018: [($225,800 – $126,765) / $225,800] = 43.9% 2017: [($220,900 – $125,489) / $220,900] = 43.2% 2016: [($219,696 – $123,775) / $219,696] = 43.7%

While there was a slight decrease from 2016 to 2017, the gross profit margin has remained relatively constant over the three years. (b) Profit margin

2018: ($1,050 / $225,800) = 0.5% 2017: [($7,750) / $220,900] = (3.5)% 2016: ($840 / $219,696) = 0.4%

While there was a significant loss in 2017 the company more than recovered exceeding the profit margin realized in 2016.

Ex. 171 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 Operating expenses ................................. 7,962 10,435 Net income ............................................... 594 1,072 Income before income tax ........................ 955 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?

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Solution 171 (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. 172 The following selected information for the year ended October 31, 2018 is for Trotman Inc.: Advertising expense Freight In Freight Out Income tax expense Inventory, November 1, 2017 Inventory, October 31, 2018 Purchases Purchase discounts

81,500 20,000 26,000 52,620 90,000 51,600 800,000 12,000

Purchases returns and allowances 40,000 Rent expense 24,000 Salaries expense 285,500 Sales 1,476,000 Sales discounts 8,000 Sales returns and allowances 56,000 Utilities expense 13,200

Instructions (a) Prepare a multiple-step income statement for Trotman Inc. for the year ended October 31, 2018. (b) Calculate the gross profit margin and profit margin for the year. *Solution 172 (a) TROTMAN INC. Income Statement Year Ended October 31, 2018 Sales .................................................................................................... Less: Sales returns and allowances ................................................... Sales discounts ........................................................................ Net sales .............................................................................................. Cost of goods sold

$1,476,000 $ 56,000 8,000

64,000 1,412,000

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Inventory, November 1, 2017 ............................................................... $ 90,000 Purchases ............................................................................................ 800,000 Less: Purchases returns and allowances ........................ $40,000 Purchase discounts ............................................... 12,000 52,000 Net purchases ...................................................................................... 748,000 Add: Freight in .................................................................................. 20,000 Cost of goods purchased ..................................................................... 768,000 Cost of goods available for sale ........................................................... 858,000 Inventory, October 31, 2018 ................................................................. 51,600 Cost of goods sold ............................................................................... 806,400 Gross profit .......................................................................................... $605,600 Operating expenses Salaries expense........................................................................ $285,500 Advertising expense ................................................................... 81,500 Freight out .................................................................................. 26,000 Rent expense ............................................................................. 24,000 Utilities expense ......................................................................... 13,200 Total operating expenses .................................................... 430,200 Income before income tax ................................................. 175,400 Income tax expense .......................................................... 52,620 Net income........................................................................ $ 122,780 (b) Gross profit margin = $605,600 ÷ $1,412,000 = 42.9% Profit margin = $122,780 ÷ $1,412,000 = 8.7%

*Ex. 173 Summarized below are the transactions recorded by Rummy Ltd. for calendar 2018, using a perpetual inventory system. Their Jan 1 opening balances were: accounts receivable $145,000, inventory $45,000, and accounts payable $122,000. Inventory .............................................................................................. Accounts Payable ......................................................................... (Purchase of inventory)

400,000

Inventory .............................................................................................. Cash ............................................................................................. (Payment of freight in on inventory)

10,000

Accounts Payable ................................................................................ Inventory ....................................................................................... (Returned merchandise to supplier for credit)

20,000

Accounts Receivable............................................................................ Cash .................................................................................................... Sales ............................................................................................. (Record sales for year)

538,000 200,000

Cost of Goods Sold ..............................................................................

420,000

400,000

10,000

20,000

738,000

Merchandising Operations

Inventory ....................................................................................... (Record COGS for year)

420,000

Sales Returns and Allowances............................................................. Accounts Receivable ..................................................................... (Record goods returned from customers)

28,000

Inventory .............................................................................................. Cost of Goods Sold ....................................................................... (Record goods returned from customers)

16,800

28,000

16,800

Accounts Payable ................................................................................ 400,000 Inventory ....................................................................................... Cash ............................................................................................. (Record payments to suppliers, with a $6,000 purchase discount) Cash .................................................................................................... Sales Discounts ................................................................................... Accounts Receivable ..................................................................... (Record receipts from customers)

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6,000 394,000

560,000 4,000 564,000

Instructions Prepare the 2018 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 173 (20–25 min.) (a) Perpetual RUMMY LTD. Income Statement (partial) Year Ended December 31, 2018 ___________________________________________________________________________ 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, 2018 Sales .................................................................................................... Less: Sales returns and allowances ................................................... Sales discounts ........................................................................ Net sales ..............................................................................................

$738,000 $ 28,000 4,000

32,000 706,000

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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 ..........................................................................................

$ 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. 174 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 174 (15–20 min.) ($ in thousands) Beginning inventory Purchases Purchase returns and allowances Net purchases Freight in Freight out Cost of goods purchased Cost of goods available for sale

Co. A $ 24 123 10 113 34 10 147 171

Co. B $ 35 214 9 205 20 12 225 260

Co. C $12 67 1 66 7 9 73 85

Co. D $ 0 189 11 178 12 8 190 190

Merchandising Operations

Ending inventory Cost of goods sold

30 141

25 235

8 77

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19 171

*Ex. 175 On June 1, Grill Master Ltd. had an inventory of 10 barbeques at a cost of $440 each. Grill Master uses a periodic inventory system. During the month of June the following transactions occurred: Jun 3 Purchased 25 barbeques at a cost of $440 each from BBQ King Ltd., terms n/30. 5 Paid $200 freight for the barbeques purchased on June 3. 6 Sold 12 barbeques to Outdoor Grill for $760 each, terms 2/10, n/30. 7 Received credit from BBQ King for the return of two defective barbeques. 13 Issued a credit to Outdoor Grill for the return of one defective barbeque. 16 Received a credit from BBQ King for the defective barbeque returned by Outdoor Grill. 19 Purchased 10 barbeques from Backyard Barbecues at a cost of $440 each, terms 2/10, n/30. 20 Paid freight of $200 on the June 19 purchase. On June 30, Grill Masters ending inventory was $6,440 Instructions (a) Prepare journal entries to record the above transactions. (b) Calculate the cost of goods sold for June. *Solution 175 (20 min.) (a) Jun 3 Purchases ($440 x 25) ....................................................... Accounts Payable ....................................................... 5

11,000 11,000

Freight In ........................................................................... Cash ...........................................................................

200

Accounts Receivable ($760 x 12)....................................... Sales ...........................................................................

9,120

Accounts Payable ($440 x 2) ............................................. Purchase Returns and Allowances..............................

880

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

760

Accounts Payable .............................................................. Purchase Returns and Allowances..............................

440

Purchases ($440 x 10) ....................................................... Accounts Payable .......................................................

4,400

Freight In ........................................................................... Cash ...........................................................................

200

9,120

880

760

440

4,400

200

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(b) Inventory, June 1 (10 @ $440) ...................................................... Purchases (35 @ $440) ................................................................ Less: purchase returns and allowances (3 @ $440) ...................... Net purchases ............................................................................... Add: freight in ($200 + $200) ......................................................... Cost of goods purchased .............................................................. Cost of goods available for sale .................................................... Inventory, June 30......................................................................... Cost of goods sold ........................................................................

$4,400 $15,400 1,320 14,080 400 14,480 18,880 6,440 $12,440

*Ex. 176 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 176 (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

Merchandising Operations

Sales Discounts ($700 x 2%) ............................................. Accounts Receivable ($1,000 – $300).........................

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14 700

*Ex. 177 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 177 (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. 178 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 178 (15 min.) Oct 3 Purchases.......................................................................... Accounts Payable ....................................................... 6

Accounts Payable .............................................................. Purchase Returns and Allowances..............................

16,000 16,000 1,600 1,600

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Freight In ........................................................................... Cash ...........................................................................

250

Accounts Payable ($16,000 – $1,600) ............................... Purchase Discounts ($14,400x 4%) ............................ Cash ($14,400 x 96%) ................................................

14,400

250

576 13,824

*Ex. 179 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 179 (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. 180 Given the following information, prepare in good form the cost of goods sold section of an income statement, using the periodic inventory system.

Merchandising Operations

Beginning inventory.................................................... Ending inventory ........................................................ Freight in .................................................................... Purchases .................................................................. Purchase discounts .................................................... Purchase returns and allowances .............................. *Solution 180 (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 ............................................................

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$30,000 32,000 8,000 76,000 1,000 3,600

$30,000 $76,000 $3,600 1,000

4,600 71,400 8,000 79,400 109,400 32,000 $77,400

*Ex. 181 Three items are missing in each of the following columns and are identified by a letter. Sales $ (a) $1,720,000 Sales returns and allowances 30,000 40,000 Sales discounts 20,000 30,000 Net sales 900,000 (d) Beginning inventory (b) 650,000 Cost of goods purchased 400,000 (e) Ending inventory 340,000 606,000 Cost of goods sold 500,000 1,150,000 Gross profit (c) (f) Instructions Calculate the missing amounts and identify them by letter. *Solution 181 (15 min.) (a) $950,000 (b) $440,000 (c) $400,000 (d) $1,650,000 (e) $1,106,000 (f) $500,000

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*Ex. 182 Mendez Electronics Limited uses the periodic inventory system and prepares monthly financial statements. All accounts have been adjusted except for inventory. A physical count of inventory on September 30, 2018 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 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 Mendez Electronics for the month ended September 30, 2018. *Solution 182 (15 min.) MENDEZ ELECTRONICS LIMITED Income Statement Month Ended September 30, 2018 ___________________________________________________________________________ Sales revenue Sales .......................................................................... $70,000 Less: Sales discounts ................................................ 750 Net sales .................................................................... $69,250 Cost of goods sold Inventory, September 1 .............................................. Purchases .................................................................. Less: Purchase returns and allowances ..................... Net purchases ............................................................ Add: Freight in ............................................................ Cost of goods purchased ........................................... Cost of goods available for sale ................................. Inventory, September 30 ............................................ Cost of goods sold............................................... Gross profit ....................................................................... Operating expenses .......................................................... Income before income tax ................................................. Income tax expense .......................................................... Net income........................................................................

$ 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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MATCHING QUESTIONS 183. 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 1.

10. F

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SHORT-ANSWER ESSAY QUESTIONS S-A E 184 There are different types of inventories and physical assets that an organization may report on their statement of financial position. (a) What kind of businesses would report what type of inventory? (b) Explain the difference between inventory and property, plant and equipment. Solution 184 (a) Retailers and wholesalers would report 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 that has been started into production but is not yet complete), and finished goods inventory (manufactured items that are complete and ready for sale). (b) Inventory has two common characteristics: (1) the company owns it, and (2) it is either in the process of production for sale to customers or in the form ready for sale to customers. Property, plant, and equipment are tangible assets with relatively long useful lives that are currently being used in operating the business. This category includes items such as land, buildings, equipment, furniture, computers, and vehicles.

S-A E 185 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 185 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 186 What is the main consideration when choosing between a periodic and a perpetual inventory system?

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Solution 186 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 187 Distinguish between cost of goods sold, operating expenses, and non-operating expenses. Describe the nature of these three items and their placement on a multiple-step income statement. Solution 187 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 188 The income statement for a merchandising company presents three amounts not shown in a service company’s income statement. The statement of financial position for a manufacturing company presents different inventory accounts not shown in a merchandising company’s statement of financial position. Identify and briefly explain the differences for each. Solution 188 The items reported on an income statement for a merchandising company that are not reported for a service company include: net sales revenues, cost of goods sold, and gross profit. Net 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. The inventory items reported on a statement of financial position for a manufacturing company that are not reported for a merchandising company include: raw materials, work in process and finished goods inventory. Raw materials reflect basic materials on hand ready to go into production, work in process inventory reflects inventory that has been started in production but is not yet complete and finished goods inventory reflects manufactured items that are complete and ready for sale.

S-A E 189 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 189 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 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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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 190 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 190 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, income from operations, other revenues and gains, and other expenses and losses.

S-A E 191 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 191 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 markup although its value will be limited as they can only calculate the markup in its aggregate (total) and not by product category.

S-A E 192 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 net income. Instructions Does the classification of the invoices matter? Explain. Solution 192

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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 193 Explain why gross profit margin is considered to be more informative than gross profit. Solution 193 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 profitability relative to its size.

*S-A E 194 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 194 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.

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OBJECTIVE FORMAT QUESTIONS 195. The following is a selection of journal entries that Glipon Corporation recorded in July 2018. Glipon uses a perpetual inventory system. Indicate all of the entries that were recorded correctly. (a) July 31

(b) July 2

(c)

July 2

(d) July 8

(e) July 11

(f)

July 15

(g) July 31

(h) July 31

Cash Sales Discount Accounts Receivable (To record receipt of payment on account on sales to TGT Company. TGT paid within the discount period (terms 2/10, n/30))

9,800 200

Inventory Accounts Payable (To record goods purchased on account, terms 2/10, n/30,)

4,900

10,000

4,900

Freight In Cash (To record payment of freight on goods purchased on July 2, FOB shipping point)

115

Accounts Payable Inventory [To record the return of a portion of the goods purchased on account on July 2; see transaction (b)]

400

115

400

Accounts Payable Cash Purchase Discount [To record payment for remainder of goods purchased on July 2; see transaction (b)]

4,500

Accounts Payable Cash (To record payment for goods purchased in June—no discount taken)

1,500

Freight Out Cash (To record freight costs on sales to customer shipped FOB shipping point)

185

Sales Accounts Receivable (To record return of goods sold to RBB

400

4,410 90

1,500

185

400

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Company on account) Solution 195 (a), (b), (d), and (f) are correct; (c), (e), (g), and (h) are not correct. (c) When freight is recorded on goods purchased in a perpetual inventory system, the cost of the freight is added to the inventory value for the goods. The journal entry should be: Inventory 115 Cash 115 (e) Under a perpetual inventory system, when a discount is taken on a purchase, the value of inventory reported by the company is decreased. The journal entry should be: Accounts Payable 4,500 Cash 4,410 Inventory 90 (g) If Glipon shipped the goods FOB shipping point, the shipping costs are the responsibility of the customer, not Glipon. Therefore, this entry should not be made and the shipping costs should be paid by the customer. (h) When goods sold are returned, the contra account, Sales Returns and Allowances, is debited. This account is used, instead of debiting Sales, so management can monitor returns. The journal entry should be: Sales Returns and Allowances 400 Accounts Receivable 400 A corresponding entry for amount of the cost of goods returned to inventory would be recorded as follows: Inventory XXX’ Cost of Goods Sold XXX

196. Indicate which of the following statements about the income statement are correct: (a) Companies that report under ASPE should report expenses in a specified order on the income statement. (b) Companies that report under IFRS must classify expenses by nature or function; whichever is more relevant. (c) A company that reports under IFRS and classifies expenses by nature must disclose additional information on the function of certain expenses, such as whether they are related to administration, production or sales. (d) More management judgement is required if a company decides to classify expenses by function. (e) Most Canadian companies use the single-step form of income statement. (f) Income before income tax is only reported on the multiple-step form of income statement. (g) On a multiple-step income statement, income from operations is determined by subtracting operating expenses from gross profit. (h) For evaluative purposes, income from operations has more predictive value than income before tax.

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Solution 196 (b), (d), (g), and (h) are correct; while (a), (c), (e), and (f) are incorrect. (a) Companies that report under ASPE do not need to report expenses in any particular order on the income statement. Expenses can be classified in any manner the company finds useful. (c) A company that reports under IFRS and classifies expenses by nature does not need to disclose any additional information about the function of expenses. On the other hand, a company that reports under IFRS and classifies expenses by function, they must disclose additional information on the nature of the expenses. If, for instance, expenses are shown on the income statement as administrative expenses, the breakdown of these expenses would be disclosed in the notes. (e) Most Canadian companies use the multiple-step format of income statement. The multiplestep income statement provides more detail by segregating operating revenues and expenses from non-operating revenues and expenses. (f) Income before tax is reported on both the single-step and multiple-step income statements.

197. The following incomplete multiple-step income statement is provided for Almond Industries Ltd. for the year ended November 30, 2018. Almond Industries Ltd. Income Statement Year Ended November 30, 2018 Sales .......................................................................................................... Less: Sales returns and allowances ............................... $42,000 Sales discounts .................................................... a. Net sales ............................................................................................. Cost of goods sold ....................................................................................... Gross profit .................................................................................................. Operating expenses Salaries expense ............................................................ $47,500 Depreciation expense ...................................................... 4,500 Freight-out ..................................................................... 1,200 Insurance expense .......................................................... 1,800 Total operating expenses............................................................ Income from operations ................................................................................ Other revenues Interest revenue .................................................................................. Income before income tax ............................................................................. Income tax expense ...................................................................................... Net income....................................................................................................

$409,000 b. c. d. 186,955

e. 131,955 f. g. h. $104,941

Additional Information: The income tax rate is 11%. Of the $409,000 in sales, 25% of the customers took the sales discount (terms offered to all customers are 2/10, n/30).

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Complete the missing data in the income statement by choosing the corresponding number for each missing item from the following list. Note: some values will not be used.

a. Sales discounts b. Total of Sales returns and allowances and Sales discounts c. Net sales d. Cost of goods sold e. Total operating expenses f. Interest revenue g. Income before income tax h. Income tax expense

Solution 197 a. Sales discounts Sales discounts $409,000 x 25% x 2% = $2,045 b. Total of Sales returns and allowances and Sales discounts Sales discounts $2,045 from (a) + Sales returns and Allowances of $42,000 = $44,045 c. Net sales Sales less (b) = $409,000 – $44,045 = $364,955 d. Cost of goods sold Net sales (c)$ 364,955 less gross profit of $186,955 = $178,000 e. Total operating expenses $47,500 + $4,500 + $1,200 + $1,800 = $55,000 f. Interest revenue Income before income taxes -Income from operations $132,875 - $131,955 = $920 g. Income before income tax Net income ÷ (1-.21) = $132,875

2 1 4 17

9 15

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h. Income tax expense Income before income tax $132,875 x 21% = $27,904

The completed multiple-step income statement for Almond Industries Ltd. is as follows: Almond Industries Ltd. Income Statement Year Ended November 30, 2018 Sales .......................................................................................................... Less: Sales returns and allowances ............................... $42,000 Sales discounts .................................................... 2,045 Net sales ............................................................................................. Cost of goods sold ....................................................................................... Gross profit .................................................................................................. Operating expenses Salaries expense ............................................................ $47,500 Depreciation expense ...................................................... 4,500 Freight-out ..................................................................... 1,200 Insurance expense .......................................................... 1,800 Total operating expenses............................................................ Income from operations ................................................................................ Other revenues Interest revenue .................................................................................. Income before income tax ............................................................................. Income tax expense ...................................................................................... Net income....................................................................................................

$409,000 44,045 364,955 178,000 186,955

55,000 131,955 920 132,875 27,904 $104,941

*198. The cost of goods sold section of London Industries Ltd.’s income statement for the year ended December 31, 2018 is shown below. For each missing item, choose the item number from the list below to complete the report.

London Industries Ltd. Partial Income Statement Year Ended December 31, 2018 Cost of goods sold

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(a) __________________________________

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$ 78,500

(b).__________________________________

$185,400

Less: (c) _____________________________

4,250

Purchase discounts

2,800

Net purchases

178,350

(d) __________________________________

6,580

(e).__________________________________

184,930

(f) __________________________________

263,430

(g)._________________________________

52,700

Cost of goods sold

$ 210,730

*Solution 198 (a) Inventory January 1 (b) Purchases (c) Purchase returns and allowances (d) Freight in (e) Cost of goods purchased (f) Cost of goods available for sale (g Inventory Dec. 31

7 4 3 5 6 1 2

The following is the completed cost of goods sold section for London Industries Ltd.’s income statement: London Industries Ltd. Partial Income Statement Year Ended December 31, 2018 Cost of goods sold 7. Inventory, January 1 4. Purchases

$78,500 $185,400

Less: 3. Purchase returns and allowances

4,250

Purchase discounts

2,800

Net purchases 5. Add: Freight in

178,350 6,580

6. Cost of goods purchased

184,930

1. Cost of goods available for sale

263,430

2. Inventory, December 31

52,700

Cost of goods sold

$210,730

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*199. The following is a selection of journal entries that Giraffe Company Ltd. recorded for the month of August 2018. Giraffe uses a periodic inventory system. Indicate all of the entries that were correctly recorded. (a)

(b)

(c)

(d)

(e)

(f)

(g)

(h)

Aug 1

Aug 5

Aug 14

Aug 15

Aug 16

Aug 24

Purchases Accounts Payable (To record goods purchased on account from Llama Company, invoice #L134, terms 2/15, n/30, shipped FOB shipping point)

72,000

Purchases Cash (To record payment of freight on goods purchased from Llama Company)

3,785

Accounts Payable Inventory (To record return of damaged goods purchased on account from Llama Company)

17,500

Accounts Payable Cash Purchase Discount (To record payment of accounts payable to Llama Company)

54,500

Accounts Payable Cash (To record payment for goods purchased from Hippo Industries in July – no discount taken)

18,500

Accounts Receivable Sales (To record goods sold to Zoo Inc., Invoice 13425, Terms 2/10, n/30)

115,000

Freight Out Cash (To record freight costs on sales to customer shipped FOB shipping point to Zoo Inc.)

5,890

Cash Accounts Receivable (To record receipt of payment on account for sales to Zoo Inc., Invoice 13425)

72,000

3,875

17,500

53,410 1,090

18,500

115,000

5,890

112,700 112,700

*Solution 199 (a), (d), (e), and (f) are correct; (b), (c), (g), and (h) are not correct.

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(b) Under a periodic inventory system, freight costs are recorded to the freight in account, as follows: Freight In 3,785 Cash 3,785 (c) Under a periodic system, purchase returns and allowances are kept track of by recording returns to the purchase returns and allowances account, as follows: Accounts Payable 17,500 Purchase Returns and Allowances

17,500

(g) Giraffe shipped the goods FOB shipping point, the shipping costs are the responsibility of the customer, not Giraffe. Therefore, this entry should not be made and the shipping costs should be paid by the customer. (h) The company did not record the discount taken by Zoo Inc. The entry should be: Cash 112,700 Sales Discounts 2,300 Accounts Receivable 115,000

CHAPTER 6 REPORTING AND ANALYZING INVENTORY SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E C F AN 10. 2 E C F AN 19. 5 E C F AN 2. 1 E K F AN 11. 2 E K F AN 20. 5 E C F AN 3. 1 E C F AN 12. 2 M K F AN 21. 5 M K F AN F AN K F AN K F AN 4. 1 M C 13. 2 E 22. 5 M 5. 2 E K F AN 14. 2 M K F AN 23. 5 E C F AN 6. 2 M C F AN 15. 3 M K F AN 24. 5 E C F AN 7. 2 E K F AN 16. 3 E K F AN 25. 5 M K F AN 8. 2 M C F AN 17. 3 M C F AN *26. 6 E C F AN 9. 2 E K F AN 18. 3 M K F AN Multiple Choice Questions 27. 1 H C F AN 51. 2 E AP F AN 75. 3 M C F AN 28. 1 M K F AN 52. 2 E K F AN 76. 4 H C F AN 29. 1 M K F AN 53. 2 E C F AN 77. 4 M C F AN 30. 1 E K F AN 54. 3 M C F AN 78. 4 M C F AN 31. 1 H C F AN 55. 3 E C F AN 79. 4 E C F AN 32. 1 E K F AN 56. 3 E K F AN 80. 4 E C F AN 33. 2 H C F AN 57. 3 E K F AN 81. 5 E K F AN 34. 2 E AP F AN 58. 3 M K F AN 82. 5 E C F AN 35. 2 E K F AN 59. 3 E K F AN 83. 5 M AP F AN 36. 2 M AP F AN 60. 3 E K F AN 84. 5 M AP F AN 37. 2 M AP F AN 61. 3 E C F AN 85. 5 H AP F AN 38. 2 M AP F AN 62. 3 E C F AN 86. 5 E C F AN 39. 2 H AP F AN 63. 3 E C F AN 87. 5 E K F AN 40. 2 M C F AN 64. 3 M C F AN 88. 5 E K F AN 41. 2 M AP F AN 65. 3 M C F AN 89. 5 E AP F AN 42. 2 E AP F AN 66. 3 E C F AN 90. 5 E AP F AN 43. 2 M AP F AN 67. 3 E C F AN 91. 5 M C F AN 44. 2 H AP F AN 68. 3 M C F AN 92. 5 H AP F AN 45. 2 M AP F AN 69. 3 E C F AN *93. 6 H C F AN 46. 2 M C F AN 70. 3 E K F AN *94. 6 E K F AN 47. 2 M AP F AN 71. 3 M C F AN *95. 6 M C F AN 48. 2 M AP F AN 72. 3 E C F AN *96. 6 E AP F AN 49. 2 H AP F AN 73. 3 E K F AN *97. 6 E AP F AN 50. 2 M AP F AN 74. 3 E C F AN *98. 6 M C F AN LOD: Bloom’s: CPA: AACSB:

E = Easy M = Medium H = Hard AP = Application C = Comprehension K = Knowledge F = Financial Reporting AN = Analytic

*This topic is dealt with in an Appendix to the chapter.

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’sCPA AACSB Item LO LOD Bloom’sCPA AACSB Exercises 99. 1 H C F AN 107. 3 M AP F AN 115. 5 M C F AN 100. 2 H C F AN 108. 4 H AP F AN 116. 5 M C F AN 101. 2 M C F AN 109. 4 M C F AN *117. 6 M AP F AN 102. 2 H C F AN 110. 4 M AP F AN *118. 6 E C F AN F AN 111. 5 E AP F AN *119. 6 M F AN 103. 2 H AP AP 104. 2 M AP F AN 112. 5 M AP F AN *120. 6 M AP F AN 105. 2,3 E AP F AN 113. 5 E AP F AN *121. 6 M AP F AN 106. 3 M AP F AN 114. 5 M C F AN Matching 122. 1,2,5 E,M K F AN Short-Answer Essay 123. 1 M C F,E AN,E 125. 2,3 H C F AN 127. 4 M C F,C AN,C 124. 1,5 M AP F AN, E 126. 2,3 M C F AN 128. 5 E C F AN CPA Questions 129. 2 M C F AN 131. 4,5 H K F AN *133. 6 M AN F AN 130. 3 M K F AN 132. 5 M K F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: C = Communication E = Professional and Ethical Behaviour F = Financial Reporting AACSB: AN = Analytic C = Communication E = Ethics *This topic is dealt with in an Appendix to the chapter.

Reporting and Analyzing Inventory

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Item Type Learning Objective 1 1. TF 3. TF 27. MC 29. MC 31. MC 99. Ex 2. TF 4. TF 28. MC 30. MC 32. MC 122. Ma Learning Objective 2 5. TF 11. TF 35. MC 41. MC 47. MC 53. MC 6. TF 12. TF 36. MC 42. MC 48. MC 100. Ex 7. TF 13. TF 37. MC 43. MC 49. MC 101. Ex 8. TF 14. TF 38. MC 44. MC 50. MC 102. Ex 9. TF 33. MC 39. MC 45. MC 51. MC 103. Ex 10. TF 34. MC 40. MC 46. MC 52. MC 104. Ex Learning Objective 3 15. TF 55. MC 60. MC 65. MC 70. MC 75. MC 16. TF 56. MC 61. MC 66. MC 71. MC 105. Ex 17. TF 57. MC 62. MC 67. MC 72. MC 106. Ex 18. TF 58. MC 63. MC 68. MC 73. MC 107. Ex 54. MC 59. MC 64. MC 69. MC 74. MC 125. SAE Learning Objective 4 76. MC 78. MC 80. MC 109. Ex 127. SAE 77. MC 79. MC 108. Ex 110. Ex 131. CP Learning Objective 5 19. TF 24. TF 84. MC 89. MC 112. Ex 122. Ma 20. TF 25. TF 85. MC 90. MC 113. Ex 124. SAE 21. TF 81. MC 86. MC 91. MC 114. Ex 128. SAE 22. TF 82. MC 87. MC 92. MC 115. Ex 131. CP 23. TF 83. MC 88. MC 111. Ex 116. Ex 132. CP *Learning Objective 6 *26. TF *94. MC *96. MC *98. MC *118. Ex *120. Ex *93. MC *95. MC *97. MC *117. Ex *119. Ex *121. Ex Note:

TF = True-False Ex = Exercise

MC = Multiple Choice SAE = Short-Answer Essay

Item

Type

123. 124.

SAE SAE

105. 122. 125. 126. 129.

Ex Ma SAE SAE CP

126. 130.

SAE CP

*133.

Ma = Matching CP = CPA Questions

*This topic is dealt with in an Appendix to the chapter.

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CHAPTER LEARNING OBJECTIVES 1.

Describe the steps in determining inventory quantities. The steps are (1) determining the ownership of goods in transit, on consignment, and in similar situations; and (2) taking a physical inventory of goods on hand.

Apply the cost formulas 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 using the specific identification; first-in, first-out (FIFO); or average cost formula. Specific identification must be used for goods that are not ordinarily interchangeable. This cost formula tracks the actual physical flow of goods, allocating the exact cost of each merchandise item to cost of goods sold and ending inventory. If a company’s goods are interchangeable (homogeneous), then either the FIFO or average cost formula may be used. 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. Under the average cost formula, 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 formulas. The specific identification cost formula must be used for goods that are not ordinarily interchangeable. (Typically the goods are unique, high-value items.) Either the FIFO or average cost formula can be used for goods that are interchangeable (that is, they are homogeneous or non-distinguishable from one another). Management should select the cost formula that most closely corresponds to the physical flow of goods and should report inventory on the statement of financial position at an amount that is closest to the cost of inventory recently purchased. 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 net income than FIFO. The average cost formula therefore results in a better allocation on the income statement of more current (recent) costs with current revenues than does FIFO. In terms of the statement of financial position, FIFO is considered to be superior because it results in an ending inventory that is closest to current (replacement) value. All three cost formulas 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 net income to be overstated. Therefore, an error that overstates inventory will also overstate net income and after recording closing entries, the overstatement in net income will be reflected as an overstatement in retained earnings. In the following period, the overstatement in inventory will flow into cost of goods sold and overstate cost of goods sold and understate net

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income, 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 the end of the following accounting period. If an error is made by recording goods in transit as an inventory purchase in a period before title to the goods changes hands, 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.

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 are desired.

Apply the FIFO and average cost formulas 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). The cost of goods sold and ending inventory amounts under FIFO are the same regardless of whether a periodic or perpetual inventory system is used. Under the average cost formula, 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). The main difference between a periodic and a perpetual inventory system is that in a periodic system, average cost is only determined once (at the end of the accounting period), while average cost is determined at the date of each sale in a perpetual inventory system.

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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. Consigned goods are held for sale by one party, although ownership of the goods is retained by another party. 3. Once goods leave the premises of the seller, they should never be added to the seller’s physical inventory count.

4. In order to remove the cost of items sold from inventory, a unit cost must be determined.

5. When using the perpetual system, the average cost formula relies on a simple average calculation.

6. If prices never changed, there would be no need for alternative inventory cost formulas.

7. Inventory cost formulas such as FIFO and average cost, deal more with the flow of costs than with the flow of goods.

8. The first-in, first-out (FIFO) inventory cost formula results in an ending inventory valued at the most recent cost.

9. The specific identification formula is desirable when a company sells a large number of lowunit-cost items.

10. 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.

11. A company may use more than one inventory cost formula if it has different types of inventory.

12. The cost formula a company chooses should correspond as closely as possible to the actual physical flow of goods.

13. The FIFO inventory cost formula agrees closely to the actual physical movement of goods in most businesses.

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14. The inventory cost formula that best matches cost and revenues is FIFO.

15. A change in the method of cost formula for inventory must be disclosed in the financial statements.

16. Approximating the physical flow of inventory is not important when selecting an inventory cost formula.

17. All three methods of inventory cost formula will produce the same cumulative cost of goods sold over the life cycle of the business.

18. When the value of inventory is lower than its cost, the inventory is written down to its net realizable value.

19. If net realizable value of the inventory is lower than its cost, the total assets on the statement of financial position and net income on the income statement will be reduced.

20. 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 writedown in value should be reversed.

21. An inventory writedown from cost to net realizable value should not be made in the period in which the price decline occurs.

22. The lower of cost and net realizable value should be applied to the total inventory, rather than to individual inventory items.

23. A low inventory turnover ratio could mean a company is at risk of experiencing inventory shortages.

24. A high inventory turnover ratio indicates that minimal funds are tied up in inventory.

25. In the average cost formula 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.

*26. The results under FIFO in a perpetual inventory system are the same as in a periodic inventory system.

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

Ans. F T F F F

Item 6. 7. 8. 9. 10.

Ans. T F T T T

Item 11. 12. 13. 14. 15.

Ans. F T T T F

Item 16. 17. 18. 19. 20.

Ans. T F T F T

Item 21. 22. 23. 24. 25.

Ans. T T F F F

Item *26.

Ans. F

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MULTIPLE CHOICE QUESTIONS 27. Goods in transit shipped (a) FOB shipping point should be included in the buyer’s ending inventory. (b) FOB destination should not be excluded from the buyer’s ending inventory. (c) FOB shipping point should not be included in the buyer’s ending inventory. (d) FOB destination should not be included in the seller’s ending inventory.

28. The factor that 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.

29. 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.

30. 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.

31. 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)

32. 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.

33. In periods of falling prices

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(a) FIFO will result in a higher ending inventory valuation than the average cost formula. (b) FIFO will result in a higher cost of goods sold than the average cost formula. (c) the average cost formula will result in a higher cost of goods sold than the FIFO cost formula. (d) the average cost formula will result in a lower ending inventory valuation than the FIFO cost formula.

34. A company just starting in business purchased three merchandise inventory items at the following prices. March 2, $150; March 7, $160; and March 15, $180. If the company sold two units for $250 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) $200. (b) $190. (c) $180. (d) $150. Solution: $250 x 2 units = $500 sales revenue; COGS = $150 + $160 = $310; Gross profit: $500 – $310 = $190

35. Inventory cost methods make assumptions about the flow of (a) costs. (b) goods. (c) resale prices. (d) fair values.

36. A company just starting a business purchased three inventory items at the following prices: March 2, $150; March 7, $160; and March 15, $180. If the company sold one unit for $230 on March 10 and one unit for $250 on March 20 and uses the average cost formula in a perpetual inventory system, what is the cost of ending inventory? (a) $163.34 (b) $167.50 (c) $180.00 (d) $250.00 Solution: ($150 + $160) / 2 = $155; ($155 + $180) / 2 = $167.50

Use the following information for questions 37–40. A company just starting its 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.

37. Using the FIFO cost formula, the cost of the ending inventory on June 30 is

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(a) $645. (b) $695. (c) $1,650. (d) $1,700. Solution: ($680 / 200 x 50 = $170; $170 + $525 = $695

38. Using the FIFO cost formula, the amount of the cost of goods sold for June is (a) $645. (b) $695. (c) $1,650. (d) $1,700. Solution: [($480 + $660) + ($680 / 200 x 150)] = $1650

39. Using the average cost formula, the cost of the ending inventory on June 30 is (a) $670.00. (b) $690.50. (c) $1,645.55. (d) $1,675.00. Solution: [($480 + $660 +$680) / (150 +200 +200)] x 50 +525 = $690.50

40. 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.

41. Mandy Corp. purchased inventory as follows: March 3 500 units at $18 March 4 300 units at $20 March 7 200 units at $22 On March 5, Mandy sold 600 units for $18 each. The average unit cost to be used for the cost of goods sold on March 5, in a perpetual inventory system, is (a) $18.80. (b) $19.40. (c) $25.00. (d) $16.67. Solution: [(500 x $18) + (300 x $20)] / (500 + 300) = $18.80

Use the following information for the month of July for questions 42–46. ABC Inc. uses the FIFO cost formula 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

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Jul 22

Sales

40 units

42. The cost of goods sold for the July 8 sale was (a) $950. (b) $980. (c) $989. (d) $1,000. Solution: [(20 x $19) + (30 x $20)] = $980

43. The cost of goods sold for the July 9 sale was (a) $475. (b) $480. (c) $495. (d) $500. Solution: (25 x $20) = $500

44. Total cost of goods sold for the month of July is (a) $2,330. (b) $2,530. (c) $2,830. (d) $2,880. Solution: [(15 x $20) + (25 x $22)] = $850; $850 +$980 +$500 = $2,330

45. Ending inventory at July 31 is (a) $2,330. (b) $720. (c) $680. (d) $550. Solution: (25 x $22) = $550

46. If ABC Inc. used the average cost formula 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 47–50. 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

Reporting and Analyzing Inventory

Jun 9 Jun 10 Jun 22

Purchase Sale Sale

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80 units @ 22.31 per unit 25 units 40 units

47. 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. Solution: [(20 x $19) + (100 x $22)] / (20 +100) = $21.55; $21.50 x 70 = $1,505

48. The cost of goods sold for the June 10 sale is (a) $545.60. (b) $549.96. (c) $550.00. (d) $557.75. Solution: [(20 x $19) + (100 x $22) – (70 x $21.50) + (80 x $22.31)] = $2,859.80; $2,859.80 / (20 + 100 – 70 + 80) = $22.00; $22.00 x 25 = $549.96

49. Total cost of goods sold for the month of June is (a) $2,914.65. (b) $2,934.96. (c) $2,946.24. (d) $2,994.80. Solution: [($1,505 + $549.96) + ($22.00 x 40)] = $2,934.96

50. 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. Solution: ($22.00 x 65) = $1,429.90 51. Anderson’s Used Cars uses the specific identification formula of costing inventory. During March, Anderson purchased three cars: a Honda Civic for $6,200, a Chevy Malibu for $7,300, and a Ford Pinto $8,400, respectively. During March, two cars are sold for $8,600 each. Anderson determines that at March 31, the Ford Pinto is still on hand. What is Anderson’s cost of goods sold for March? (a) $8,400 (b) $13,500 (c) $15,700 (d) $17,200 Solution: ($6,200 + $7,300) = $13,500

52. Which of the following statements regarding inventories is correct?

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(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.

53. Management may be able to manipulate net income using (a) the FIFO cost formula. (b) specific identification. (c) the average cost formula. (d) need more information to answer.

54. 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 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.

55. Of the following businesses, which one would not be likely to use the specific identification formula for inventory costing? (a) piano store (b) car dealership (c) antique shop (d) grocery store

56. A problem with the specific identification formula is that (a) inventories can be reported at actual costs. (b) management can manipulate net income. (c) matching is not achieved. (d) lower of cost and net realizable value cannot be applied.

57. 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.

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58. 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.

59. Which of the following statements regarding inventory cost formulas is correct? (a) A company may use more than one inventory cost formula. (b) A company should use the method that is easiest. (c) A company must use the method that allows them to manage net income. (d) A company may never change its inventory cost method once it has chosen it.

60. The specific identification method of inventory cost formula must be used (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.

61. The inventory cost formula 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.

62. 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

63. In a period of rising prices, which of the following inventory cost formulas generally results in the lowest net income figure? (a) average cost (b) FIFO (c) The inventory cost formula only affects the statement of financial position. (d) Need more information to answer.

64. 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

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

(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.

65. In a period of inflation (prices are rising), which inventory cost formula will result in higher net income? (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 net income.

66. The specific identification formula of costing inventories is used when the (a) physical flow of units cannot be determined. (b) company sells large quantities of relatively homogeneous items. (c) company has sophisticated technology to account for its inventory. (d) company sells a small number of expensive, easily distinguishable items.

67. The specific identification formula of inventory costing (a) always maximizes a company's net income. (b) always minimizes a company's net income. (c) has no effect on a company's net income. (d) may enable management to manipulate net income. 68. The managers of Winning Ways Ltd. receive performance bonuses based on the company’s net income. 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.

69. Which cost formula smooths the effects of price changes? (a) specific identification (b) FIFO (c) average cost (d) lower of cost and net realizable value

70. Selection of an inventory cost formula 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.

71. Which cost formula provides the better (1) income statement and (2) statement of financial

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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 72. During a period of inflation, using ___ will approximate a company’s current cost of ending inventory. (a) the average cost formula (b) FIFO (c) the lower of cost and net realizable value (d) both FIFO and the average cost formula

73. The consistent application of an inventory cost formula is essential for (a) neutrality. (b) accuracy. (c) comparability. (d) relevance.

74. 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.

75. 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.

76. An error (a) in the ending inventory of the current period will have no effect on net income of the next accounting period. (b) that understates the ending inventory will cause net income for the period to be overstated. (c) that understates the ending inventory will cause assets to be understated. (d) that understates the ending inventory will cause the cost of goods sold for the period to be understated.

77. 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 Net income. (a) understated understated (b) overstated overstated (c) understated overstated

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

(d) overstated

understated

78. If beginning inventory is understated by $10,000, the effect of this error in the current period is Cost of Goods Sold Net income. (a) understated understated (b) overstated overstated (c) understated overstated (d) overstated understated

79. An overstatement of the beginning inventory results in (a) an overstatement of net income. (b) an understatement of net income. (c) no effect on the period’s net income. (d) a need to adjust purchases.

80. An overstatement of ending inventory in one period results in (a) no effect on net income of the next period. (b) an overstatement of net income of the next period. (c) an understatement of net income of the next period. (d) an overstatement of the ending inventory of the next period.

81. 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.

82. 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.

83. Babal Inc. is a wholesaler of electronics. It purchased 1,200 units of Product X for $600 each during 2018. The selling price during the year was $800 per unit. At year end, it had 200 units on hand and due to changes in technology, the selling price will have to be reduced by 35% in order to sell them. The value of each unit of Product X for the year-end inventory presentation should be (a) $600. (b) $600. (c) $280. (d) $520.

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Solution: $800 x.65 = $520

84. Inventory that originally cost $11,200 was written down to its net realizable value of $9,400 at the end of 2017. At the end of 2018, the net realizable value is determined to be $11,700. At what amount should the inventory be reported on the December 31, 2018 statement of financial position? (a) $11,700 (b) $11,200 (c) $9,700 (d) $9,400 Solution: The original cost since the writedown can only be reversed up to the original cost of $11,200

85. For 2018, Superplus Inc. reported $48,000 beginning inventory and $52,000 ending inventory. Net sales were $320,000 and gross profit was $110,000 for the same period. Based on these figures, inventory turnover for 2018 was (a) 3.4 times. (b) 4.2 times. (c) 6.4 times. (d) 9.2 times. Solution: ($320,000 – $110,000) / ($48,000 + $52,000) / 2 = 4.2 times

86. An aircraft manufacturer would most likely have a (a) high inventory turnover. (b) low profit margin. (c) high volume. (d) low inventory turnover.

87. 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.

88. 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 89–90. The following information was available for Free for All Limited at December 31, 2018: Beginning inventory ............................... $ 220,000 Ending inventory .................................... 260,000

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

Cost of goods sold ................................. 1,680,000 Net sales ................................................ 2,800,000

89. Free for All inventory turnover was (a) 6.0 times. (b) 7.0 times. (c) 8.5 times. (d) 10.0 times. Solution: $1,680,000 / ($220,000 + $260,000) / 2 = 7.0 times

90. Free for All days in inventory was (a) 60.8 days. (b) 42.9 days. (c) 52.1 days. (d) 36.5 days. Solution: 365 / 7.0 = 52.1 days

91. An increase in inventory turnover means days in inventory (a) increases. (b) decreases. (c) remains the same. (d) cannot be determined.

92. Wholesome Ltd. has a days in inventory ratio of 50 and average inventory of $320,000. What is its cost of goods sold? (a) cannot be determined (b) $16,000,000 (c) $2,336,000 (d) $2,191,780 Solution: (365 / 50) x $320,000 = $2,336,000

*93. When the average cost method is applied in a periodic inventory system, (a) the sale of goods during the year will change the unit cost used for calculating ending inventory. (b) an average cost per unit is calculated after each purchase rather than at the end of the period. (c) an average cost per unit is calculated at the end of the period rather than after each sale. (d) an average cost per unit is not calculated in the same manner that is used for a perpetual inventory system.

*94. 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.

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*95. 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 *96–*98. 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.

*96. Under the FIFO cost method, ending inventory at July 31 was (a) $1,500. (b) $1,480. (c) $500. (d) $500. Solution :( 15x$20) + (10 x $22) = $500

*97. Under the average cost method, cost of goods sold for July was (a) $1,600. (b) $1,500. (c) $520. (d) $500. Solution: ($2,000 / (20 + 70 +10) = $20 x (20 +70 +10 – 25) = $1,500

*98. Which cost method will provide the highest net income? (a) average cost (b) FIFO (c) Net income 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. 27. a 38. c 49. b 60. d 71. a 82. b *93. c 28. b 39. b 50. c 61. b 72. b 83. d *94. d 29. a 40. a 51. b 62. b 73. c 84. b *95. c 30. d 41. a 52. c 63. a 74. c 85. b *96. c 31. b 42. b 53. b 64. b 75. d 86. d *97. b 32. a 43. d 54. a 65. a 76. c 87. c *98. b 33. b 44. a 55. d 66. d 77. c 88. d 34. b 45. d 56. b 67. d 78. c 89. b 35. a 46. b 57. d 68. b 79. b 90. c 36. b 47. b 58. d 69. c 80. c 91. b 37. b 48. b 59. a 70. b 81. d *92. c

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EXERCISES Ex. 99 Bunkers Corporation has just completed a physical inventory count at year end, December 31, 2018. 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 year-end audit, the independent C.A. discovered the following additional information: 1. There were goods in transit on December 31, 2018, 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, 2018, a regular customer purchased goods for cash amounting to $1,000 and left them for pickup on January 4, 2019. 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, 2018; the terms were FOB shipping point. Because the shipment had not arrived on December 31, 2018, it was excluded from the physical inventory. 4. On December 31, 2018, there were goods in transit to customers, with terms FOB shipping point, amounting to $800 (expected delivery on January 8, 2019). Because the goods had been shipped, they were excluded from the physical inventory count. 5. On December 31, 2018, Bunkers shipped $2,500 worth of goods to a customer, FOB destination. This shipment arrived on January 5, 2019. 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, 2018, 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 99 (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.)

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

Item 6.

– 5,000

Corrected inventory

$83,300

(These goods are owned by the consignor, not the consignee, and should not be included in Bunkers' inventory.)

Ex. 100 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 Answer the following independent questions and show calculations supporting your answers: (a) Assume that the company uses the FIFO cost formula. The cost of goods sold for the Jan 21 sale was $__________. (b) Assume that the company uses the average cost formula. 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 formula. 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 formula. The value of the inventory after the Oct 20 purchase is $__________. Solution 100 (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

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Ex. 101 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 formula, calculate the cost of goods sold for March. Show calculations. (b) Using the average cost formula, 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 101 (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

760

Purchases 100

$60

COGS

$ 6,000 190 $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

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10 Purchase

6,600

610

46.65

28,459

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

100 16 Sale 19 Sale 25 Sale 30 Purchase 30 Ending

275 220 75 460

46.65 46.65 46.65

34,500 760

Please note that discrepancies may result in the above schedule due to rounding.

Ex. 102 Kiwi 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 90 $ 16 25 Purchase 300 18 May 4 Purchase 130 20 16 Sale 240 $32 Jun 4 Purchase 100 24 Instructions (a) Using the FIFO cost formula, calculate the cost of goods sold for the quarter ended June 30. Show calculations. (b) Using the average cost formula, 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 102 (30 min.) (a) Purchases

Cost of Goods Sold

Apr 1

Balance (90 @ $16) = $1,440

Apr 25

(300 @ $18) = $5,400

(90 @ $16) = $1,440 (300 @ $18) = 5,400 $6,840

May 4

(130 @ $20) = $2,600

(90 @ $16) = $1,440 (300 @ $18) = 5,400 (130 @ $20) = $2,600 $9,440

May 16

Jun 4

(90 @ $16) = $1,440 (150 @ $18) = $2,700 $4,140 (100 @ $24) = $2,400

(150 @ $18) = $2,700 (130 @ $20) = $2,600 $5,300 (150 @ $18) = $2,700 (130 @ $20) = $2,600 (100 @ $24) = $2,400

Reporting and Analyzing Inventory

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$7,700 (b) Apr 1 Apr 25 May 4 May 16 Jun 4

Purchases

Cost of Goods Sold

(90 @ $16) = $1,440.00 (300 @ $18) = $5,400.00 (130 @ $20) = $2,600.00 (100 @ $24) = $2,400.00

Balance

(390 @ $17.54) = $6,840.00 (520 @ $18.15) = $9,440.00 (240 @ $18.15) = $4,356.92)(280 @ $18.15) = $5,083.08 (380 @ $19.69) = $7,483.08

Please note that discrepancies may result in the above schedule due to rounding.

Ex. 103 Rayleigh Corporation, which uses a perpetual inventory system, recorded the following inventory transactions during the last two months of 2018: Purchases Sales Units Unit Cost Units Selling Price/Unit Nov 1 Beginning inventory 210 $120 13 Purchase 140 116 29 Sale 192 $174 Dec 3 Purchase 100 112 16 Sale 104 168 Instructions (a) Using the FIFO cost formula, calculate the cost of goods sold for the two months of November and December. Show calculations. (b) Using the average cost formula, 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 103 (30 min.) (a) Purchases

Cost of Goods Sold

Nov 1 Nov 13

Nov 29

Balance (210 @ $120) = $25,200

(140 @ $116) = $16,240

(210 @ $120) = $25,200 (140 @ $116) = $16,240 $41,440

(192 @ $120) = $23,040 (18 @ $120) = $2,160 (140@$116)=$16,240 $18,400

Dec 3

Dec 16

(100 @ $112) = $11,200

(18 @ $120) = $2,160 (140 @ $116) = $16,240 (100 @ $112) = $11,200 $29,600 (18 @ $120) = $2,160

(54 @ $116) = $6,264

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(86 @ $116)= $9,976 $12,136

(100 @ $112) = $11,200 $17,464

COGS = $35,176 (b)

Purchases

Cost of Goods Sold

Balance

Nov 1 (210 @ $120) = $25,200.00 Nov 13 (140 @ $116) $16,240.00 (350 @ $118.40) = $41,440.00 Nov 29 (192 @ $118.40) = $22,732.80(158 @ $118.40) =$18,707.20 Dec 3 (100 @ $112) $11,200.00 (258 @ $115.92) = $29,907.20 Dec 16 (104 @ $115.92) = $12,055.62(154 @ $115.92) = $17,851.58 COGS = $34,788.48 Please note that discrepancies may result in the above schedule due to rounding.

Ex. 104 Coucous Corp. uses the perpetual 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 12 Sale 500 units 16 Purchase 400 units @ $10.80 = 4,320 24 Purchase 100 units @ $11.60 = 1,160 29 Sale 400 units Instructions (a) Calculate the ending inventory using the FIFO cost formula at September 30 (show calculations). (b) Calculate the ending inventory using the average cost formula at September 30 (show calculations). Solution 104 (a) (200 + 600 – 500 + 400 + 100 – 400) = 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)

Purchases

Cost of Goods Sold

Sep 1 Sep 8 (600 @ $10.40) = $6,240.00 Sep 12 (500 @ $10.30) = $5,150.00 Sep 16 (400 @ $10.80) = $4,320 Sep 24 (100 @ $11.60) = $1,160 Sep 29 (400 @ $10.71) = $4,285.00

Balance (200 @ $10) = $2,000.00 (800 @ $10.30) = $8,240.00 (300 @ $10.30) = $3,090.00 (700 @ $10.59) = $7,410.00 (800 @ $10.71) = $8,570.00 (400 @ $10.71) = $4,285.00

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Ex. 105 Glamorous Gold Inc. opened for business on April 1, 2018 selling unique jewellery, which it purchases from local artisans. During April, the company made the following purchases: Date Inventory Tag Number Cost Apr 1 001 $2,750 Apr 3 002 600 Apr 5 003 1,150 004 2,300 Apr 10 005 700 Apr 13 006 1,200 007 3,900 Apr 26 008 600 009 1,700 Apr 30 010 2,400 On April 30, 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 formula. (b) Discuss whether or not specific identification is an appropriate cost formula for this company. Solution 105 (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. 106 Complete the table by identifying the cost formula that provides the following advantage:

1. 2. 3.

ADVANTAGE Tracks the actual physical flow Ending inventory is closest to replacement cost Approximates the physical flow of most retailers

COST FORMULA ________________ ________________ ________________

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

Exactly matches costs and revenues Smooths the effects of price changes

________________ ________________

Solution 106 ADVANTAGE

COST FORMULA

Tracks the actual physical flow

Specific Identification

Ending inventory is closest to replacement cost

FIFO

Approximates the physical flow of most retailers

FIFO

Exactly matches costs and revenues

Specific Identification

Smooths the effects of price changes

Average Cost

Ex. 107 Houle Limited reported the following summarized annual data at the end of 2018: Sales revenue ............................................................ $3,500,000 Cost of goods sold* .................................................... 1,700,000 Gross profit ................................................................ 1,800,000 Operating expenses ................................................... 1,200,000 Income before income tax .......................................... $ 600,000 *Based on an ending inventory of $420,000, using FIFO. 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 107 (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 Income 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 income before income tax. In addition, the inventory cost formula 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.

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Ex. 108 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 Net income 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 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 108 (20 min.) Items Shareholders’ Cost of Equity Goods Sold NA O

Events 1.

Assets NA

Net income U

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

Ex. 109 Condensed income statements for Collingwood Limited are shown below for two years: 2017 2018 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 Income before income tax ...................................... $23,000 $ 26,000 Instructions (a) Calculate the corrected net income before income tax for 2017 and 2018, assuming that the inventory as of the end of 2017 was mistakenly understated by $7,000. 2017 $____________ 2018 $____________ (b) Calculate the ending retained earnings at the end of 2018, assuming retained earnings at the end of 2017 was $195,000 and at the end of 2018, $205,000. Solution 109 (5 min.) (a) 2017 = $30,000 ($23,000 + $7,000) 2018 = $19,000 ($26,000 – $7,000) (b) Retained earnings at the end of 2018 would be unchanged at $205,000 because the net income corrects itself over the two year period.

Ex. 110 Miller’s Grocery reported the following selected information: Cost of goods sold ................................................. Ending inventory ....................................................

2017 $837,000 64,000

2018 $900,000 55,000

Miller made two errors: 1. 2017 ending inventory was overstated by $5,000. 2. 2018 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

2017 Overstated/ Amount Understated $_________ _______

2018 Overstated/ Amount Understated $_________ _______

Shareholders’ equity

$_________

_______

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Cost of goods sold

$_________

_______

$_________

_______

Income before income tax

$_________

_______

$_________

_______

Solution 110 (20 min.)

Total assets

2017 Overstated/ Amount Understated $5,000 O

2018 Overstated/ Amount Understated $9,000 U

Shareholders’ equity

$5,000

$9,000

Cost of goods sold

$5,000

$14,000

Income before income tax

$5,000

$14,000

Ex. 111 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, 2017, 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, 2018, the market value of the same copper inventory has increased and would be worth $4.6 million. Instructions (a) Prepare the adjusting entry required at December 31, 2017 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, 2018, if any. Solution 111 (10 min.) (a) Dec 31, 2017

Cost of Goods Sold .............................................. 1,000,000 Inventory ....................................................... 1,000,000 ($4,500,000 – $3,500,000 = $1,000,000)

(b) Dec 31, 2018

Inventory .............................................................. 1,000,000 Cost of Goods Sold ....................................... 1,000,000 Note that inventory cannot be written up above cost.

Ex. 112 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

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

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 112 (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.

Ex. 113 The following information is available for Omari Corporation for 2018: 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 113 (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. 114 Solve for the missing amounts: Sales .................................................. Cost of goods sold ............................. Inventory, beginning of year ...............

A $100,000 (a) 23,000

B $239,000 122,000 45,000

C $438,000 345,000 (h)

Reporting and Analyzing Inventory

Inventory, end of year ........................ Average inventory .............................. Gross profit ........................................ Inventory turnover .............................. Days in inventory ...............................

17,000 (b) 46% (c) (d)

39,000 (e) (f) (g) 126

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

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Solution 114 (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. 115 Parts Plus has the following individual inventory items at cost and net realizable value: Part Units Unit Cost NRV per Unit X123 20 $5.00 $4.50 Y135 30 3.00 3.75 Z246 25 4.25 5.00 A369 10 1.10 1.10 B258 15 2.30 2.00 Instructions (a) Determine the lower of cost and net realizable value of the ending inventory for Parts Plus. (b) Prepare the journal entry required, if any, to record the adjustments from cost to net realizable value. Solution 115 (a) Part Units X123 20 Y135 30 Z246 25 A369 10 B258 15 Total Inventory

Unit Cost $5.00 3.00 4.25 1.10 2.30

NRV per Unit $4.50 3.75 5.00 1.10 2.00

(b) Cost of Goods Sold Inventory (X123: $100 – $90 = $10)

Cost of Goods Sold

4.50

Cost $100.00 90.00 106.25 11.00 34.50 $341.75

NRV $90.00 112.50 125.00 11.00 30.00 $368.50

LCNRV $90.00 90.00 106.25 11.00 30.00 $327.25

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

Inventory (B258: $34.50 – $30 = $4.50)

4.50

Ex. 116 Codify Lighting has the following groups of inventory and net realizable value for its light fixtures: Cost NRV Ceiling Lights $23,500 $18,100 Chandeliers 17,500 15,100 Table Lamps 19,300 21,800 Floor Lamps 16,000 19,400 Desk Lamps 8,700 6,200 Total Inventory $85,000 $80,600 Instructions (a) Determine the lower of cost and net realizable value of the ending inventory for Codify Lighting. (b) Prepare the journal entry required, if any, to record the adjustments from cost to net realizable value. Solution 116 (a) Ceiling Lights Chandeliers Table Lamps Floor Lamps Desk Lamps Total Inventory (b)

Cost $23,500 17,500 19,300 16,000 8,700 $85,000

NRV $18,100 15,100 21,800 19,400 6,200 $80,600

LCNRV $18,100 15,100 19,300 16,000 6,200 $74,700

Cost of Goods Sold 10,300 Inventory 10,300 ($85,000 – $74,700 = $10,300)

*Ex. 117 Hansen Corporation uses the periodic 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 Answer the following independent questions and show calculations supporting your answers: (a) Assume that the company uses the FIFO cost formula. The cost of goods sold for the Jan 21

Reporting and Analyzing Inventory

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sale was $__________. (b) Assume that the company uses the average cost formula. 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 formula. 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 formula. The value of the inventory after the Oct 20 purchase is $__________. *Solution 117 (a) Cost of Goods Sold (FIFO):

(15 units @ $4) + (50 units @ $4.40) = $280

(b) Cost of Goods Sold (average): ($60 + $264 +$126 + $216) ÷ (15 + 60 + 30 + 45) = $4.44 per unit Sold 65 units @ $4.44 = $288.60 (c) 10 units on hand (85 – 75) @ $4.44 = $44.40 (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. 118 Breaker Corp. uses the periodic inventory system, and has the following information about purchases and sales during the year: Jan 1 Beginning inventory 300 items @ $6 = $ 1,800 May 1 Purchases 900 items @ $10 = 9,000 Total 1,200 items $10,800 Total sales 600 items Dec 31 Ending inventory 600 Instructions Calculate the cost to be assigned to ending inventory for each of the cost formula below: (a) Average $____________ (b) FIFO $____________ *Solution 118 (10 min.) (a) $5,400 ($10,800  1,200 = $9.00  600) (b) $6,000 (600  $10)

*Ex. 119

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

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 30 (show calculations). (b) Calculate the ending inventory using average cost assuming 400 units remain on hand at September 30 (show calculations). *Solution 119 (20 min.) (a) 400 units in ending inventory Under the FIFO cost formula, 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 formula, the weighted average cost per unit must be calculated: $13,720  1,300 units = $10.55 400 units  $10.55 = $4,220

*Ex. 120 Alto Ltd. uses the periodic inventory system and had the following inventory information available: Units Unit Cost Total Cost Jan 1 Beginning inventory 200 $8 $ 1,600 20 Purchase 1,000 $10 10,000 Jul 25 Purchase 200 $12 2,400 Nov 20 Purchase 600 $14 8,400 2,000 $22,400 A physical count of inventory on December 31 showed that there were 700 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 net income that the company would have reported if it had used FIFO instead of average cost. Would net income have been greater or less?

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*Solution 120 (20 min.) (a) FIFO: Ending inventory $9,600 600 units @ $14 = $8,400 100 units @ $12= 1200 700 units $9,600 (b) Average Cost: Ending inventory $7,840 $22,400  2,000 = $11.20 per unit  700 units = $7,840 (c) FIFO: Cost of goods sold $3,200 Cost of goods available – Ending Inventory = Cost of goods sold $22,400 – $9,600 = $12,800 Proof: 200 units @ $8 = 1,000 units @ $10= 100 units @ $12= 1,300 units

$ 1,600 10,000 1,200 $12,800

Average: Cost of goods sold $14,560 Proof: Cost of goods available – Ending Inventory = Cost of goods sold $22,400 – $7,840 = $14,560 Net income would have been $1,760 ($14,560 vs. $12,800) greater if the company used the FIFO cost formula instead of average cost formula.

*Ex. 121 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 Oct 20 Purchase 45 4.80 216 150 $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

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December 31 is $__________. *Solution 121 (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 QUESTIONS 122. Match the items below by entering the appropriate code letter in the space provided. A. B. C. D. E.

Inventory Cost FOB shipping point FOB destination Specific identification cost formula

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(n) ___ 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 formulas used in a perpetual inventory system may be used in a(n) ___ inventory system.

The ___ cost formula tracks the actual physical flow for each inventory item available for sale.

Ending inventory consists of the most recent inventory purchases in the ___ cost formula.

The same unit cost is used to determine the cost of inventory and cost of goods sold in the ___ cost formula.

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.

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ANSWERS TO MATCHING 1.

10. J

Reporting and Analyzing Inventory

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SHORT-ANSWER ESSAY QUESTIONS S-A E 123 Lucia Kraus and Tren Lee are department managers in the housewares and shoe departments, respectively, for Beaton’s, 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. Beaton’s 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 123 (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 Beaton’s 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 124 Consigned goods are goods belonging to one party and sold for a fee by another without transfer of ownership. Instructions (a) Why do you think a business will take goods on consignment, rather than purchasing them outright? (b) Explain how the consignor and the consignee should account for consigned goods.

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Solution 124 (a) 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. (b) The consignee, holder of the goods, does not own the goods. Ownership remains with the individual or company that wants to sell the goods, called the consignor, until the goods are actually sold to a customer. Because the consignee does not own consigned goods, the goods should not be included in the consignee’s physical inventory count. Conversely, the consignor should include in its inventory any of its merchandise that is being held by the consignee.

S-A E 125 The general manager of Winnipeg Manufacturing Corp. wants to use the specific identification formula 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 formula 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 125 They are both right. It is acceptable to use two different inventory cost formulas 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 that 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 cost formula to use.

S-A E 126 FIFO and average cost are the two most commonly used cost formulas in Canada. The amounts assigned to the same inventory items on hand may be different under each cost formula. Instructions (a) 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. (b) Explain how a company should choose between using the FIFO and average cost formulas. Solution 126 (a) The FIFO cost formula 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 formula 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 formula 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 formula is used and prices during the period are decreasing, the ending inventory

Reporting and Analyzing Inventory

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under FIFO will be less than under average. If prices remain constant, then there will be no difference in the ending inventory values. (b) It should consider the following guidelines in making its choice: 1. Choose a cost formula that corresponds as closely as possible to the physical flow of goods. 2. Report an inventory cost on the statement of financial position that is close to the inventory’s recent cost. 3. Use the same cost formula for all inventories of a similar nature and use. After a company chooses a cost formula for determining the cost of its inventory that cost formula should be used consistently from one period to the next.

S-A E 127 Vu Mobutu, a new employee of Crafter's Paradise, recorded $3,000 in consigned goods received as part of the company's January 2018 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 You are Vu's supervisor. Write a memo to Vu explaining why the error should have been corrected.

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

Solution 127 MEMO

TO:

Vu Mobutu, Accounting Department

FROM: Supervisor DATE:

March 12, 2018

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 128 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 writedown 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? Solution 128 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

Reporting and Analyzing Inventory

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that the net realizable value has declined below cost. The facts in this case, including information from previous years, do not support a writedown. The fact that Winter Wonderland is a private company or that the writedown 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 writedown would have to be reversed.

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

OBJECTIVE FORMAT QUESTIONS 129. The following inventory transactions occurred during November 2018 for London Cables, Ltd., a company that sells mini USB cables. The company uses a perpetual inventory system. London Cables Ltd. Inventory Transactions Number of Transaction Units

Date 2018 Nov.

1 4 8 11 18 22 27 29 29

Beginning Balance Sales Sales Purchases Sales Purchases Sales Purchases Sales

15,000 (5,000) (4,000) 3,000 (2,000) 10,000 (7,000) 2,000 (3,000)

Unit Cost $4.75

5.25 5.15 5.35

Identify all of the following statements that are correct, assuming that when using the average cost formula the calculated unit cost is rounded to the nearest cent . (a) If the company used the FIFO formula for determining ending inventory, the cost of ending inventory for November 30, 2018 would be $46,750. (b) Using the average cost formula, the amount of cost of goods sold is $102,450. (c) Using the FIFO formula, the amount of cost of goods sold is $105,050. (d) It is unlikely the company would use the specific identification formula for determining ending inventory and cost of goods sold. (e) If the company used the average cost formula, the ending inventory would be $45,930.00. (f) Using the average cost formula, the cost of goods sold would be 103,270.00. (g) If the company used the FIFO formula for determining cost of goods sold, it would be $102,450. (h) The FIFO formula results in a lower ending inventory balance than the average cost formula. Solution 129 (a), (d), (e), (f), and (g) are correct; (b), (c), and (h) are incorrect. The following charts shows the correct values for cost of goods sold and ending inventory using the FIFO and average cost formulas under a perpetual inventory system for London Cables Ltd.:

Reporting and Analyzing Inventory

Date 2018 Nov. 1 4 8 11

Units

3,000

Purchases Cost Total

5.25

10,000

5.15

2,000

5.35

4.75 4.75

23,750.00 19,000.00

2,000

4.75

9,500.00

51,500.00

27 29

5,000 4,000 15,750.00

18 22

London Cables Ltd. Average Cost Cost of Goods Sold Units Cost Total

4,000 3,000

4.75 5.25

34,750.00

3,000

5.15

15,450.00

10,700.00

29 Total

Date 2018 Nov.1 4 8 11 18 22 27 29 29 Total

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Units 15,000 10,000 6,000 6,000 3,000 4,000 3,000 4,000 3,000

Balance Cost Total 4.75 71,250.00 4.75 47,500.00 4.75 28,500.00 4.75 } 4,250.00 5.25 } 4.75 } 34,750.00 5.25 } 4.75 } 5.25 } 86,250.00

10,000

5.15

}

10,000 10,000 2,000 7,000 2,000

5.15 5.15 5.35 5.15 5.35

51,500.00 } 62,200.00 } } 6,750.00 }

Units 15,000 10,000 6,000 9,000 7,000 17,000 10,000 12,000 9,000

Balance Cost 4.75 4.75 4.75 4.92 4.92 5.05 5.06 5.11 5.10

$102,450.00

Units 15,000

Purchases Cost Total 4.75 71,250.00

3,000

5.25

15,750.00

10,000

5.15

51,500.00

2,000

5.35

London Cables Ltd. Average Cost Cost of Goods Sold Units Cost Total 5,000 4,000

4.75 4.75

23,750.00 19,000.00

2,000

4.92

9,840.00

7,000

5.05

35,350.00

3,000

5.11

15,330.00 $103,270.00

10,700.00

Total 71,250.00 47,500.00 28,500.00 44,250.00 34,410.00 85,910.00 50,560.00 61,260.00 45,930.00

Nov. 11 Weighted average cost $44,250.00 ÷ 9,000 = $4.92 per unit Nov. 22 Weighted average cost $85,910.00 ÷ 17,000 = $5.05 per unit Nov. 27 Weighted average cost $50,560.00 ÷ 10,000 = $5.06 per unit Nov. 29 Weighted average cost $61,260.00 ÷ 12,000 = $5.11 per unit Nov. 29 Weighted average cost $45,930.00 ÷ 9,000 = $5.10 per unit

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

130. For each financial statement item listed below, take into consideration whether inventory prices are rising or falling. Then choose whether the item’s value will be higher or lower if the company uses FIFO as compared to the average cost formula. Item (a) Net income (b) Cost of goods sold (c) Ending inventory (d) Gross profit (e) Retained earnings (f) Cost of goods sold (g) Net income (h) Retained earnings

Period of Rising or Falling Prices Falling prices Rising prices Falling prices Rising prices Rising prices Falling prices Rising prices Falling prices

Higher or Lower Higher or Lower Higher or Lower Higher or Lower Higher or Lower Higher or Lower Higher or Lower Higher or Lower Higher or Lower

Solution 130 (a) Lower. When prices are falling, the cost of goods sold will have a higher value under FIFO, as compared to the average cost formula. The cost of goods sold will be higher; therefore, net income will be lower. (b) Lower. When prices are rising, the cost of goods sold be a lower value under FIFO, as compared to the average cost formula. (c) Lower. When prices are falling, the cost of goods sold will be higher value under FIFO, as compared to the average cost formula. The cost of goods sold will be higher; therefore, ending inventory will be lower. (d) Higher. When prices are rising, the cost of goods sold will be lower value under FIFO, as compared to the average cost formula. The cost of goods sold will be lower; therefore, ending inventory will be higher. Therefore, gross profit would be higher under FIFO. (e) Higher. When prices are rising, the cost of goods sold will be lower value under FIFO, as compared to the average cost formula. The cost of goods sold will be lower; therefore, net income will be higher and retained earnings will be higher. (f) Higher. When prices are falling, the cost of goods sold will be higher value under FIFO, as compared to the average cost formula. (g) Higher. When prices are rising, the cost of goods sold will be lower value under FIFO, as compared to the average cost formula. The cost of goods sold will be lower; therefore, net income will be higher. (h) Lower. When prices are falling, the cost of goods sold will be higher value under FIFO, as compared to the average cost formula. The cost of goods sold will be higher; therefore, net income will be lower and retained earnings will be lower.

131. Identify all of the following statements that are correct with regards to valuing inventories: (a) When the net realizable value of inventory is lower than its cost, inventory is written down to its net realizable value only when the net realizable value is not expected to recover.

Reporting and Analyzing Inventory

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(b) Net realizable value is the selling price that a company could expect to sell the merchandise for less any costs required to make the goods ready for sale. (c) The lower of cost and net realizable value rule is normally applied to groups of inventory items, not to individual items. (d) When merchandise is written down to its net realizable value, the Cost of Goods Sold account is debited for the amount of the loss. (e) When merchandise is written down below cost, this cannot be reversed. (f) Companies are required to disclose in the notes to the financial statement the amount of any writedown to net realizable value for inventory. (g) Only companies using IFRS are required to apply the lower of cost and net realizable value rule; the rule is optional for companies using ASPE. Solution 131 Statements (b), (d), and (f) are correct; (a), (c), (e), and (g) are incorrect. (a) When the net realizable value of inventory is lower than its cost, inventory is written down to its net realizable value less any costs incurred to get the inventory ready for sale, even if the price may recover in the future. If the net realizable value increases for inventory that was previously written down, the amount of the writedown can be reversed. (c) The lower of cost and net realizable value rule is normally applied to individual inventory items, if possible. Only in certain cases can it be applied to groups of items as in the case when items are part of a product line of similar items. (e) Although it doesn’t occur often, when an item of inventory that is carried at net realizable value, because its selling price had declined, is still on hand in a subsequent period and its selling price has increased, a reversal of the writedown can be made. (g) Writedowns to net realizable value are made by both companies reporting under IFRS and companies reporting under ASPE.

132. The 2018 industry ratios for the industry in which Paper Clip Incorporated operates were as follows: Industry Data Days in inventory 28 days Inventory turnover 12 times On their statement of financial position, Paper Clip reported $255,000 in inventory for 2018 and $212,000 for 2017. During 2018, the company had sales of $7,800,000 and cost of goods sold is 45% of sales. Based on the above information, identify all the following statements that are correct. (Ratios are rounded to the nearest whole number). (a) Paper Clip is holding inventory for a longer time than the industry average. (Assume inventories were recorded correctly in both years.) (b) Paper Clip’s average inventory for 2018 is $233,500. (Assume inventories were recorded correctly in both years.)

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

(c) Paper Clip is able to turn over its inventory at a faster rate than industry. (Assume inventories were recorded correctly in both years.) (d) Paper Clip holds its inventory for 4 less days than the industry. (Assume inventories were recorded correctly in both years.) (e) If Paper Clip’s inventory for 2017 was understated by $128,000, their days in inventory ratio for 2018 would be understated by 6 days. (f) If Paper Clip’s inventory for 2017 was understated by $128,000, their days in inventory ratio for 2018 would be understated by 9 days. (g) If Paper Clip’s inventory for 2017 was understated by $128,000, there will be no impact on the ratios for 2018. Solution 132 In order to complete this question, students will need to determine the inventory turnover and days in inventory ratios. Cost of Goods Sold Inventory Turnover = Average Inventory Days in Inventory =

365 Inventory Turnover

Cost of Goods Sold = 45% x $7,800,000 = $3,510,000 Average Inventory =

($255,000 + $212,000) = $233,500 2

Inventory Turnover =

Days in Inventory =

$3,510,000 = 15 times $233,500

365 = 24 days 15

If Paper Clip’s ending inventory for 2017 was understated by $128,000, this would mean the cost of goods sold for 2017 was overstated and the cost of goods sold for 2018 is understated. Recall from your text, an over or overstatement in inventories will be reversed the subsequent year as long as the inventory count is done correctly and the correct costs are assigned at the end of that subsequent year. [($255,000 + ($212,000 + $128,000)]) Average Inventory = = $297,500 2 ($3,510,000 − $128,000) = 11 times $297,500 365 Days in Inventory = = 33 days 11 Inventory Turnover =

Based on these calculations, statements (b), (c), (d), and (f) are correct; (a), (e), and (g) are incorrect.

Reporting and Analyzing Inventory

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133. The following inventory transactions occurred during November 2018 for London Cables, Ltd., a company that sells mini USB cables. The company uses a periodic inventory system.

A physical count of inventory at the end of November shows 9,000 units on hand. (Average unit costs are rounded to two decimals.) Identify all of the following statements that are correct: (a) Under the FIFO formula, the value of ending inventory for November 30th would be the same if the company used the perpetual system rather than the periodic system. (b) Using the average cost formula, the value of cost of goods sold is $104,470. (c) Using the FIFO formula, the value of cost of goods sold is $102,450. (d) Under the average cost formula, the unit cost used to calculate cost of goods sold is different than the unit cost used to calculate ending inventory. (e) Under the average cost formula, the value of ending inventory would be $46,750. (f) Using the average cost formula, the value of cost of goods sold is $102,450. (g) Using the FIFO formula, the value of cost of goods sold would be $149,200. (h) The FIFO formula results in a higher ending inventory balance than the average cost method. Solution 133 (a), (b), (c), and (h) are correct; (d), (e), (f), and (g) are incorrect. The following charts shows the correct values for cost of goods sold and ending inventory using the FIFO and average cost formulas for London Cables Ltd.

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

AVERAGE COST Average cost = $149,200 ÷ 30,000 units = Goods available for sale Less: Ending inventory (9,000 x $4.97) Cost of goods sold

$4.97 $149,200 44,730 $104,470

CHAPTER 7 INTERNAL CONTROL AND CASH SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K AA AN 11. 2 E C AA AN 21. 3 M C AA AN 2. 1 E K AA AN 12. 2 E C AA AN 22. 3 E C AA AN 3. 1 M C AA AN 13. 2 M C AA AN 23. 3 M C AA AN 4. 1 M C AA AN 14. 2 E C AA AN 24. 4 E K AA AN 5. 1 M K AA AN 15. 2 E C AA AN 25. 4 M K AA AN AA AN C AA AN C AA AN 6. 1 M K 16. 3 E 26. 4 M 7. 1 M C AA AN 17. 3 E C AA AN 27. 4 E K AA AN 8. 1 E C AA AN 18. 3 M K AA AN 28. 4 E C AA AN AA AN AA AN AA AN 9. 1 M C 19. 3 M K 29. 4 E C 10. 1 E C AA AN 20. 3 E K AA AN Multiple Choice Questions 30. 1 M C AA AN 52. 1 H C AA AN 74. 3 M C AA AN 31. 1 M C AA AN 53. 1 M C AA AN 75. 3 E C AA AN 32. 1 H K AA AN 54. 1 E C AA AN 76. 3 M AP AA AN 33. 1 E K AA AN 55. 2 E C AA AN 77. 3 M AP AA AN 1 AA AN 2 C AA AN 3 C AA AN 34. E C 56. E 78. M AA AN C AA AN C AA AN 35. 1 M K 57. 2 M 79. 3 M AA AN C AA AN C AA AN 36. 1 M K 58. 2 E 80. 3 M AA AN AA AN AA AN 37. 1 E K 59. 2 E C 81. 3 E C AA AN AA AN AA AN 38. 1 M K 60. 2 M C 82. 3 E AP 39. 1 M C AA AN 61. 2 M C AA AN 83. 3 H AP AA AN 40. 1 M C AA AN 62. 2 E K AA AN 84. 3 M AP AA AN 41. 1 M C AA AN 63. 2 E C AA AN 85. 3 M AP AA AN 42. 1 M C AA AN 64. 2 M C AA AN 86. 3 H AP AA AN 43. 1 E C AA AN 65. 3 M K AA AN 87. 4 M C AA AN 44. 1 M K AA AN 66. 3 M C AA AN 88. 4 M C AA AN 45. 1 E K AA AN 67. 3 M C AA AN 89. 4 M C AA AN 46. 1 E K AA AN 68. 3 M C AA AN 90. 4 M C AA AN 47. 1 E C AA AN 69. 3 M C AA AN 91. 4 E K AA AN 48. 1 M K AA AN 70. 3 M C AA AN 92. 4 M K AA AN 49. 1 M C AA AN 71. 3 E C AA AN 93. 4 M K AA AN 50. 1 H C AA AN 72. 3 E C AA AN 94. 4 E K AA AN 51. 1 M K AA AN 73. 3 M K AA AN 95. 4 E C AA AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: AA = Audit & Assurance AACSB: AN = Analytic

K = Knowledge

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

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Exercises 96. 1 H C AA AN 104. 3 H AP AA AN 112. 3 M C AA AN 97. 1 E C AA AN 105. 3 M C AA AN 113. 3 H AP AA AN 98. 1 E C AA AN 106. 3 E AP AA AN 114. 3 M AP AA AN 99. 1 M C AA AN 107. 3 E AP AA AN 115. 3 E AP AA AN 100. 1,2 M C AA AN 108. 3 E AA AN 3 AP AA AN AP 116. M 101. 1,2 M C AA AN 109. 3 M AP AA AN 117. 3 E AA AN C 102. 1,3 H AP AA AN 110. 3 M AP AA AN 118. 3 H AP AA AN 103. 2,4 M AP AA AN 111. 3 M AP AA AN 119. 4 H AN AA AN Matching 120. 1–4 E,M K AA AN Short-Answer Essay 121. 1 E C AA AN 124. 3 M C AA AN 127. 4 E C AA AN 122. 1 M C AA,C AN 125. 3 M C AA AN 128. 4 M C AA AN 123. 2 M C AA AN 126. 3 M C AA,C AN CPA Questions 129. 1 M C AA AN 131. 3,4 H AN AA AN 133. 4 M AN AA AN 130. 3 M AN AA AN 132. 4 M C AA AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension CPA: AA = Audit & Assurance C = Communication AACSB: AN = Analytic

Internal Control and Cash 7 - 3

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Learning Objective 1 1. TF 8. TF 34. MC 41. MC 47. MC 2. TF 9. TF 35. MC 41. MC 48. MC 3. TF 10. TF 36. MC 42. MC 49. MC 4. TF 30. MC 37. MC 43. MC 50. MC 5. TF 31. MC 38. MC 44. MC 51. MC 6. TF 32. MC 39. MC 45. MC 52. MC 7. TF 33. MC 40. MC 46. MC 53. MC Learning Objective 2 11. TF 14. TF 56. MC 59. MC 62. MC 12. TF 15. TF 57. MC 60. MC 63. MC 13. TF 55. MC 58. MC 61. MC 64. MC Learning Objective 3 16. TF 65. MC 73. MC 81. MC 105. Ex 17. TF 66. MC 74. MC 82. MC 106. Ex 18. TF 67. MC 75. MC 83. MC 107. Ex 19. TF 68. MC 76. MC 84. MC 108. Ex 20. TF 69. MC 77. MC 85. MC 109. Ex 21. TF 70. MC 78. MC 86. MC 110. Ex 22. TF 71. MC 79. MC 102. Ex 111. Ex 23. TF 72. MC 80. MC 104. Ex 112. Ex Learning Objective 4 24. TF 28. TF 89. MC 93. MC 119. Ex 25. TF 29. TF 90. MC 94. MC 120. Ma 26. TF 87. MC 91. MC 95. MC 127. SAE 27. TF 88. MC 92. MC 103. Ex 128. SAE

Item

Type

Item

Type

54. 96. 97. 98. 99. 100. 101.

MC Ex Ex Ex Ex Ex Ex

102. 120. 121. 122. 129.

Ex Ma SAE SAE CP

100. 101. 103.

Ex Ex Ex

120. 123.

Ma SAE

113. 114. 115. 116. 117. 118. 120. 124.

Ex Ex Ex Ex Ex Ex Ma SAE

125. 126. 130. 131.

SAE SAE CP CP

131. 132. 133.

CP CP CP

Note:

Ma = Matching CP = CPA Questions

TF = True-False Ex = Exercise

MC = Multiple Choice SAE = Short-Answer Essay

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

CHAPTER LEARNING OBJECTIVES 1.

Explain the components of an internal control system, including its control activities and limitations. Internal control systems have the following components: the control environment, risk assessment, control activities, information and communication, and monitoring activities. Control activities include assignment of responsibility, segregation of duties, documentation, physical controls, and review and reconciliation.

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 custody of cash to different individuals; (c) obtaining remittance advices for mail receipts, cash register tapes for overthe-counter receipts, and deposit slips or confirmations for bank deposits; (d) using company safes and banks 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; and (f) making independent daily counts of register receipts and daily comparisons of total receipts with total deposits. 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 blank cheques in a safe with access restricted to authorized personnel, and using electronic methods to print amounts on cheques; (f) comparing each cheque or EFT payment with the approved invoices before initiating payments; and (g) making monthly reconciliations of bank and book balances.

Prepare a bank reconciliation. In reconciling the bank account, the cash balance per the company’s books is reconciled with the cash balance reported by the bank on the bank statement. There can be differences between the company’s books and the bank due to timing differences and errors. Reconciling items for the bank include deposits in transit, outstanding cheques, and any errors made by the bank. Reconciling items for the company include EFT receipts, interest, EFT payments, service charges, NSF cheques, and any errors made by the company. Journal entries must be made for all items required to adjust the balance per books to the reconciled cash balance.

Explain the reporting and management of cash. Cash is usually the first current asset listed on the statement of financial position. Cash that is 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) collect receivables quicker, (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. Errors give rise to unintentional misstatements in the financial statements.

3. The responsibility for keeping the records for an asset should be separate from the physical custody of that asset.

4. The person responsible for making credit sales should be the vice-president of finance. 5. External auditors report on whether or not the company’s financial statements fairly present its financial position and results of operations.

6. External auditors are usually employees of the company.

7. 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.

8. The responsibility for ordering, receiving, and paying for merchandise should be assigned to different individuals.

9. Segregation of duties among employees eliminates the possibility of collusion.

10. All documents should be prenumbered.

11. The use of a bank account makes internal control over cash more difficult.

12. The use of electronic funds transfers normally results in better control over cash.

13. Control over cash disbursements is improved if all expenditures are paid by cheque or through use of electronic funds transfers.

14. An example of segregation of duties is having a cheque signer record cash disbursements.

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

15. An authorized signing officer should sign a cheque only after reviewing the appropriate supporting documentation.

16. To obtain maximum benefit from a bank reconciliation, the reconciliation should be prepared by the person authorized to sign cheques.

17. Electronic funds transfers never have to be recorded.

18. All reconciling items in determining the reconciled cash balance per books require the depositor to make adjusting journal entries to the Cash account. 19. NSF cheques received from customers are debited by the bank to the depositor’s account.

20. A bank reconciliation is generally prepared by the bank and sent to the depositor along with cancelled cheques.

21. An NSF cheque that was received is recorded as an account receivable.

22. NSF cheques received are accounted for by adding them to the cash balance per books.

23. Deposits in transit require an adjustment to the cash balance per books.

24. Management only needs to know how much cash is available at the end of the month (when the bank reconciliation is prepared).

25. Debt investments due within three months are normally classified as cash equivalents.

26. A compensating balance is always reported as a non-current asset.

27. Cash restricted in use should be reported separately on the statement of financial position.

28. When the cash account has a credit balance in the general ledger, it is reported as a noncurrent liability.

29. Idle cash should be reported as restricted cash.

Internal Control and Cash

ANSWERS TO TRUE-FALSE STATEMENTS Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. Item Ans. 1. F 6. F 11. F 16. F 21. T 26. F 2. T 7. F 12. T 17. F 22. F 27. T 3. T 8. T 13. T 18. T 23. F 28. F 4. F 9. F 14. F 19. T 24. F 29. F 5. T 10. T 15. T 20. F 25. T

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MULTIPLE CHOICE QUESTIONS 30. Which of the following statements is true? (a) A good system of internal control does not require monitoring. (b) Risk assessment is one component of a good system of internal control. (c) When one individual is responsible for all related activities, the potential for errors and irregularities is decreased. (d) Control activities are most effective when several people are responsible for a given task.

31. Which of the following statements is true in terms of an internal control system? (a) A good internal control system will help a company achieve reliable financial reporting, effective and efficient operations, and compliance with laws and regulations. (b) An internal control system cannot be considered effective until the possibility of human error has been completely eliminated. (c) Only large companies need to be concerned with a system of internal control. (d) The extent of internal control activities adopted by a company must not be evaluated in terms of cost-benefit.

32. Internal controls may be limited by each of the following except (a) the size of the business. (b) the human element. (c) internal audits. (d) collusion.

33. 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

34. 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.

35. 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) prenumbering cheques.

36. All of the following are examples of a control activity except

Internal Control and Cash

(a) an extensive marketing plan. (b) assignment of responsibility. (c) segregation of duties. (d) insurance on assets.

37. All of the following are examples of a control activity except (a) limited access to assets. (b) review and reconciliation. (c) assignment of responsibility. (d) increasing the speed of collection on receivables.

38. 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

39. 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.

40. An employee who makes a sale, ships the goods, and bills the customer violates which control activity? (a) review and reconciliation (b) documentation (c) segregation of duties (d) assignment of responsibility

41. Physical controls are not designed to safeguard assets from (a) natural disasters. (b) employee theft. (c) robbery. (d) unauthorized use.

42. 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.

43. External auditors

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(a) evaluate the system of internal controls for the companies that employ them. (b) are employees of the company. (c) are independent of the company. (d) plan and perform an internal audit.

44. 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.

45. When two or more people get together for the purpose of circumventing prescribed controls, it is called (a) fraud prevention. (b) collusion. (c) a division of duties. (d) assignment of responsibilities.

46. The control activity related to not having the same person authorize and pay for goods is known as (a) physical controls. (b) review and reconciliation. (c) segregation of duties. (d) assignment of responsibility.

47. Arthur is warehouse custodian and also maintains the accounting records of the inventory held at the warehouse. Which control activity is violated? (a) documentation (b) review and reconciliation (c) segregation of duties (d) assignment of responsibility

48. Physical controls to safeguard assets do not include (a) cashier department supervisors. (b) vaults. (c) safety deposit boxes. (d) locked warehouses.

49. In large companies, review and reconciliation is often assigned to (a) shift supervisors. (b) management. (c) internal auditors. (d) external auditors.

Internal Control and Cash

50. Maximum benefit from review and reconciliation 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.

51. The independent audit committee of the board of directors is not responsible for reviewing the company’s internal control systems to ensure that they are adequate to result in (a) fair financial results. (b) complete financial results. (c) reasonable financial results. (d) accurate financial results.

52. 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.

53. Two employees at a retail store work the same cash register. You evaluate this situation as (a) a violation of assignment of responsibility. (b) a violation of segregation of duties. (c) supporting assignment of responsibility. (d) supporting review and reconciliation.

54. An accounts payable clerk also has cheque signing authority. Which control procedure is violated? (a) assignment of responsibility (b) review and reconciliation (c) documentation (d) segregation of duties

55. 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.

56. 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.

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(d) Cash should be deposited daily.

57. 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.

58. 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.

59. 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.

60. The use of prenumbered cheques is an example of (a) documentation. (b) review and reconciliation. (c) assignment of responsibility. (d) segregation of duties.

61. Allowing only the treasurer to sign cheques is an example of which control activity? (a) documentation (b) segregation of duties (c) physical controls (d) assignment of responsibility

62. Blank cheques (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.

63. An employee authorized to sign cheques should not record (a) shipping documents. (b) mail receipts. (c) cash disbursement transactions. (d) sales transactions.

Internal Control and Cash

64. Which of the following is considered to be Cash? (a) returned cheques (b) cheques (c) postdated cheques (d) stale-dated cheques

65. 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.

66. 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

67. 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.

68. 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

69. 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

70. 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

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(d) bank service charges

71. 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

72. 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

73. A cheque in the amount of $425 was returned by the bank marked "NSF". A bank service fee of $20 was charged for processing the returned cheque. Upon notification of the NSF, the company who initially received the customer’s cheque will most likely (a) reverse the customer’s payment on their books to re-establish the accounts receivable for $425. (b) make no changes to the accounting records but advise the customer that the payment was declined and is still outstanding. (c) reverse the customer’s payment on their books to re-establish the accounts receivable for $425 and debit bank charges expense for the bank service fee of $20. (d) reverse the customer’s payment on their books to re-establish the accounts receivable for $425 and debit the accounts receivable for the bank service fee of $20.

74. 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.

75. 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.

76. If a cheque correctly written and paid by the bank for $483 is incorrectly recorded on the company's books for $384, the appropriate treatment on the bank reconciliation would be to (a) add $99 to the balance per bank. (b) add $99 to the balance per books. (c) deduct $99 from the balance per books. (d) deduct $99 from the balance per bank.

Internal Control and Cash

Solution: $384 – $483 = ($99)

77. A cheque written by the company for $182 is incorrectly recorded as $218. On the bank reconciliation, the $36 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.

78. For which of the following errors should the appropriate amount be added to the balance per bank on a bank reconciliation? (a) cheque for $86 recorded as $68 by the depositor (b) deposit of $300 recorded by the bank as $30 (c) a paid cheque for $600 recorded by the bank as $60 (d) cheque for $28 recorded as $82 by the depositor

79. 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

80. 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 (c) bank service charge (d) deposit in transit

81. 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. 82. 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

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(d) No adjusting entry is necessary.

83. On Andrew Corp.’s April bank reconciliation, cheques outstanding totalled $9,620. In May, the corporation issued cheques totalling $26,800. The May bank statement shows that $24,250 in cheques cleared the bank in May. A cheque from one of Andrew Corp.'s customers in the amount of $325 was also returned marked "NSF." The amount of outstanding cheques on Andrew’s May bank reconciliation should be (a) $2,550. (b) $11,845. (c) $12,495. (d) $12,170. Solution: $9,620 + $26,800 – $24,250 = $12,170.

84. Stardust Corporation gathered the following reconciling information in preparing its October bank reconciliation: Cash balance per books, October 31 ......................... $6,200 Deposits in transit....................................................... 225 Electronic collection of account receivable ................. 1,150 Bank charge for cheque printing................................. 25 Outstanding cheques ................................................. 1,700 NSF cheque ............................................................... 200 The reconciled cash balance per books at October 31 is (a) $7,125. (b) $6,900. (c) $5,200. (d) $5,650. Solution: $6,200 + $1,150 – $25 – $200 = $7,125.

85. Angel Hair Limited gathered the following reconciling information in preparing its November bank reconciliation: Cash balance per books, November 30 ..................... $36,100 Electronic collection of account .................................. 7,200 Outstanding cheques ................................................. 13,600 Deposits in transit....................................................... 18,100 Bank service charge................................................... 3,650 NSF cheque ............................................................... 2,875 The reconciled cash balance per books at November 30 is (a) $16,675. (b) $21,175. (c) $39,275. (d) $36,775. Solution: $36,100 + $7,200 – $3,650 – $2,875 = $36,775.

86. Sunny Sky Corporation gathered the following reconciling information in preparing its August bank reconciliation: Cash balance per bank, August 31 ............................ $18,200 Note receivable collected by bank .............................. 4,500

Internal Control and Cash

Outstanding cheques ................................................. Deposit in transit ........................................................ Bank service charge................................................... NSF cheque ............................................................... The reconciled cash balance per bank at August 31 is (a) $ 17,785. (b) $ 14,075. (c) $ 9,575. (d) $18,575. Solution: $18,200 + $6,700 – $10,825 = $14,075.

10,825 6,700 40 750

87. Which of the following would not be included in the determination of cash equivalents? (a) bank overdrafts (b) 90 day treasury bills (c) restricted cash (d) money markets

88. A bank overdraft would be reported as (a) a current liability. (b) accounts payable. (c) negative cash under current assets. (d) restricted cash.

89. Which of the following statements is false? (a) A basic principle of cash management is to increase the speed of paying liabilities. (b) A company should plan the timing of major expenditures in light of its operating cycle. (c) A cash budget will help determine if additional financing will be necessary. (d) A key principle of cash management is to increase the speed of collection on receivables.

90. Restricted cash is (a) only available for general use. (b) only for overdraft purposes. (c) not available for general use. (d) included with cash and cash equivalents.

91. 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.

92. 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

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expected to be used. (d) Cash overdrafts are reported as contra-assets.

93. Cash equivalents (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.

94. 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.

95. 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. b 41. a c c d 30. 52. 63. 74. a a a b d 31. 42. 53. 64. 75. c c d d c 32. 43. 54. 65. 76. b c a b a 33. 44. 55. 66. 77. c b a d b 34. 45. 56. 67. 78. c c c b b 35. 46. 57. 68. 79. a c a d c 36. 47. 58. 69. 80. d a b c b 37. 48. 59. 70. 81. c c a a a 38. 49. 60. 71. 82. a c d b d 39. 50. 61. 72. 83. c 51. c a d a 40. 62. 73. 84.

Item 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95.

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

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EXERCISES Ex. 96 Aiken Bike Shops has two purchasing agents. Each agent prepares purchase orders to suppliers by entering the purchase details into the company’s financial system under the username “purchaser” and password “purchaser”. Both agents are using the same credentials to access the system. The purchasing agents record the receipt of the shipment and match this to the purchase order and invoice. The agents then transfer the goods to the respective shop, sign off on the invoice and forward to accounts payable for vendor payment. Instructions Identify any control activities that are violated in this situation and why. Solution 96 The assignment of responsibility control activity is violated as the username and password is not assigned to the individual purchasing agents making it impossible for the company to identify which purchasing agent has made which order. As responsibility has not been assigned to specific individuals, accountability cannot be determined. The segregation of duties control activity is also violated as the same individual is authorized to make a purchase order, record the receipt of shipment, match the purchase to the shipment and the invoice, and authorize payment. As these duties to authorize, record and take asset custody are not segregated to different individuals, opportunity for fraud exists.

Ex. 97 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. Assignment of responsibility B. Segregation of duties C. Physical controls D. Documentation E. Review and reconciliation ____ ____ ____ ____ ____ ____ ____

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 external audit firm reports on the financial statements each year.

Solution 97 (5 min.)

Internal Control and Cash

Ex. 98 Indicate whether each of the business practices listed below strengthens (S) or weakens (W) a company’s system of control activities. ____ (a) Controller pays invoices, signs cheques and makes deposits. ____ (b) All payments are made with cheques instead of cash. ____ (c) Two people handle cash sales from the same cash register drawer. ____ (d) The company uses prenumbered sales invoices. ____ (e) Audited financial statements are provided to the creditors each fiscal year. Solution 98 (5 min.) (a) W (b) S (c) W (d) S (e) S

Ex. 99 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 99 (10 min.)

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Violations: 1. It is Julia's responsibility to post payments to patient accounts. In allowing Craig to assist her, the control activity of assignment of responsibility 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. Review and reconciliation is also being violated. There is no independent counting of the cash and comparison to total receipts.

Ex. 100 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 100 (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

Internal Control and Cash

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.

•

b) Strengths • 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. 101 Listed below are six 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. Internal Control Activities (a) Assignment of responsibility (b) Segregation of duties (c) Physical controls (d) Documentation (e) Review and reconciliation Solution 101 (10 min.) 1. (b) 2.

(c)

(e)

(a) and (e)

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(d) and (e)

Ex. 102 Due to limited staff resources, the Junior Accountant Alex Short has been collecting cash from customers, posting to the accounts receivable sub-ledger and making the deposit to the bank. Alex recently met with the Accounting manager to discuss and request a $5,000 raise in pay. The manager told Alex that he had a few concerns with his performance but if these issues could be overcome he would revisit the raise in 3-months. Dissatisfied with the manager’s response Alex stole $5,000 from the cash collected from customers. To cover his tracks he cleared the customer’s receivable from the sub-ledger by posting a debit to Cash and credit to accounts receivable; however, he never made the deposit and kept the funds for himself. Instructions How will the company discover that the $5,000 is missing? Discuss any internal control weaknesses in this situation and how the company could avoid this type of fraud in the future. Solution 102 The company will discover the missing funds when they complete the bank reconciliation. Companies, in general, complete bank reconciliations on a monthly basis. Shortly after the month in which Alex stole the funds, the bank reconciliation would show a deposit in transit in the amount of $5,000 on the bank side of the reconciliation as a reconciling item. Deposits in transit reflect funds that have been recorded on the company books but not yet recorded by the bank. The item will remain as a reconciling item until the funds have been deposited to the bank. The segregation of duties control activity is violated resulting in an internal control weakness. The same individual is authorized to collect cash, record the receipt (clearing the customer’s receivable balance) and take asset custody (control of the physical cash). This allows for the opportunity to commit fraud. The company should segregate the duties to authorize, record and take asset custody to different individuals in order to minimize the risk and opportunity for fraud.

Ex. 103 The following information has been provided for Daniel Enterprises: 1. The company has $115,700 on deposit (available for use) in their chequing account with the bank. 2. The company has the following short-term investments: (a) $20,000 in government treasury bills that mature in 120 days (b) $35,000 in money market funds that mature in 90 days 3. The company has a $25,000 line of credit on their chequing account with the bank. 4. The company has a compensating balance loan and must maintain a minimum cash balance of $15,000. 5. A cheque was returned in the amount of $3,250. 6. The company has cash on hand in its cash registers for $2,100. 7. The company has $4,500 in stale-dated cheques. 8. The company has $23,600 in customer postdated cheques. Instructions Determine the amount of cash and cash equivalents and restricted cash that should be reported

Internal Control and Cash

on Daniel’s statement of financial position. If any items are not to be included, identify the reason(s) why. Solution 103 Cash and cash equivalents 1. Chequing account cash 2. Money market fund 6. Cash on hand in registers Total cash and cash equivalents

$115,700 35,000 2,100 $152,800

Restricted cash 4. Compensating balance loan $15,000 Items not included as cash and cash equivalents or restricted cash 2. Treasury bills do not mature within 90 days and therefore are not regarded as cash equivalents. 3. The company has not used the line of credit as no “negative” balance is noted. 5. Cheques received from customers, but returned by the bank because the customer’s account was lacking sufficient funds is not regarded as cash but as accounts receivable. 7. Cheques that will not be honoured because they are more than six months old are not regarded as cash. 8. Cheques payable in the future are not regarded as cash but as accounts receivable.

Ex. 104 The bank reconciliation for Burbank Ltd. showed the following deposits in transit and outstanding cheques at September 30, 2018: Deposits in transit Sept 28 $ 450 Sept 30 2,500

Outstanding cheques Sept 2 #110 $425.00 Sept 13 #109 750.00 Sept 23 #108 150.00

The general ledger Cash account for October 2018 show the following cheques issued and cash receipts:

No. 111 112 113 114 115

Cheques Amount No. $525.00 116 147.10 117 58.00 118 681.93 119 210.25

Amount $ 345.67 1,428.83 876.92 2,128.32

Receipts Amount $ 436.50 728.30 326.45 1,452.28 586.22

In addition, the deposits and cheques that cleared the bank during the month of October is presented below:

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Cheques and other debits Deposits ——————————————————————— ----------------No. Amount No. Amount No. Amount ———————————————————————————————————————— 109 750.00 111 525.00 116 345.67 2,500.00 110 425.00 117 1,428.83 450.00 113 85.00 119 2,128.32 436.50 114 681.93 728.30 115 210.25 326.45 ————————————————————————————————————————

Instructions Assuming no errors have been made by the company: (a) Calculate the amount of the deposits in transit, identifying the individual items, at October 31. (b) Calculate the amount of the outstanding cheques, identifying the individual items, at October 31. Solution 104 (a) Deposits in transit: Deposits per books in October ..................................................... $3,529.75 Deposits per the bank in October .................................................. $4,441.25 Less: September 30 deposits in transit .......................................... 2,950 October receipts deposited in October .......................................... 1,491.25 Deposits in transit, October 31 ...................................................... $ 2,038.50 October 31 deposits: $1,452.28 + $586.22 = $2,038.50 (b) Outstanding cheques: Cheques per books in October ...................................................... $6,402.02 Cheques clearing the bank in October .......................................... $6,580 Less: Outstanding cheques, September 30 ................................... 1,325 October cheques clearing in October ............................................ 5,255.00 Bank error – cheque #113 cleared for $85; should have cleared for $58 27.00 Outstanding cheques, October 31 ........................................................ $1,174.02 October 31 outstanding cheques:

#108 $150.00 #112 $147.10 #118 $876.92 Total: $1,174.02

Ex. 105 LFL Corp. has been implementing a financial system conversion project over the past year. The company is moving from its legacy system to an enterprise resource planning (ERP) system. The project was expected to be completed by September 30, 2016 but has now been extended

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to December 31, 2016. Given LFL’s small accounting & finance team, employees are strapped for time. Employees are trying to stay up to date with their regular daily activities while also devoting time to the implementation project. The Senior Accountant who is responsible for preparing the monthly bank reconciliation has fallen behind by 3-months. Instructions Explain the risks of not having the bank reconciliations up to date. Solution 105 Bank reconciliations are a key internal control related to cash. If the bank reconciliations are not up to date the company is not in a position to detect and prevent fraudulent activity or errors that may have occurred during the period in which the reconciliations were not complete. In addition, the company would not be able to determine its true cash position, which could put the company at risk of meeting its obligations. For example, 1. Cash receipts that were not deposited into the bank due to fraudulent activity will not be detected; therefore, missed and potentially lost if deposits in transit are not identified. 2. By relying on the balance provided directly from the bank and ignoring outstanding cheques could result in the company putting itself in an overdraft position and in jeopardy of meeting its obligations. 3. Bank and accounting errors would be undetectable. For example, a cheque issued for $25 by the company but cleared by the bank for $52 in error would not be discovered as no comparison between the bank statement and cash general ledger would be conducted.

Ex. 106 Using the following information, prepare a bank reconciliation for Gloss Corporation at July 31, 2018: 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 106 (10 min.) GLOSS CORPORATION Bank Reconciliation July 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $6,612 Add: (d) Deposit in transit ................................................................ 4,350 10,962 Less: (c) Outstanding cheques ......................................................... 1,170 Reconciled cash balance per books ..................................................... $9,792 Cash balance per books ...................................................................... Less: (f) Cheque amount error ($196 – $169) .................................. (e) Bank service charge ..........................................................

$9,869 $ 27 50

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

Reconciled cash balance per books .....................................................

$9,792

Ex. 107 Using the following information, prepare a bank reconciliation for Biling Inc. at May 31, 2018: 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 107 (10 min.) BILING INC. Bank Reconciliation May 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $7,200 Add: (d) Deposit in transit ................................................................ 800 8,000 Less: (c) Outstanding cheques ......................................................... 1,600 Reconciled cash balance ..................................................................... $6,400 Cash balance per books ...................................................................... Add: (f) Electronic collections ......................................................... Less (e) Bank service charge .......................................................... Reconciled cash balance .....................................................................

$6,024 400 6,424 24 $6,400

Ex. 108 Given the following information, determine the reconciled 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 108 (5 min.) $9,565 ($9,700 – $190 – $45+ $100)

Ex. 109 Seattle Coffee Limited's bank statement for the month of November 2018 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.

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2. 3.

4. 5.

6. 7.

The bank statement shows a debit memorandum for $40 for cheque printing charges. 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. The total amount of cheques outstanding at November 30 was $5,800. 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. The bank returned an NSF cheque from a customer for $560. 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, 2018. (b) Prepare any journal entries necessary as a result of the bank reconciliation. Solution 109 (25 min.) (a) SEATTLE COFFEE LIMITED Bank Reconciliation November 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $ 7,000 Add: (1) Deposit in transit.................................................................. 5,200 12,200 Less: (4) Outstanding cheques .......................................................... 5,800 Reconciled cash balance per bank....................................................... $ 6,400 Cash balance per books ...................................................................... Add: (5) Accounts payable error ($490 – $409)................................. (7) Electronic collections ........................................................... Less: (2) Cheque printing ................................................................... (6) NSF cheque ........................................................................ Reconciled 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)

1,260

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

Accounts Receivable ......................................................... Cash ........................................................................... (To record NSF cheque)

560 560

Ex. 110 The bank statement for Indiana Inc. shows an unadjusted balance of $2,330 at June 30, 2018, 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 journal entries necessary as a result of the bank reconciliation. Solution 110 (25 min.) (a) INDIANA INC. Bank Reconciliation June 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $2,330 Add: (1) Deposit in transit.................................................................. 160 2,490 Less: (2) Outstanding cheques .......................................................... 240 Reconciled cash balance per bank....................................................... $2,250 Cash balance per books ...................................................................... Add: (4) Electronic collections on account ......................................... Less: (3) Bank service charge ............................................................ (5) NSF cheque ........................................................................ Reconciled cash balance per books ..................................................... (b) Jun 30

$ 599 1,740 2,339 $ 9 80

1,740

Accounts Receivable ......................................................... Cash ........................................................................... (To record NSF cheque)

89 $2,250

1,740

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Bank Charges Expense ..................................................... Cash ........................................................................... (To record bank service charges)

9 9

Ex. 111 Smith’s Cafe Ltd. had the following information regarding its bank transactions for the month of April 2018: 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. 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 111 (20 min.) SMITH’S CAFE LTD. Bank Reconciliation April 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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 Reconciled 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 .......................................................... Reconciled cash balance per books .....................................................

$2,805 $ 540 6,150 $700 45 50

6,690 9,495

795 $ 8,700

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

Ex. 112 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 another company. 9. A cheque for $236 was correctly paid by the bank but was incorrectly entered in the general journal for $263.

Solution 112 (10 min.) 1. D 2.

Ex. 113 The reconciled cash balance per books and per bank for Maddison Ltd. at November 30, 2018 is $13,211.55. The following cheques and receipts were recorded for the month of December, 2018:

Internal Control and Cash

No. 17 18 19 20 21

Cheques Amount No. $423.22 22 981.23 23 126.00 24 622.50 25 342.15

Amount $ 534.76 1,924.43 876.92 218.05

Receipts Amount Date $ 985.5 Dec 5 846.52 21 722.63 27 1,328.00 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

$7,111.98 10 $3,942.14 5 $10,339.03 $13,508.87 —————————————————————————————————————––—— Cheques and other debits Deposits Date Balance ——————————————————————— No. Amount No. Amount No. Amount ———————————————————————————————————————— 14 184.81 17 423.22 22 534.76 6,284.38 Dec 1 $12,253.57 18 891.23 24 876.92 985.50 8 $11,470.92 19 126.00 25 218.05 846.52 23 $11,973.39 21 342.15 20.00 SC 722.63 29 $12,333.87 325.00 NSF 1,500.00 EFT 31 $13,508.87 ———————————————————————————————————————— Symbols: NSF (Not sufficient funds) SC (Service charge) EFT (Electronic funds transfer) ———————————————————————————————————————— Cheque #18 was correctly written for $891.23 for a payment on account. The NSF cheque was from Mrs. W. Rask, 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 $1,500, which has not yet been recorded by the company. The bank service charge is $20. Instructions (a) Calculate the unadjusted cash balance per books at December 31, 2018. (b) Prepare a bank reconciliation at December 31, 2018. (c) Prepare any journal entries necessary as a result of the bank reconciliation. Solution 113 (30–35 min.) (a) Nov. 30 adjusted balance per books + receipts – cheques written = Dec. 31 unadjusted balance per books $13,211.55 + $3,882.65 – $6,049.26 = $11,044.94

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

(b) MADDISON LTD. Bank Reconciliation December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank statement ................................................... $13,508.87 Add: Deposits in transit ................................................................ 1,328.00 14,836.87 Less: Outstanding cheques #20 ...................................................................................... $ 622.5 #23 ...................................................................................... 1,924.43 2,546.93 Reconciled cash balance per bank.................................................. $12,289.94 Cash balance per books ................................................................. Add: Error in recording cheque #18 (981.23 – 891.23)................. Electronic collection of accounts .......................................... Less: Bank service charge ............................................................ NSF cheque ........................................................................ Reconciled cash balance per books ................................................ (c) Dec 31

$11,044.94 $ 90.00 1,500.00

1,590.00 12,634.94

$ 20.00 325.00

345.00 $12,289.94

1,500

Bank Charges Expense ..................................................... Cash ........................................................................... (To record bank service charge)

Accounts Receivable ......................................................... Cash ........................................................................... (To record NSF cheque from W. Rask)

325

1,500

325

Ex. 114 Graham Corporation’s bank statement included two types of electronic funds transfers (EFT). One type of EFT totalled $12,500 and was from customers paying their accounts online. Another type of EFT totalled $23,000 and was from Graham paying its accounts payable online. Instructions (a) How will each of these items affect Graham’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 Graham will make to record the above information on its books.

Internal Control and Cash

Solution 114 (10 min.) (a) Graham 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 .............................................................

12,500

Accounts Payable ......................................................................... Cash.......................................................................................

23,000

12,500

23,000

Ex. 115 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 (a) Calculate the amount of the deposits in transit at February 29. (b) Calculate the amount of the outstanding cheques at February 29. Solution 115 (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. 116 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.

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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 116 (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. 117 Listed below are items that may be useful in preparing the March 2018 bank reconciliation for Kelvin Industrial. 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 Angus Reeds for $65 stamped "account closed." 2. The bank statement included a bank service charge of $45 in payment of the annual safety deposit box fee. 3. The bank statement included a bank service charge of $18 for three books of blank cheques for Kelvin Industrial. 4. The bank statement contains a credit of $38.00 for interest earned on the chequing account balance during the month. 5. The deposits of March 30 and March 31, for $4,282 and $4,391 respectively, were not included on the bank statement. 6. Two cheques totalling $742.44, which were outstanding at the end of February, cleared in March and were returned with the March statement.

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____

7. The bank statement included a credit of $85 for the monthly interest on a certificate of deposit that the company owns. ____ 8. Four cheques, #3416, #3420, #3422, #3423, totalling $7,412.32, did not clear the bank during March. ____ 9. On March 24, 2018, $2,600 was credited by the bank to Kelvin Industrial 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, 2018, Kelvin Industrial paid its $650 utility bill using the bank online payment system. As Kelvin Industrial initiated this payment, it recorded it in advance of receiving the bank statement. Solution 117 (10 min.) 1. B 2.

10. E

Ex. 118 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 2018. 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 Revenue ...........................................................

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.

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

Instructions Using the above information prepare, in good form, the bank reconciliation for Home Energy Limited for June. Solution 118 (25–30 min.) HOME ENERGY LIMITED Bank Reconciliation June 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash balance per bank ........................................................................ $(22,314) Add: Deposit in transit ....................................................................... 21,789 (525) Less: Outstanding cheques (see note below) ..................................... 21,612 Reconciled cash per bank .................................................................... $(22,137) Cash balance per books ...................................................................... Add: Electronic collection of account ................................................. Interest earned ......................................................................... Less: Bank service charge ................................................................. NSF cheque ............................................................................. Reconciled 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 reconciled cash balance per bank will be unknown. After you arrive at the reconciled cash balance per books, you enter this as the reconciled cash per bank and solve for the outstanding cheques.

Ex. 119 About eight months ago, your friend Minnie Minder 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 Minnie’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, Minnie 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 self-employed 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:

Internal Control and Cash

MINNIE MINDER ENTERPRISES Trial Balance (date) ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Dr Cr Cash ........................................................................................... $ 3,375 Accounts receivable .................................................................... 56,250 Prepaid insurance ....................................................................... 2,250 Supplies ...................................................................................... 3,500 Equipment................................................................................... 11,250 Vehicles ...................................................................................... 31,250 Accounts payable........................................................................ $ 17,625 Unearned revenue ...................................................................... 10,125 Dividends declared ..................................................................... 22,500 Common shares.......................................................................... 18,750 Service revenue .......................................................................... 137,500 Rent expense .............................................................................. 40,000 Utilities expense .......................................................................... 8,750 Salaries expenses....................................................................... 4,875 _______ Totals .......................................................................................... $184,000 $184,000 Notes: The “official” credit terms for receivables and payables are n/30. Instructions Suggest ways that Minnie can improve her cash flows. Do not list generalities, but address her specific situation. Solution 119 (20 min.) (The following are some suggestions. Students may come up with others.) 1. First of all, you must address your receivables and collect them more quickly. You have recorded $137,500 in revenue: currently over 40% ($56,250/$137,500) of it is still uncollected. I would suggest that you prepare an aged schedule of the receivables to find out which are the oldest receivables, and contact your clients and pressure them to pay. You could suggest that you will not do any more work for them until they pay up. 2.

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 (nearly 30%, $40,000 / $137,500). 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

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cash and when you will have excess cash available. This won’t happen for a while, but if you follow my suggestions, it will. 7.

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 QUESTIONS 120. 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 90-day treasury bill investment Collusion Electronic funds transfer Invest idle cash Cancelled cheques NSF cheques Outstanding cheques

____ 1.

Segregation of duties

____ 2.

Two or more employees circumventing prescribed procedures

____ 3.

Prevent a transaction from being recorded more than once

____ 4.

Physical controls

____ 5.

Cash equivalents

____ 6.

Transferring money electronically from one bank account to another without any paper money changing hands

____ 7.

Cheques that have been returned by the issuer's bank for lack of funds

____ 8.

Cheques that have been paid by the depositor's bank

____ 9.

Issued cheques that have not been paid by the bank

____ 10.

A basic principle of cash management

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ANSWERS TO MATCHING 1.

10. G

Internal Control and Cash

SHORT-ANSWER ESSAY QUESTIONS S-A E 121 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 121 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 122 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 122 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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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian Edition

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 123 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 online banking. Instructions Explain the implications of EFT payments from an internal control standpoint. Does EFT guarantee that fraud will be eliminated? Solution 123 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 124 Your friend Marcus is puzzled about the debits and credits on his bank statement and the lesson about debits and credits you are both studying in accounting class. “According to our accounting instructor, a debit to cash is an increase and a credit is a decrease” he says. “When the bank debits my account though, it is reduced, and when they credit it, it is increased. Completely backward to what we’ve learned. Which way is right? I don’t get it!” Instructions Prepare an explanation to your friend why the debits and the credits on a bank statement are not really backward. Solution 124 The bank statement reflects the bank’s accounting, so the debits and credits are not really backward when they are viewed from the perspective of the bank. While Cash is an asset account for you (Marcus), to the bank, the funds it holds for you are a liability because you can request those funds at any time. Liabilities are increased by credits and decreased by debits. When you deposit money into your bank account, the bank’s liability to you increases. When you write a cheque or make an electronic payment, the bank pays out this amount and decreases (debits) its liability to you. So, what to the bank is a credit is a debit to you, and vice

versa. S-A E 125 The preparation of a bank reconciliation is an important cash control procedure. If a company deposits cash receipts daily and makes all cash disbursements by cheque, explain why the cash

Internal Control and 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 125 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 126 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 126 • 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 127 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 two line items. One is called “Cash and Cash Equivalents” and the other is called “Restricted Cash.”. Pete comments: “That doesn’t make sense!” he exclaims. “How can you have an equivalent to cash? Cash is cash! There is no equivalent! Also, why would a company restrict cash? What the heck does that mean?” Instructions Explain to Pete what “cash equivalents” and “restricted cash” are and why they are included with cash on the statement of financial position. Solution 127

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In accounting, cash equivalents are short-term, trading investments subject to insignificant risk 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. A company may have cash that is not available for general use because it is restricted for a special purpose. For example, a company may set aside funds to pay off a debt in the future in which case these funds would be restricted for future use. Cash that has a restricted use should be reported separately on the statement of financial position as restricted cash so that users of the financial statements are aware that it is not available for use by the company. Restricted cash may be reported as a current or non-current asset, depending on when the cash will be required

S-A E 128 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 128 (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

Internal Control and Cash

OBJECTIVE FORMAT QUESTIONS 129. From the following list of activities, identify whether there is an internal control risk for Jelly Industries Ltd., a chain of furniture stores. If the activity presents an internal control risk, choose the control that is missing. If the activity does not present an internal control risk, choose the control that is being properly used. Control Risk Yes or No?

Control

(a) Deepak Sadana, the company’s purchaser, places orders for furniture, receives the orders in the warehouse and makes payments to vendors. (b) When employees of the Brentwood store clock in on the store’s point-of-sale (POS) system, they need to type in their employee password. For simplicity’s sake, the password used for each employee is their last name in lower case letters. (c) The cashier of the Brentwood store receives a float of $500 at the start of each shift. At the end the employee’s shift, the cashier reconciles the cash in the cash register to ensure the total in the cash register equals the total cash sales plus the opening float. He leaves $500 in the till for the next cashier. This is checked by the store manager. (d) When cash collections on account are received by mail, the mail room sends it straight to the company’s accountant, who records the cash receipt in the accounting records and deposits the cash in the bank. (e) Each inventory item is recorded in the POS system at the Arbour Lake store. When Celia Lu, a new store clerk, entered a sale of five different picture frames, she entered the same code for all five frames, as they were the same price and it would take more time to enter five separate codes. (f) The Arbour Lake store has a security system that is turned on each night when the last employee leaves. Cash is placed in the store safe and security cameras are used to monitor the premises when it is closed. (g) The company’s books are reviewed by an external auditor each year. (h) Internal audits are performed each month by each store’s manager. Solution 129 (a) Yes/Segregation of duties. There is an internal control risk in this case as the employee is ordering, receiving and paying for goods. When the same individual is responsible for authorization, recording, and asset custody, the potential for unintentional and intentional errors increases. For instance, the employee could collude with a seller to sell a product for an inflated price or they could set up their own company to send out fictitious invoices and then record purchases of goods that were never received. (b) Yes/Physical controls. Passwords are given to employees for exclusive use only and

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should not be shared with others. If passwords are known to everyone, employees could accidently/purposely change the time records for other employees. (c) No/Assignment of responsibility. In this case, an employee is assigned responsibility of the cash float and reconciles the cash drawer at the end of the shift. This is then verified by the manager, confirming the employee has managed the cash appropriately. (d) Yes/Segregation of duties. The employee making the bank deposit should not be the same employee who is recording the cash receipt. Otherwise, the employee could steal the cash and cover up the theft by understating the value of cash receipt in the journal entries. (e) Yes/Documentation. POS systems maintain an inventory of each item held by the store. The selling price of the frames may be the same, but the costs could be different. By typing in the incorrect code, the inventory records will be inaccurate. Also, if a customer wishes to return a picture frame, there may be problems if the picture frame’s code doesn’t match their receipt. (f) No/Physical controls. Physical controls such as security systems, security cameras and safes help safeguard the assets of the company. (g) No/Review and reconciliation. Since they are independent from the company, an external audit of the company’s financial statements provides a check on the internal control systems of the company. (h) Yes/Segregation of duties. Having the store manager perform the internal audit represents a conflict of interest. For internal audits, the employee performing the review should be independent of the personnel responsible for the information; otherwise, there is potential for fraud or errors.

130. After reviewing ATG Company Ltd.’s bank statement for the month of September, 2018, the company accountant noted the following: Deposits in transit

Outstanding cheques

Bank errors

EFT receipts Interest

A deposit of $550.00 was made to the bank account on September 29th but is not yet reflected on the bank statement. Three outstanding cheques (cheque #134, $45.45; cheque #135, $440.05 and cheque #136, $121.12) were recorded in the company's accounting records but not yet shown on the bank statement. A bank charge of $50.00 is shown on the bank statement for a new cheque printing order. The company has not ordered new cheques and is planning to have this charge removed. Unrecorded electronic receipts were identified on the bank statement. These were for $500.00 on September 2 and $120.00 on September 22. Interest charges of $57.00 were shown on the bank statement.

Internal Control and Cash

EFT payments

NSF cheques

Unrecorded electronic payments are shown on the bank statement. These included: $69.56 paid to the cable company for internet service on September 5th and $120.45 paid to the local office supply store on September 12th. A returned cheque plus NSF fee was shown on the bank statement (Cheque date September 19th, $560.00 plus $50.00 NSF fee).

Service fees

Service fees shown on the bank statement but not recorded in the company accounts totalled $125.00.

Company errors

The bank statement shows a payment on September 9th for utilities of $165.85. The company books show $156.85. After investigation, $165.85 is determined as the correct payment.

Note: the cash balance on the bank statement is showing $7,754.48. Instructions Indicate all of the following statements that are correct: (a) The cash balance per the books is not determinable from the information provided. (b) The reconciled cash balance per the bank should be $$7,847.86. (c) The cash balance per the books is $8,118.87. (d) The reconciled cash balance per the books is $7,747.86. (e) The company error of $9 should be added back to the cash balance per the books. (f) The unrecorded EFT receipts will understate the bank balance while the unrecorded EFT payments will overstate the bank balance. (g) The deposit in transit understates the cash balance shown on the bank statement. (h) The cash balance per the books is $8,100.87. Solution 130 (c), (d), and (g) are correct; (a), (b), (e), (f), and (h) incorrect. In order to answer this question, students will likely want to prepare a bank reconciliation for ATG Company Ltd. as follows:

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

ATG Company Ltd. Bank Reconciliation September 30,2018 Cash balance per bank statement Add:

Deposits in transit Error in cheque printing order

Less: Outstanding cheques No. 134 No. 135 No. 136

$ 7,754.48 $550.00 50.00

45.45 440.05 121.12

600.00 8,354.48

606.62

Reconciled cash balance per bank

$7,747.86

Cash balance per books Add: Unrecorded electronic receipts Sept. 2: $500.00 and Sept. 22: $120.00

$8,118.87 620.00 8,738.87

Less: Unrecorded electronic payments Office supplies $120.45 Internet $69.56 NSF cheque plus service fee Interest charge Bank service charges Sept. 9 utilities $165.85 - $156.85 Reconciled cash balance per books

$190.01 610.00 57.00 125.00 9.00

991.01 $ 7,747.86

Cash balance per books = Reconciled cash balance per bank $7,747.86 + $991.01 - $620.00 = $8,118.87

131. The following data has been reported for Big Game Limited for 2018: 1. The company purchased treasury bills totalling $5,500 on December 5th. 2. The company made an equity investment in Small Toys Ltd. totalling $25,000 on December 1, which it intends to hold for the long-term. 3. Accounts receivable uncollected as of December 31 were $21,600. 4. The company wrote cheques totalling $3,500 that were not reflected in the bank balance on December 31. 5. Interest charges from the bank totalled $35 and were accrued at Dec.31, 2018. 6. Supplies on hand as of December 31 were $4,300. 7. The bank requires a compensating balance (for a non-current loan) of $35,000. 8. The inventory balance as of December 31 was $27,200.

Internal Control and Cash

9. The cash balance in the bank account was $55,000 on December 31. 10. A deposit of $550 was made to the bank account on December 29th but is not yet reflected on the bank statement. 11. A second chequing account is in an allowed overdraft position of $10,000. 12. Total carrying amount for land on December 31 was $45,000. 13. Total book value of buildings on December 31 was $238,000. 14. Accumulated depreciation on buildings totalled $35,700. Instructions Indicate all of the following statements that are correct. (a) Total cash and cash equivalents on December 31 are $57,550. (b) Total assets for Big Games Limited for December 31, 2018 are $372,950. (c) Total current assets on December 31 are $65,650. (d) Total non-current assets are $272,300. (e) Total property, plant and equipment is $318,700. (f) Total cash and cash equivalents on December 31 are $12,515. (g) Total non-current assets are $307,300. (h) Total cash and cash equivalents on December 31 are $12,550. Solution 131 (b), (c), (g), and (h) are true; (a), (d), (e), and (f) are false. Students may want to complete a partial statement of financial position to help answer this question. The following partial statement of financial position indicates the correct balances and classifications for Big Game Limited: Big Game Limited Partial Statement of Financial Position December 31, 2018 Assets Current Assets Cash and cash equivalents* Accounts receivable Inventory Supplies Total current assets Non-current assets Compensating cash balance Long-term investments Property, plant, and equipment Land $ 45,000 Buildings 238,000 Less: Accumulated depreciation 35,700 Total property, plant, and equipment Total non-current assets Total assets

$12,550 21,600 27,200 4,300 65,650 $ 35,000 25,000

$247,300 $307,300 $372,950

*cash and cash equivalents = $55,000 – $3,500 + $550 + $5,500 – $35,000 – $10,000 =

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

$12,550

132. Identify from the following list all activities that help a company manage cash effectively: (a) Using bank overdrafts when possible. (b) Offering terms such as 2/10, n/30 to customers. (c) Reducing inventory levels by monitoring sales needs more closely. (d) Paying invoices early to ensure payments are not missed. (e) Delaying payment to employees. (f) Paying for a major expenditure on an upgrade to the computer systems when cash reserves are high. (g) Ensuring there is enough idle cash on hand to cover potential emergencies. (h) Preparing a cash budget to help identify cash requirements. (i) Making investments in short-term securities when cash is available. Solution 132 Activities (b), (c), (f), (h), and (i) help provide strong management of cash; (a), (d), (e), and (g) do not. (a) Bank overdrafts help a company for short-term cash shortfalls but they should not be used regularly as a means to manage cash. (d) By keeping track of when bills are due, a company can avoid paying bills too early. When they are offered terms such as n/30, they should take advantage of this 30-day credit. They can invest any idle cash in short-term investments until the bill is due. Companies need to be careful, though, not to pay late and damage their credit ratings with suppliers. (e) Employees are required to be paid on time regardless of cash flow. (g) No return is earned on cash on hand. Companies who manage cash well, invest excess cash, even if it is only overnight.

133. From the following list, select all of the items that would be included in the balance of cash and cash equivalents at September 30, 2018 for Kelly Green Enterprises Ltd.: (a) Treasury bills, due in 90 days (b) Cash held in petty cash in main office (c) Equity investment (in common shares of XYZ Company Ltd.) (d) Cash (restricted for purchasing new sorting machine in January 2019) (e) Money owing from customers at the end of the month (f) Bank chequing account that is in an allowed overdraft position (g) Compensating balance in savings account (for a non-current loan) Solution 133 (a), (b), and (f) would be included in cash and cash equivalents; (c), (d), (e), and (g) would not. (c) An equity investment in the shares of another company is a long term investment and not included in cash equivalents.

Internal Control and Cash

(d) Restricted cash is not included in cash and cash equivalents but rather included as restricted cash under current assets. (e) Money owing from customers is an accounts receivable and will not be recorded as cash until collected. (g) A compensating balance is a form of restricted cash. It provides the bank with security over a loan in case the company fails to make payment. Compensating balances are shown as a non-current asset on the statement of financial position.

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CHAPTER 8 REPORTING AND ANALYZING RECEIVABLES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 11. 2 M C F AN 21. 3 E C F AN 2. 1 E K F AN 12. 2 M C F AN 22. 3 E C F AN 3. 1 E K F AN 13. 2 E C F AN 23. 3 E C F AN 4. 1 E C F AN 14. 2 E K F AN 24. 3 M K F AN 5. 1 E C F AN 15. 2 M K F AN 25. 4 E K F AN F AN F AN F AN 6. 1 E K 16. 2 E C 26. 4 E K 7. 1 E C F AN 17. 2 E K F AN 27. 5 E K F AN 8. 2 E C F AN 18. 3 E K F AN 28. 5 E K F AN F AN F AN F AN 9. 2 E C 19. 3 E K 29. 5 E C 10. 2 M C F AN 20. 3 M K F AN Multiple Choice Questions F AN F AN F AN 30. 1 M C 57. 2 E K 84. 3 E C 31. 1 M C F AN 58. 2 E C F AN 85. 3 E K F AN 32. 1 M C F AN 59. 2 E K F AN 86. 3 E K F AN 33. 1 H K F AN 60. 2 E C F AN 87. 3 E C F AN F AN F AN F AN 34. 1 M K 61. 2 E C 88. 3 E AP 35. 1 E K F AN 62. 2 H C F AN 89. 3 E AP F AN 36. 1 E K F AN 63. 2 M C F AN 90. 3 E AP F AN 37. 1 E K F AN 64. 2 E K F AN 91. 3 E K F AN F AN F AN F AN 38. 2 H C 65. 2 M C 92. 3 M C 39. 2 H C F AN 66. 2 M C F AN 93. 3 M K F AN 40. 2 E K F AN 67. 2 E C F AN 94. 3 M AP F AN 41. 2 E C F AN 68. 2 M C F AN 95. 3 M AP F AN 42. 2 E K F AN 69. 2 E C F AN 96. 3 M AP F AN 43. 2 E C F AN 70. 2 M AP F AN 97. 3 M AP F AN 44. 2 M C F AN 71. 2 E C F AN 98. 3 E AP F AN 45. 2 E K F AN 72. 2 M C F AN 99. 3 M C F AN 46. 2 M C F AN 73. 2 E K F AN 100. 3 M C F AN 47. 2 M C F AN 74. 2 M AP F AN 101. 3 M AP F AN 48. 2 M C F AN 75. 2 M AP F AN 102. 3 E K F AN 49. 2 M C F AN 76. 2 M AP F AN 103. 4 E C F AN 50. 2 E C F AN 77. 2 M AP F AN 104. 5 E K F AN 51. 2 M C F AN 78. 2 E C F AN 105. 5 E C F AN 52. 2 M C F AN 79. 2 E C F AN 106. 5 E K F AN 53. 2 M C F AN 80. 3 E K F AN 107. 5 E K F AN 54. 2 E C F AN 81. 3 E K F AN 108. 5 E AP F AN 55. 2 E C F AN 82. 3 E K F AN 109. 5 E AP F AN 56. 2 E K F AN 83. 3 E C F AN 110. 5 M K F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

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

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135. 1 M 136. 2 M

C C

F F

AN AN

137. 138.

141. 1,2 M 142. 2–4 M

C C

F F

AN AN

143. 144.

Short-Answer Essay 2 M C F,C AN,C 139. 5 2 E C F,C AN,C 140. 5 CPA Questions 4 M C F AN 145. 5 4 M AN F AN

LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension CPA: F = Financial Reporting C = Communication AACSB: AN = Analytic C = Communication

M M

C C

F,C F,C

AN,C AN,C

K = Knowledge

Reporting and Analyzing Receivables

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type Learning Objective 1 1. TF 5. TF 31. MC 35. MC 112. Ex 2. TF 6. TF 32. MC 36. MC 113. Ex 3. TF 7. TF 33. MC 37. MC 114. Ex 4. TF 30. MC 34. MC 111. Ex 115. Ex Learning Objective 2 8. TF 38. MC 48. MC 58. MC 68. MC 9. TF 39. MC 49. MC 59. MC 69. MC 10. TF 40. MC 50. MC 60. MC 70. MC 11. TF 41. MC 51. MC 61. MC 71. MC 12. TF 42. MC 52. MC 62. MC 72. MC 13. TF 43. MC 53. MC 63. MC 73. MC 14. TF 44. MC 54. MC 64. MC 74. MC 15. TF 45. MC 55. MC 65. MC 75. MC 16. TF 46. MC 56. MC 66. MC 76. MC 17. TF 47. MC 57. MC 67. MC 77. MC Learning Objective 3 18. TF 24. TF 85. MC 91. MC 97. MC 19. TF 80. MC 86. MC 92. MC 98. MC 20. TF 81. MC 87. MC 93. MC 99. MC 21. TF 82. MC 88. MC 94. MC 100. MC 22. TF 83. MC 89. MC 95. MC 101. MC 23. TF 84. MC 90. MC 96. MC 102. MC Learning Objective 4 25. TF 103. MC 118. Ex 129. Ex 143. CP 26. TF 117. Ex 123. Ex 142. CP 144. CP Learning Objective 5 27. TF 104. MC 107. MC 110. MC 132. Ex 28. TF 105. MC 108. MC 130. Ex 133. Ex 29. TF 106. MC 109. MC 131. Ex 134. Ma

Item

Type

Item

Type

116. 117. 118. 134.

Ex Ex Ex Ma

135. 141.

SAE CP

78. 79. 114. 115. 116. 118. 119. 120. 121. 122.

MC MC Ex Ex Ex Ex Ex Ex Ex Ex

123. 134. 136. 137. 138. 141. 142.

Ex Ma SAE SAE SAE CP CP

117. 118. 124. 125. 126. 127.

Ex Ex Ex Ex Ex Ex

128. 134. 142.

Ex Ma CP

139. 140. 145.

SAE SAE CP

Note:

Ma = Matching CP = CPA Questions

TF = True-False Ex = Exercise

MC = Multiple Choice SAE = Short-Answer Essay

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

CHAPTER LEARNING 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 are recorded at the invoice price, and are reduced by any sales returns and allowances. The accounts receivable subsidiary ledger is used to keep track of the account balances of each customer. Accounts Receivable is a control account, meaning it controls the accounts receivable subsidiary ledger. Any entry to the control account must also be made in the subsidiary ledger, and any entry in the subsidiary ledger must also be made in the control account. Normally a single entry is made to the control account for the total of all the entries made to the individual customer accounts in the subsidiary ledger. It is essential that the total of the customer account information in the subsidiary ledger equal the balance in the control account. When interest is charged on a past-due receivable, interest is added to the Accounts Receivable balance and is realized as interest revenue.

Account for bad debts. The allowance method, using a percentage of receivables, is used to ensure that the carrying amount of accounts receivable reflects management’s best estimate of the amount that will ultimately be collected. It also results in bad debts expense being recorded in the same period when the revenue from the related credit sales was earned. Because the specific customer accounts that will become uncollectible are not known at the time the bad debt estimate is made, no entry can be made to Accounts Receivable because it would not be possible to make an entry to the subsidiary ledger. Instead, Allowance for Doubtful Accounts, a contra-asset account, is used to record the estimated uncollectible receivables. A percentage of total receivables, or an aging schedule applying percentages to different age groupings of receivables, is used to estimate the uncollectible accounts (which is also the ending balance in Allowance for Doubtful Accounts). When a specific account receivable is determined to be uncollectible, it is written off and the allowance account reduced. When an account that has previously been written off is collected, the write off is reversed and then the collection is 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. 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

Reporting and Analyzing Receivables

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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 carrying amount 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 non-operating section of the statement.

Apply the principles of sound accounts receivable management. To properly manage receivables, management must (a) determine whom 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. 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. A higher receivables turnover or a lower average collection period indicates that the company is doing a good job collecting its accounts and not experiencing collection issues.

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

TRUE-FALSE STATEMENTS 1. Other receivables include nontrade receivables such as loans to company officers.

2. Advances to employees are a type of accounts receivable.

3. Receivables are considered to be financial assets.

4. Both accounts receivable and notes receivable represent claims that are expected to be collected in cash.

5. Accounts receivable can be the result of either cash or credit sales.

6. When posting is up-to-date, the balance in the accounts receivable subsidiary ledger must equal the balance in the general ledger.

7. Interest revenue is never earned on accounts receivable.

8. 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.

9. Uncollectible accounts must be estimated because it is not possible to know which accounts will not be collected.

10. 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.

11. 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.

12. It is possible for the allowance account to have a debit balance before the year-end adjusting entry is recorded.

13. Allowance for Doubtful Accounts is credited when an account is determined to be uncollectible.

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14. Allowance for Doubtful Accounts is a contra account that is deducted from Accounts Receivable on the statement of financial position.

15. The Allowance for Doubtful Accounts is a liability account and has a normal credit balance.

16. The carrying amount of Accounts Receivable is determined by adding the Allowance for Doubtful Accounts to Accounts Receivable.

17. Bad Debts Expense is a contra account to the Sales account.

18. A note receivable is a written promise by the maker to the payee to pay a specified amount of money at a definite time.

19. The two key parties to a note are the maker and the payee.

20. Atlas Inc. borrowed money from a bank and is therefore regarded as the payee.

21. 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. 22. Interest on a 3-month, 3%, $20,000 note is calculated by multiplying $20,000  3%  3. Solution: ($20,000 X 3%) X 3/12 = $150

23. Uncollectible notes receivable should be estimated at year end and recorded as a debit to Bad Debts Expense and a credit to Notes Receivable.

24. If eventual collection is expected after a note has been dishonoured an accounts receivable replaces the note including any unpaid interest.

25. 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.

26. Receivables are generally valued and reported in the statement of financial position at their gross amount less the allowance for doubtful accounts.

27. A critical part of managing receivables is determining who should be extended credit and who should not.

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

28. The average collection period is frequently used to assess the effectiveness of a company’s credit and collection policies.

29. 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.

Ans. T F T T F

Item 6. 7. 8. 9. 10.

Ans. T F F T F

Item 11. 12. 13. 14. 15.

Ans. T T F T F

Item 16. 17. 18. 19. 20.

Ans. F F T T F

Item 21. 22. 23. 24. 25.

Ans. T F F T T

Item 26. 27. 28. 29.

Ans. T T T T

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

MULTIPLE CHOICE QUESTIONS 30. Trade receivables (a) occur when two companies trade or exchange notes receivables. (b) can be accounts receivable or notes receivable. (c) include employee advances. (d) do not result from the operations of the business.

31. A receivable is recognized (a) when the sales effort is substantially complete. (b) regardless of collection risk. (c) only when payment has been received. (d) when a service is performed.

32. Which of the following statements is false? (a) A subsidiary ledger is a group of accounts that provides details about a control account in the general ledger. (b) When a subsidiary ledger and a control account are used, each journal entry that affects accounts receivable must be posted twice. (c) The balance in the control account must always equal the total of the subsidiary ledger. (d) A subsidiary ledger includes supporting detail to the general ledger.

33. 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. 34. 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

35. Notes or accounts receivables that result from sales transactions are often called (a) sales receivables. (b) nontrade receivables. (c) trade receivables. (d) merchandise receivables.

36. The term "receivables" refers to (a) amounts due from individuals or companies. (b) merchandise to be collected from individuals or companies.

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37. 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.

38. Under the allowance method for uncollectible accounts, (a) bad debts expense is not recorded until a customer defaults. (b) the entry to write off an uncollectible account only involves statement of financial position accounts. (c) allowance for doubtful accounts increases, while accounts receivables decrease when writing off an uncollectible account. (d) bad debt expense increases, while allowance for doubtful accounts decreases when writing off an uncollectible account.

39. Under the allowance method for uncollectible accounts, (a) the recovery of an account receivable previously written off results in a credit to the Bad Debt Expense account. (b) Bad Debts Expense is debited when an account is deemed uncollectible and must be written off. (c) the carrying value of receivables is the same both before and after an account has been written off. (d) the carrying amount of receivables is the same both before and after an account that had previously been written off is recovered.

40. 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 carrying amount. (d) only if they are not past due.

41. 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.

42. The account Allowance for Doubtful Accounts is classified as a(n) (a) liability. (b) contra account to Bad Debts Expense. (c) expense.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

(d) contra account to Accounts Receivable.

43. 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.

44. 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.

45. The net amount expected to be received in cash from receivables is termed the (a) carrying amount. (b) fair value. (c) gross cash value. (d) cash-equivalent value.

46. If a company fails to record estimated bad debts expense, then (a) the carrying amount is understated. (b) expenses are understated. (c) revenues are understated. (d) receivables are understated.

47. If the amount of bad debts expense is understated at year end, then (a) net income will be understated. (b) shareholders’ equity will be understated. (c) Allowance for Doubtful Accounts will be overstated. (d) net Accounts Receivable will be overstated.

48. 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.

49. 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.

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50. The collection of an account that had been previously written off under the allowance method for uncollectible accounts (a) will increase net income in the period it is collected. (b) will decrease net income 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 net income in the period it is collected.

51. The collection of an account that had been previously written off under the allowance method for uncollectible accounts (a) increases net income 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.

52. An aging of a company's accounts receivable indicates that $4,200 is estimated to be uncollectible. If Allowance for Doubtful Accounts has a $800 credit balance, the adjustment to record bad debts for the period will require a (a) debit to Bad Debts Expense for $4,200. (b) debit to Allowance for Doubtful Accounts for $3,400. (c) debit to Bad Debts Expense for $3,400. (d) credit to Allowance for Doubtful Accounts for $5,000. Solution: $4,200 – $800 = $3,400

53. 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.

54. 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. (d) when an account is determined to be uncollectible.

55. Estimated uncollectibles are recorded as a debit to (a) Allowance for Doubtful Accounts. (b) Bad Debts Expense. (c) Sales. (d) Accounts Receivable.

56. Bad Debts Expense is considered

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(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.

57. 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.

58. 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.

59. 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.

60. 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.

61. 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.

62. Under the allowance method for uncollectible accounts (a) the carrying amount 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 carrying amount 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.

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63. 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.

64. Allowance for Doubtful Accounts on the statement of financial position (a) is included in current liabilities. (b) increases the carrying amount of accounts receivable. (c) appears under the heading "Other Assets." (d) is deducted from accounts receivable.

65. When an account is written off using the allowance method for uncollectible accounts, the (a) carrying amount 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.

66. 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.

67. 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.

68. 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. (d) decreases and the allowance account increases.

69. Under the allowance method for uncollectible accounts, when a specific account is written off (a) total assets will be unchanged. (b) net income will decrease. (c) total assets will decrease. (d) total assets will increase.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

70. An aging of a company's accounts receivable indicates that $11,000 is estimated to be uncollectible. If the Allowance for Doubtful Accounts has a $1,600 debit balance, the adjustment to record bad debts for the period will require a (a) debit to Bad Debts Expense for $12,600. (b) debit to Bad Debts Expense for $11,000. (c) debit to Bad Debts Expense for $9,400. (d) debit to Allowance for Doubtful Accounts for $11,000. Solution: $11,000 + $1,600 = $12,600

71. 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 income is unchanged. (d) liabilities decrease.

72. 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.

73. 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 74–75. Under the aging of a company's accounts receivable, the uncollectible accounts are estimated to be $10,000. The unadjusted balance for the Allowance for Doubtful Accounts is $1,500 credit.

74. What is the balance in the Allowance for Doubtful Accounts account after adjustment? (a) $11,500 (b) $10,000 (c) $1,500 (d) $7,000 Solution: $8,500 + $1,500 = $10,000

75. What is the amount of bad debts expense for the year? (a) $11,500 (b) $10,000

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76. 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 Solution: $26,000 + $9,000 = $35,000

77. The carrying amount of the Accounts Receivable is $19,000 before the write off of a $2,500 account. What is the carrying amount after the write off? (a) $21,500 (b) $19,000 (c) $16,500 (d) $2,500 Solution: no change; therefore, $ 19,000

78. 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.

79. 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.

80. 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.

81. Which of the following is not true regarding promissory notes? (a) Promissory notes are not shown at carrying amount 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. (d) Promissory notes are frequently accepted from customers who need to extend the payment

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

of an outstanding account receivable.

82. Interest is usually associated with (a) accounts receivable. (b) notes receivable. (c) doubtful accounts. (d) bad debts.

83. 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.

84. 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.

85. 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.

86. 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.

87. 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.

88. The total interest on a $10,000, 4%, 3-month note receivable is (a) $100. (b) $200. (c) $400. (d) $1,200.

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Solution: $10,000 x 4% x 3/12 = $100

89. The total interest on a $6,000, 4%, 2-month note receivable is (a) $20. (b) $40. (c) $240. (d) $6,040. Solution: $6,000 x 4% x 2/12 = $40

90. The total interest on a $10,000, 6%, 6-month note receivable is (a) $50. (b) $100. (c) $300. (d) $600. Solution: $10,000 x 6% x 6/12 = $300

91. 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.

92. 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.

93. 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.

94. Right Corp. receives a $5,000, 4-month, 6% note from Wrong Corp. in settlement of a pastdue account receivable. What entry will Night Corp. make upon receiving the note? (a) Notes Receivable ....................................................... 5,100 Accounts Receivable. .......................................... 5,100 (b) Notes Receivable ....................................................... 5,100 Accounts Receivable. .......................................... 5,000 Interest Revenue ................................................. 100 (c) Notes Receivable ....................................................... 5,000 Interest Receivable .................................................... 100 Accounts Receivable. .......................................... 5,000 Interest Revenue ................................................. 100

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(d) Notes Receivable ....................................................... Accounts Receivable. .......................................... Solution: $5,000 x 6% x 4/12 = $100 interest

5,000 5,000

95. Wrong Corp. receives a $7,000, 6-month, 4% note from Right Corp. in settlement of a pastdue account receivable. What entry will Day Corp. make upon receiving the note? (a) Notes Receivable ....................................................... 7,140 Accounts Receivable. .......................................... 7,140 (b) Notes Receivable ....................................................... 7,140 Accounts Receivable. .......................................... 7,000 Interest Revenue ................................................ 140 (c) Notes Receivable ....................................................... 7,000 Accounts Receivable. .......................................... 7,000 (d) Notes Receivable ....................................................... 7,000 Interest Receivable .................................................... 140 Accounts Receivable. .......................................... 7,000 Interest Revenue ................................................. 140 Solution: $7,000 x 4% x 6/12 = $140 interest

96. Tabby Inc. lends Siamese Ltd. $50,000 on April 1, accepting a 3-month, 3% interest note. Interest is due the first of each month, commencing May 1. Tabby Inc. prepares financial statements on April 30. What adjusting entry should be made before the financial statements can be prepared? (a) Note Receivable ......................................................... 50,000 Cash.................................................................... 50,000 (b) Interest Receivable .................................................... 125 Interest Revenue ................................................. 125 (c) Cash .......................................................................... 125 Interest Revenue ................................................. 125 (d) Interest Receivable .................................................... 375 Interest Revenue ................................................. 375 Solution: $50,000 x 3% x 1/12 = $125 interest

97. 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. Solution: $20,000 x 6% x 4/12 = $400 interest + $20,000 maturity value = $20,400

98. 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.

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Solution: $8,000 x 6.5% x 3/12 = $130 interest + $8,000 maturity value = $8,130 99. 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.

100. 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.

101. 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. Solution: $20,000 x 9% x 3/12 = $450

102. 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.

103. 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 carrying amount 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.

104. The receivables turnover ratio is used to analyze (a) profitability. (b) liquidity. (c) risk.

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(d) solvency.

105. 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.

106. 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. (d) net credit sales by ending average net accounts receivable.

107. 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 108–109. The financial statements of Andreo Manufacturing Inc. report net credit sales of $600,000 and accounts receivable of $60,000 and $40,000 at the beginning of the year and end of the year, respectively.

108. What is the receivables turnover ratio for Bolero? (a) 7.5 times (b) 11.25 times (c) 15.0 times (d) 22.5 times Solution: $600,000 / [($60,000 + $40,000)/2] = 12 times

109. What is the average collection period for accounts receivable in days (rounded)? (a) 16 (b) 24 (c) 32 (d) 49 Solution: 365 / 12 times = 24 days

110. 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.

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(d) average collection period.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. Item Ans. Item Ans. 30. b 42. d 54. b 31. a 43. c 55. b 32. b 44. a 56. c 33. b 45. a 57. d 34. c 46. b 58. b 35. c 47. d 59. c 36. a 48. c 60. b 37. c 49. b 61. b 38. b 50. d 62. c 39. c 51. c 63. d 40. c 52. c 64. d 41. a 53. b 65. d

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

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

Item 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89.

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

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

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

Item 102. 103. 104. 105. 106. 107. 108. 109. 110.

Ans. d b b c c d c b d

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EXERCISES Ex. 111 Paradine Corp., which uses a perpetual inventory system and charges 21% interest on the balance due if not paid within the payment terms, sells merchandise on account to two customers: The first customer was Vertigo Inc. where Paradine sold $1,500 worth of merchandise on August 1, terms 2/10, n/30. The goods had cost Paradine $900. On October 1 Vertigo paid the entire balance due. The second customer was Notorious Limited where Paradine sold $2,500 worth of merchandise on August 2, terms 2/10, n/30. The goods had cost Paradine $1,500. On August 6, Notorious returned merchandise worth $500 to Paradine. This merchandise had a cost of $300 and there was nothing wrong with the merchandise. On August 11, Paradine received payment from Notorious for the balance due. Instructions Assuming that Paradine Corp. prepares adjusting entries on a monthly basis, prepare the appropriate journal entries. Round to the nearest dollar. Solution 111 Aug 1 Accounts Receivable ......................................................... Sales ........................................................................... Cost of Goods Sold ............................................................ Inventory ..................................................................... Aug 2

Aug 6

Aug 11

Aug 31

Sep 30

Oct

1,500 1,500 900 900

Accounts Receivable ......................................................... Accounts Receivable................................................... Cost of Goods Sold ............................................................ Inventory .....................................................................

2,500

Sales Returns and Allowances .......................................... Accounts Receivable................................................... Inventory ............................................................................ Cost of Goods Sold .....................................................

500

Cash [($2,500 – $500) x.98]............................................... Sales Discount [($2,500 – $500) x.02] ............................... Accounts Receivable ($2,500 – $500).........................

1,960 40

Accounts Receivable ......................................................... Interest Revenue ($1,500 x.21 x 1/12) ........................

Cash ..................................................................................

1,552

2,500 1,500 1,500

500 300 300

2,000

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

1,553

Ex. 112 Eyre Inc. uses a perpetual inventory system and charges 19% interest on the balance due if not paid within the payment terms, sells merchandise on account to two customers: The first customer was Jane Limited where Eyre sold $1,800 worth of merchandise on October 31, terms 2/10, n/30. The goods had cost Eyre $990. On November 4, Jane returned merchandise worth $500. This merchandise had a cost of $275 and the merchandise was not returned to inventory as it was defective. On December 2, Eyre received payment from Jane for the entire balance due. The second customer was Pride Inc. where Eyre sold $5,000 worth of merchandise on November 1, terms 2/10, n/30. The goods had cost Eyre $2,750. On November 9 Pride paid off their account. Instructions Assuming that Eyre Inc. prepares adjusting entries on a monthly basis, prepare the appropriate journal entries. Round to the nearest dollar. Solution 112 Oct 31 Accounts Receivable ......................................................... Accounts Receivable................................................... Cost of Goods Sold ............................................................ Inventory ..................................................................... Nov 1

Nov 4

Nov 9

Nov 30

Dec 2

1,800 1,800 990 990

Accounts Receivable ......................................................... Sales ........................................................................... Cost of Goods Sold ............................................................ Inventory .....................................................................

5,000

Sales Returns and Allowances .......................................... Accounts Receivable...................................................

500

Cash ($5,000 x.98) ............................................................ Sales Discount ($5,000 x.02) ............................................. Accounts Receivable...................................................

4,900 100

Accounts Receivable ......................................................... Interest Revenue [($1,800 - $500) x.19 x 1/12] ...........

Cash ($1,800 - $500 + $21) ............................................... Accounts Receivable...................................................

1,321

5,000 2,750 2,750

500

5,000

1,321

Ex. 113 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.

Reporting and Analyzing Receivables

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

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Advanced $4,500 to a trusted employee. Accepted a $7,000 promissory note from a customer as payment on account. Determined that a $10,500 income tax refund is due from the government. Sold goods to a customer on account for $5,000. Recorded $350 accrued interest on a note receivable due next year. Lent a company officer $10,000.

Solution 113 (2–3 min.) 1. Other Receivables 2.

Notes Receivable

Other Receivables

Accounts Receivable

Other Receivables

Ex. 114 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 114 (15 min.) Jan 1 Accounts Receivable ......................................................... Sales ........................................................................... Cost of Goods Sold ............................................................ 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

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

350

150

350

Ex. 115

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

The December 31, 2017 statement of financial position of Ocean Breezes Limited reported Accounts Receivable of $450,000 and the Allowance for Doubtful Accounts of $45,000. During 2018, 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 2018 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, 2018. Solution 115 (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%) ............................................... Balance before adjustment ............................................................ Adjustment required ......................................................................

$30,650 12,000 $18,650

Reporting and Analyzing Receivables

Dec 31

Bad Debts Expense....................................................... Allowance for Doubtful Accounts ............................

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18,650 18,650

Ex. 116 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 carrying amount 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 116 (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. 117 Prepare journal entries to record the following transactions entered into by Bluenote Corporation: 2017 Jun 1 Received a $9,000, 4%, 1-year note from Kim Sharp as full payment on her account. Interest is due at maturity.

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Nov 1 5 9 Dec 31 2018 Jun 1

Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Sold merchandise on account to Henrik Inc. for $7,000, terms 2/10, n/30. The cost of the merchandise was $5,950 and Bluenote uses a perpetual inventory system. Henrik Inc. returned unopened merchandise that they had paid $2,000 for, which had cost Bluenote $1,700. The inventory was returned to the store shelves. Received payment in full from Henrik Inc. Accrued interest on Sharp’s note.

Kim Sharp honoured her promissory note by sending the principal amount plus interest. No interest has been accrued in 2018.

Solution 117 (15 min.) 2017 Jun 1 Notes Receivable ............................................................... Accounts Receivable................................................... Nov 1

Nov 5

Nov 9

Dec 31

2018 Jun 1

9,000 9,000

7,000

2,000

Cash .................................................................................. Sales Discounts ($5,000  2%) .......................................... Accounts Receivable...................................................

4,900 100

Interest Receivable ............................................................ Interest Revenue ($9,000  4%  7/12) .......................

210

Cash .................................................................................. Notes Receivable ........................................................ Interest Receivable ..................................................... Interest Revenue ($9,000  4%  5/12) .......................

9,360

7,000 5,950 5,950

2,000 1,700 1,700

5,000

210

9,000 210 150

Ex. 118 L&S Sales Limited had the following transactions in June 2018. 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 2018 were $120,000. 2. $168,000 was received as payments on account during the month. This included $7,500 from Mini- Store 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.

Reporting and Analyzing Receivables

5. 6.

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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). 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, 2018 was a credit of $5,000. The balance in accounts receivable at June 1, 2018 was $210,000. There were no other receivables at June 1, 2018.

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, 2018. Solution 118 (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

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Statement of Financial Position (partial) June 30, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Current Assets Accounts Receivable ($210,000 + $120,000 – $168,000 + $7,500 – $4,000 – $24,000) . $141,500 Less: Allowance for Doubtful Accounts ......................................... 16,000 125,500 Notes Receivable .......................................................................... 24,000 Other Receivables......................................................................... 6,000 Interest Receivable ....................................................................... 50

Ex. 119 You have replaced the accountant who prepared the following entries incorrectly. In each case, the explanation and amount to the entry is correct. Dec 31

Jan 25

Feb 3

Allowance for Doubtful Accounts........................................ Accounts Receivable................................................... (To record estimate of uncollectible accounts)

6,500

Bad Debts Expense ........................................................... Accounts Receivable................................................... (To write off an uncollectible account)

1,800

Accounts Receivable ......................................................... Bad Debts Expense .................................................... (To reverse write off of an uncollectible account)

1,800

6,500

1,800

Cash .................................................................................. 1,800 Bad Debts Expense .................................................... (Collection of account previously written off as uncollectible)

1,800

Instructions Prepare the correcting entries. Solution 119 Dec 31 Bad Debts Expense ........................................................... Accounts Receivable ......................................................... Allowance for Doubtful Accounts ................................. (To record estimate of uncollectible accounts) Jan 25

Feb 3

6,500 6,500 13,000

Allowance for Doubtful Accounts........................................ Bad Debts Expense .................................................... (To write off an uncollectible account)

1,800

Bad Debts Expense ........................................................... Allowance for Doubtful Accounts ................................. (To reverse write off an uncollectible account)

1,800

Bad Debts Expense ........................................................... Accounts Receivable...................................................

1,800

Reporting and Analyzing Receivables

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(Collection of account previously written off as uncollectible)

Ex. 120 Broadway Limited had an $800 credit balance in Allowance for Doubtful Accounts at December 31, 2018, 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, 2018, to recognize bad debts expense. (b) Assume the same facts as above except that the Allowance for Doubtful Accounts account had an $800 debit balance before the current year's provision for uncollectible accounts. Prepare the adjusting entry for the current year's bad debts. Solution 120 (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. 121 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. Apr 15 Received partial payment of $500 from Amy Ward. Aug 21 Wrote off as uncollectible the balance of the Amy Ward account when she declared

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Oct

Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

bankruptcy. Received a cheque for $350 from Amy Ward. No further collections are expected.

Solution 121 (10 min.) Jan 5 Accounts Receivable ......................................................... Sales ........................................................................... Cost of Goods Sold ............................................................ Inventory ..................................................................... Apr 15

Aug 21

Oct

1,500 1,500 900 900

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

500

Allowance for Doubtful Accounts........................................ Accounts Receivable...................................................

1,000

Accounts Receivable ......................................................... Allowance for Doubtful Accounts ................................. Cash .................................................................................. Accounts Receivable...................................................

350

500

1,000

350 350 350

Ex. 122 For their fiscal year ended December 31, 2017, 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, 2018 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 2017. (b) Show the statement of financial position presentation of accounts receivable at December 31, 2017. (c) On March 4, 2018, 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 122 (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

(c) Allowance for Doubtful Accounts ................................................... Accounts Receivable—A. Mountain........................................

2,000 2,000

Reporting and Analyzing Receivables

Accounts Receivable .................................................. Less: Allowance for Doubtful Accounts ...................... Carrying Amount ........................................................

Before Write off $175,000 5,500 $169,500

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After Write off $173,000 3,500 $169,500

Ex. 123 The general ledger of Grangehill Corporation at December 31, 2018 shows the following balances, all of which are normal: Cash ........................................................ $ 34,000 Inventory .................................................. 160,000 Prepaid expenses .................................... 8,000 Accounts receivable ................................. 182,000 Allowance for doubtful accounts ............... 10,000 Management estimates the carrying amount of accounts receivable should be $158,000. Instructions (a) Prepare the adjusting entry for bad debts for 2018. (b) Show how the current assets would be presented on the statement of financial position at December 31, 2018. Solution 123 (15 min.) (a) Bad Debts Expense ...................................................................... 14,000 Allowance for Doubtful Accounts ............................................ 14,000 ($182,000 – $158,000 = $24,000 required allowance balance; 24,000 – 10,000 = 14,000) (b) GRANGEHILL CORPORATION Statement of Financial Position (Partial) December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Current assets Cash....................................................................................... $ 34,000 Accounts receivable ............................................................... $182,000 Less: Allowance for doubtful accounts.................................... 24,000 158,000 Inventory ................................................................................ 160,000 Prepaid expenses................................................................... 8,000 Total current assets....................................................................... $360,000

Ex. 124 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) An $8,000, 3%, 1-month note dated September 10.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Solution 124 (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. 125 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 125 (15 min.) (a) $2,250 ($60,000  5%  9/12) (b) 5%

($4,000  12/8  $120,000)

Ex. 126 Record the following transactions for Lucea Corporation: Jul 1 Received an $8,000, 3%, 3-month note, dated July 1, from Frank Baker in payment of his open account. Interest is due at maturity. Oct 1 Received notification from Frank Baker that he is unable to honour his note at this time. It is expected that Baker will pay at a later date. Nov 15 Received full payment from Frank Baker for note receivable previously dishonoured. Solution 126 (15 min.) Jul 1 Notes Receivable ............................................................... Accounts Receivable................................................... (To record acceptance of Frank Baker note as payment on account) Oct

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

8,000 8,000

8,060

Reporting and Analyzing Receivables

Notes Receivable ........................................................ Interest Revenue ($8,000  3%  3/12) ....................... (To record dishonoured note, $5,000, plus interest) Nov 15

Cash .................................................................................. Accounts Receivable................................................... (To record payment on account)

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8,000 60

8,060 8,060

Ex. 127 Copeland Industries has the following transactions related to notes receivable during the last month of the year: Dec 1 Lent $75,000 cash to P. Arthur on a 1-year, 6% note. Interest is due the first of each month, commencing January 1. 15 Sold goods to F. Murdoch, receiving a $12,000, 4-month, 4% note. Interest is due the 15 of each month, commencing January 15. Copeland uses the periodic inventory method. 31 Accrued interest revenue on notes receivable. Instructions Record the above transactions for Greenland Distributors. Solution 127 (10 min.) Dec 1 Notes Receivable ............................................................... Cash ........................................................................... 15

75,000 75,000

Notes Receivable ............................................................... Sales ...........................................................................

12,000

Interest Receivable ............................................................ Interest Revenue* .......................................................

395

*Calculation of interest revenue Arthur note: $75,000  6%  1/12 .......... = Murdoch note: $12,000  4%  0.5/12 ....... = Total accrued interest ...............

12,000

395

$375 20 $395

Ex. 128 Alvira Inc. often requires customers to sign notes for major credit purchases. Record the following transactions for Alvira: Feb 12 Accepted a $42,000, 4%, 2-month note from John Doe 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 John Doe 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 John Doe for the total amount owed. Jun 1 Received notification by the bank that John Doe’s cheque was being returned "NSF" and that Mr. Doe had declared personal bankruptcy.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Solution 128 (15 min.) Feb 12 Notes Receivable ............................................................... Sales ...........................................................................

42,000

Apr 14

Accounts Receivable ......................................................... Notes Receivable ........................................................ Interest Revenue ($42,000  4%  2/12) .....................

42,280

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

42,280

Accounts Receivable ......................................................... Cash ........................................................................... Allowance for Doubtful Accounts........................................ Accounts Receivable...................................................

42,280

May 26

Jun

42,000

42,000 280

42,280

42,280 42,280 42,280

Ex. 129 The following partial statement of financial position has been incorrectly presented for Alpha Corporation: ALPHA CORPORATION Statement of Financial Position (Partial) December 31, 2018 (in thousands) Current Assets Accounts receivable ................................................................. $3,920 Allowance for doubtful notes .......................................................... 35 Cash .............................................................................................. Notes receivable (due 2020) ...................................................... 1,459 Allowance for doubtful accounts ..................................................... 62 Held-for-Trading Investments.............................................................. Interest receivable ..............................................................................

$3,885 6,525 1,397 3,500 145

Instructions Prepare the partial statement of financial position in good form. Solution 129 ALPHA CORPORATION Statement of Financial Position (Partial) December 31, 2018 (in thousands) Current Assets Cash .............................................................................................. Held-for-Trading Investments.............................................................. Accounts receivable ................................................................. $3,920

$6,525 3,500

Reporting and Analyzing Receivables

Less: Allowance for doubtful accounts ...................................... 62 Interest receivable ..............................................................................

Non-current Assets Notes receivable (due 2020) ........................................................... $1,459 Less: Allowance for doubtful notes............................................ 35

Ex. 130 The following data are presented for Ratalan Ltd. for 2018: Beginning Accounts receivable ........................................ $135,500 Allowance for doubtful accounts ...................... 3,500 Net sales ......................................................... 0

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$3,858 145 $14,028

1,424

Ending $350,000 11,000 975,000

Instructions Calculate the receivables turnover and the average collection period for accounts receivable in days. Solution 130 (5 min.) Receivables turnover =

$975,000 ——————————---— ($135,500 + $350,000)  2

= 4.0 times

365 days Average collection period = ————— = 91 days 4.0

Ex. 131 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 131 (10 min.) (a) Amamco Corp.

Brindle Corp.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Receivables turnover

Average collection period

$45,000 ($22,000 + $17,500) ÷ 2 $45,000 ÷ $19,750 = 2.3 times

$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. 132 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 132 (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

Reporting and Analyzing Receivables

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Ex. 133 The financial statements of Secrets Inc. reported the following information for the years ended December 31, 2018 and December 31, 2017: Dec. 31, 2018 $ (b) $265,500 (a) 72 days

Sales Accounts receivable Receivables turnover Average collection period

Dec. 31, 2017 $1,323,000 $308,000 4.5x (c)

Dec. 31, 2016 $1,385,000 (d) 4.2x 87 days

Instructions Assuming all sales are on credit, complete the missing data in the above table. Solution 133 (a) Average collection period =

Receivable Turnover =

365 days ––––––––———–—— = 72 days Receivable Turnover 365 days –––––––– = 5.1 times 72 days

(b) Receivables turnover =

Credit Sales ——————————---— ($265,500 + $308,000)  2

= 5.1 times

Receivables turnover =

Credit Sales ——————————---— $286,750

= 5.1 times

Credit Sales =

$1,462,425

365 days ————— 4.5 times

= 81 days

(d) Receivables turnover =

$1,323,000 = x=

$1,323,000 ——————————---— ($308,000 + $X)  2

= 4.5 times

$693,000 + 2.25x $280,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

MATCHING 134. Match the items below by entering the appropriate code letter in the space provided. A. Aging the accounts receivable B. C. D. E.

_____

Recovery of an uncollectible account Promissory note Trade receivables Receivables turnover

Allowance method for uncollectible accounts G. Other Receivables H. Dishonoured note I. Subsidiary ledger J. 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 carrying amount.

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.

Reporting and Analyzing Receivables

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ANSWERS TO MATCHING 1.

10. E

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

SHORT-ANSWER ESSAY QUESTIONS S-A E 135 (a) What is the benefit of using a subsidiary accounts receivable ledger? (b) Does the balance in the subsidiary accounts receivable ledger have to equal the balance in the control account? Explain. (c) What other accounts are supported by a subsidiary ledger? Solution 135 (a) 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. (b) Yes. Accounts Receivable is the control account for the accounts receivable subsidiary ledger. When receivables transactions are recorded in the subsidiary ledgers on a customer-by-customer basis, summaries of these transactions are also recorded in the general ledger so the account balance must be equal to all of the individual customer receivables balances recorded in the subsidiary ledger. (c) In addition to Accounts Receivable, other accounts that are supported by subsidiary ledgers include Inventory (to track inventory quantities and balances), Accounts Payable (to track individual creditor balances), and Payroll (to track individual employee pay records).

S-A E 136 (a) Explain the allowance method for uncollectible accounts. (b) Discuss why the allowance method accomplishes expense recognition. (c) Why is a contra account used when recording the estimate for uncollectible accounts? Solution 136 (a) Under the allowance method for uncollectible accounts, the emphasis is on establishing the carrying amount 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. (c) A contra account must be used because bad debt is an estimate and, at the time it is determined, the company does not know which specific accounts will not be paid. If the specific accounts are not known, then no entry can be made in the accounts receivable subsidiary ledger. If this is not possible, then no entry can be made to Accounts Receivable either, because it is the control account. Since no entry can be made to the control account for A/R, then a contra account must be used as a “holding place” for the unknown amounts.

S-A E 137

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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 137 (date) Ms. Keresha King 123 Any Street Any Town, Any Province 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.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Sincerely, Sally Sutton Accounting Manager

S-A E 138 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 138 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 the bad debts expense. Thus, the ADA balance is very unlikely to be the same as the Bad Debts Expense.

S-A E 139 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 139 (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.

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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 140 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 140 (date) Dana Stephens Mountain of Gold Sales Ltd. 123 Any Street 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,

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

A Good Student

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OBJECTIVE FORMAT QUESTIONS 141. Review the following transactions for Chemistry Cosmetics Corporation (CCC). Determine if the transaction will increase (I), decrease (D), or not change (NC) the carrying amount of accounts receivable. Increase (I), Decrease (D) or No Change (NC) (a) On April 15, 2018, CCC received payment totalling $7,600 from Sully’s Studios. The original sale was recorded on March 1, 2018. (b) On May 2, 2018, CCC discovered that JJT Ltd. Had recently closed its doors due to lack of sales. CCC wrote off its receivable from JJT Ltd totalling $450. (c) On June 30, 2018, Betty Boop Inc. returned $145 of merchandise they purchased on May 4th. Betty Boop Inc. had paid for the merchandise in full on June 15th. (d) On September 5th, CCC received payment from JJT Ltd. for $450. This amount was previously written off. (e) On October 4, 2018, the company sold $670 of merchandise on their website. Payment was made using a bank credit card. The cost of the merchandise sold was $376. (f) On October 30, CCC recorded interest accrued on accounts receivable of $75. (g) On December 3, 2018, CCC received an interest payment of $50 from a customer that was late paying its outstanding account. (h) On December 28, 2018, the company recorded the estimated bad debt expense for the year using the percentage of receivables method. They estimated 6% of all outstanding receivables would be uncollectible, a total of $1,450. Solution 141 Transaction (f) will increase the carrying amount of accounts receivable; transactions (a), (d), (g) and (h) will decrease the carrying amount of accounts receivable; and transactions (b), (c) and (e) do not change the carrying amount of accounts receivable. The journal entries to record the transactions would be: Change in net AR (a) Apr 15

(b) May 2

(c)

May 4

Cash Accounts Receivable

7,600 7,600

Allowance for Doubtful Accounts Accounts Receivable

450

Accounts Receivable Sales

145

450

-7,600

No change

} 145 } }

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Jun 15

Cash Accounts Receivable

145

Jun 30

Sales Returns and Allowances Cash

145

Accounts Receivable Allowance for Doubtful Accounts

450

(d) Sep 5

(e) Oct 4

Cash Accounts Receivable

450

Cash Sales

670

Cost of Goods Sold Inventory

376

Accounts Receivable Interest Revenue

Cash Accounts Receivable

} 145 } No change } } 145 } } 450 } } } } 450

- 450

670 No change

(f)

Oct 30

(g) Dec 3

376

(h) Dec 28 Bad Debt Expense 1,450 Allowance for Doubtful Accounts 1,450

+75

-50

-1,450

Oct. 4 – A bank credit card sale is considered a cash sale. 142. Identify all the statements that are correct with regards to receivables. (a) When bad debt is recovered, this doesn’t impact the income statement. (b) The adjusted balance in the Allowance for Doubtful Accounts can be either a debit or credit. (c) When a bad debt is recognized, the effect on the statement of financial position is a decrease in assets. (d) The Notes Receivable and Accounts Receivable account names are used interchangeably. (e) Uncollectable accounts receivables and notes receivable are often estimated using an aging schedule. (f) When a note receivable is collected in full at its maturity date, it is called an honoured note. (g) When a note is dishonoured but may be collectible in the future, Accounts Receivable is debited with the amount of the note and any accrued interest. (h) The amount of trade receivables must be reported separately from the allowance for doubtful accounts on the statement of financial position. Solution 142 (a), (c), (f), and (g) are correct; (b), (d), (e), and (h) are incorrect. (b) The adjusted balance of the allowance for doubtful accounts is always a credit.

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(d) Accounts Receivable are different than Notes Receivable. Notes receivable represents a formal promise to pay; whereas, accounts receivable is less formal. There is a stronger legal claim for the holder of a note. Also, accounts receivable generally are due in 30 days, while notes receivable can cover a longer period. (e) Because companies generally don’t have many notes, preparing an aging schedule, as is usually done for accounts receivable, is not the best way to estimate uncollectible notes. Instead, each note should be individually analyzed to determine its probability of collection. (h) The carrying amount of trade receivables must be reported on the statement of financial position. However, the gross amount of receivables and the allowance for doubtful accounts must be reported either in the statement of financial position or in the notes to the financial statements.

143. During 2018, Sung Ltd. accepted two promissory notes from Black Ltd., a key customer who was experiencing an unexpected cash shortfall. Sung does not have an allowance for • The first 6-month promissory note (PM1) was issued to Black on January 1, 2018 for $8,000 with interest of 9% payable at maturity of the note. This note was accepted from Black in settlement of overdue accounts receivable. Black paid the note and interest in full at maturity. • The second 6-month promissory note (PM2) was issued as a cash loan to Black on July 1, 2018 for $5,000, with an interest rate of 12%, payable monthly Black made their interest payments for July, August and September, but, on October 2, 2018, Black declared bankruptcy and defaulted on the second promissory note. Select from the following all the entries that would be recorded in 2018 regarding the two promissory notes. (a) Notes Receivable 8,000 Accounts Receivable 8,000 (b) Notes Receivable Cash (c)

Interest Receivable Interest Revenue

5,000 5,000 800 800

(d) Notes Receivable 5,000 Accounts Receivable 5,000 (e) Bad Debts Expense Notes Receivable (f)

Interest Receivable Interest Revenue

(g) Notes Receivable Cash

5,000 5,000 200 200 8,000 8,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

(h) Interest Receivable Interest Revenue (i)

Cash Notes Receivable Interest Receivable

360 360 8,360 8,000 360

Solution 143 (a), (b), (e), (h) and (i) are correct; (c), (d), (f) and (g) are incorrect. The entries for the first promissory note (PN1) would be: Jan 1 Notes Receivable

8,000

Accounts Receivable

8,000

(To record acceptance of Black six -month, 9% note in settlement of accounts receivable) Jan. 30 Feb. 28 Mar. 31 Apr. 30 May 31 June 30

Jun 30

At each date entry is: Interest Receivable Interest Revenue

To record accrued interest revenue for the month on 9% note receivable from Black ( $8,000 x 9% x1/12) = $60 Cash Notes Receivable Interest Receivable (To record collection of note in full from Black plus accrued interest)

The entries for the second promissory note (PN2) would be: Jul 1 Notes Receivable

60 60

8,360 8,000 360

5,000

Cash July 31 Aug.31 Sep 30

Oct. 2

5,000

(To record acceptance of Black six -month, 12% note) At each date entry is: Cash Interest Revenue (To record interest paid on note by Black. Interest = 5,000 x 15% x 1/12) Bad Debts Expense Notes Receivable

50 50

5,000 5,000

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144. The following balances related to the current asset accounts and income statement accounts of Kalize Ltd. were reported on December 31, 2018: Kalize Ltd. Balances at December 31, 2018 Accounts Receivable....................................... $475,000 Administrative Expense................................... 125,000 Advances to Employees.................................. 45,000 Allowance for Doubtful Accounts ..................... 28,500 Bad Debts Expense ........................................ 23,500 Cash ............................................................... 4,500 Cost of Goods Sold ......................................... 2,584,000 Depreciation Expense ..................................... 85,000 Held for trading Investments ........................... 145,000 Income Tax Expense ...................................... 189,000 Interest Receivable ......................................... 17,500 Interest Expense ............................................. 14,700 Interest Revenue............................................. 28,000 Inventory ......................................................... 458,000 Notes Receivable (due in 6 months) ............... 125,000 Salaries Expense ............................................ 595,000 Sales ............................................................... 4,580,000 Sales Discounts .............................................. 85,400 Sales Tax Recoverable ................................... 47,500 Utilities Expense ............................................. 28,500 Kalize estimates all the receivables are collectible. Prepare the current assets section of the statement of financial position and a multiple step income statement for Kalize. Once you are complete, indicate all the following that are correct. (a) The total carrying amount for accounts receivable is $681,500. (b) Total current assets are $1,289,000. (c) Gross profit is $1,996,000. (d) Income from operations is $1,053,600. (e) Total operating expenses are $949,500. (f) Income before income tax is $1,066,900. (g) Total current assets are $1,196,500. (h) Income from operations is $1,066,900. Solution 144 (b), (d), and (f) are correct; (a), (c), (e), (g), and (h) are incorrect. The completed statements are as follows:

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Kalize Ltd. Statement of Financial Position December 31, 2018 Current assets Cash Held for trading investments Accounts receivable Less: Allowance for doubtful accounts Notes receivable Advances to employees Interest receivable Sales Tax Recoverable Inventory Total current assets

$ $475,000 28,500

4,500 145,000

446,500 125,000 45,000 17,500 47,500 458,000 $1,289,000

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145. Industry ratios for the same industry as Fleur Designs Ltd. for 2018 were reported as follows: Industry Data Average collection period 45 days Receivables turnover 8 times On their financial statements for 2017 and 2018, Fleur Designs reported the following:

Fleur Designs generally offers credit terms of 2/30, n/45. Based on the above information, identify all the following statements that are correct. (Ratios are rounded to the nearest whole number and each item should be considered independently). (a) Fleur Designs collects their receivables slower than industry. (b) Fleur Design’s average gross accounts receivable for 2018 is $1,096,500. (c) Fleur Designs average collection period is acceptable given the credit terms they offer to customers. (d) Fleur Designs collects their receivables approximately 28 days slower than industry. (e) If Fleur Designs Ltd. failed to write-off the account one of its customers who owed it $10,000, the carrying amount of the company’s receivables would be overstated. (f) If Fleur Designs Ltd. failed to write-off the account one of its customers who owed it $60,000, the company’s receivables turnover would be lower. (g) As Fleur Designs Ltd’s receivable turnover is lower than the industry average, we know that the company is collecting its accounts receivable more quickly than its competitors. Solution 145 (a), (d), (f) are correct; (b), (c), (e) and (g) are incorrect. The ratios for Fleur Designs Ltd. are shown below: 2017 Accounts Receivable

$1,075,000

2018

$1,118,000 $1,096,500

Allowance for Doubtful Accounts

114,000

125,000

Carrying Amount

961,000

993,000

5,814,000

6,350,000

Sales Discounts

45,000

42,000

Sales Returns

278,500

397,500

5,490,500

5,910,500

Sales

Net Sales

Average

2018

Industry Difference

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Receivables Turnover ($5,910,500/$1,096,500) Average collection period (365/5)

-28

(b) The average gross accounts receivable is the average of the last two years. It is $1,096,500 (($1,075,000 + $1,118,000)/2). (c) Fleur Design’s average collection period is 73 days. They offer terms of 2/30, n/45. They should be showing a collection period of less than 45 days. As seen in the above data, some customers are taking advantage of the 2% discount. Therefore, there must be other customers who are paying long after the 45 day term. (e) Writing off an account has no effect on the carrying amount of accounts receivable, so failure to do so would not affect the carrying amount. (g) The statement is incorrect. The lower a company’s receivables turnover ratio, the longer it is taking to collect its accounts receivable.

CHAPTER 9 REPORTING AND ANALYZING LONG-LIVED ASSETS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 15. 2 M C F AN 29. 4 M K F AN 2. 1 M C F AN 16. 2 E K F AN 30. 4 E K F AN 3. 1 E C F AN 17. 2 M C F AN 31. 4 E K F AN 4. 1 E C F AN 18. 2 M C F AN 32. 4 E K F AN 5. 1 M C F AN 19. 2 M C F AN 33. 4 M K F AN F AN F AN F AN 6. 1 E C 20. 2 M C 34. 4 M K 7. 1 E C F AN 21. 2 H K F AN 35. 4 M K F AN 8. 1 H C F AN 22. 2 M K F AN 36. 4 M K F AN 9. 2 E C F AN 23. 2 E C F AN 37. 5 M K F AN 10. 2 E C F AN 24. 3 E K F AN 38. 5 E C F AN 11. 2 E C F AN 25. 3 E C F AN 39. 6 M K F AN 12. 2 E C F AN 26. 3 M C F AN 40. 6 M K F AN 13. 2 E C F AN 27. 3 E C F AN 41. 6 M C F AN 14. 2 E C F AN 28. 3 E C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional and Ethical Behaviour C = Communication AACSB: AN = Analytic E = Ethics

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

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Multiple Choice Questions 42. 1 M C F AN 78. 2 E K F AN 114. 3 E C F AN 43. 1 E AP F AN 79. 2 E AP F AN 115. 3 M AP F AN 44. 1 E K F AN 80. 2 M AP F AN 116. 3 H AP F AN 45. 1 M C F AN 81. 2 H AP F AN 117. 3 H AP F AN F AN F AN 118. 4 E F AN 46. 1 E C 82. 2 E K C F AN F AN F AN 47. 1 E C 83. 2 M C 119. 4 E C F AN F AN 120. 4 E F AN 48. 1 E C 84. 2 M AP C F AN F AN 121. 4 E F AN 49. 1 E C 85. 2 M AP C F AN F AN 122. 4 E F AN 50. 1 M C 86. 2 H AP C 51. 1 M AP F AN 87. 2 H AP F AN 123. 4 E AP F AN 52. 1 M C F AN 88. 2 H AP F AN 124. 4 M K F AN 53. 1 H AP F AN 89. 2 H AP F AN 125. 4 E K F AN 54. 1 M AP F AN 90. 2 H AP F AN 126. 4 H K F AN 55. 1 E C F AN 91. 2 H AP F AN 127. 4 E K F AN 56. 1 E K F AN 92. 2 H AP F AN 128. 4 M C F AN 57. 1 M C F AN 93. 2 M AP F AN 129. 4 E K F AN 58. 1 E AP F AN 94. 2 M AP F AN 130. 4 E K F AN 59. 1 M K F AN 95. 2 H AP F AN 131. 4 M K F AN 60. 1 M K F AN 96. 2 M C F AN 132. 4 E K F AN 61. 1 M C F AN 97. 2 E C F AN 133. 4 M K F AN 62. 2 E C F AN 98. 2 E AP F AN 134. 4 M C F AN 63. 2 E K F AN 99. 2 M AP F AN 135. 4 H C F AN 64. 2 M C F AN 100. 2 M K F AN 136. 5 E K F AN 65. 2 M K F AN 101. 2 M C F AN 137. 5 M C F AN 66. 2 E K F AN 102. 2 E K F AN 138. 5 M K F AN 67. 2 E C F AN 103. 2 E K F AN 139. 5 E K F AN 68. 2 E K F AN 104. 2 M K F AN 140. 5 M K F AN 69. 2 M C F AN 105. 2 E AP F AN 141. 5 E AP F AN 70. 2 E K F AN 106. 2 H C F AN 142. 5 E K F AN 71. 2 E C F AN 107. 3 E C F AN 143. 5 E C F AN 72. 2 M K F AN 108. 3 E C F AN 144. 6 M AP F AN 73. 2 E AP F AN 109. 3 H AP F AN 145. 6 M AP F AN 74. 2 M AP F AN 110. 3 E AP F AN 146. 6 M AP F AN 75. 2 M AP F AN 111. 3 E AP F AN 147. 6 H C F AN 76. 2 H AP F AN 112. 3 E C F AN 148. 6 M C F AN 77. 2 E AP F AN 113. 3 E C F AN 149. 6 M K F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional and Ethical Behaviour C = Communication AACSB: AN = Analytic E = Ethics

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Exercises 150. 1 E AP F AN 165. 2 H AP F AN 180. 3 E AP F AN 151. 1 E K F AN 166. 2 E AP F AN 181. 3 M AP F AN 152. 1 E K F AN 167. 2 M AP F AN 182. 4 E AP F AN 153. 1 E AP F AN 168. 2 H AP F AN 183. 4 H AP F AN F AN F AN 184. 4 E F AN 154. 1 M C 169. 2 E AP AP F AN F AN F AN 155. 1 E C 170. 2 H AP 185. 4 E AP AP F AN F AN 186. 4 M F AN 156. 1,2 H 171. 2 H AP C F AN F AN 187. 4 H F AN 157. 1,2 E AP 172. 2,3 H AP AP F AN F AN 188. 5 E F AN 158. 2 M AP 173. 2,3 H AP K 159. 2 E AP F AN 174. 2,3 M AP F AN 189. 5 E AP F AN 160. 2 E AP F AN 175. 2,3,5 E AP F AN 190. 6 E AP F AN 161. 2 E AP F AN 176. 2,4 E K F AN 191. 6 H AP F AN 162. 2 E AP F AN 177. 3 M AP F AN 192. 6 M AP F AN 163. 2 E AP F AN 178. 3 E AP F AN 193. 6 H AP F AN 164. 2 E AP F AN 179. 3 E AP F AN Matching 194. 1,2 E K F AN 195. 2–4,6 M,H C F AN Short-Answer Essay 196. 1 E C F AN 200. 2 M C F AN 204. 4 E C F AN F,P,C AN,E 197. 1 E C F AN 201. 2 M C F AN 205. 4 H C 198. 2 H C F AN 202. 2 M C F AN 206. 5 H K F AN 199. 2 E C F AN 203. 3 M C F,C AN 207. 6 M C F AN CPA Questions 208. 1-4 H AN F AN 210. 2 M C F AN 212. 6 H AN F AN 209. 2 M C F AN 211. 4 M C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional and Ethical Behaviour C = Communication AACSB: AN = Analytic E = Ethics

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

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note:

Item Type Item

Type

Item

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

TF TF TF TF TF TF

7. 8. 42. 43. 44. 45.

TF TF MC MC MC MC

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

9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21.

TF TF TF TF TF TF TF TF TF TF TF TF TF

22. 23. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72.

TF TF MC MC MC MC MC MC MC MC MC MC MC

73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

24. 25. 26. 27.

TF TF TF TF

28. 107. 108. 109.

TF MC MC MC

110. 111. 112. 113.

29. 30. 31. 32. 33. 34.

TF TF TF TF TF TF

35. 36. 118. 119. 120. 121.

TF TF MC MC MC MC

122. 123. 124. 125. 126. 127.

37. 38.

TF TF

136. 137.

MC MC

138. 139.

39. 40. 41.

TF TF TF

144. 145. 146.

MC MC MC

147. 148. 149.

TF = True/False Ex = Exercise

Type Item Type Item Learning Objective 1 MC 52. MC 58. MC 53. MC 59. MC 54. MC 60. MC 55. MC 61. MC 56. MC 150. MC 57. MC 151. Learning Objective 2 MC 86. MC 99. MC 87. MC 100. 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 156. MC 95. MC 157. MC 96. MC 158. MC 97. MC 159. MC 98. MC 160. Learning Objective 3 MC 114. MC 172. MC 115. MC 173. MC 116. MC 174. MC 117. MC 175. Learning Objective 4 MC 128. MC 134. MC 129. MC 135. MC 130. MC 176. MC 131. MC 182. MC 132. MC 183. MC 133. MC 184. Learning Objective 5 MC 140. MC 142. MC 141. MC 143. Learning Objective 6 MC 190. Ex 193. MC 191. Ex 195. MC 192. Ex 207.

MC = Multiple Choice SAE = Short-Answer Essay

Type

Item

Type Item Type

MC MC MC MC Ex Ex

152. 153. 154. 155. 156. 157.

Ex Ex Ex Ex Ex Ex

194. 196. 197. 208.

Ma SAE SAE CP

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

174. 175. 176. 194. 195. 198. 199. 200. 201. 202. 208. 209. 210.

Ex Ex Ex Ma Ma SAE SAE SAE SAE SAE CP CP CP

Ex Ex Ex Ex

177. 178. 179. 180.

Ex Ex Ex Ex

181. 195. 203. 208.

Ex Ma SAE CP

MC MC Ex Ex Ex Ex

185. 186. 187. 195. 204. 205.

Ex 208. Ex 211. Ex Ma SAE SAE

CP CP

MC MC

175. 188.

Ex Ex

Ex SAE

Ex 212. Ma SAE

189. 206.

Ma = Matching CP = CPA

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CHAPTER LEARNING 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 whereas costs that benefit only the current period (operating expenditures) are expensed. When applicable, cost also includes asset retirement costs. If a company leases an asset, 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 recording the leased asset as if it were purchased with a corresponding liability for the future lease payments to be made. This gives rise to depreciation on the asset and interest on the liability for the payments being recorded in the future. Under IFRS, most leases with a term greater than 12 months are to be accounted for as finance leases commencing in 2019. Under ASPE, the criteria for determining whether a leased asset is operating or not is covered in intermediate accounting courses.

Explain and calculate depreciation for plant and equipment. 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 amount

(Cost – residual value) ÷ estimated useful life (in years)

Diminishing-balance

Diminishing amount

Carrying amount at beginning of year × depreciation rate (straight-line rate × multiplier)

(Cost – residual value) ÷ estimated total units of activity × 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. Units-of-production

Varying amount

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). If the carrying amount is greater than proceeds then there is a loss on disposal.

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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 (which we have assumed are accounted for under the cost model) are initially reported at cost, 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 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 (events and circumstances) 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.” Only purchased, not internally generated goodwill can be recorded. Goodwill has an indefinite life and is not amortized. Impairment tests for goodwill are similar to those for intangibles with indefinite lives. 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 (net income ÷ average total assets) indicates how well assets are used to generate net income. Return on assets can be determined by multiplying two ratios: asset turnover (net sales ÷ average total assets), which indicates how efficiently assets are used to generate revenue, and profit margin (net income ÷ net sales), which measures the net income made on each sale.

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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. Under an operating lease, both the leased asset and the related lease obligation are shown on the statement of financial position.

7. Under a finance lease, both the leased asset and the related lease obligation are shown on the statement of financial position.

8. Leasehold improvements are depreciated over the remaining life of the lease or the useful life of the improvements, whichever is longer.

9. Recording depreciation on equipment affects both the statement of financial position and the income statement.

10. The depreciable amount of property, plant, and equipment is its original cost minus the depreciation for the current year.

11. The Accumulated Depreciation account represents a cash fund available to replace property, plant, and equipment.

12. In calculating depreciation, cost, useful life, and residual value are all based on estimates.

13. Carrying amount is used in determining the amount that the diminishing-balance rate is applied to.

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

14. 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.

15. Using the diminishing-balance method results in higher expense in the early years, and therefore lower net income.

16. Canada Revenue Agency requires a company to use the same depreciation method on its income tax return that is used in preparing financial statements.

17. 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.

18. The carrying amount of an asset is the original cost less anticipated residual value.

19. When an impairment loss is recorded for a depreciable asset, the offsetting credit is recorded in accumulated depreciation.

20. An item of property, plant, and equipment is considered to be impaired if its carrying amount exceeds its recoverable amount.

21. 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.

22. A change in the estimated residual value of property, plant, and equipment requires a restatement of prior years' depreciation.

23. When a change in estimate is made, there is no correction of previously recorded depreciation expense.

24. Normally, businesses only dispose of property, plant, and equipment by either sale or exchange.

25. If the proceeds from the sale of equipment exceed its carrying amount, a gain on disposal is reported.

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26. When an asset is retired, a gain or loss must be recorded.

27. A tangible asset must be fully depreciated before it can be removed from the books.

28. A loss on disposal results if the cash proceeds received from the asset sale are less than the asset's carrying amount.

29. Intangible assets involve rights, privileges, and/or competitive advantages that result from ownership of identifiable assets that do not possess physical substance.

30. The cost of a patent should be amortized over its legal life or useful life, whichever is shorter.

31. If an acquired franchise or licence is for an indefinite time period, then the cost of the asset should not be amortized.

32. An intangible asset must be identifiable.

33. If a trademark is developed internally, it cannot be recognized as an intangible asset on the statement of financial position.

34. When an entire business is purchased, goodwill is the excess of the purchase price over the carrying amount of the net identifiable assets acquired.

35. All research costs should be capitalized when incurred.

36. Impairment losses on goodwill are never reversed.

37. If a building is sold at a gain, the gain on disposal should be reported in the non-operating section of the income statement.

38. The cash flows from the purchase and sale of long-lived assets are reported in the operating activities section of the cash flow statement.

39. The asset turnover ratio is calculated as net sales divided by ending total assets.

40. Profit margin can be determined by multiplying the asset turnover by the return on assets. Copyright © 2017 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, Seventh Canadian Edition

41. The asset turnover indicates how efficiently a company uses its assets.

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Reporting and Analyzing Long-Lived Assets

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

Ans. F F T F F F

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

Ans. T F T F F F

Item 13. 14. 15. 16. 17. 18.

Ans. T F T F F F

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

Ans. T T T F T F

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

Ans. T F F T T T

Item 31. 32. 33. 34. 35. 36.

Ans. T T T F F T

Item 37. 38. 39. 40. 41.

Ans. F F F F T

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

MULTIPLE CHOICE QUESTIONS 42. Asset retirement costs are (a) added to the cost of a depreciable asset. (b) treated as a separate asset. (c) deducted from the cost of a depreciation asset. (d) have no effect on a depreciable asset.

43. 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. Solution: $120,000 + $7,000 – $1,500 = $125,500

44. 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

45. 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.

46. 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

47. 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

48. Which of the following assets does not decline in service potential over the course of its

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useful life? (a) office equipment (b) furnishings (c) land (d) computers

49. The cost of land does not include (a) closing costs. (b) annual property taxes. (c) removal costs of an old building. (d) title fees.

50. 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.

51. Harmon Medical Ltd. purchases land for $290,500 cash. The title and legal fees totalled $1,500. The clinic has the land graded for $25,000. What amount does Harmon Medical record as the cost for the land? (a) $290,500 (b) $292,000 (c) $315,500 (d) $317,000 Solution: $290,500 + 1,500 + $25,000 = $317,000

52. 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.

53. Angus Corp. acquires land for $105,000 cash. Additional costs are as follows: Removal of shed ...................................... $ 500 Filling and grading .................................... 3,200 Residual value of lumber from shed ......... 150 Paving of parking lot................................. 16,000 Closing costs............................................ 1,350 Angus will record the cost of the land as (a) $105,000. (b) $109,400. (c) $109,900. (d) $126,200. Solution: $105,000 + $500 + $3,200 – $150 + $1,350 = $109,900

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

54. 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.

55. 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.

56. 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.

57. 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.

58. Enmerick Corporation purchases a new delivery truck for $45,000. The company logo is painted on the side of the truck for $1,500. The motor vehicle licence is $175. Annual insurance is $1,500. At what amount does Enmerick record the cost of the new truck? (a) $45,000 (b) $45,175 (c) $46,500 (d) $46,675 Solution: $45,000 + $1,500 = $46,500

59. 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 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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60. 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.

61. 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

62. Assuming there are no impairment losses, the balance in the Accumulated Depreciation account represents the (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.

63. Which of the following is not an acceptable method of depreciation? (a) straight-line (b) increasing-balance (c) diminishing-balance (d) units-of-production

64. The carrying amount of property, plant, and equipment (a) is always equal to its fair value. (b) is always greater than its fair value. (c) is always less than its fair value. (d) may be different than its fair value.

65. 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.

66. 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.

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

67. 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.

68. The carrying amount of an asset is equal to the (a) asset's fair value less its original cost. (b) asset’s cost less residual value less accumulated depreciation. (c) asset’s cost less residual value. (d) asset's cost less accumulated depreciation.

69. 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 70. 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. (d) the revaluation amount.

71. 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.

72. 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.

73. 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. Solution: ($20,000 – $3,000) / 5 years = $3,400 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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74. 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. Solution: ($25,000 +$700 +$3,000 – $1,600) / 5 years= $5,420

75. 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, 2018. If the straight-line method is used, the depreciation expense for calendar 2018 is (a) $40,000. (b) $37,500. (c) $30,000. (d) $28,125. Solution: ($160,000 – $10,000) / 48 months = $3,125/month; $3,125 x 9 months = $28,125

76. 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%. Solution: $600 x 12 months = $7,200/year; ($40,000 – $4,000) / $7,200 = 5 years; 1/5 = 20%

77. A company purchased factory equipment on May 1, 2018 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, 2018 and 2019 is (a) $2,500 in 2018 and $3,750 in 2019. (b) $3,225 in 2018 and $3,225 in 2019. (c) $2,150 in 2018 and $3,225 in 2019. (d) none of the above Solution: ($30,000 – $4,200) / 96 months = $268.75/month; 2018: $268.75 x 8 months = $2,150 and 2019: $268.75 x 12 = $3,225

78. 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.

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

Use the following information for questions 79–81. On January 1, 2018, Anvil Corp. purchased equipment for $60,000. It was expected to last 5 years, after which it will be sold for $5,000. It is expected to be used for a total of 10,000 machine hours, and was used for 750 hours during the year ended December 31, 2018.

79. The depreciation expense for 2018 using the straight-line method will be (a) $4,125. (b) $11,000. (c) $12,000. (d) $12,250. Solution: ($60,000 – $5,000) / 5 years = $11,000

80. The depreciation expense for 2018 using the units-of-production method will be (a) $4,125. (b) $11,000. (c) $4,500. (d) $12,250. Solution: ($60,000 – $5,000) / 10,000 mhrs. = $5.5/mhr. X 750 mhrs. = $4,125

81. The depreciation expense for 2018 using the double diminishing-balance method will be (a) $11,000. (b) $12,250. (c) $12,000. (d) $24,000. Solution: 1/5 years x 2 = 40%; $60,000 x.40 = $24,000

82. 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.

83. 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.

84. On October 1, 2018, 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, 2019 is (a) $ 600. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) $ 800. (c) $1,067. (d) $2,400. Solution: ($16,000 – $4,000) / 60 months = $200/mth; $200 x 4 months = $800

85. On July 1, 2018, 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 2019? (a) $4,000 (b) $3,556 (c) $3,200 (d) $1,600 Solution: ($20,000 – $4,000) / 5 years = $3,200

86. 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. Solution: ($39,000 – $3,000 – $12,000) / $4,000 = 6 years

87. 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. Solution: 1/8 years x 2 = 25%

88. 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. (c) $72,000. (d) $80,000. Solution: 1/5 years x 2 = 40%: [$200,000 – ($200,000 x.40)] x.40 = $48,000

89. 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 Copyright © 2017 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, Seventh Canadian Edition

(a) $9,000. (b) $6,750. (c) $6,188. (d) $5,500. Solution: 1/8 years x 2 = 25%: Yr 1: ($48,000 x.25) = $12,000; Yr 2: ($48,000 – $12,000) x.25 = $9,000; Yr 3: ($48,000 – $12,000 – $9,000) x.25 = $6,750

90. On January 1, 2018, 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, 2019 would be (a) $10,000. (b) $ 9,000. (c) $ 6,000. (d) $ 5,400. Solution: 1/5 years x 2 = 40%: Yr 1: ($25,000 x.40) = $10,000; Yr 2: ($25,000 – $10,000) x.40 = $6,000

91. On April 1, 2018, 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 2018 was 12,000 hours and the company uses the units-of-production method of depreciation, the depreciation expense for 2018 would be (a) $5,040. (b) $4,560. (c) $3,780. (d) $3,420. Solution: ($33,600 – $3,200) / 80,000 hrs = $0.38/hr; $0.38 x 12,000 = $4,560

92. 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. Solution: ($72,000 – $6,000) / 30,000 hrs = $2.2/hr; $2.2 x 5,000 = $11,000

93. 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. Solution: ($180,000 – $15,000) / 25,000 hrs = $6.6/hr; $6.6 x 3,300 = $21,780

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94. On April 1, 2018, Check Mate Ltd. places a new asset into service. The cost of the asset is $40,000 with an estimated 8-year life and $2,500 residual value. Assuming that Check Mate uses the double diminishing-balance method of depreciation, what is the carrying amount of the asset at December 31, 2018? (a) $32,500 (b) $30,625 (c) $38,125 (d) $35,000 Solution: 1/8 years x 2 = 25%: Yr 1: ($40,000 x.25) = 10,000 x 9/12 = $7,500; Carrying amount = $40,000 – $7,500 = $32,500

95. Cordo Ltd. uses the units-of-production depreciation method. A new asset is purchased for $30,000 that will produce an estimated 90,000 units over its useful life. Estimated residual value is $3,000. What is the depreciable cost per unit? (a) $3.30 (b) $3.00 (c) $0.33 (d) $0.30 Solution: ($30,000 – $3,000) / 90,000 = $0.30/unit

96. 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.

97. 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 98–99. On January 1, 2017, 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.

98. What is the depreciation expense for calendar 2017? (a) $ 3,000 (b) $ 6,000 (c) $12,000 (d) $14,000 Solution: 1/5 years x 2 = 40%: Yr 1: ($35,000 x.40) = $14,000

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

99. What is the balance in the Accumulated Depreciation account at the end of 2018? (a) $22,400 (b) $19,200 (c) $12,600 (d) $10,800 Solution: 1/5 years x 2 = 40%: Yr 1: ($35,000 x.40) = $14,000; Yr 2: ($35,000 – $14,000) x.40 = $8,400; $14,000 + $8,400 = $22,400

100. 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.

101. 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-of-production 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 net income compared to the straight-line depreciation method in the early years.

102. 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 net income for the current year be increased.

103. 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.

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(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.

105. 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 (b) $70,000 (c) $45,000 (d) $210,000 Solution: Carrying Amount: ($210,000 – $140,000) = $70,000 greater than net recoverable of $45,000; therefore, impairment for the difference of $25,000

106. 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

107. 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.

108. 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.

109. On December 31, 2018, Cee Corp. sells an asset that originally cost $300,000 for $75,000. The company recognized a loss on disposal of $25,000. What was the balance of the accumulated depreciation account after the current year’s depreciation of $15,000 was recorded? (a) $ 25,000 gain (b) $ 25,000 loss (c) $125,000 gain (d) $125,000 loss Solution: $300,000 – $75,000 – $25,000 = $200,000.

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

110. 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. Solution: Carrying Amount: ($15,000 – $14,000) = $1,000 loss as no offsetting proceeds

111. 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. Solution: Carrying Amount: ($14,000 – $12,000) = $2,000 less than proceeds of $3,000; therefore, a gain for the difference of $1,000

112. If disposal of an asset occurs during the year, depreciation is (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.

113. 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.

114. 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.

115. 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. Solution: Carrying Amount: ($32,000 – $16,000) = $16,000 less than proceeds of $37,000; therefore, a gain for the difference of $21,000 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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116. On July 1, 2018, 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, 2018, 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. Solution: Depreciation Jan 1 – July 1 = ($80,000 – $10,000) / 60 months x 6 months = $7,000; Carrying Amount: ($80,000 – $49,000 – $7,000) = $24,000 greater than proceeds of $20,000 therefore a loss for the difference of $4,000

117. An asset with a cost of $45,000 was sold for $9,500 and resulted in a gain of $2,000. How much was accumulated depreciation at the time of sale? (a) $39,500 (b) $45,000 (c) $37,500 (d) $35,500 Solution: $45,000 + $2,000 – $9,500 = $37,500

118. 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. (d) do not have physical substance.

119. 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.

120. 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.

121. An asset that cannot be sold separately in the market place is (a) a patent. (b) goodwill. (c) a copyright. (d) a trade name.

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122. 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.

123. On October 1, 2018, Benji Corporation purchased a copyright for $100,000. It is estimated that the copyright will have a useful life of 8 years with no residual value. The amount of amortization expense recognized for the calendar year 2018 would be (a) $0. (b) $3,125. (c) $1,042. (d) $100,000. Solution: $100,000 / 8 years x 3/12 months = $3,125

124. Which of the following combinations reflects intangible assets with a finite life? (a) copyrights and patents (b) copyrights and trademarks (c) trademarks and brands (d) brands and trade names

125. 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

126. 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.

127. The cost allocation of an intangible asset is referred to as (a) amortization. (b) impairment. (c) depreciation. (d) depletion.

128. The cost of a finite intangible asset is (a) not amortized, but the asset is tested periodically for impairment. (b) amortized and tested periodically for impairment. (c) neither amortized or tested periodically for impairment. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(d) amortized, but not tested periodically for impairment.

129. 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.

130. If a company incurs legal costs in unsuccessfully defending its patent, these costs would be debited to (a) Legal Expense. (b) Intangible Loss account. (c) Patent account. (d) Other Comprehensive Income.

131. 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.

132. 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.

133. 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.

134. 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.

135. Research costs (a) are classified as intangible assets. (b) must be expensed when incurred. Copyright © 2017 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, Seventh Canadian Edition

(c) should be included in the cost of the asset they relate to. (d) are capitalized and then amortized over their estimated useful life.

136. 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.

137. Depreciation expense and impairment losses are presented in (a) the operating section of the income statement. (b) the operating section and non-operating section of the income statement, respectively. (c) the non-operating section of the income statement. (d) the non-operating section and operating section of the income statement, respectively.

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. Boulder Corp. has the following assets: Buildings and Equipment (net) ............................... $12,500,000 Trade Receivables ................................................. 1,600,000 Inventory ................................................................ 2,300,000 Land ....................................................................... 1,500,000 The total amount reported under Property, Plant, and Equipment would be (a) $14,000,000. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(b) $16,300,000. (c) $20,500,000. (d) $17,900,000. Solution: $12,500,000 + $1,500,000 = $14,000,000

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 2018, Richlieu Corporation reported: Net sales .............................................. $30,000,000 Net income ........................................... 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%. Solution: $1,500,000 / ($12,000,000 + $20,000,000) / 2 = 9.4% 145. Richlieu’s profit margin is (a) 3.7%. (b) 5.0%. (c) 6.3%. (d) 8.0%. Solution: $1,500,000 / $30,000,000 = 5% 146. Richlieu’s asset turnover ratio is Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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(a) 2.5 times. (b) 1.9 times. (c) 1.5 times. (d) 1.3 times. Solution: $30,000,000 /($12,000,000 + $20,000,000) / 2 = 1.9 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 income by average total assets. (d) dividing average total assets by net sales.

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57.

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

Item 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73.

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

Item 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89.

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

Item Ans. Item 90. c 106. 91. b 107. 92. d 108. 93. d 109. 94. a 110. 95. d 111. 96. d 112. 97. a 113. 98. d 114. 99. a 115. 100. a 116. 101. b 117. 102. c 118. 103. b 119. 104. d 120. 105. a 121.

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

Item 122. 123. 124. 125. 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136. 137.

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

Item 138. 139. 140. 141. 142. 143. 144. 145. 146. 147. 148. 149.

Ans. c d d a 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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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.

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10. X

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 and Maintenance 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 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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11. Proceeds from salvage of demolished building ............................................... Total .........................................................................................................

3,500 $3,500

Instructions 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. Expense 11. (3,500) Totals $138,000

Land Improvements

Building

Other

Account Title

$16,000

Interest Expense

$ 12,000 27,000 3,000 52,000 750,000 $32,000 5,000 _______ $32,000

________ $844,000

Property Tax

_______ $21,000

Ex. 155 Absentia Inc. purchased a machine on January 1, 2018. 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

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(d) Capital (e) Capital (f) Operating (g) Operating

Ex. 156 Montgomery Enterprises purchased a delivery truck January 1, 2014 for $50,000. The truck was expected to have a useful life of 10 years and a residual value of $10,000. On January 1, 2018 the accumulated depreciation balance on the truck was $16,000 and the 2018 depreciation is calculated as $4,000. During 2018 Montgomery had the following transactions related to the truck: 1. Oil and filter change $800 2. Engine overhaul $7,500 which will extend the useful life of the truck by 3 years. The residual value has been revised to $12,500. 3. Insurance $2,500 4. Licence plate renewal $175 Instructions (a) Calculate the carrying amount of the truck on December 31, 2018. (b) Calculate the depreciation expense for 2019 using the straight-line method of depreciation. Solution 156 (a) Truck cost January 1, 2014 Engine overhaul (capital expenditures) Less: Accumulated depreciation—Truck ($16,000 + $4,000) Carrying Amount, December 31, 2018

$50,000 7,500 20,000 $37,500

(b) The revised annual deprecation (not illustrated in text but steps discussed) will be Carrying amount (original cost – accumulated deprec. + capital expenditures) – Revised residual amount Remaining estimated useful life

$37,500 – $12,500 ————––––—— (3+5) years

= $3,125

Ex. 157 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.

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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 157 (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. 158 A machine was acquired on January 1, 2018, 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 2018, 20,000 in 2019, 20,000 in 2020, 30,000 in 2021, and 15,000 in 2022. 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 158 (a) 1. Straight-line Asset Date Cost Jan. 1, 2018 $80,000 Dec. 31, 2018 Dec. 31, 2019 Dec. 31, 2020 Dec. 31, 2021 Dec. 31, 2022

Depreciation Rate

Depreciable Cost

20% 20% 20% 20% 20%

$75,000 75,000 75,000 75,000 75,000

Depreciation Accumulated Carrying Expense Depreciation Amount $80,000 $15,000 $15,000 65,000 15,000 30,000 50,000 15,000 45,000 35,000 15,000 60,000 20,000 15,000 75,000 5,000

Straight-line rate: 1 ÷ 5 = 20% Annual depreciation: ($80,000 – $5,000) ÷ 5 years = $15,000

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(a) 2. Units-of-production Asset Date Cost Jan. 1, 2018 $80,000 Dec. 31, 2018 Dec. 31, 2019 Dec. 31, 2020 Dec. 31, 2021 Dec. 31, 2022

Depreciation Per Component

Number Of Components

$0.75 0.75 0.75 0.75 0.75

15,000 20,000 20,000 30,000 15,000 100,000

Depreciation Accumulated Carrying Expense Depreciation Amount $80,000 $11,250 $11,250 68,750 15,000 26,250 53,750 15,000 41,250 38,750 22,500 63,750 16,250 11,250 75,000 5,000

Depreciation per component: ($80,000 – $5,000) ÷ 100,000 units = $0.75

(a) 3. Double diminishing-balance Asset Depreciation Date Cost Rate Jan. 1, 2018 $80,000 Dec. 31, 2018 40% Dec. 31, 2019 40% Dec. 31, 2020 40% Dec. 31, 2021 40% Dec. 31, 2022 40%

Asset Carrying Depreciation Accumulated Carrying Amount Expense Depreciation Amount $80,000 $80,000 $32,000 $32,000 48,000 48,000 19,200 51,200 28,800 28,800 11,520 62,720 17,280 17,280 6,912 69,632 10,368 10,368 *5,368 75,000 5,000

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. 159 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: 2017 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 2017 depreciation on the basis of a four-year life and estimated residual value of $200. 2018 Dec 31 Recorded 2018 depreciation. 2019 Jan 1 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.)

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Reporting and Analyzing Long-Lived Assets

Solution 159 (15 min.) 2017 Jul 1 Equipment ................................................................ Cash ($32,000 + $2,000) ................................... Nov 3

Dec 31

2018 Dec 31

2019 Jan

34000 34,000

Repairs and Maintenance Expense .......................... Cash ..................................................................

360

Depreciation Expense ............................................... Accumulated Depreciation—Equipment ............. [($34,000 – $200)/4  6/12]

4,225

Depreciation Expense ............................................... Accumulated Depreciation—Equipment ............. ($34,000 – $200)/4

8,450

Equipment ................................................................ Cash ..................................................................

1,600

360

4,225

8,450

1,600

Ex. 160 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 5-year life. Solution 160 (10 min.) Diminishing-balance rate = 1 ÷ 5 = 20% x 2 = 40% Carrying Amount Beginning Depreciation Amount 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

Accumulated

Expense $32,000 19,200 11,520 6,912 2,368*

Depreciation $32,000 51,200 62,720 69,632 72,000

Carrying 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.

Ex. 161 Chevrette Corporation purchased equipment on January 1, 2017 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.

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Instructions (a) Using straight-line depreciation, calculate the depreciation expense for the year ended December 31, 2017. (b) Now assume Chevrette uses the units-of-production depreciation. If 16,000 units of product are produced in 2017 and 24,000 units are produced in 2018, what is the carrying amount of the equipment at December 31, 2018? (c) Now assume Chevrette uses double diminishing-balance depreciation. What is the balance of the Accumulated Depreciation—Equipment account at December 31, 2019? Round amounts to the nearest dollar. Solution 161 (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 2017 16,000 units  $0.50 = $ 8,000 2018 24,000 units  $0.50 = 12,000 Accumulated depreciation = $20,000 Cost of asset Less: Accumulated depreciation Carrying amount at December 31, 2018

= $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 Amount of Year  Balance Rate = Expense Depreciation Year 2017 $87,000 25% $21,750 $21,750 2018 65,250 25% 16,313 38,063 2019 48,937 25% 12,234 50,297

Carrying End of $65,250 48,937 36,703

Ex. 162 Equipment acquired on October 1, 2018, 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. (b) double diminishing-balance method.

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Reporting and Analyzing Long-Lived Assets

Solution 162 (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. 163 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 163 (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

(c) Depreciation Expense ................................................................... Accumulated Depreciation—Vehicles 1 ..................................

13,600 3,960

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Accumulated Depreciation—Vehicles 2 .................................. Accumulated Depreciation—Vehicles 3 ..................................

6,400 3,240

Ex. 164 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 net income for the first two years? Which method would result in the lower total reported net income over the six-year period? Solution 164 (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

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

(b)

The units-of-production method would be more appropriate, given the variable usage expected of the laser during its useful life.

(c)

The units-of-production method provides the higher depreciation expense for the first

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Reporting and Analyzing Long-Lived Assets

two years, and therefore the lower net income. Over the six-year period, both methods result in the same total depreciation expense ($84,000) and, therefore, the same total net income. Ex. 165 On Jan 1, 2016, Holloway Inc. purchased equipment for $840,000, and, at Dec 31, 2016, recorded straight-line depreciation based on a twenty-year life with $20,000 residual value. Holloway tests its property, plant and equipment annually for impairment and at Dec 31, 2017, determined that the recoverable amount of this equipment was $722,000. Instructions (a) Determine the carrying amount of the equipment at December 31, 2017 assuming that depreciation has already been recorded for the year. (b) Determine the impairment loss (if any) and record the appropriate journal (if any) entry at December 31, 2017. (c) Calculate the 2018 annual depreciation expense subsequent to the impairment loss and record the appropriate journal entry. Solution 165 (a) Carrying amount at December 31, 2017 (before impairment loss): $840,000 – $20,000 ————————— 20 years

= $41,000 annual depreciation expense

Equipment has been depreciated for 2 years: $41,000  2 = $82,000 Carrying amount at December 31, 2017: $840,000 – $82,000 = $758,000 (b) Impairment Loss $758,000 – $722,000= $36,000 Dec 31/17

Impairment Loss............................................................ Accumulated Depreciation—Equipment ...............

36,000 36,000

= $39,000 annual 2018 depreciation expense

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

39,000 39,000

Ex. 166 Northwest Airlines purchased an aircraft on January 1, 2018, 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.

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Instructions Calculate the accumulated depreciation and carrying amount at December 31, 2020 using the straight-line method and the double diminishing-balance method. Solution 166 (20 min.) Straight-Line Depreciable Depreciation Annual Year Amount  Rate = Depreciation Amount 2018 $30,000,000 4% $1,200,000 2019 30,000,000 4% 1,200,000 2020 30,000,000 4% 1,200,000 Double Diminishing-Balance (rate is 1/25 = 4% x 2 = 8%) Carrying Amount Depreciation Annual Year Beginning Year  Rate = Depreciation Amount 2018 $35,000,000 8% $2,800,000 2019 32,200,000 8% 2,576,000 2020 29,624,000 8% 2,369,920

Accumulated Depreciation

Carrying

$1,200,000 2,400,000 3,600,000

$33,800,000 32,600,000 31,400,000

Accumulated Depreciation

Carrying

$2,800,000 5,376,000 7,745,920

$32,200,000 29,624,000 27,254,080

Ex. 167 Zen Fitness Inc. purchased a machine on April 1, 2018 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 straight-line depreciation for machinery, the company accountant neglected to follow policy and depreciated it in 2018 using the double diminishing-balance method. Income before income tax for the year ended December 31, 2018 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 net income. Ignore income tax. (Show calculations.) Solution 167 (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—Equipment ............................................... Depreciation Expense ................................................................. Correct income (before income tax): Net income as reported ........................................................................ Add: overstatement of depreciation expense ....................................... Correct Net income ..............................................................................

$36,000 17,250 $18,750 18,750 18,750

$73,000 18,750 $91,750

Ex. 168 On January 1, 2017, Wanders Corporation purchased and installed a telephone system at a

Reporting and Analyzing Long-Lived Assets

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cost of $55,000. The equipment was expected to last five years with no residual value. On January 1, 2018 more telephone equipment was purchased for $7,500 to augment the existing system. The new equipment is expected to have a useful life of six years. Through an error, the new equipment was debited to Telephone Expense. Wanders Corporation uses straight-line depreciation. Instructions Prepare a schedule showing the effects of the error in dollars on Telephone Expense, Depreciation Expense, and Net Income for each year and in total beginning in 2018 through the useful life of the new equipment. Use the following format: Telephone Expense Depreciation Expense Net income Overstated Overstated Overstated Year (Understated) (Understated) (Understated) —————————————————————————————————————————— — 2018 2019 2020 2021 2022 2023 Solution 168 (20 min.) Telephone Expense Depreciation Expense Net income Overstated Overstated Overstated Year (Understated) (Understated) (Understated) —————————————————————————————————————————— — 2018 $7,500 $(1,250)* $(6,250) 2019 (1,250) 1,250 2020 (1,250) 1,250 2021 (1,250) 1,250 2022 (1,250) 1,250 2023 (1,250) 1,250 Total $7,500 $(7,500) -0* $7,500  6 = $1,250

Ex. 169 On July 1, 2018, 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 2018 and 2019. (b) How much will the accumulated depreciation be on June 30, 2024?

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Solution 169 (15 min.) (a) Purchase Equipment ..................................................................................... Cash....................................................................................... Equipment ..................................................................................... Cash....................................................................................... Equipment ..................................................................................... Cash.......................................................................................

65,000 65,000 28,000 28,000 2,000 2,000

(Note these entries could be combined.) Depreciation 2018 Depreciation Expense ................................................................ Accumulated Depreciation—Equipment .............................. ($95,000 – $5,000)/6 × 6/12 = $7,500 Depreciation 2019 Depreciation Expense ................................................................... Accumulated Depreciation—Equipment ................................. ($95,000 – $5,000)/6 = $15,000

7,500 7,500

15,000 15,000

(b) On June 30, 2024, 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. 170 Arnprior Packing (ANP) tests its property, plant and equipment annually for impairment. On Jan 1, 2018, ANP purchased equipment for $650,000, and, at Dec 31, 2018, recorded straight-line depreciation based on a ten-year life with no residual value. However, at Dec 31, 2018, ANP also determined that the recoverable amount of this equipment was $540,000. Instructions (a) What is the formula to determine an impairment loss? (b) Calculate the equipment’s carrying amount at Dec 31, 2018 (c) Calculate the amount of the impairment loss Arnprior Packing will be required to record at Dec 31, 2018. Solution 170 (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, 2018 $650,000 – $0 —————— 10 years

= $65,000 annual depreciation expense

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Carrying amount at Dec 31, 2018: $650,000 – $65,000 = $585,000 (c) Impairment Loss $585,000 – $540,000= $45,000

Ex. 171 At the beginning of 2019, Annakin Corp. reviewed the expected useful life and residual value of their main packaging machine. This machine had cost $850,000 on Jan 1, 2009, had been expected to last for 25 years, with $75,000 residual value (straight-line depreciation). Now, ten years later, Annakin is revising the expected life to a total of 30 years (that is, 20 years remaining) with a $50,000 residual value. Instructions (a) Calculate the machine’s carrying amount at Dec 31, 2018. (b) As a result of this revision, will the depreciation expense for 2019 and subsequent years be higher or lower? Explain. (You do not have do show any detailed calculations.) (c) With this revision, will Annakin have to revise previous years’ depreciation expense? Why or why not? Solution 171 (15 min.) (a) Annual depreciation: $850,000 – $75,000 —————––––— 25 years

= $31,000

Carrying amount at Dec 31, 2018: $850,000 – (10 x $31,000) = $540,000 (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: $540,000 – $50,000 ————––––—— 20 years

= $24,500

(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 2009). Now, ten years later, new information has become available that was not available before, thus the change should only affect current and future periods.

Ex. 172 Solve for the missing items, assuming straight-line depreciation is used:

Cost

Machine A $150,000

Machine B $60,000

Machine C (i)

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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

$15,000 20 years (a) (b) 12 (c) $42,000 (d)

(e) (f) 20% $12,000 3.5 (g) (h) $2,000

$10,000 40 years (j) $6,000 (k) (l) $220,000 $18,000

Machine A $150,000 $15,000 20 years (a) 5% (b) $6,750 12 (c) $81,000 $42,000 (d) $(27,000)

Machine B $60,000 (e) 0 (f) 5 years 20% $12,000 3.5 (g) $42,000 (h) $20,000 $2,000

Machine C $(i) 250,000 $10,000 40 years (j) 2.5% $6,000 (k) 8 (l) $48,000 $220,000 $18,000

Solution 172 (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. 173 Hertford Manufacturing Inc. sold two machines in 2018. 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 1/15 5 yrs. $6,000 Straight-line Jun 30/18 $28,000 #2 $60,000 Jul 1/17 8 yrs. $3,000 Double diminishing- Dec 31/18 $45,000 balance Instructions (a) Calculate the depreciation on each machine to the date of disposal. (b) Prepare the journal entries to record 2018 depreciation and the sale of each machine. Solution 173 (20 min.) (a) Machine #1 Annual Year Depreciable Amount 2015 $70,000 2016 70,000 2017 70,000 2018 70,000 *Half a year only. Machine #2 Carrying Amount Year Beginning of Year  2017 $60,000

Depreciation Rate = 20% (1 ÷ 5) 20% 20% 20%

DDB Rate 25%

Accumulated Depreciation $ 7,000* 14,000 14,000 7,000*

Depreciation $ 7,000 21,000 35,000 42,000

Annual Depreciation $7,500*

Accumulated Depreciation $7,500

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2018

52,500

25%

13,125

20,625

DDB rate: 1 ÷ 8 = 12.5% x 2 = 25% *Half a year only. (b) Machine #1 Depreciation Expense ................................................................... Accumulated Depreciation—Equipment ................................. Cash ............................................................................................. Loss on Disposal ........................................................................... Accumulated Depreciation—Equipment ........................................ Equipment .............................................................................. *$76,000 – $42,000 = $34,000; $28,000 – $34,000 = ($6,000) loss. Machine #2 Depreciation Expense ................................................................... Accumulated Depreciation—Equipment ................................. Cash ............................................................................................. Accumulated Depreciation—Equipment ........................................ 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. 174 Paulson Corporation purchased equipment on January 1, 2016 for $168,000. It is estimated that the equipment will have a $14,000 residual value at the end of its 8-year useful life. It is also estimated that the equipment will produce 110,000 units over its 8-year life. On December 31, 2018, Paulson sells the equipment for $85,000. Paulson produced 20,000 units in 2016, 24,000 units in 2017 and 22,000 units in 2018. Instructions (a) Determine the carrying amount of the equipment at December 31, 2018 using the units-ofproduction method of depreciation. (b) Prepare the appropriate journal entry for the sale of the equipment. Solution 174 (a) Units-of-production method: Cost – Residual Value $168,000 – $14,000 —————–——— = $1.40 per unit Total estimated 110,000 units Units of activity 2016 20,000 units  $1.40 2017 24,000 units  $1.40 2018 22,000 units x $1.40 Accumulated depreciation

= $ 28,000 = 33,600 = 30,800 = $92,400

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Cost of asset $168,000 Less: Accumulated depreciation - Equipment 92,400 Carrying amount at December 31, 2018 $75,600 (b) Dec 31/18 Cash ................................................................................. Accumulated Depreciation—Equipment ............................. Equipment ................................................................ Gain on disposal ($85,000 – $75,600) ......................

85,000 92,400 168,000 9,400

Ex. 175 Coquitlam Corporation, a publicly-traded company, purchased a piece of equipment on January 1, 2017, for $275,000. It has an estimated useful life of eight years and a $25,000 residual value. Coquitlam uses straight-line depreciation and has a December 31 year end. At December 31, 2018, the equipment had a recoverable value of $200,000. Instructions (a) Calculate the equipment’s carrying amount at December 31, 2018. (b) Calculate the amount of the impairment loss at Dec 31, 2018. (c) Where should the impairment loss be reported in the financial statements? Solution 175 (10 min.) (a) Calculate the carrying amount at December 31, 2018: $275,000 – $25,000 ————————— 8 years

= $31,250 annual depreciation expense

Equipment has been depreciated for 2 years: $31,250  2 = $62,500 Carrying amount at December 31, 2018: $275,000 – $62,500 = $212,500 (b) Impairment Loss: $212,500 – $200,000= $12,500 (c) The impairment loss is reported in the operating section of the income statement.

Ex. 176 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. Licences ____ 2. Land _____ 7. Equipment ____ 3. Buildings _____ 8. Franchises ____ 4. Patents _____ 9. Goodwill ____ 5. Trademarks _____ 10. Land Improvements Solution 176 (10 min.)

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10. D

Ex. 177 (a) Alpha Corporation purchased equipment in 2011 for $120,000 and estimated a $12,000 residual value at the end of the equipment's 10-year useful life. At December 31, 2017, there was $75,600 in the Accumulated Depreciation account for this equipment using straight-line depreciation. On March 31, 2018, 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, 2018. (b) On July 31, 2018, Beta Corporation sold a delivery truck for $10,000. The truck originally cost $38,000 on January 1, 2010. 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. Instructions Prepare the appropriate journal entry to record the sale of the office equipment. Assume depreciation is up-to-date. Solution 177 (15 min.) (a) Depreciation Expense ................................................................... Accumulated Depreciation—Equipment ................................. ($120,000 – 12,000)/10 × 3/12 = $2,700) Cash ............................................................................................. Loss on Disposal ........................................................................... Accumulated Depreciation—Equipment ($75,600 + $2,700) ......... Equipment ..............................................................................

2,700 2,700

28,000 13,700 78,300 120,000

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(b) Cash ............................................................................................. Accumulated Depreciation—Vehicles............................................ Loss on Disposal ........................................................................... Vehicles .................................................................................

10,000 25,500 2,500 38,000

Accumulated depreciation to July 31, 2018: $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. 178 Prepare the journal entries to record the following transactions for Bermuda Inc., which has a calendar year end and uses straight-line depreciation. (a) On June 30, 2018, the company sold office equipment for $22,000. The office equipment originally cost $34,000 and had accumulated depreciation to the date of disposal of $15,000. (b) On September 30, 2018, the company sold delivery equipment for $15,500. The equipment was purchased on January 1, 2016, for $30,000 and was estimated to have a $2,000 residual value at the end of its 8-year life. Depreciation on the delivery equipment has been recorded through December 31, 2017. Solution 178 (15 min.) (a) June 30, 2018 Cash ......................................................................................... Accumulated Depreciation—Equipment ................................... Equipment..................................................................... Gain on Disposal ($34,000 – $22,000 – $15,000) ......... (b)

Sept 30, 2018 Depreciation Expense .............................................................. Accumulated Depreciation—Equipment ........................... ($30,000 – $2,000)/8  9/12 = $2,625) Cash ......................................................................................... Accumulated Depreciation—Equipment ($7,000 + $2,625) ...... Loss on Disposal ($30,000 – $15,500 – $9,625)....................... Equipment .......................................................................

22,000 15,000 34,000 3,000

2,625 2,625

15,500 9,625 4,875 30,000

Ex. 179

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(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 179 (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. 180 Presented below are selected transactions for Cameron Inc. for 2018: Jan 1 Retired a machine that was purchased on January 1, 2010. The machine cost $350,000, and had been estimated to have a useful life of 8 years with no residual value. Jun 30 Sold another machine for $90,000 that was purchased on January 1, 2015. The machine cost $125,000, and had a useful life of 10 years with no residual value. Sep 30 Retired a business automobile (no proceeds) that was purchased on September 30, 2012. The car cost $30,600 and was depreciated on a 6-year useful life with a residual value of $3,600. Instructions Record all entries required as a result of the above transactions. Cameron Inc. uses straight-line depreciation and has recorded depreciation through December 31, 2017. Solution 180 (15 min.) Jan 1 Accumulated Depreciation—Equipment ............................. 350,000 Equipment................................................................... 350,000 (note: machine is at the end of its service life; therefore, fully depreciated) Jun 30

Sep 30

Depreciation Expense ........................................................ Accumulated Depreciation—Equipment ...................... ($125,000 ÷ 10) = $12,500 annually  6/12 = $6,250)

6,250

Cash .................................................................................. Accumulated Depreciation—Equipment ($12,500  3.5 yrs) Equipment................................................................... Gain on Disposal ($90,000 – $81,250) ........................

90,000 43,750

Depreciation Expense ($30,600 – $3,600)/6) = $4,500 x 9/12 Accumulated Depreciation—Vehicles .........................

3,375

Accumulated Depreciation—Vehicles ($4,500  6) ............ Loss on Disposal ............................................................... Vehicles ......................................................................

27,000 3,600

6,250

125,000 8,750

3,375

30,600

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Ex. 181 Birmingham Limited sold the following two assets in 2018:

Cost Purchase date Useful life Residual value Depreciation method Date sold Selling price

Furniture $143,500 July 1, 2013 8 years $5,000 Straight-line September 30, 2018 $30,000

Equipment $162,000 January 1, 2015 5 years $33,000 Straight-line August 1, 2018 $75,000

Instructions Record all entries required to update depreciation and record the sales of the two assets in 2018. Birmingham has a December 31 year end. Solution 181 (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 .................................................................................. Accumulated Depreciation—Furniture*............................... Loss on Disposal ($143,500 – $30,000 – *$90,891) ........... *($143,500 – $5,000)/8  5.25 years = 90,891 Furniture .....................................................................

30,000 90,891 22,609

162,000 5,450

12,985

143,500

Ex. 182 (a) On January 1, 2018, 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, 2018. (b) On January 1, 2018, 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

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and any necessary adjusting entry at year end, December 31, 2018. Epsilon follows ASPE. (c) In 2018, Kappa Corporation incurred research costs of $350,000 to develop a new product. Record this event. Solution 182 (15 min.) (a) December 31, 2018 Amortization Expense ................................................................... Accumulated Amortization—Patents ...................................... (To record patent amortization) ($1,500,000 + $180,000) /5 years = $336,000 (b) January 1, 2018 Franchise ...................................................................................... Cash....................................................................................... (To record acquisition of Wing Food franchise)

336,000 336,000

500,000 500,000

December 31, 2018—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) 2018 Research Expense ........................................................................ Cash....................................................................................... (To record research expense for the current year)

350,000 350,000

Ex. 183 On January 1, 2016, Paint Palette Inc. paid $122,000 to obtain a patent. The cost of the patent registration was $2,500. The patent has a legal life of 20 years and a useful life of 15 years. On December 31, 2017 management determined that the recoverable amount of the patent is $100,000. On January 1, 2018, Paint Palette incurred a cost of $15,000 related to an unsuccessful patent infringement lawsuit. Instructions (a) Record the purchase of the patent. (b) Record amortization expense for the year ended December 31, 2017. (c) Determine if there is an impairment loss on the patent and if so, record the December 31, 2017 journal entry. (d) Record the legal costs incurred on February 1, 2018. Solution 183 (a) January 1, 2016 Patent ........................................................................................... 124,500 Cash....................................................................................... (To record patent purchase and registration: $122,000 + $2,500) (b) December 31, 2017 Amortization Expense ................................................................... Accumulated Amortization—Patents ......................................

124,500

8,300 8,300

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(To record patent amortization) ($124,500) /15 years (c) Carrying amount at December 31, 2017: Patent has been depreciated for 2 years: $8,300  2 = $16,600 Carrying amount at December 31, 2017: $124,500 – $16,600 = $107,900 Impairment Loss: $107,900 – $100,000= $7,900 December 31, 2017 Impairment Loss............................................................................ Accumulated Amortization—Patents ......................................

7,900 7,900

(d) February 1, 2018 Legal Expense .............................................................................. 15,000 Cash....................................................................................... (To record legal costs for unsuccessful patent infringement lawsuit)

15,000

Ex. 184 (a) A patent acquired for $2,250,000 at the beginning of the current year expires in 10 years and is expected to have economic value for 5 years. Present the adjusting entry to amortize the patent for the current year. (b) A renewable trade name purchased for $225,000 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. Solution 184 (10 min.) (a) Amortization Expense ($2,250,000/5) ........................................... Accumulated Amortization—Patents ......................................

450,000 450,000

(b) Zero. Trade names normally have indefinite lives and are not amortized.

Ex. 185 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 185 (10 min.) 1. (a) Legal costs to successfully defend a patent are capitalized. ($37,000 + $35,000)  12 years = $6,000)

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(b) Amortization Expense ............................................................ Accumulated Amortization—Patents................................ 2.

6,000 6,000

(a) Trademarks have an indefinite life and are not amortized. (b) No entry required.

Ex. 186 During the current year, Graydon 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 $82,500 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 $5,600,000. The company selling the patent has spent $1,625,000 on its research and development. The patent has a remaining life of 12 years. (d) Graydon is spending considerable time and money in developing a different patent for another product. So far, $3,600,000 has been spent this year on research and development. Graydon is hopeful it will obtain this patent in the next few years, but has not been successful as yet. Solution 186 (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 $5,600,000 should be amortized over its remaining useful life of 12 years because this is a shorter period of time than the patent’s legal life. The amount the selling company spent is irrelevant for Graydon. (d) Operating Expense. All research costs must be expensed. Development costs must also be expensed, unless they satisfy strict criteria.

Ex. 187 Nova Futures Inc. is a company that creates new products through research and development and has a December 31 fiscal year. In fiscal 2017, Nova Futures spent $452,000 researching a new process. The research was completed in fiscal 2018 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 2018 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 2017

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and 2018. Support your answer with calculations. Solution 187 (10 min.) 2017 $452,000 research costs shown as an expense on the income statement. 2018 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. 188 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. 2. 3. 4. 5.

Goodwill Land Improvements Buildings Accumulated Depreciation Trademarks

___ 6. ___ 7. ___ 8. ___ 9. ___ 10.

Research Costs Land Franchises Accumulated Amortization Equipment

Solution 188 (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

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10. PPE

Equipment

Ex. 189 Presented below is information related to tangible and intangible assets at year end, December 31, 2018, 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 189 (10 min.) ROUND MOUND CORPORATION Statement of Financial Position (Partial) December 31, 2018 Property, plant, and equipment Land ................................................................................ Buildings ......................................................................... Less: Accumulated depreciation—Buildings .................... ................................................................................... Intangible assets Patents............................................................................ Less: Accumulated amortization—Patents ...................... Goodwill .................................................................................

$1,500,000 $1,200,000 _ 600,000

$392,000 196,000

600,000 2,100,000

196,000 160,000

Ex. 190 The following information is available from recent annual reports of Hanson Corp. and Jasper Corp.: (in millions) Competitor A Competitor B Net income $ 550 $ 1,645 Sales 19,500 23,500 Average total assets 13,000 8,500 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.

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(b) What conclusion concerning the management of assets can be drawn from these data? Solution 190 (15 min.) (a) 1. Profit margin

Hanson $550 ÷ $19,500 = 2.8%

Jasper_ $1,645 ÷ $23,500 = 7.0%

2. Asset turnover ratio

$19,500 ÷ $13,000 = 1.5 times

$23,500 ÷ $8,500 = 2.8 times

3. Return on assets

$550 ÷ $13,000 = 4.2%

$1,645 ÷ $8,500 = 19.4%

(b) All of Jasper’s numbers are better than those of Hanson. Jasper is using its assets much more efficiently. It is generating close to the same amount of sales with only two-thirds the assets. Jasper’s return on assets is more than four and a half times that of Hanson. It also has two and a half times the profit margin.

Ex. 191 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)

Solution 191 (20 min.)

Sales Operating income Average total assets Profit margin Asset turnover Return on assets

Acme Corp. $ 8,500,000 950,000 (a) 4,750,000 (b) 11.2% (c) 1.8 times 20.0%%

Barker Limited (d) $4,000,000 280,000 (e) 2,000,000 7.0% (f) 2.0 times 14%

Connors Inc. (g) $1,800,000 (h) 72,000 600,000 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

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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. 192 After its first year of operations, Thompson Industries reported the following in its 2018 financial statements (in thousands):

Net sales Net income Total assets

2018 $125,650 10,975 150,510

2017 $83,750 5,550 69,800

Instructions (a) Calculate Thompson’s return on assets, asset turnover and profit margin. (b) What are two ways Thompson could increase its return on assets? Solution 192 (a) 1. Profit margin

2018 $10,975 $125,650 = 8.7%

2017 $5,550 $83,750 = 6.6%

Asset turnover ratio

$125,650_ ($150,510+69,800)/2 = 1.1 times

$83,750 ($69,800+$0)/2 = 2.4 times

Return on assets

$10,975 ($150,510+69,800)/2 = 10.0%

$5,550 ($69,800+$0)/2 = 15.9%

(b) If a company wants to increase its return on assets, it can do so either by increasing the margin it generates from each dollar of goods that it sells (profit margin), or by trying to increase the volume of goods or services that it sells (asset turnover).

Ex. 193 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 income 4. Decrease in net income

Return on Assets

Asset Turnover

Leave Blank

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5. Decrease in asset turnover due to decrease in net sales

Leave Blank

Solution 193 (20 min.)

1. Increase in net sales 2. Increase in average total assets 3. Decrease in profit margin due to decrease in net income 4. Decrease in net income 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 1 194. 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

Reporting and Analyzing Long-Lived Assets

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MATCHING QUESTIONS SET 2 195. 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 net income 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

Reporting and Analyzing Long-Lived Assets

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SHORT-ANSWER ESSAY QUESTIONS S-A E 196 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 196 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 197 In general, how does one determine whether or not an expenditure should be included in the acquisition cost of property, plant, and equipment? Solution 197 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 198 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 198 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 199 Depreciation is generally calculated using one of three different methods: straight-line, units-ofproduction or diminishing-balance. Assuming no corrections or revisions to estimates, compare the three depreciation methods distinguishing the annual and cumulative impact (e.g. over a 3year period) each would have on:

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(a) cash (b) the income statement (c) the statement of financial position Solution 199 (a) As depreciation does not involve cash, there is no effect on an annual or cumulative basis. Depreciation is a non-cash item. The entry to record depreciation is: Depreciation Expense Accumulated Depreciation

XXX XXX

(b) As the application of each method is different, so too will the annual depreciation expense and impact on the income statement. Straight-line depreciation expense will be the same each year, while the units-of-production depreciation expense will vary in accordance to use. The diminishing-balance (accelerated) method will result in higher depreciation expense in early years and lower in the assets latter years. On a cumulative basis, however, all three depreciation methods will result in the same total amount of depreciation and total impact on net income. (c) The accumulated depreciation reported on the statement of financial position will increase each year in accordance to the annual depreciation expense reported on the income statement which will be different as discussed in part (b). The total amount of accumulated depreciation will be the same on a cumulative basis under all three methods.

S-A E 200 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 in saying that the previous six income statements will have to be corrected? If not, explain your reasoning. Solution 200 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 201 What is a “significant component?” How does it affect calculation of depreciation?

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Solution 201 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 202 What is the difference between accounting depreciation and capital cost allowance? Solution 202 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 203 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. 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 203 MEMO DATE: today TO:

Ms. Dale Velletta, President

FROM: Martha King, Accountant RE:

Loss on Azilda showcase house

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

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 net income—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 204 Given the below independent situations identify which depreciation method, if any, best reflects the pattern in which the asset’s future economic benefits are expected to be consumed. Provide an explanation for any items where depreciation or amortization is not applicable. (a) Alfin Industries purchased a patent from another company that is expected to expire in 10 years. The patent has an estimated useful life of 8 years. (b) Carmichael & Sons purchased a building and a parcel of land for $750,000. The building has an estimated useful life of 20 years. (c) Commander Inc. purchased Captains Ltd. resulting in goodwill of $450,000. (d) Bags & Lifts purchased computer equipment with an estimated useful life of 3 years. The equipment is expected to be heavily used in the initial years of service. (e) Honeycomb Inc. purchased machinery equipment for $250,000. The equipment has an estimated useful life of 5 years and an estimated output total of 175,000 units - 25,000 will be produced in the first year; 30,000 in the second year and 35,000 in the third year; 40,000 in the fourth year and 45,000 in the fifth year. Honeycomb earns $6/unit produced. (f) LLB registered a trademark with the Canadian Intellectual Property Office 14 years ago. The company intends on renewing the trademark next year. Solution 204 (a) The patent is an intangible asset with a finite life. Intangible assets are typically amortized on a straight-line basis. As the patent has a finite life its amortizable cost should be allocated over the shorter of the estimated useful life and the legal life. The shorter would be the useful life of 8 years. (b) The building should be amortized on a straight-line basis over the estimated useful life of 20 years. Land is not depreciated because its usefulness and revenue-producing ability

Reporting and Analyzing Long-Lived Assets

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generally remain intact as long as the land is owned. (c) Goodwill has an indefinite life so it is not amortized but tested annually for impairment. (d) Given that the computer equipment is expected to be heavily used in the initial years of services, the diminishing-balance method would be most appropriate. (e) While the useful life of the machinery has been expressed in both years and volume of output, the units-of-production method is the best match for Honeycomb as revenue (the economic benefit) is based on units produced and production can be measured. (f) The trademark has an indefinite life so it is not amortized but tested annually for impairment.

S-A E 205 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 205 (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

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

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 licence but further information would have to be obtained with regard to the 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 206 Under International Financial Reporting Standards (IFRS), what are the requirements regarding presentation of long-lived assets? Solution 206 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 207 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. Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is prohibited

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Instructions Prepare, in point form, the points you would make to clarify these items for Jill. Solution 207 • 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. • 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 net income will also decrease if depreciation or amortization is taken at a higher rate.

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

OBJECTIVE FORMAT QUESTIONS 208. GTC Inc. purchased two new assets on January 1, 2016, the beginning of its fiscal year: a forklift (purchase price, $16,600; residual value, $1,600) and a sorting machine (purchase price, $60,000; residual value, $0). When determining the annual depreciation for these assets, GTC’s accountant assumed that the forklift and sorter had useful lives of 6 years and 10 years, respectively, and used these estimates to record depreciation each year. Unfortunately, the forklift should have had a useful life of 10 years, while the sorter should have had a useful life of 6 years. A full year of depreciation was recorded for both the forklift and sorter in 2016, 2017, and 2018 before the error was discovered. Instructions Select all of the statements that are correct. (a) The depreciation expense for the 2018 fiscal year for the forklift was understated by $1,000. (b) The depreciation expense for the 2018 fiscal year for the sorter was understated by $4,000. (c) Income before tax for the 2018 fiscal year was overstated by $3,000. (d) The depreciation expense for the fiscal years 2016, 2017 and 2018 for the forklift should be $1,500 in each year. (e) The carrying amount for the sorting machine at December 31, 2018 should be $40,000. (f) The asset turnover ratio was overstated for the 2018 fiscal year. (g) The return on assets ratio for the 2018 fiscal year was understated. Solution 208 (b), (c), and (d) are correct. (a) The depreciation expense for the forklift has been overstated by $1,000 for fiscal year 2018. Depreciation was recorded as $2,500 each year (($16,600-$1,600) ÷ 6 years = $2,500) but should have been recorded as $1,500 each year (($16,600-$1,600) ÷ 10 years = $1,500). (e) The carrying amount for the sorting machine at the end of fiscal year 2018 should be $30,000 ($60,000 ÷ 6 years = $10,000 x 3 years= $30,000 accumulated depreciation; carrying amount = $60,000 - $30,000 = $30,000). (f) The asset turnover ratio is understated. The numerator in this ratio is net sales and this is unaffected by the fact that depreciation was understated for the 2018 fiscal year. The denominator is the average total assets. Because depreciation expense has been understated (see calculations below) in each of the past three years, this denominator will be overstated. Consequently, the turnover ratio will be understated. Original Correct Depreciation Depreciation Forklift $2,500 $1,500 Sorter 6,000 10,000 Total $8,500 $11,500 (g) The effect on the return on assets ratio cannot be determined. The numerator in this ratio is net income and this will be overstated in 2018 because the depreciation expense is understated. The amount of the overstatement to income before taxes is $3,000 per year as

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given in item (c). The denominator in this ratio is average total assets and this amount will be overstated because lower amounts of accumulated depreciation have been recorded over the three-year period. Cumulatively, the amount of the overstatement of the carrying amount of assets is $9,000 ($3,000 x 3 years). Both the numerator and denominator of this ratio have been overstated. Without knowing the net income and the total asset amounts, it is not possible to conclude that these overstatements to both the numerator and denominator will increase or decrease the overall value of this ratio. This is particularly the case because the numerator was overstated by one year’s effect of the error while the denominator was overstated by the effect of three years of the error.

209. Determine if the company is using: (1) the straight-line method of depreciation, (2) diminishing-balance method of depreciation, (3) the units-of-production method of depreciation or (4) it cannot be determined from the information given. (a) Urban Corporation deducts the residual value of its depreciable assets from the asset’s cost in order to calculate the depreciable amount. (b) In 2018, Leader Industries Ltd. recorded $5,450 in depreciation for its assembly equipment. In 2019, Leader recorded $5,140 in depreciation for the same equipment. Production volumes have remained equal each year. (c) Uphill Ltd. reported the following depreciation schedule for its new office equipment: Year Units of Depreciation Accumulated Carrying Production Expense Depreciation Amount 2018 5,000 $3,000 $3,000 $27,000 2019 10,000 5,000 8,000 22,000 2020 12,500 5,000 13,000 17,000 2021 11,000 5,000 18,000 12,000 (d) In determining the annual deprecation on its processing equipment, Skyward Corp. estimated the total units the machine will be able to process over its useful life. (e) Airways Inc. depreciates its aircraft based on the number of flight hours each plane can fly over its useful life. (f) Country Villas Inc. uses a depreciation rate of 20% per year. (g) When using this method, no pro-ration is used in determining depreciation expense in the partial years of acquisition or disposal. Solution 209 (a) 4. Cannot Be Determined. The company could be using either straight-line depreciation or units-of-production depreciation as both of these methods deduct residual value from cost in order to arrive at the depreciable amount when calculating depreciation. (b) 2. Diminishing-Balance Method. In this case, the company is likely using the diminishingbalance method as the depreciation expense is declining each year. If the company was using straight-line depreciation, the yearly amounts would be equal. If the company was using units-of-production method, and the units of production were stable, the depreciation would also be equal each year. (c) 1. Straight-Line Method. The company is using the straight-line method as the depreciation is equal each year (except for year 1 where they only claimed a portion of the

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

depreciation, as the asset was acquired mid-year). They are not using the units-ofproduction method, as the depreciation is equal each year, while production volumes have varied. (d) 3. Units-of-Production. In this case, the company is likely using the units-of-production method using the total units the machine will produce as the allocation base for depreciation. (e) 3. Units-of-Production. The company is likely using the units-of-production method (or more appropriately, in this case, the units-of-activity method). They are using the total flight hours each plane can fly as the allocation base for depreciation. (f) 4. Cannot Be Determined. It depends on whether the percentage is being applied to a declining balance or to the original cost less residual value. If it is the former, the company would be using the diminishing-balance method. Whereas if it is the latter, the company would be using the straight-line method. (g) 3. Units-of-Production. Under the units-of-production method, depreciation expense is calculated based on the amount of units produced, which is automatically pro-rated to the amount of time the asset is available for use. 210. Select all of the following statements that are correct. (a) Estimated production expected over an asset’s useful life can be used as the denominator in the formula for straight-line depreciation. (b) If a company uses the diminishing-balance method of depreciation instead of the straightline method, the company will report higher amounts of net income over the useful life of the asset depreciated, if all other items on the income statement remain unchanged during those years. (c) The formula for depreciation using the diminishing-balance method is represented as: (cost – accumulated depreciation) x depreciation rate (d) If revenues and other expenses remain equal, a company will experience diminishing net income if the company use the units-of-production method of depreciation. (e) A company will often use straight-line depreciation so that the company’s accounting policies are consistent with depreciation required under the provisions of the Income Tax Act. (f) When assets are comprised of components that have different useful lives and straight-line depreciation is used, an average useful life is often used as the denominator for calculating depreciation expense. (g) An impairment loss is recorded as a credit to the accumulated depreciation account of the asset that is impaired. (h) If there are indicators that an asset’s value may be impaired due to obsolescence or declining demand for the products produced by the asset, a company must record an impairment loss on its financial statements. Solution 210 Answers (b), (c), and (g) are correct. (a) The formula for straight-line depreciation uses the asset’s useful life as the denominator. The formula is:

Reporting and Analyzing Long-Lived Assets

𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 =

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(𝐶𝑜𝑠𝑡 − 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑉𝑎𝑙𝑢𝑒) 𝑈𝑠𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒

(d) The depreciation expense claimed under the units-of-production method will vary based on the number of units produced each year. If a company produces more units each year, then net income will decline. If the company produces varying numbers of units each year, depreciation expense will increase or decrease accordingly. (e) For income tax purposes, the Canadian Revenue Agency requires that companies use capital cost allowance (CCA), which is usually a diminishing-balance method of depreciation with a 50% rate in the year of the asset’s purchase. (f) If assets are made up of components that have different useful lives, the cost of each component should be determined and separate calculations of depreciation should be made for each component. (h) Under ASPE, if there are indicators that an asset’s value may be impaired due to obsolescence or declining demand for the products produced by the asset, a company must first perform an impairment test by determining the asset’s recoverable amount. If the carrying amount exceeds an asset’s recoverable amount, then the company should record an impairment loss on its financial statements.

211. Determine whether the following that should be included or excluded when determining the cost of intangible assets on a company’s statement of financial position: (a) Legal fees incurred successfully defending a patent in a patent infringement case (b) Development costs for a new software application that is expected to be on the market in six months (c) Salaries paid to research staff who are researching new product ideas (d) Wages to an employee to develop a logo and brand for the company (e) Fee paid an external company to develop a trademark (f) The excess of the amount paid to purchase the net identifiable assets over the underlying fair value of those net identifiable assets Solution 211 (a) Included. Legal fees incurred successfully defending a patent are expected to have a future benefit and are; therefore, recorded as an intangible asset under the account Patents. (b) Included. In this case, the development costs appear to relate to a product that is feasible, has a completion date, and is intended to be sold by the company. Therefore, it is expected that these costs will have a future economic benefit to the company. In this case, the costs will be capitalized as an intangible asset under the account Development Costs. (c) Not included. In accounting, research costs are distinguished from development costs. Research costs are not considered to be assets because the existence of future benefits cannot yet be determined. Therefore, these costs are expensed in the accounting period they are incurred. (d) Not included. In this case, the trademark is internally developed. Therefore, these costs are not recorded as an intangible asset because they are difficult to distinguish from the

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

cost of developing the business as a whole. (e) Included. Since the cost of the trademark was paid to an external company, it is easily distinguished from other costs incurred by the company and because the cost is expected to benefit future periods, it should be capitalized as an intangible asset under the account Trademarks. (f) Included. This is considered goodwill. Goodwill will be recorded as an asset on the statement of financial position under the account Goodwill. It is not amortized because its useful life is considered indefinite but goodwill must be assessed annually to determine if the carrying amount of the goodwill has been impaired, in which case the carrying amount would be reduced accordingly.

212. The following data is provided for Crystal Homes Ltd. for the years 2017, 2018 and 2019:

Net Sales Net Income Total Assets

2017 $4,500,000 $785,000 $7,200,000

CRYSTAL HOMES LTD. Select Financial Data 2018 2019 $5,200,000 $5,800,000 $875,000 $1,127,000 $7,750,000 $7,750,000

Instructions Select all of the statements that are correct. (a) The asset turnover ratio for 2018 is 0.70 and for 2019 is 0.75. (b) The profit margin for 2018 is 16.8% and for 2019 is 19.4%. (c) Crystal Homes’ return on assets for 2018 is 11.7% and for 2019 is 14.5%. (d) The sales generating ability of the company’s assets has declined since 2018. (e) Crystal Homes’ return on assets ratio was higher in 2019 because both its asset turnover and profit margin improved in 2019. (f) The average return on assets ratio for this industry is 9%. Considering this, Crystal Homes’ return on assets is very good. (g) In 2020, Crystal Homes’ is expecting to invest in new assets and by the end of the year; total assets should be $500,000 higher at the end of that year compared to the end of 2019. The company also expects to increase sales and net income by 20% over 2019. If these results materialize, the company’s return on assets will increase by 2.4% over 2019. (h) In 2020, Crystal Homes is expecting to invest $750,000 in new assets and by the end of the year; total assets should be $750,000 higher at the end of that year compared to the end of 2019. The company also expects to increase sales by 15% and net income by 10%. If these results occur, the company’s profit margin will increase over 2019. Solution 212 (a), (b), (c), (e), (f), and (g) are correct while (d), and (h) are incorrect. The following chart shows the correct calculations for each year.

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Reporting and Analyzing Long-Lived Assets

Net Sales Net Income Total Assets Ratios: Asset Turnover Profit Margin ROA

Crystal Homes Ltd. (dollar amounts in thousands) 2017 2018 2019 2020 (Part g) $4,500 $5,200 $5,800 $6,960.0 $785 $875 $1,127 $1,352.4 $7,200 $7,750 $7,750 $8,250.0

2020 (Part h) $6,670.0 $1,239.7 $8,500.0

0.70 16.83% 11.71%

0.75 19.43% 14.54%

0.87 19.43% 16.91%

0.82 18.59% 15.26%

Average total assets

($7,200 + $7,750) / 2) = $7,475

($7,750 + $7,750) / 2) = $7,750

($7,750 + $8,250) / 2) = $8,000

($7,750 + $8,500) / 2) = $8,125

Asset Turnover

$5,200/$7,475

$5,800/$7,750

$6,960/$8,000

$6,670/$8,125

$875/$5,200 $875 / $7,475

$1,127/$5,800 $1,352.4/$6,960 $1,239.7/$6,670 $1,127/$7,750 $1,352.4/$8,000 $1,239.7/$8,125

17.44%

Formulas:

Profit Margin ROA

$785/$4,500

(d) The asset turnover ratio demonstrates a company’s ability to generate sales with their assets. From 2018 to 2019, the asset turnover has improved by 0.05. (h) The profit margin in 2020, in this scenario, will be 18.59%, which is a reduction of 0.84% over 2019.

CHAPTER 10 REPORTING AND ANALYZING LIABILITIES SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 M C F AN 11. 1 E K F AN 21. 3 E K F AN 2. 1 E K F AN 12. 1 M K F AN 22. 3 M K F AN 3. 1 M C F AN 13. 2 E K F AN 23. 3 M K F AN 4. 1 E C F AN 14. 2 M K F AN 24. 4 M C F AN 5. 1 M K F AN 15. 2 M K F AN 25. 4 M K F AN 6. 1 M C F AN 16. 2 M K F AN 26. 4 M C F AN 7. 1 M K F AN 17. 2 M K F AN 27. 4 M C F AN 8. 1 M K F AN 18. 3 M C F AN 28. 4 H C F AN 9. 1 E K F AN 19. 3 M K F AN 29. 4 E K F AN 10. 1 M K F AN 20. 3 M K F AN Multiple Choice Questions 30. 1 H C F AN 51. 1 H K F AN 72. 3 M K F AN F AN F AN F AN 31. 1 M K 52. 1,3 H K 73. 3 H K 32. 1 H AP F AN 53. 1,3 H K F AN 74. 3 H AP F AN 33. 1 H AP F AN 54. 2 M C F AN 75. 3 E K F AN 34. 1 M K F AN 55. 2 M C F AN 76. 4 H C F AN 35. 1 M K F AN 56. 2 M C F AN 77. 4 M AP F AN 36. 1 H C F AN 57. 2 E K F AN 78. 4 M AP F AN 37. 1 H AP F AN 58. 2 M K F AN 79. 4 E K F AN 38. 1 M C F AN 59. 2 M C F AN 80. 4 M AP F AN 39. 1 M C F AN 60. 2 M AP F AN 81. 4 M C F AN 40. 1 E AP F AN 61. 2 H AP F AN 82. 4 M AP F AN 41. 1 M AP F AN 62. 2 M C F AN 83. 4 H K F AN 42. 1 H AP F AN 63. 2 M K F AN 84. 4 M K F AN 43. 1 M AP F AN 64. 2 H C F AN 85. 4 M C F AN 44. 1 M AP F AN 65. 2 E K F AN 86. 4 E C F AN 45. 1 M AP F AN 66. 2 M K F AN 87. 4 M K F AN 46. 1 M C F AN 67. 2 M K F AN 88. 4 M AP F AN 47. 1 M AP F AN 68. 3 M K F AN 89. 4 M AP F AN 48. 1 E AP F AN 69. 3 M K F AN 90. 4 H AP F AN 49. 1 M AP F AN 70. 3 E C F AN 91. 4 H AP F AN 50. 1 E K F AN 71. 3 E K F AN 92. 4 M AP F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional & Ethical Behaviour CM = Communication AACSB: AN = Analytic E = Ethics CM = Communication

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian Edition

LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting P = Professional & Ethical Behaviour CM = Communication AACSB: AN = Analytic E = Ethics CM = Communication

Reporting and Analyzing Liabilities

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type

Item

Type

Item

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

TF TF TF TF TF TF TF TF

9. 10. 11. 12. 30. 31. 32. 33.

TF TF TF TF MC MC MC MC

34. 35. 36. 37. 38. 39. 40. 41.

13. 14. 15. 16. 17.

TF TF TF TF TF

54. 55. 56. 57. 58.

MC MC MC MC MC

59. 60. 61. 62. 63.

18. 19. 20. 21.

TF TF TF TF

22. 23. 52. 53.

TF TF MC MC

68. 69. 70. 71.

24. 25. 26. 27. 28. 29. 76.

TF TF TF TF TF TF MC

77. 78. 79. 80. 81. 82. 83.

MC MC MC MC MC MC MC

84. 85. 86. 87. 88. 89. 90.

Type:

TF = True-False Ex = Exercise

Type Item Type Learning Objective 1 MC 42. MC MC 43. MC MC 44. MC MC 45. MC MC 46. MC MC 47. MC MC 48. MC MC 49. MC Learning Objective 2 MC 64. MC MC 65. MC MC 66. MC MC 67. MC MC 98. Ex Learning Objective 3 MC 72. MC MC 73. MC MC 74. MC MC 75. MC Learning Objective 4 MC 91. MC MC 92. MC MC 111. Ex MC 112. Ex MC 113. Ex MC 114. Ex MC 115. Ex

Item

Type

Item

Type

50. 51. 52. 53. 93. 94. 95. 96.

MC MC MC MC Ex Ex Ex Ex

97. 119. 120. 121. 127. 128.

Ex Ma SAE SAE CP CP

99. 100. 101. 102. 103.

Ex Ex Ex Ex Ex

104. 119. 122.

Ex Ma SAE

105. 106. 107. 108.

Ex Ex Ex Ex

109. 110. 119. 129.

Ex Ex Ma CP

116. 117. 118. 119. 124. 125. 126.

Ex Ex Ex Ma SAE SAE SAE

130. 131.

CP CP

MC = Multiple Choice Ma = Matching SAE = Short-Answer Essay CP = CPA

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

CHAPTER LEARNING 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 or operating cycle. 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 tax 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 non-current debt and reported as a current liability. All of the above are “certain” or determinable liabilities. Provisions are “uncertain” liabilities that are recorded because their outcome is considered probable and can be measured. A contingent liability is an uncertain liability that is not recorded because it does not meet the two conditions necessary for recognition as a provision or because its outcome cannot be determined. The terms and nature of each recorded provision and contingent liability should be described in the notes accompanying the financial statements unless the probability of an outflow of resources arising from a contingent liability is remote.

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 of 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. Within the current liability section, items are listed in the order they fall due. Typically bank indebtedness (operating lines of credit) is listed first, followed by accounts payable and other types of payables followed by unearned revenue and the current portions of any loans. 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 the impact of unrecorded debt, such as operating lease obligations, when interpreting these ratios.

Account for bonds payable (Appendix 10A). When bonds 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 face value and price of the bonds. They are amortized to interest expense over the life of the bonds using the effective-interest method of amortization. Amortization is calculated as the difference

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between the interest paid and the interest expense. Interest paid is calculated by multiplying the face value of the bonds by the coupon interest rate. Interest expense is calculated by multiplying the carrying amount of the bonds (which is equal to their present value at that time) at the beginning of the interest period by the market interest rate when the bonds were issued. 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, Seventh Canadian

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. If drawing on an operating line of credit results in a negative cash balance, a current liability known as bank indebtedness results.

5. Interest expense on a bank loan payable is only recorded at maturity.

6. When a business sells an item and collects Harmonized Sales Tax (HST) on it, a current liability arises. 7. Payroll liabilities include the employer’s share of CPP contributions and EI premiums.

8. Provisions are liabilities of uncertain timing or amount, along with some uncertainty as to whether the liability will have to be paid.

9. A contingent liability may materialize in the future because of something that happened in the past.

10. Under IFRS, contingent liabilities should be recorded in the accounts if there is a remote possibility that the contingency will actually occur. 11. A financial liability means there is a contractual obligation to pay cash in the future.

12. Unearned revenue is a financial liability.

13. 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.

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14. Long-term notes payable can only have floating interest rates.

15. Secured notes are often also referred to as mortgages.

16. Unsecured notes are issued against the general credit of the borrower.

17. Instalment payments consist of a mix of interest on the unpaid balance of the loan and a reduction of the loan principal.

18. The classification of a liability as current or non-current is important because it may affect the evaluation of a company’s liquidity.

19. The debt to total assets ratio measures the percentage of the total assets provided by creditors. 20. “Off-balance-sheet financing” refers to a situation where liabilities are recorded in the income statement instead of the statement of financial position. 21. Interest (finance) expenses are separately reported in the “other gain and revenues” section of the income statement.

22. The terms of an operating line of credit and a notes (loans) payable are disclosed in the notes to the financial statements.

23. 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.

24. The face value of a bond is the amount of principal and interest due at the maturity date.

25. All transactions between bondholders and other investors must be recorded by the issuing corporation.

26. 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.

27. If bonds are issued at a discount, the issuing corporation will pay a principal amount that is

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less than the face amount of the bonds on the maturity date.

28. Amortization of a bond premium decreases interest expense recorded by the issuer.

29. 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.

Ans. T F T T F T T F

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

Ans. T F T F T F T T

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

Ans. T T T F F T T F

Item 25. 26. 27. 28. 29.

Ans. F F F T T

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

MULTIPLE CHOICE QUESTIONS 30. The entry to record interest expense on a bank loan payable is a (a) debit to interest expense and credit to note payable. (b) debit to note payable and credit to interest revenue. (c) debit to interest payable and credit to interest revenue. (d) debit to interest expense and credit to interest payable.

31. Which of the following statements is true? (a) 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. (b) “Current maturities of non-current debt” refers to the amount of interest on notes payable that must be paid in the current year. (c) 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. (d) A non- current liability is an obligation that is expected to be paid within one year.

Use the following information to answer questions 32–33. Angel Eyes Corporation operates on a calendar year basis. The company is in its first year of operations and received its annual property tax bill on March 31 for $21,000. The bill is due May 1. Even though the company records adjusting entries on a monthly basis, no entries related to property taxes have been recorded.

32. The March 31 entry to record property tax should be (a) debit property tax expense $5,250 and credit property tax payable $5,250. (b) debit property tax expense $21,000 and credit property tax payable $21,000. (c) debits to prepaid property tax and property tax expense for $15,750 and $5,250, respectively and credits to property tax payable and cash for $15,750 and $5,250, respectively. (d) debits to prepaid property tax and property tax expense for $15,750 and $5,250, respectively and credit to property tax payable for $21,000. Solution: $21,000 / 12 x 3 = $5,250

33. Assuming appropriate adjusting entries were completed for the April month end, what entry should be recorded for the payment on May 1? (a) debit prepaid property tax $21,000 and credit cash $21,000 (b) debits to prepaid property tax and property tax expense for $14,000 and $7,000, respectively and credit to cash for $21,000 (c) debits to prepaid property tax and property tax payable for $14,000 and $7,000, respectively and credit to cash $21,000 (d) debit property tax payable $15,750 and credit to cash $15,750. Solution: $21,000 – $5,750 – $1,750 = $14,000; $5,750 + $1,750 = $7,000

34. Which of the following statements is false?

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(a) Notes payable usually require the borrower to pay interest. (b) Notes payable are sometimes used instead of accounts payable. (c) Most notes and bank loans are non-interest bearing. (d) Notes payable reflect a promise to repay a specified amount of money either at a fixed future date or on demand.

35. 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

36. Failure to record a liability will probably (a) result in overstated net income. (b) result in overstated total liabilities and shareholders’ equity. (c) have no effect on net income. (d) result in overstated total assets.

37. McMichael Exhibits Inc. received its annual property tax bill for $26,200 in January. It was paid when due on March 31. McMichael Exhibits year end is Dec 31. The Dec 31 balances should be (a) $6,550 for Prepaid Property Tax; $19,650 for Property Tax Expense. (b) $0 for Prepaid Property Tax; $0 for Property Tax Payable. (c) $6,550 for Prepaid Property Tax; $6,550 for Property Tax Payable. (d) $2,183 for Prepaid Property Tax; $24,017 for Property Tax Expense. 38. 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).

39. 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 40–41. 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.

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40. 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 Bank Loan Payable ................................................................ (b) Cash ............................................................................................. 150,000 Bank Loan Payable ................................................................ (c) Cash ............................................................................................. 150,000 Interest Expense ........................................................................... 6,750 Bank Loan Payable ................................................................ (d) Cash ............................................................................................. 150,000 Interest Expense ........................................................................... 6,750 Bank Loan Payable ................................................................ Interest Payable .....................................................................

150,000 150,000

156,750

150,000 6,750

41. 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 Solution: Interest payable = $150,000 x.06 x 6/12 = $4,500; Interest expense = $150,000 x.06 x 3/12 = $2,250

Use the following information for questions 42–43. On October 1, 2018, 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.

42. What adjusting entry is required at December 31, 2018? (a) Interest Payable ............................................................................ Interest Expense .................................................................... (b) Interest Expense ........................................................................... Interest Payable ..................................................................... (c) Interest Expense ........................................................................... Interest Payable ..................................................................... (d) Interest Expense ........................................................................... Bank Loan Payable ................................................................ Solution: ($80,000 x.04 / 12 = $267

800 800 800 800 267 267 267 267

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43. The entry by Mekhi’s Golf Service to record payment of the loan and accrued interest on January 1, 2019 is (a) Bank Loan Payable ....................................................................... 83,200 Cash....................................................................................... 83,200 (b) Bank Loan Payable ....................................................................... 80,000 Interest Payable ............................................................................ 267 Cash....................................................................................... 80,267 (c) Bank Loan Payable ....................................................................... 80,000 Interest Payable ............................................................................ 800 Cash....................................................................................... 80,800 (d) Bank Loan Payable ....................................................................... 80,000 Interest Expense ........................................................................... 800 Cash....................................................................................... 80,800

44. 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 Solution: ($8,960 / 1.13 x.13) = $1,031)

45. On January 1, 2018, 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, 2018, 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.

46. 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 47–48. The following totals for the month of April were taken from the payroll register of Branson Corp.: Gross salaries ................................. $26,850 CPP withheld .................................. 1,330 Employee income taxes withheld .... 5,785 Medical insurance deductions ......... 930 EI withheld ...................................... 478 Union dues withheld ........................ 446

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47. The journal entry to record payment of the net payroll would include a (a) debit to Salaries Payable for $17,881. (b) debit to Salaries Payable for $15,300. (c) debit to Salaries Payable for $21,065. (d) credit to Cash for $26,850. Solution: ($26,850 – $1,330 – $5,785 – $930 – $478 – $446) = $17,881 48. The journal entry to record the accrual of the employee’s portion of Canada Pension Plan (CPP) would include a (a) debit to CPP Payable of $1,330. (b) debit to CPP Expense of $1,330. (c) credit to Employee Benefits Expense of $1,330. (d) credit to CPP Payable of $1,330.

49. If interest is due at maturity, a $50,000, 4%, 9-month note payable requires an interest payment of (a) $1,500. (b) $222. (c) $167. (d) $2,000. Solution: $50,000 x.04 / 12 x 9 = $1,500

50. 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.

51. One example of a liability that is not a financial liability is a) notes payable. b) unearned revenue. c) bonds payable. d) financial lease.

52. 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. (c) neither disclose in the notes nor accrue the loss. (d) pay the amount estimated.

53. 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.

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(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.

54. Which of the following statements is true? (a) With fixed principal payments on a long-term note payable, the principal portion increases each period. (b) With fixed principal payments on a long-term note payable, the interest portion decreases each period. (c) With fixed principal payments on a long-term note payable, the interest portion does not change each period. (d) With fixed principal payments on a long-term note payable, the interest portion increases each period.

55. Which of the following statements is false? (a) With blended principal and interest payments, the equal periodic payments result in the interest portion increasing each period. (b) With blended principal and interest payments, the equal periodic payments result in the principal portion increasing each period. (c) With blended principal and interest payments, the equal periodic payments result in the interest portion decreasing each period. (d) With blended principal and interest payments, the equal periodic payments are constant each period.

56. 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.

57. 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.

58. A long-term note secured by collateral maybe referred to as a (a) premium. (b) debenture. (c) bond. (d) mortgage.

59. As blended principal and interest payments are made on a long-term loan, (a) the interest portion increases and the principal portion decreases.

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(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.

60. A five-year, 4%, $80,000 note payable is issued on January 1. Terms include fixed annual principal payments of $16,000, plus interest on the outstanding balance. The entry to record the first instalment payment will include a (a) debit to Notes Payable of $16,000. (b) credit to Interest Expense of $3,200. (c) credit to Notes Payable of $12,800. (d) debit to Cash of $16,000.

61. 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. Solution: ($1,799 – (($60,000 – $1,549) x.05 x 1/12 = $244) = $1,555; $1,549 = ($1,799 – ($60,000 x.05 x 1/12 = $250))

62. 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

63. 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.

64. With fixed principal payments, the interest ___ each period as the principal ___. a) decreases, decreases b) increases, increases c) increases, decreases d) decreases, increases

65. Instalments can be paid a) monthly. b) quarterly. c) semi-annually.

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d) all of the above

66. With fixed principal loans, 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. d) varying periodic amounts including interest.

67. 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.

68. Which of the following statements is true? (a) Liquidity ratios measure a company’s long-term ability to pay debt. (b) Solvency ratios measure a company’s ability to repay current debt. (c) A high liquidity ratio generally indicates that a company has a greater ability to meet its current obligations. (d) Solvency ratios measure a company’s ability to survive on a short-term basis.

69. Which of the following statements is true? (a) Current liabilities are generally presented on the statement of financial position in order of liquidity, but IFRS allows presentation in reverse order of liquidity as well. (b) Current liabilities are listed in order of descending dollar value. (c) All companies are prohibited to report current liabilities in reverse order of liquidity. (d) Current liabilities are listed in order of ascending dollar value.

70. 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.

71. Liquidity ratios measure a company's (a) operating cycle. (b) revenue-producing ability. (c) short-term debt-paying ability. (d) long-range solvency.

72. A measure of a company's solvency is the (a) inventory turnover ratio. (b) current ratio. (c) times interest earned ratio.

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

(d) asset turnover ratio.

73. The times interest earned ratio is calculated by dividing (a) net income by interest expense. (b) net income plus income tax expense by interest expense. (c) net income plus interest expense by interest expense. (d) net income plus interest expense plus income tax expense by interest expense. 74. Last year, Hadley Bakery’s income statement reported the following: net income, $325,600; interest expense, $81,400; and income tax expense, $113,960. The company’s times interest earned ratio is (a) 5.0 times. (b) 6.4 times. (c) 4.0 times. (d) 4.6 times. Solution: ($325,600 + $81,400 + $113,960) / $81,400 = 6.4 x

75. 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.

76. Which of the following statements is true? (a) The carrying amount of bonds issued at a discount will initially be higher than the face value. (b) The carrying amount of a bond is its face value less any unamortized premium or plus any unamortized discount. (c) The carrying amount of a bond is its face value plus any unamortized premium or less any unamortized discount. (d) The carrying amount of bonds issued at a premium will initially be lower than the face value.

77. If a bond has a face value of $10,000, a 6% coupon interest rate and a 4% market interest rate, then the semi-annual interest payment will be (a) $600. (b) $400. (c) $200. (d) $300. Solution: $10,000 x.06 x 6/12 = $300

78. 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.

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(d) debit to Interest Expense of $250. Solution: $60,000 x.05 x 1/12 = $250

79. 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.

80. 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. Solution: $100,000 x 1.0225= $102,250

81. 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.

82. $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. Solution: $8 million x.03 = $240,000 semi-annual interest to be received for 20 periods (10 years x 2 times per year)

83. $2 million, 6%, 10-year bonds are issued when the market rate is 8%. Interest will be paid quarterly. 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) 4%. (b) 8%. (c) 6%. (d) 2%.

84. The market interest rate is often called the (a) stated interest rate. (b) effective interest rate.

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85. 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.

86. 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.

87. 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.

88. 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. (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 89–90. Coldwater Inc. issues $575,000 of 4%, 8-year bonds for cash proceeds of $502,774. The market interest rate is 6%. Interest is paid semi-annually.

89. To the nearest dollar, how much bond interest expense is recorded on the first interest date? (a) $11,500 (b) $15,083 (c) $17,250 (d) $3,583 Solution: $502,774 x.03= $15,083

90. To the nearest dollar, what is the carrying amount of the bonds after the first interest payment?

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(a) $ 506,357 (b) $ 507,802 (c) $ 499.191 (d) $ 575,000 Solution: (($502,774 x.03) – ($575,000 x 0.02) = $3,583 + $502,774 = $506,357

91. How much is the discount or premium on the bond? (a) $575,000 premium (b) $72,226 premium (c) $502,747 discount (d) $72,226 discount Solution: $575,000 – $502,774 = $72,226 discount

92. 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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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45.

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

Item Ans. 46. b 47. a 48. d 49. a 50. b 51. b 52. a 53. a 54. b 55. a 56. c 57. d 58. d 59. c 60. a 61. a

Item 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77.

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

Item 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92.

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

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Reporting and Analyzing Liabilities

EXERCISES Ex. 93 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 93 (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. 94 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 94 (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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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

Ex. 95 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. (d) Prepare the entry to record repayment of the loan at maturity on August 1. Solution 95 (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. 96 Jancy Corporation had cash sales of $150,000 for the month of August. Sales are subject to 13% harmonized sales tax (HST). Prepare the entry to record the sales. Solution 96 (5 min.) Cash ............................................................................................. Sales Revenue ....................................................................... Sales Tax Payable ($150,000 x 13%).....................................

169,500 150,000 19,500

Ex. 97 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). Apr 15 Paid the note due.

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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 97 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 ....................................................................... Employee 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. 98 On December 31, 2018, 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, 2019 to record the first monthly payment. Include your calculations. Solution 98 (5 min.) Jan 31 Interest Expense.............................................................. Mortgage Payable ........................................................... Cash .........................................................................

1,825 790 2,615

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

To record mortgage payment Calculations: $365,000  6% x 1/12 = $1,825 interest $2,615 – $1,825 = $790 principal repayment

Ex. 99 On January 1, 2018, Barney Inc. issues a $480,000, 4%, 15-year note payable. The terms require semi-annual fixed principal payments of $16,000 plus applicable interest. Instructions: Prepare the journal entry at Dec 31, 2018 to record the second semi-annual payment. Include your calculations. Solution 99 Dec. 31 Interest Expense [($480,000 – $16,000)  4% x 6/12] ..... Notes Payable ................................................................. Cash ......................................................................... To record note payment

9,280 16,000 25,280

Ex. 100 On December 31, 2018, 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, 2019. Instructions (a) Record the issue of the mortgage payable on December 31, 2018. (b) Record the first two instalment payments on January 31, 2019 and February 28, 2019, 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 100 (a) Dec 31, 2018

(b) (1) Jan 31, 2019

Feb 28, 2019

(b) (2) Jan 31, 2019

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

Mortgage Payable ($2,220 – $1,000) .......................... Interest Expense ($200,000 x 6% x 1/12)....................

1,220 1,000

200,000

2,667

2,659

Reporting and Analyzing Liabilities

Cash .................................................................... Feb 28, 2019

Mortgage Payable ($2,220 – $994) ............................. Interest Expense [($200,000 – $1,220) x 6% x 1/12] ... Cash ....................................................................

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2,220 1,226 994 2,220

Ex. 101 The following instalment payment schedule is for a long-term instalment note 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 note? (c) Prepare the journal entry to record the first instalment payment. (d) What are the current and non-current portions of the note at the end of period 1? Solution 101 (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 = $22,546.82 + $76,147.61 = $98,712.43

Ex. 102 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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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

WONDER WATER INSTALMENT PAYMENT SCHEDULE- FIXED PRINCIPAL PAYMENTS Interest Period Jan 1 Mar 1 Jun 1 Sep 1 Dec 1

Cash Pmt ? 8,319 ? ?

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 102 (a) Interest Period Jan 1 Mar 1 Jun 1 Sep 1 Dec 1

Cash Pmt

Interest Expense

Reduction of Principal

8,375 (1) 8,319 8,263 (4) 8,206 (6)

3,375 3,319 (2) 3,263 3,206 (5)

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. 103 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 (a) Complete the instalment schedule listed below (round to the nearest dollar).

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(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

Reduction of Principal

10,785 ? 10,785 10,785 ?

? ? 6,956 ? ?

3,785 3,807 ? ? ?

Cash Pmt

Interest Expense (D x 7% x 1/12)

Reduction of Principal

10,785 10,785 10,785 10,785 10,785

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)

Principal 1,200,000 1,196,215 ? ? 1,184,727 ?

Solution 103 (a) Interest Period Jan 1 Feb 1 Mar 1 Apr 1 May 1 Jun 1

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 .................................................................... Bank Loan Payable ................................................................

6,911 3,874

10,785

Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

10 - 30 Edition

Cash ................................................................................

10,785

Ex. 104 On January 1, 2018 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 semi-annually 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 104 (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 interest expense in regards to financing. Principal repayments are not reflected on the income statement.

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Ex. 105 National Supplies Corporation has the following selected accounts at December 31, 2018 after posting adjusting entries: Accounts Payable ...................................................... $ 85,250 Bank Loan Payable, 3-month ..................................... 125,000 Accumulated Depreciation—Equipment ..................... 22,000 Notes Payable, 5-year, 4% ......................................... 75,000 Employee Benefits Expense ...................................... 7,000 Interest Payable ......................................................... 10,400 Mortgage Payable ...................................................... 165,000 Sales Tax Payable ..................................................... 16,000 Instructions (a) Prepare the current liability section of National Supplies’ statement of financial position, assuming $24,000 of the mortgage is payable next year. (b) Comment on National Supplies’ liquidity, assuming total current assets are $225,000. Solution 105 (10 min.) (a) NATIONAL SUPPLIES CORPORATION Statement of Financial Position (partial) December 31, 2018 Current Liabilities Current portion of long-term debt .................................................. Bank loan payable, 3-month .......................................................... Accounts payable .......................................................................... Sales tax payable .......................................................................... Interest payable............................................................................. Total current liabilities .............................................................

$ 24,000 125,000 85,250 16,000 10,400 $260,650

(b) The liquidity position looks unfavourable reflecting a current ratio of 0.86 : 1. The current assets of $225,000 are not sufficient to meet the company’s current obligations of $260,650 when due. There is a shortfall of $35,650.

Ex. 106 The following information is available from the 2018 financial statements of Alpha Inc. and Omega Ltd.: (in millions) Alpha Inc. Omega Ltd. Income tax expense .......................................... $ 361 $ 766 Interest expense................................................ 480 1,423 Net income ........................................................ 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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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

(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 106 (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 long-run solvency than Omega. Omega’s debt load is extremely high, and should be a cause for alarm.

Ex. 107 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

2019 1.6:1 5.2 6.8

2018 1.2:1 7.5 9.4

Solution 107 (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.

Other information that would be useful includes:

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(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. 108 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 108 1. C 2.

10. C

Ex. 109 Kahluha Manufacturers Inc. reported the following information in its financial statements: KAHLUHA MANFACTURERS INC. Statement of Financial Position June 30

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

Assets ......................................................................................... 2019 Cash .................................................................................... $32,000 Accounts receivable ............................................................. 7,500 Prepaid Insurance ................................................................ 1,100 Inventory .............................................................................. 220,000 Building ................................................................................ 145,000 Equipment ............................................................................ 36,000 Total Assets ................................................................................ $441,600

2018 $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 Income from operations .............................................................. 150,000 Interest expense ......................................................................... 6,000 Income tax expense .................................................................... 36,000 Net income.................................................................................. $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 2018- 2019 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 109 (a) Debt to total assets

2019 =(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

2018 =(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. Kahluha’s times interest earned ratio is better than industry average, which means Kahluha has

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a greater ability to meet interest payments as they come due than industry average.

Ex. 110 The following data (000’s) has been extracted from the year-end reports for Grant Corporation: 2019 2018 Interest expense $28 $30 Income tax 270 240 Net income (a) 600 Current assets 3,085 (b) Total Assets (c) 3,600 Current Liabilities (d) 1,510 Total Liabilities 2,240 (e) Total Shareholders’ Equity $1,760 $1,800 Current ratio 2.5:1 1.4:1 Debt to total assets 56.0% 50.0% Times interest earned 34.75 times (f) Instructions Solve for the missing data. Solution 110 (a) Net income: (NI):

(NI + $270 +$28) / $28 = 34.75 NI = (34.75 x $28) - $270 - $28 NI = $675

(b) Current Assets (CA):

CA/$1,510 = 1.4 CA = 1.4 x $1,510 CA =$2,114

TA = $2,240 + $1,760 TA = $4,000

(d) Current Liabilities (CL):

CL = $3,085 / 2.5 CL = $1,234

(e) Total Liabilities (TL):

TL = $3,600 - $1,800 TL = $1,800

(f) Times interest earned (TIE):

TIE =($600 + $240 + $30) / $30 TIE = 29.0x

Ex. 111 On January 1, 2018, Supreme Industrial Corp. issued bonds with a face value of $1,000,000. The bonds have a coupon interest rate of 5%, payable each July 1 and January 1. Instructions

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

(a) Prepare the journal entry for the issue, assuming the bonds are issued at 98.5. (b) Prepare the journal entry for the issue, assuming the bonds are issued at 104.5. Solution 111 (5 min.) (a) Cash ($1,000,000 x 0.985) ............................................................ Bonds Payable .......................................................................

985,000 985,000

(b) Cash ($1,000,000 x 1.045) ............................................................ 1,045,000 Bonds Payable ....................................................................... 1,045,000

Ex. 112 On January 1, 2018, 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 112 (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, 2018 Cash ............................................................................................. Bonds Payable ....................................................................... To record sale of bonds (c) July 1, 2018 Interest Expense ........................................................................... Bonds Payable .............................................................................. Cash....................................................................................... To record semi-annual payment of interest $644,635 x 3% = $19,339

644,635 644,635

19,339 1,661 21,000

Ex. 113 On January 1, 2018, Pinehill Ltd. issued $500,000, 6%, 5-year bonds, when the market interest rate was 8%. Interest is payable semi-annually on July 1 and January 1. The company has a

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calendar year end. Instructions (a) Using a financial 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, 2018. Round to nearest dollar. Solution 113 (20 min.) (a) (using financial calculator) N 10 I 4 (8%/2) PMT -15000 FV -500000 CPT PV ➔ 459,446 OR

Periodic interest payments $500,000 x 6% x 6/12 = $15,000 n = 5 x 2 = 10, i = 8% x 6/12 = 4% Present value factor for the principal = 0.675564 Present value factor for the interest = 8.11090 $500,000 x 0.67556 = $ 337,780 $15,000 x 8.11090 = 121,664 Issue price $459,444 (note that rounding discrepancies can sometimes arise between calculations using present value tables and financial calculators)

(b) Jan 1 Cash .................................................................................. Bonds Payable ............................................................

459,446

18,378

Interest Expense ($459,446 x 4%) ..................................... Bonds Payable ............................................................ Cash ($500,000 x 6% x ½) ..........................................

459,446

3,378 15,000

Ex. 114 On January 1, 2018, 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, Seventh Canadian

Solution 114 (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

$1,953

(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

Ex. 115 Emery Trust Inc. issued $100,000, 5 year bond on January 1, 2018 paying 6% interest on a semi-annual basis every January 1 and July 1. Instructions Using a financial calculator, prepare the first year journal entries for the bond issue and interest expense assuming that the company uses the effective interest method, a market interest rate of 4% and has a year-end of December 31, 2018. Solution 115 Jan 1 Cash

Jul 1

Dec 31

108,983 Bonds Payable To record the bond issue (n=10, i=2, PMT=3,000, FV=$100,000)

Interest Expense Bonds Payable Cash To record the payment of interest ($100,000 x 6% x 6/12 = $3,000) ($108,983 x 4% x 6/12 = $2,180)

108,983

2,180 820

Interest Expense 2,163 Bonds Payable 837 Interest Payable To accrue year-end interest and amortization ($100,000 x 6% x 6/12 = $3,000) ($108,163 x 4% x 6/12 = $2,163)

3,000

Ex. 116

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Emery Trust Inc. issued $100,000, 5 year bond on January 1, 2018 paying 4% interest on a semi-annual basis every January 1 and July 1. Instructions Using a financial calculator, prepare the first year journal entries for the bond issue and interest expense assuming that the company uses the effective interest method, a market interest rate of 6% and has a year-end of December 31, 2018. Solution 116 Jan 1 Cash

91,470 Bonds Payable To record the bond issue (n=10, i=3, PMT=2,000, FV=$100,000)

Jul 1

Dec 31

Interest Expense Bonds Payable Cash To record the payment of interest ($100,000 x 4% x 6/12 = $2,000) ($91,470 x 6% x 6/12 = $2,744)

91,470

2,744

Interest Expense 2,766 Bonds Payable Interest Payable To accrue year-end interest and amortization ($100,000 x 4% x 6/12 = $2,000) ($92,214 x 6% x 6/12 = $2,766)

744 2,000

766 2,000

Ex. 117 Calculate the selling price for each of the following bonds: (a) 5% bonds with a par value of $100,000 due in 5 years, paying interest on January 1 and July 1 each year, issued at par. (b) Bonds with face value of $500,000, due in 10 years, paying 7% interest semi-annually, issued at par. (c) Bonds with a face value of $1,000,000 and a coupon rate of 10%, issued to yield 12%, due in 10 years, paying interest semi-annually. (d) 8% bonds with a par value of $5,000,000 due in 5 years, paying interest on January 1 and July 1 each year, issued to yield 6%. Solution 117 (a) Present value of principal Present value of interest

$78,120 21,880 $100,000

(b) Present value of principal Present value of interest

$251,283 248,717 $500,000

$311,805

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

Present value of interest

573,496 $885,301

(d) Present value of principal Present value of interest

$3,720,470 1,706,041 $5,426,511

Ex. 118 Harpers Group has $1,000,000 par value bonds with a coupon rate of 5% paid semi-annually. The bonds are selling for $981,415. Instructions Using a financial calculator, determine the yield assuming the bonds mature in: 2 years 5 years Solution 118 a) PV = -$981,415 FV = $1,000,000 PMT = $1,000,000 x.025 = $25,000 N=4 CPT I/Y = 3.0% b) PV = -$981,415 FV = $1,000,000 PMT = $1,000,000 x.025 = $25,000 N = 10 CPT I/Y = 2.72%

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MATCHING 119. 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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ANSWERS TO MATCHING 1.

10. F

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SHORT-ANSWER ESSAY QUESTIONS S-A E 120 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 120 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 121 Below is a list of independent situations: 1. A customer, John Doe, of Winkler Enterprises has sued for negligence in the amount of $500,000. Winkler’s lawyers have advised that it is probable that the company will lose the case but could settle out of court for $250,000. 2. An employee who was fired has filed a law suit against Gunderson Industries for wrongful dismissal. Lawyers are defending the company but the outcome is uncertain. 3. Appliance Central manufactures and sells its over-the-range microwave with a 2-year warranty. In 2018 the company sold $1,100 microwaves and based on history estimate an average of $40/microwave for warranty repairs. 4. Arnprior Inc. has a year-end of October 31, 2018 and prepares and reports its financial statements on a quarterly-basis. On November 5, 2018 the company’s manufacturing plant had a fire destroying a substantial portion of the site. Instructions Discuss the type of liability, if any, and the way in which each should be treated/recorded under IFRS. Solution 121 1. As it is probable that the company will lose the case and the amount can be reasonably estimated Winkler Enterprises should record the estimated liability as a provision. 2. As the amount to be settled and the outcome is unknown this would be regarded as a contingent liability. The company should disclose the contingent liability in the notes to the financial statements. 3. While the company does not know when the repairs will take place or exactly how much it

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will cost, these costs are probable and can be estimated. The liability would be regarded as a provision. Appliance Central should accrue the expense in the same period in which revenues were generated. 4. As the fire occurred after October 31, 2018 no entry would be recorded for the year end. (Instructor can advise that this would be treated as a subsequent event and disclosed in the notes to the financial statements).

S-A E 122 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 interest versus blended payments. Solution 122 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 123 When determining the issue price of a bond using present value, what are the two components used in the calculation? Solution 123 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.

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S-A E 124 Bonds can be issued at a discount, a premium or par. Identify any differences between the three types of issues when using the effective interest method. Solution 124 There are two areas that differ under the effective interest method: 1. BOND AMORTIZED COST a) When a bond is issued at a discount the bond’s amortized cost increases to face value at maturity. b) When a bond is issued at a premium the bond’s amortized cost decreases to face value at maturity. c) When a bond is issued at par the bond’s amortized cost is equal to the face value at maturity. 2. INTEREST EXPENSE a) When a bond is issued at a discount the periodic interest expense is greater than the interest payment. b) When a bond is issued at a premium the periodic interest expense is less than the interest payment. c) When a bond is issued at par the periodic interest expense is equal to the interest payment.

S-A E 125 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 125 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 bonds will be issued at a premium.

S-A E 126 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 126 Many answers are possible. The format should be fairly informal, and the point that a discount or

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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. Sally

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OBJECTIVE FORMAT QUESTIONS 127. Under IFRS, identify whether each of the following is a provision, contingent liability, or neither. a) GHT Company Inc. purchased a historic building early this year and renovations to the building are ongoing. An engineering company, hired by GHT, has prepared a preliminary report stating there are likely structural issues the company will need to address in the next year. Before the building can be used it must pass inspection and this will not happen unless these issues are resolved. They are not sure of the cost of reparation. b) Goodfellow Motors Ltd. Noticed an error in one of their engine models, GT35X. A recall has been issued to all of the car manufacturers who purchased the GT35X model. The company is expecting to pay $4.7 million in repairs to fix the issue. c) A Long Ride Stable Inc. provides boarding and coaching services. Recently a prize horse was injured while under their care. The owner has negotiated that A Long Ride will need to pay 50% of the veterinary bills. The vet has not yet given A Long Ride or the owner a quote. d) Helga Cosmetics Inc. discovered their new organic face cream was not really organic as the suppliers of the jojoba oil misrepresented their product. As a result, Helga’s customers are unhappy and have filed a class action law suit. e) True North Industries Ltd. offers a one-year warranty for every tent it sells. On average for the last 2 years, 3% of all tents are returned under warranty. The cost to fix an average repair is $35.

Choose an item.

Choose an item. Choose an item.

Solution 127 a) Contingent liability. The repairs, in this case, are highly probable but the amount is not yet determined. Once the amount can be reasonably determined it can be recorded as a provision. b)

Provision. In this case, they are able to estimate the cost of the recall and the likelihood the costs will be incurred is highly probable.

Contingent liability. The vet bill, in this case, is probable but the amount is not yet determined. Once the amount can be reasonably estimated by the vet it can be recorded as a provision.

Contingent liability. In this case, a law suit has been filed; the cost is not yet determinable and could be recovered from the supplier.

Provision. The existence of warranties give rise to the recognition of a provision as an obligation could exist as soon as a sale occurs. Companies know the percentage of products, on average, that are returned under warranty and the cost of the repairs; therefore, the cost of the repairs is both probable and can be estimated so the amount should be recorded as a provision.

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128. The current liabilities section of Boom Ltd.’s Statement of Financial Position is shown below. Boom Ltd. Statement of Financial Position (partial) June 30, 2018 Current liabilities Accounts payable Provisions Rent payable Unearned revenue Notes payable Total current liabilities

$12,500 2,500 3,875 7,500 15,000 $41,375

Additional information: 1. The notes payable balance is for a 6-month loan taken by Boom on January 31, 2018. The loan is due July 31, 2018. Interest (6%) and principal are due at maturity. No interest expense has yet been recorded on this loan. 2. During 2017, 5% of the fireworks manufactured by Boom were returned due to faulty operation. This percentage is normal and expected in this industry. The value shown under provisions for $2,500 is the value of expected refunds the company will need to make for the period, based on 5% of sales in 2018. 3. During the period January 1 through June 30, unearned revenues were earned totalling $5,500. These earned revenues are not reflected in the above statement. 4. While the following salaries and employee benefits have accrued for the month, they are not reflected in the above statement: Salaries accrued $10,000 CPP (employee share) $495 EI (employee share) $188 CPP (employer share) $495 EI (employer share) $263 Employee income tax payable $1,893 Instructions Select all of the statements that are correct. a) The current liabilities should include interest payable of $375. b) The amount the company calculated under provisions should be zero as it is a contingent liability, not a provision. c) Unearned revenues as of June 30 should be $13,000. d) Salaries payable on June 30 should be $7,424. e) On June 30, the correct balance of current liabilities should be $47,691. f) CPP payable as of June 30 will be $990. g) The notes payable is correctly classified as a current liability. Solution 128 a), d), f), and g) are correct while b), c), and e) are incorrect. Students may find it easiest to prepare an adjusted Statement of Financial Position (partial) prior

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to answering this question, as follows: BOOM LTD. Statement of Financial Position (partial) June 30, 2018 Current liabilities Adjustments Accounts payable $12,500 No change Salaries payable 7,424 $10,000–$495–$188–$1,893 CPP payable 990 $495+$495 EI payable 451 $188+$263 Interest payable 375 $15,000x6%/12 x 5 months Provisions 2,500 No change Employee income tax payable 1,893 +$1,893 Rent Payable 3,875 No change Unearned revenue 2,000 $7,500–$5,500 Notes payable 15,000 No change Total current liabilities $47,008 b)

The amount included as a provision for $2,500 is correct. Provisions are probable and can be estimated. Since returns are a normal part of Boom’s business, they are probable. The historical record of 5% of units sold returned provides a reasonable method of estimation in this case.

Unearned revenues should be $2,000. Unearned revenues would decrease by the revenues that have been earned for the period. ($7,500 – $5,500 = $2,000).

As shown above, the current liabilities will be $47,008.

129. The following select data is shown for two backcountry lodges located in the Rocky Mountains, Alberta: Spirit Creek Lodge Inc. and Big Mountain Lodge Ltd.: Select financial data For the period January 1 – December 31, 2018

Interest expense Income tax expense Net income Total debt Total assets

Spirit Creek Lodge Inc. $ 16,200 32,000 78,000 135,000 254,000

Big Mountain Lodge Ltd. $ 58,000 125,000 782,000 1,628,500 1,987,000

Instructions Select all of the statements that are correct. a) The times interest earned ratios for Spirit Creek and Big Mountain are 4.8 times and 13.5 times, respectively. b) The debt to total assets ratio for Spirit Creek and Big Mountain are 53.1% and 82.0%, respectively. c) Although Big Mountain is more indebted than Spirit Creek, Big Mountain can more easily cover its interest payments than Spirit Creek.

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Test Bank for Financial Accounting: Tools for Business Decision Making, Seventh Canadian

Both Spirit Creek’s debt to total assets ratio and times interest earned ratio are better than Big Mountain’s. Big Mountain’s debt position is likely not concerning as the company has sufficient income to cover interest payments on debt. It would be acceptable for Spirit Creek to assume more debt considering their low debt to total assets ratio. Spirit Creek is in a better position in terms of solvency than Big Mountain.

Solution 129 b), c), and e) are correct. a)

In order to calculate times interest earned the numerator is EBIT (Earnings Before Interest and Taxes); therefore, income tax expense and interest expense must be added back to net income. Spirit Creek Times Interest Earned = ($78,000+$32,000+$16,200) ÷ $16,200 = 7.8 times; Big Mountain = ($782,000+$125,000+$58,000) ÷ $58,000 = 16.7 times.

Spirit Creek’s debt to total assets ratio is higher than Big Mountain’s ratio (53.1% to 82.0%). Spirit Creek’s debt to total assets = $135,000 ÷ $254,000 = 53.1%. Big Mountain’s debt to total assets = $1,628,500 ÷ $1,987,000 = 82.0%. However, Big Mountain can cover their interest payments better because that company’s times interest earned ratio is higher (see the answer to item a) above).

Having a low debt to total assets ratio is just one consideration when structuring the relationship between a company’s debt and equity levels. Just because a company has a low debt to total assets ratio does not mean it can take on more debt especially if its times interest earned ratio is low. So both the debt to total assets ratio and the times interest earned ratio need to be considered when taking on more debt.

Neither company is necessarily better off. Spirit Creek has less debt while Big Mountain has a higher times interest earned ratio which indicates that it is more capable of paying interest on its debt.

*130. Select all of the following statements that are correct. a) The term market interest rate has the same meaning as the terms effective interest rate and yield. b) If a bond is sold at face value, the coupon interest rate will be equal to the market interest rate. c) If a bond is sold at a discount, the interest expense recorded will include only the interest payments on the principal. d) It is more common for companies to sell bonds at face value than at a discount or premium. e) The following chart depicts the relationship between the coupon rate and market interest rates for bonds:

Coupon Interest Rate 4%

Market Interest Rate 3%

Sell at discount

Market Interest Rate 4%

Sell at face value

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The journal entry to record the interest payment on a bond issued at a premium will include a debit to Interest Expense, a debit to Bonds Payable, and a credit to Cash.

Solution 130 a), b), and f) are correct. c)

When a company issues bonds at a discount, both the discount and the interest payments are considered a cost of borrowing and are recorded as interest expense. Since the interest payments are based on the coupon interest rate which was lower than the going market interest rate, the company did not receive the full face value of the bond when they were issued. If the market interest rate and the coupon interest rate were equal, the company would have received the full face value of the bond when they were issued. Therefore, the difference between the face value and the price is a cost of borrowing.

It is more common for companies to sell bonds at a discount or premium. Market interest rates fluctuate on a daily basis. By the time a company has printed its bond certificates and sells these on the market, it is likely the market interest rate will be different than the coupon interest rate stated on the bond.

This chart does not correctly depict the relationship between the coupon interest rate and the market interest rate. If the market interest rate is lower than the coupon interest rate, the company will be able to sell the bond at a premium as the investor will be receiving higher interest payments with their bond investment than they would if they invested in the market. If the market interest rate is higher than the coupon interest rate, the company will need to sell the bonds at a discount as an investor could earn more if they purchase other financial instruments than if they buy the bonds. The chart shows that a bond will be sold for face value if the market interest rate is equal to the coupon interest rate, which is correct.

131. The following bond amortization schedule prepared for Bailey Investments Inc. relates to a 5-year bond issue with a face value of $500,000 that was sold on January 1, 2018 for which interest payments are made semi-annually on June 30 and December 31. Bailey Investments Inc. Bond Amortization Schedule Interest Period 01-Jan-18 30-Jun-18 31-Dec-18 30-Jun -19 31-Dec-19 30-Jun -20 31-Dec-20 30-Jun-21

Interest Payment $17,500 17,500 17,500 17,500 17,500 17,500 17,500

Interest Expense $19,189 19,256 19,327 19,400 19,476 19,555 19,637

Discount Amortization $1,689 1,756 1,827 1,900 1,976 2,055 2,137

Unamortized Discount $ 20,277 18,588 16,832 15,005 13,105 11,129 9,074 6,937

Bond Carrying Amount $479,723 481,412 483,168 484,995 486,895 488,871 490,926 493,063

Instructions

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Select all of the statements that are correct. a) The interest payment on December 31, 2023 will be $17,500. b) The coupon rate on the bond is 8% per annum. c) The bond carrying amount on December 31, 2022, after the interest payment will be $500,000 d) After the interest payment of June 30, 2022, the unamortized discount balance will be $2,403 (rounded to the nearest dollar) e) The bond was issued at a premium. f) The market interest rate is 8%. g) The amount of cash received on the issuance of the bond was $500,000. h) The interest expense for the six month period ending December 31, 2021 is $17,500. Solution 131 c), d), and f) are correct. a)

The bond matures on December 31, 2022; therefore, the interest will be zero.

The coupon rate is 7% per annum. The coupon rate is determined by dividing the annual interest payment by the face value of the bond issue. Semi-annual interest payment = $17,500 Annual interest payment = $17,500 x 2 = $35,000 Coupon rate = $35,000/$500,000 = 7%

Is correct, refer to completed table below

The bond was issued at a discount. The face value of $500,000 is more than the cash proceeds from the bond sale of $479,723. The bond was sold at a discount of $20,277.

Is correct. The market interest rate can be calculated using the information on the amortization table that was given: $19,189 ÷ $479,723 = 4% x 2 = 8% annual rate.

The amount the company received on issuance of the bond was the discounted value of $479,723. Since the market interest rate was higher than the bond coupon rate, investors would not pay the full face value of the bond.

The semi-annual interest payable is $17,500 but the interest expense is based on the bond carrying amount multiplied by the semi-annual market rate (8%/2 = 4%). Here is a full amortization schedule for the bond issue. The interest expense for the six month period ending December 31, 2021 is $19,723. An alternative is to take the carrying amount at June 30, 2021 $493,063 x 4% = $19,723 rounded to the nearest dollar. Bailey Investments Inc. Bond Discount Amortization Schedule Interest Period

01-Jan-18

Interest Payment

Interest Expense

Discount Amortization

Unamortized Discount $20,277

Bond Carrying Amount $479,723

Reporting and Analyzing Liabilities

30-Jun-18 $17,500 31-Dec-18 17,500 30-Jun-19 17,500 31-Dec-19 17,500 30-Jun-20 17,500 31-Dec-20 17,500 30-Jun-21 17,500 31-Dec-21 17,500 30-Jun-22 17,500 31-Dec-22 17,500 *Rounded by $1

$19,189 19,256 19,327 19,400 19,476 19,555 19,637 19,723 19,811 $19,903*

$1,689 1,756 1,827 1,900 1,976 2,055 2,137 2,223 2,311 2,403

18,588 16,832 15,005 13,105 11,129 9,074 6,937 4,714 2,403 0.00

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481,412 483,168 484,995 486,895 488,871 490,926 493,063 495,286 497,597 500,000

CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E C F AN 13. 2 E C F AN 25. 4 E C F AN 2. 1 M C F AN 14. 2 M K F AN 26. 4 E K F AN 3. 1 E K F AN 15. 2 M K F AN 27. 4 E K F AN 4. 1 E K F AN 16. 2 E K F AN 28. 4 E K F AN 5. 1 E K F AN 17. 2 E K F AN 29. 4 E K F AN F AN F AN F AN 6. 1 E C 18. 3 E C 30. 4 M K 7. 1 E K F AN 19. 3 M C F AN 31. 5 M K F AN 8. 1 E K F AN 20. 3 E C F AN 32. 5 M K F AN 9. 1 E K F AN 21. 3 M C F AN 33. 5 M K F AN 10. 1 H K F AN 22. 3 M C F AN 34. 5 E K F AN 11. 1 M C F AN 23. 3 E K F AN 35. 5 E K F AN 12. 2 M K F AN 24. 4 E C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: C = Comprehension K = Knowledge CPA: F = Financial Reporting AACSB: AN = Analytic

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

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Multiple Choice Questions 36. 1 M C F AN 70. 2 M K F AN 104. 3 M K F AN 37. 1 M C F AN 71. 2 H K F AN 105. 3 M C F AN 38. 1 E K F AN 72. 2 H K F AN 106. 3 E C F AN 39. 1 M K F AN 73. 3 E K F AN 107. 3 E C F AN F AN F AN 108. 3 H F AN 40. 1 M K 74. 3 M C C F AN C F AN F AN 41. 1 E K 75. 3 E 109. 3 E C F AN C F AN 110. 3 M AP F AN 42. 1 E K 76. 3 M F AN C F AN 111. 3 E AP F AN 43. 1 M K 77. 3 E F AN F AN 112. 3 H C F AN 44. 1 E C 78. 3 E C 45. 1 M C F AN 79. 3 H C F AN 113. 3 E C F AN 46. 1 M K F AN 80. 3 E C F AN 114. 3 H C F AN 47. 1 E K F AN 81. 3 H C F AN 115. 3 E C F AN 48. 1 M K F AN 82. 3 M C F AN 116. 4 H C F AN 49. 1 E K F AN 83. 3 E K F AN 117. 4 E C F AN 50. 1 M K F AN 84. 3 E K F AN 118. 4 M K F AN 51. 1 M K F AN 85. 3 M C F AN 119. 4 E C F AN 52. 1 M K F AN 86. 3 E C F AN 120. 4 M C F AN 53. 1 H K F AN 87. 3 E C F AN 121. 4 E C F AN 54. 1 H K F AN 88. 3 E K F AN 122. 4 H AP F AN 55. 1 M C F AN 89. 3 M C F AN 123. 4 M K F AN 56. 1 E K F AN 90. 3 M K F AN 124. 4 E K F AN 57. 1 M K F AN 91. 3 M K F AN 125. 4 E K F AN 58. 1 E K F AN 92. 3 E K F AN 126. 4 E K F AN 59. 2 M C F AN 93. 3 E K F AN 127. 4 E K F AN 60. 2 E C F AN 94. 3 E K F AN 128. 4 M AP F AN 61. 2 E C F AN 95. 3 M C F AN 129. 4 M K F AN 62. 2 M K F AN 96. 3 E K F AN 130. 5 E K F AN 63. 2 M K F AN 97. 3 E C F AN 131. 5 E K F AN 64. 2 H K F AN 98. 3 E AP F AN 132. 5 M C F AN 65. 2 E K F AN 99. 3 E AP F AN 133. 5 M C F AN 66. 2 H K F AN 100. 3 M C F AN 134. 5 E AP F AN 67. 2 E AP F AN 101. 3 H AP F AN 135. 5 M C F AN 68. 2 E C F AN 102. 3 E K F AN 136. 5 M AP F AN 69. 2 M K F AN 103. 3 E K F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

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K = Knowledge F = Financial Reporting

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

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SUMMARY OF LEARNING 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. 36.

TF TF TF TF TF MC

37. 38. 39. 40. 41. 42.

MC MC MC MC MC MC

12. 13. 14. 15. 16. 17.

TF TF TF TF TF TF

59. 60. 61. 62. 63. 64.

MC MC MC MC MC MC

65. 66. 67. 68. 69. 70.

MC MC MC MC MC MC

18. 19. 20. 21. 22. 23. 73. 74. 75.

TF TF TF TF TF TF MC MC MC

76. 77. 78. 79. 80. 81. 82. 83. 84.

MC MC MC MC MC MC MC MC MC

85. 86. 87. 88. 89. 90. 91. 92. 93.

MC MC MC MC MC MC MC MC MC

24. 25. 26. 27. 28. 29.

TF TF TF TF TF TF

30. 116. 117. 118. 119. 120.

TF MC MC MC MC MC

121. 122. 123. 124. 125. 126.

MC MC MC MC MC MC

31. 32. 33.

TF 34. TF TF 35. TF TF 130. MC

131. 132. 133.

MC MC MC

Note:

TF = True-False Ex = Exercise

Item

Type

Item

Type

Item

Type

Learning Objective 1 43. MC 49. MC 44. MC 50. MC 45. MC 51. MC 46. MC 52. MC 47. MC 53. MC 48. MC 54. MC Learning Objective 2

55. 56. 57. 58. 137. 138.

MC MC MC MC Ex Ex

166. 167. 174. 175.

Ma SAE CP CP

71. MC 143. Ex 72. MC 144. Ex 139. Ex 145. Ex 140. Ex 146. Ex 141. Ex 147. Ex 142. Ex 148. Ex Learning Objective 3 94. MC 103. MC 95. MC 104. MC 96. MC 105. MC 97. MC 106. MC 98. MC 107. MC 99. MC 108. MC 100. MC 109. MC 101. MC 110. MC 102. MC 111. MC Learning Objective 4 127. MC 155. Ex 128. MC 156. Ex 129. MC 157. Ex 149. Ex 158. Ex 150. Ex 159. Ex 154. Ex 160. Ex Learning Objective 5 134. MC 163. Ex 135. MC 164. Ex 136. MC 165. Ex

149. 150. 166. 167. 168. 176.

Ex Ex Ma SAE SAE CP

112. 113. 114. 115. 145. 146. 147. 148. 151.

MC MC MC MC Ex Ex Ex Ex Ex

152. 153. 154. 166. 168. 169. 170. 177.

Ex Ex Ex Ma SAE SAE SAE CP

161. 162. 166. 171. 175. 178.

Ex Ex Ma SAE CP CP

166. 172. 173.

Ma SAE SAE

175.

MC = Multiple Choice SAE = Short-Answer Essay

Ma = Matching CP = CPA Questions

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CHAPTER LEARNING 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, continuous life, separation of corporation management from ownership, increased cost and complexity of government regulations, and the possibility of reduced corporate income tax. Some of these characteristics may differ depending on the size of the corporation. 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. Common shareholders have the right to vote and, as such, are the “owners” of the company. 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. When shares are reacquired, the Common Shares (or Preferred Shares) account is reduced by the average cost of these shares immediately prior to the reacquisition. If the price paid to reacquire the shares is lower than their average cost, the difference is recorded as an increase to the Contributed Surplus account. If the price paid to reacquire the shares is greater than their average cost, the difference is first applied to any Contributed Surplus previously recorded from acquisitions of shares of the same class and any remaining difference is then applied to reduce the Retained Earnings account. The accounting for preferred shares is similar to the accounting for common shares. Preferred shares do not have the right to vote—only common shares have voting rights— but have contractual provisions that give them preference over common shares for dividends and assets in the event of liquidation. Dividends are quoted at an annual rate (such as $5 preferred), but are normally paid quarterly (such as $1.25 per quarter). In addition, preferred shares may have other preferences, such as the right to redeem or to periodically reset dividend rates based on changes in interest rates.

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

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

any, are reported separately. If contributed surplus exists, then the caption “contributed capital” is used for share capital (preferred and common shares) and contributed surplus 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.

Evaluate dividend and earnings performance. A company’s dividend record can be evaluated by looking at the dividend payout ratio (cash dividends declared divided by net income), which measures what percentage of net income it chooses to pay out in dividends, and by the dividend yield ratio (dividends per share divided by the share price), which measures dividends as a percentage of the share price. Earnings performance can be measured by two profitability ratios: basic earnings per share (net income less preferred dividends divided by the weighted average number of common shares) and the return on common shareholders’ equity ratio (net income less preferred dividends divided by average common shareholders’ equity). The return on shareholders’ equity is affected by the extent to which a company uses debt or equity to finance the acquisition of its assets. Taking on more debt is risky because the company is legally bound to make principal and interest payments on debt, but on the other hand, the ownership interests of existing shareholders are not diluted when greater debt is assumed. Furthermore, any excess income generated from assets financed with debt accrues to the shareholders, not the creditors.

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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. A corporation acts under its’ own name rather than in the name of its shareholders.

8. A shareholder owning common shares has the right to vote in the election of the board of directors.

9. An initial public offering occurs the first time a corporation sells shares to the public.

10. The market capitalization of a company is calculated by multiplying the number of shares authorized by the share price at any given date.

11. The number of common shares authorized can never be greater than the number of shares issued.

12. Contributed capital is the amount shareholders paid or contributed to the corporation in exchange for shares of ownership.

13. The issue of common shares affects both share capital and retained earnings.

14. One of the reasons a company may reacquire its own shares is to reduce the market value to

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make the shares more affordable.

15. Preferred shares have a contractual preference over common shares in certain areas, but do not have the right to vote.

16. Preferred shares are generally issued to appeal to a larger segment of potential investors.

17. When preferred shares are cumulative, preferred dividends not declared in a given period are called dividends in arrears.

18. Cash dividends are not a liability of the corporation until they are declared by the board of directors.

19. 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.

20. Declaration and distribution of a stock dividend does not affect the total amount of shareholders’ equity.

21. Stock Dividends Distributable is reported as a liability on the statement of financial position.

22. A stock split results in a transfer at market value from retained earnings to share capital.

23. The main purpose of a stock split is to increase the marketability of the shares.

24. Retained earnings represents the amount of cash available for dividends.

25. If a corporation reports a net income, it should be closed to retained earnings. If it reports a loss, it should be closed to a contributed capital account.

26. A debit balance in the Retained Earnings account is called a deficit.

27. Retained earnings that are restricted are unavailable for dividends. 28. The statement of changes in equity discloses changes in total shareholders’ equity for the period as well as changes in each shareholders’ equity account.

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29. Corporations reporting under IFRS have the option of preparing either a statement of changes in equity or a statement of retained earnings. 30. Accumulated other comprehensive income is reported in the shareholders’ equity section of the statement of financial position for a publicly-traded company.

31. The payout ratio is calculated by dividing the cash dividends paid on common shares by retained earnings. 32. Return on common shareholders’ equity is calculated by dividing net income by ending shareholders’ equity.

33. Investors tend to buy shares with low payout ratios and dividend yields if they are looking for more capital appreciation from the shares.

34. Basic earnings per share is calculated by dividing the net income available to common shareholders by the number of common shares issued at year end.

35. Companies reporting under ASPE must disclose basic earnings per share, but companies reporting under IFRS do not.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

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

Ans. T F T F T

Item 6. 7. 8. 9. 10.

Ans. F T T T F

Item 11. 12. 13. 14. 15.

Ans. F T F F T

Item 16. 17. 18. 19. 20.

Ans. T T T F T

Item 21. 22. 23. 24. 25.

Ans. F F T F F

Item 26. 27. 28. 29. 30.

Ans. T T T F T

Item 31. 32. 33. 34. 35.

Ans. F F T F F

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MULTIPLE CHOICE QUESTIONS 36. Legal capital (a) can be distributed to shareholders. (b) does not need to remain invested in the corporation. (c) can be distributed to shareholders up to the limit of their investment. (d) cannot be distributed to the shareholders, but must remain invested in the corporation.

37. 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. 38. Shareholders directly elect the corporation’s (a) president. (b) board of directors. (c) controller. (d) auditor.

39. Those most responsible for the major policy decisions of a corporation are the (a) shareholders. (b) board of directors. (c) management. (d) employees.

40. 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

41. 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.

42. 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.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

(d) It is usually smaller than a publicly held company.

43. 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.

44. 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

45. 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.

46. A corporate board of directors does not generally (a) select officers. (b) formulate operating policies. (c) declare dividends. (d) execute policy.

47. Limited liability of shareholders means (a) dividends will be paid regardless of net income. (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.

48. 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.

49. Which of the following statements is considered an advantage of the corporate form of organization? (a) additional income tax

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(b) government regulations (c) limited liability of shareholders (d) increased disclosure requirements

50. 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.

51. 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.

52. 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 net income

53. Which of the following factors does not affect the initial market price of a share? (a) the company's anticipated future net income (b) the legal value of the share (c) the current state of the economy (d) the expected dividend rate per share

54. 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.

55. Mr. Gold sold 100 shares of Delia Corp. to Mrs. Silver for $2,200. As a result of this transaction, Delia Corp.’s (a) shareholders’ equity did not change. (b) shareholders’ equity increased by $2,200. (c) shareholders’ equity decreased by $2,200. (d) assets increased by $2,200.

56. The authorization of common shares (a) must be approved by Canada Revenue Agency. (b) does not require a journal entry.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

57. 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. 58. The number of shares that may be issued according to the corporation’s articles of incorporation is referred to as the (a) authorized shares. (b) issued shares. (c) unissued shares. (d) redeemable shares.

59. $3 cumulative preferred shares means that each preferred shareholder is eligible to receive (a) a quarterly dividend of $3 per share. (b) an annual dividend of $3 per share. (c) a monthly dividend of $3 per share. (d) no dividend.

60. If Tools Corporation issues 5,000 common shares for $200,000, which account will be credited? (a) Common Shares (b) Retained Earnings (c) Contributed Capital (d) Cash

61. 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.

62. When setting the price of a new share issue, a corporation does not need to consider (a) future net income. (b) expected dividend rate. (c) current financial position. (d) future trading on the secondary market.

63. Which of the following usually represents the largest number of common shares? (a) restricted shares. (b) issued shares.

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64. For a corporation reporting under IFRS, when shares are issued for a noncash 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.

65. 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 basic earnings per share. (d) have additional shares available for use.

66. Apricot Inc. is reacquiring 25,000 common shares. The price is $4.25/share and the average price is $4.00. Assuming that there is a contributed surplus balance of $5,000, the entry to record the transaction would be (a) debit to Common shares, Contributed Surplus, and Retained Earnings and credit to Cash (b) debit to Common shares and Contributed Surplus and credit to Cash (c) debit to Common shares and Retained Earnings and credit to Cash (d) debit to Common shares and credit to Cash Solution: ($4.25 – $4.00) * 25,000 shares = $6,250 – $5,000 Dr. to Contributed surplus, $1,250 Dr. to R/E

Use the following information for questions 67–68. Fair Corporation issues 7,500 preferred shares for $25 per share.

67. The entry to record the transaction will consist of a debit to Cash for $187,500 and a credit or credits to (a) Preferred Shares for $187,500. (b) Preferred Shares for $100,000 and Share Capital for $87,500. (c) Preferred Shares for $100,000 and Retained Earnings for $87,500. (d) Investment in Preferred Shares for $187,500. Solution: $7,500 x $25 = $187,500

68. 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.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

69. Baria Inc. is reacquiring 10,000 common shares. The price is $5.00/share and the average price is $5.10. Assuming that there is a contributed surplus balance of $5,000, which accounts will be affected by the transaction? (a) Common shares, Contributed Surplus, Retained Earnings and Cash (b) Common shares, Contributed Surplus and Cash (c) Common shares, Retained Earnings and Cash (d) Common shares and Cash Solution: ($5.00 – $5.10) * 10,000 shares = $1,000 – $1,000 Cr. to Contributed Surplus

70. 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.

71. Dividends in arrears are dividends on (a) cumulative preferred shares that have been declared but have not been paid. (b) noncumulative 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.

72. 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.

73. 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.

74. The board of directors of Wessex Inc. declared a cash dividend on November 15, 2018, to be paid on December 15, 2018, to shareholders owning shares on November 30, 2018. Given these facts, the date of November 30, 2018, is referred to as the (a) declaration date. (b) record date. (c) payment date. (d) authorization date.

75. The effect of the declaration of a cash dividend is to Increase Decrease (a) Shareholders’ equity Assets

Reporting and Analyzing Shareholders’ Equity

(b) (c) (d)

Assets Liabilities Liabilities

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Liabilities Shareholders’ equity Assets

76. 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.

77. Which of the following is the appropriate general journal entry to record the declaration of cash dividends? (a) Dividends Declared Cash (b) Dividends Payable Cash (c) Share Capital Dividends Payable (d) Dividends Declared Dividends Payable

Use the following information for questions 78–81. On July 15, 2018, 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, 2018, to shareholders of record on July 31, 2018.

78. The journal entry to be recorded on July 15, 2018, will include a (a) debit to Dividends Payable. (b) debit to Dividends Declared. (c) credit to Cash. (d) credit to Retained Earnings.

79. The effects of the journal entry to record the declaration of the dividend on July 15, 2018, 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.

80. The correct entry to be recorded on August 15, 2018 will include a (a) debit to Dividends Declared. (b) credit to Retained Earnings. (c) credit to Dividends Payable.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

(d) debit to Dividends Payable.

81. The effects of the journal entry to record the payment of the dividend on August 15, 2018, 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. 82. 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.

83. 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.

84. Stock Dividends Distributable is classified as a(n) (a) asset account. (b) shareholders' equity account. (c) expense account. (d) liability account.

85. The effect of a stock dividend is to (a) decrease total assets and shareholders' equity. (b) change the composition of shareholders' equity. (c) decrease total assets and total liabilities. (d) increase the book value per share of common shares.

86. 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) Dividends Declared.

87. Which one of the following events would not require a journal entry on a corporation's books? (a) 2-for-1 stock split

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(b) 100% stock dividend (c) 2% stock dividend (d) $1 per share cash dividend

88. Which of the following would not affect the balance of the Retained Earnings account? (a) net income (b) stock dividend (c) stock split (d) cash dividend

89. 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

90. 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.

91. Cash dividends are declared out of (a) Dividends Payable. (b) Preferred Shares. (c) Common Shares. (d) Retained Earnings.

92. Which of the following is not a significant date with respect to dividends? (a) the declaration date (b) the incorporation date (c) the record date (d) the payment date

93. 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.

94. 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.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

(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.

95. 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

96. 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.

97. 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.

98. Ethel Inc. has 15,000, $3, noncumulative preferred shares and 200,000 common shares issued. What is the total annual dividend on the preferred shares? (a) $15,000 (b) $45,000 (c) $200,000 (d) $400,000 Solution: 15,000 x $3 = $45,000

99. At December 31, 2018, Fashion Forward Inc. has 15,000, $4, cumulative preferred shares issued. If the board of directors declares a $55,000 dividend at this date (a) the company will still owe the preferred shareholders $5,000 and should record a dividend payable for this amount. (b) the company will owe the preferred shareholders nothing further. (c) $5,000 will be disclosed as dividends in arrears in the notes to the financial statements. (d) the company still has to pay the preferred shareholders $60,000, regardless of what amount was declared. Solution: 15,000 x $4 = $60,000 – $55,000 = $5,000 in arrears

100. 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?

Reporting and Analyzing Shareholders’ Equity

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(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%.

101. 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. Solution: 300 x 1.05 = 315 shares

102. 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.

103. 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.

104. 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.

105. When stock dividends are distributed (a) Stock Dividends Distributable is decreased. (b) Retained Earnings is decreased. (c) Common Shares is debited. (d) no entry is necessary.

106. A stock dividend results in a decrease in (a) current liabilities. (b) net income.

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107. 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 Dividends Declared. (d) a credit to Cash.

108. 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

109. 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 110–111. On January 1, BearBack Corporation had 300,000 common shares issued. On April 10, the company declared a 10% stock dividend to be distributed on April 30. The market value of the shares was $7 on April 10 and $10 on April 30.

110. The entry to record the transaction of April 10 would include a (a) credit to Retained Earnings for $30,000. (b) credit to Cash for $210,000. (c) credit to Stock Dividends Distributable for $210,000. (d) debit to Stock Dividends Distributable for $300,000. Solution: 300,000 x.10 = 30,000 shares; 30,000 x $7 = $210,000

111. The entry to record the transaction of April 30 would include a (a) credit to Cash for $210,000. (b) debit to Stock Dividends Distributable for $210,000. (c) credit to Retained Earnings for $300,000. (d) debit to Dividends Declared for $210,000. Solution: 300,000 x.10 = 30,000 shares; 30,000 x $7 = $210,000

112. Which of the following shows the proper effect of a stock split and a stock dividend?

Reporting and Analyzing Shareholders’ Equity

Item (a) Total share capital (b) Total retained earnings (c) Total shareholders’ equity (d) Number of shares

Stock Split increase decrease decrease increase

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Stock Dividend increase decrease increase increase

113. 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.

114. 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.

115. 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. Solution: 600,000 / 300,000 = 2 for 1

116. Total comprehensive income equals (a) net income plus other comprehensive income. (b) net income plus accumulated other comprehensive income. (c) net income plus comprehensive income. (d) other comprehensive income plus comprehensive income.

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.

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119. When retained earnings are restricted, total retained earnings (a) are unaffected. (b) increase. (c) decrease. (d) may increase or decrease.

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 Dividends Payable ..................................................... 30,000 (a) $620,000 (b) $800,000 (c) $820,000 (d) $850,000 Solution: $600,000 + $40,000 + $190,000 + $20,000 = $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

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(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 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, 2018, Blue Corporation had a credit balance of $3,050,000 in its retained earnings account. During the year, Blue paid $275,000 in dividends, reported net income of $420,000 and other comprehensive income of $750,000. The December 31 balance of retained earnings is (a) $3,195,000. (b) $3,945,000. (c) $2,445,000. (d) $2,775,000. Solution: $3,050,000 – $275,000 + $420,000 = $3,195,000

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 net income. (c) total cash dividends paid by net income. (d) dividends paid per share by year-end share price. 131. The return on common shareholders’ equity is calculated by dividing net income (a) by ending common shareholders’ equity. (b) by average common shareholders’ equity.

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

(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 net income 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 133. Return on common shareholders’ equity is a ratio that (a) is calculated by dividing net income plus preferred dividends by average common shareholders’ equity. (b) shows the relationship between net income 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 net income plus preferred dividends by average common shareholders’ equity and shows the relationship between net income available for common shareholders and average common shareholders’ equity.

134. For last year, Casper Corporation reported net income of $625,000, and paid $175,000 in dividends for the 300,000 preferred shares issued. The weighted average of common shares was 1,000,000 shares. Roxy’s basic earnings per share was (a) $0.63. (b) $0.33. (c) $0.45. (d) $0.15. Solution: ($625,000 – $175,000) / 1,000,000 = $0.45

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 2018, Jicama Ltd. reported net sales of $2,200,000, net income of $120,000 and yearend total assets of $3 million. For the year, Jicama’s average common shareholders’ equity was $1.5 million. There are no preferred shares issued. Therefore, for 2018, Jicama’s return on common shareholders’ equity is (a) 8.0%. (b) 12.5%. (c) 5.5%. (d) 4.0%. Solution: $120,000 / $1,500,000 = 8%

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ANSWERS TO MULTIPLE CHOICE QUESTIONS Item Ans. 36. d 37. c 38. b 39. b 40. d 41. a 42. b 43. c 44. a 45. b 46. d 47. b 48. a 49. c 50. a

Item 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65.

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

Item 66. 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 d

Item 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95.

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

Item 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110.

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

Item 111. 112. 113. 114. 115. 116. 117. 118. 119. 120. 121. 122. 123. 124. 125.

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

Item 126. 127. 128. 129. 130. 131. 132. 133. 134. 135. 136.

Ans. 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.

Ex. 138

Reporting and Analyzing Shareholders’ Equity

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Name three advantages of a corporation. 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

Cash .................................................................................. Common Shares .........................................................

225,000 225,000

129,000 129,000

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Issued 3,000 shares at $43 per share Nov 1

Land .................................................................................. Common Shares .........................................................

160,000 160,000

Ex. 141 The following items were shown on the statement of financial position of Kettle Corporation on December 31, 2018: 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 Mannequin Ltd. was incorporated on January 1, 2018. During the year the company entered into the following transactions: Jan 5 Issued 50,000 common shares for $2.50 per share. Jan 20 Issued 3,000 common shares to settle legal expenses. The value of the legal expenses was $10,000. Feb 10 Issued 10,000 preferred shares for $30.00 per share. Aug 12 Reacquired 15,000 common shares for $2.40 per share. Oct 1 Issued 5,000 common shares for $2.25 per share. Dec 31 Reacquired 20,000 common shares for $2.65 per share. Instructions Record the above transactions. Solution 142 Jan 5 Cash .................................................................................. Common Shares (50,000 × $2.50) .............................. 20

Legal Expense ...................................................................

125,000 125,000 10,000

Reporting and Analyzing Shareholders’ Equity

Common Shares ......................................................... Feb 10

Aug 12

Oct

Dec 15

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10,000

Cash .................................................................................. Preferred Shares (10,000 × $30).................................

300,000

Common Shares (15,000 × $2.55*).................................... Contributed Surplus .................................................... Cash (15,000 × $2.40) ................................................ *[($125,000 + $10,000) / (50,000 + 3,000) = $2.55

38,250

Cash ................................................................................. Common Shares (5,000 x $2.25) ................................

11,250

300,000

2,250 36,000

11,250

Common Shares (20,000 x $2.51*) .................................... 50,200 Contributed Surplus .......................................................... 2,250 Retained Earnings ............................................................. 550 Cash (20,000 x $2.65)................................................. 53,000 *[($125,000 + $10,000 – $38,250 + $11,250) / (50,000 + 3,000 – 15,000 + 5,000)] = $2.51

Ex. 143 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 143 (5 min.) 1. Cash (10,000 x $7.50) ................................................................... Preferred Shares ....................................................................

75,000

84,000

Cash ............................................................................................. Common Shares ....................................................................

75,000

84,000

Ex. 144 Afrikana Crafts Inc. had the following transactions related to common shares: Jan 5 Issued 25,000 common shares for $2 per share. Mar 10 Issued 10,000 common shares in exchange for land. The land was valued at $25,000. Apr 21 Issued 2,500 common shares to settle legal expenses of $7,500. Oct 5 Issued 5,000 common shares for $3.50 per share. Instructions (a) Journalize the share transactions. (b) Calculate the average cost of Afrikana’s common shares, assuming the company has a December 31 year end.

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Solution 144 (a) Jan 5 Cash (25,000 x $2) ............................................................ Common Shares (25,000 shares) ............................... Mar 10

Apr 21

Oct

50,000 50,000

Land .................................................................................. Common Shares (10,000 shares) ...............................

25,000

Legal Expense ................................................................... Common Shares (2,500 shares) .................................

7,500

Cash (5,000 x $3.50) ......................................................... Common Shares (5,000 shares) ...............................

17,500

25,000

7,500

17,500

(b) Total shares issued = 25,000 + 10,000 + 2,500 + 5,000 = 42,500 Total cost = $50,000 + $25,000 + $7,500 + $17,500 = $100,000 Average cost = $100,000 ÷ 42,500 = $2.35

Ex. 145 Herold Corporation is authorized to issue 2,000,000 common shares. During 2018, 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 Record the above transactions for Herold Corporation. Solution 145 (5–7 min.) Jan. 15 Cash (550,000 x $3) .......................................................... 1,650,000 Common Shares ......................................................... 1,650,000 Dec. 6

Dividends Declared ............................................................ Dividends Payable (550,000 × $0.20) .........................

110,000 110,000

Ex 146 During 2018, 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

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Prepare the journal entries to record the above transactions assuming Maldives Corporation follows IFRS. Solution 146 (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

Dividends Declared ............................................................ Stock Dividend Distributable ....................................... (22,000 x 10% x $12)

26,400

Stock Dividends 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. 147 On January 1, 2018, AntEater Corporation had 80,000 common shares issued. During the year, the following transactions occurred: Mar 1 Issued 30,000 common shares for $300,000. Jun 1 Declared a cash dividend of $0.50 per share to shareholders of record on June 15. Jun 30 Paid the $0.50 cash dividend. Instructions Prepare journal entries to record the above transactions. Solution 147 (10 min.) Mar 1 Cash .................................................................................. Common Shares .........................................................

300,000

Jun

Dividends Declared ............................................................ Dividends Payable ...................................................... (110,000 × $0.50 = $55,000)

55,000

Dividends Payable ............................................................. Cash ...........................................................................

55,000

Jun 30

300,000

55,000

Ex. 148 The shareholders’ equity section of Alumni Inc. is shown below:

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Alumni Inc. Statement of Financial Position (partial) December 31, 2017 Shareholders’ Equity Share Capital $2 noncumulative Preferred Shares, 50,000 shares authorized, 10,000 shares issued ...................................................... Common shares, unlimited number authorized, 500,000 issued Total Share Capital .......................................................... Retained earnings ......................................................................... Total Shareholders’ Equity .....................................................

$ 650,000 2,100,000 2,750,000 975,000 $3,725,000

During 2018 Alumni entered into the following transactions: 1. Jan 10 Declared a $2 cash dividend to preferred shareholders, payable February 10. 2. Jul 1 Split the common shares 2-for-1. The market price per share was $4.75. 3. Oct 15 Declared a 10% stock dividend to common shareholders of record at November 5 to be distributed November 22. The share price on declaration was $2.50 per share and $2.25 on distribution date. Instructions (a) Prepare the appropriate journal entries. (b) Determine the number of common shares and value at November 30, 2018. (c) Record the journal entry assuming that Alumni reacquired 25,000 shares at $1.75 on December 20, 2018. Solution 148 (a) Jan 10 Dividends Declared—Preferred ($2 x 10,000) .................... Dividend Payable ........................................................ Feb 10

Jul

Oct 15

Nov 22

Dividends Payable—Preferred ($2 x 10,000) ..................... Cash ...........................................................................

20,000 20,000 20,000 20,000

No entry - memorandum entry only, Number of Common shares increases by 500,000 Dividends Declared (100,000 x $2.50) ............................... Stock Dividends Distributable......................................

250,000

Stock Dividends Distributable ............................................ Common Shares (100,000 shares) ............................. (1,000,000 shares * 10%)

250,000

(b) Common Shares Issued Stock Split (500,000 x 1) Stock Dividend (1,000,000 x.10) Total

Shares 500,000 500,000 100,000 1,100,000

250,000

Cost $2,100,000 250,000 $2,350,000

250,000

Avg. Cost

$2.14/share

(c)

Reporting and Analyzing Shareholders’ Equity

Dec 20

Common Shares (25,000 x $2.14) ................................... Contributed Surplus .................................................. Cash (25,000 x $1.75) ..............................................

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53,500 9,750 43,750

Ex. 149 As of December 31, 2017, Shannon Corporation had 500,000 common shares authorized, 100,000 of which had been issued for proceeds of $1.9 million. The Retained Earnings balance was $1,150,000 and Accumulated Other Comprehensive Income was $1,800,000. On January 18, 2018, 50,000 common shares were issued at $25 per share. Net income for 2018 was $275,000. No dividends were declared in 2018. 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, 2018. Solution 149 (10 min.) (a) Jan. 18 Cash ........................................................................... 1,250,000 Common Shares .................................................. 1,250,000 To record issue of 50,000 common shares (50,000* $25/share) (b) Shareholders' equity Share capital Common shares, 500,000 shares authorized; 150,000 shares issued* ................................................................ Retained earnings** ............................................................................ Accumulated other comprehensive income ......................................... Total shareholders' equity .............................................................

$3,150,000 1,425,000 1,800,000 $6,375,000

* $1,900,000 + $1,250,000 = $3,150,000 ** $1,150,000 + $275,000 = $1,425,000

Ex. 150 On January 1, 2018, Blue Corporation reported $3,000,000 in its Common Shares account (200,000 issued) and retained earnings of $1,000,000. During 2018, the following events occurred: 1. On July 1, the company issued 100,000 common shares at $17 per share. 2. On December 15, the board of directors declared a 15% stock dividend to common shareholders of record on December 31, payable on January 15, 2019. 3. The market value of Blue Corporation common shares was $16 per share on December 15 and $14 per share on December 31. 4. Net income for 2018 was $625,000. Instructions (a) Record the issue of shares on July 1 and the declaration of the stock dividend on December 15.

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(b) Prepare the shareholders' equity section of the statement of financial position at December 31, 2018. Solution 150 (10–15 min.) (a) Jul 1 Cash ........................................................................... 1,700,000 Common Shares .................................................. 1,700,000 Issued 100,000 shares at $17/share. Dec 15

Dividends Declared (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, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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. 151 Maha Corporation has 2,000,000 authorized common shares. As of June 30, 2018, 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, 2018 to shareholders of record on July 7, 2018. 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 151 (5–10 min.) (a) Jun 30 Dividends Declared ..................................................... Dividends Payable ............................................... (350,000 × $0.25) (b) Jul

87,500 87,500

No entry required. Dividends Payable ...................................................... Cash ....................................................................

87,500 87,500

Ex. 152 The shareholders' equity section of Starr Corporation at December 31, 2017, included the following:

Reporting and Analyzing Shareholders’ Equity

$3 preferred shares, cumulative, 10,000 shares authorized, 9,000 shares issued .................................. Common shares, 500,000 shares authorized, 400,000 shares issued........

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$ 900,000 2,000,000

Dividends were not declared on the preferred shares in 2017 and are in arrears. On September 15, 2018, the board of directors declared dividends on the preferred shares for 2017 and 2018, to shareholders of record on October 1, 2018, payable on October 15, 2018. On November 1, 2018, the board of directors declared a $0.50 per share dividend on the common shares, payable November 30, 2018, to shareholders of record on November 15, 2018. Instructions Prepare the journal entries that should be made by Starr Corporation on the following dates in 2018: September 15, October 1, October 15, November 1, November 15, and November 30. If no entry is needed write “No entry required.” Solution 152 (12–15 min.) Sep 15 Dividends Declared ............................................................ 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 54,000

No entry required. Dividends Payable ............................................................. Cash ........................................................................... To record payment of cash preferred dividend

54,000

Dividends Declared ............................................................ 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. 153 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.

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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 153 (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. 154 Glenn Corporation's shareholders' equity section at December 31, 2017 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, 2018, 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, 2018, 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, 2018, before the stock split was declared. Net income for 2018 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, 2018. (c) Fill in the amounts that would appear in the shareholders' equity section for Glenn Corporation at December 31, 2018, for the following items: 1. Common shares $______ 2. Number of shares issued ______ 3. Legal capital per share $______ 4. Retained earnings $______ 5. Total shareholders' equity $______

Reporting and Analyzing Shareholders’ Equity

Solution 154 (20 min.) (a) Jun 30 Dividends Declared ..................................................... Stock Dividends Distributable ............................... To record declaration of stock dividend (82,000 × 15% = 12,300 × $14 = $172,200) Jul 15

No entry required.

Jul 31

Stock Dividends Distributable...................................... Common Shares .................................................. To record issue of 12,300 shares in a stock dividend

172,200 172,200

Dec 1

No entry required.

Dec 15

Memo: 188,600 common shares (82,000 + 12,300) × 2

(b) Dec 31

Retained Earnings ...................................................... Dividends Declared .............................................. To close dividends

172,200

Income Summary ........................................................ Retained Earnings ................................................ To close net income 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. 155 As of December 31, 2018, 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, 2018. Solution 155 (5–10 min.) SHAKA SON INC. Statement of Financial Position (partial) December 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Share capital $10.50 preferred shares, noncumulative, 100,000 shares authorized, 10,000 shares issued ................................................................... $2,000,000

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Common shares, 750,000 shares authorized, 350,000 shares issued . Total share capital ........................................................................

5,250,000 $7,250,000

Ex. 156 The following accounts appear on the adjusted trial balance of Airway Machinery Inc. at December 31, 2018: 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, 2018, assuming that retained earnings is restricted for plant expansion in the amount of $250,000. Solution 156 (15–20 min.) AIRWAY MACHINERY INC. Statement of Financial Position (partial) December 31, 2018 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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. 157 Before closing, the Retained Earnings account of Radar Ltd. has a credit balance of $210,000 at December 31, 2018. There was a loss of $238,000 for 2018. The share capital consists of 40,000 common shares issued for $480,000. Instructions Prepare the shareholders’ equity section of the statement of financial position at December 31, 2018.

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Solution 157 (5 min.) RADAR LTD. Statement of Financial Position (partial) December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Shareholders' equity Common shares, 40,000 shares issued ................................................. $480,000 R/E Deficit ($210,000 – $238,000) ......................................................... (28,000) Total shareholders’ equity ............................................................................. $452,000

Ex. 158 Mean Green Corporation had the following shareholders’ equity balances at January 1, 2018: Common shares, unlimited authorized, 200,000 issued ............................. $800,000 Retained earnings ...................................................................................... 120,000 Accumulated other comprehensive income ................................................ 30,000 The following events occurred in 2018: 1. Issued 50,000 common shares for $150,000 cash. 2. Declared and paid dividends of $25,000. 3. Reported net income of $40,000. 4. Reported other comprehensive income of $10,000. Instructions Prepare a statement of changes in shareholders’ equity. Solution 158 (10 min.) Mean Green Inc. Statement of Changes in Shareholders’ Equity Year ended December 31, 2018

Jan 1, 2018 Issued common shares Declared Dividends

Common Shares

Retained Earnings

$800,000

$120,000

$30,000

150,000

Net income

$950,000

Total $950,000 150,000

(25,000)

40,000

Other comprehensive income Dec 31, 2018

Accumulated Other Comprehensive Income

$135,000

(10,000)

$20,000

$1,105,000

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Ex. 159 At December 31, 2017, Houston Corp. reported the following adjusted balances: Common shares: 480,000 issued ............................................................... $3,000,000 Preferred shares: 120,000 issued .............................................................. 900,000 Contributed surplus .................................................................................... 36,000 Retained earnings ...................................................................................... 480,000 Accumulated other comprehensive income ................................................ 144,000 The following events occurred in 2018: 1 Issued 60,000 preferred shares, $600,000. 2. Reported total comprehensive income of $185,000, which included net income of $225,000 and other comprehensive loss of $40,000. 3. Declared and paid dividends to the preferred shareholders of $125,000. Instructions Prepare a statement of changes in equity for the year ended December 31, 2018. Solution 159 (15 min.) Houston Corp. Statement of Changes in Shareholders’ Equity Year ended December 31, 2018

Preferred Shares Jan. 1, 2018

Contributed surplus

Retained Earnings

$900,000 $3,000,000

$36,000

$480,000

$144,000 $4,560,000

225,000

Net income Other comprehensive income Issued preferred shares Paid dividends Dec 31, 2018

Accumulated Other Comprehensive Income

Common Shares

(40,000)

$600,000

$1,500,000 $3,000,000

Total

(40,000)

600,000

$36,000

(125,000)

$580,000

$104,000 $5,220,000

Ex. 160 At December 31, 2017, 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

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During 2018, 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 net income of $325,000 for the year. Instructions Prepare a statement of retained earnings for the year ended December 31, 2018. Solution 160 (10 min.) MAGNOLIA INC. Statement of Retained Earnings Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Balance, January 1 ........................................................................................... $1,600,000 Add: Net income ............................................................................................... 325,000 $1,925,000 Less: Dividends declared (100,000 x $0.50) ..................................................... (50,000) Balance, December 31...................................................................................... $1,875,000

Ex. 161 At December 31, 2017, 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 2018, 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, 2018. (b) If Red River were a publicly-traded corporation, would it still prepare a statement of retained earnings? Explain. Solution 161 (15 min.) (a) RED ROBERTS LIMITED Statement of Retained Earnings Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Balance, January 1 ........................................................................................... $750,000 Less: Loss......................................................................................................... (106,000) Less: Dividends declared (75,000 x $0.50) + (150,000 x $0.40) ........................ (97,500) Balance, December 31...................................................................................... $546,500

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(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. 162 At December 31, 2017, Snow White Corp., a private company reporting under ASPE, had the following shareholders’ equity: Preferred shares, 30,000 issued ................................................................ $150,000 Common shares, 60,000 issued ................................................................. 420,000 Retained earnings ...................................................................................... 740,000 During 2018, the following events occurred: 1. On May 1, the company declared a 5% common stock dividend. The fair value of the common shares was estimated to be $8 at this time. The shares were distributed on June 1. 2. On September 10, the company issued 25,000 common shares at $7.95 each. 3. On December 15, the company declared a cash dividend of $0.30 per share to the common shareholders of record on December 31, payable on January 15, 2017. It also declared a cash dividend of $.50 per share to the preferred shareholders, on the same dates. 4. At December 31, the company reported a net income of $310,000 for the year. Instructions (a) Prepare a statement of retained earnings for the year ended December 31, 2018. (b) If Snow White were a publicly-traded corporation, why would it not prepare a statement of retained earnings? Explain. Solution 162 (20 min.) (a) SNOW WHITE CORP. Statement of Retained Earnings Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Balance, January 1 ........................................................................................... $ 740,000 Add: Net income ............................................................................................... _ 310,000 1,050,000 Less: Dividends declared ($26,400 + $15,000) ................................................ (41,400)1 Less: Dividends declared (60,000 x 5% x $8) ................................................... (24,000) Balance, December 31...................................................................................... $984,600 1

Common dividend: (60,000 + 3,000 + 25,000) x $0.30 = $26,400 Preferred dividend 30,000 x $0.50 = $15,000

Note: the cash dividend is deducted from retained earnings because it has been declared. The payment date is irrelevant. (b) If Snow White 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,

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preferred and common shares), not just retained earnings.

Ex. 163 Using the following information, calculate the payout ratio and the return on common shareholders’ equity: Dividends ................................................................................................... $210,000 Dividends per share ................................................................................... $0.32 Net income ................................................................................................. $1,500,000 Share price at end of year .......................................................................... $26.00 Average common shareholders’ equity ...................................................... $60,000,000 Solution 163 (5 min.) $210,000 Payout ratio: ———–––— x 100 = 14.0% $1,500,000 Return on common shareholders’ equity:

$1,500,000 ————–––— x 100 = 2.5% $60,000,000

Ex. 164 Blue Rays Incorporated reported the following selected information: 2018 Weighted average number of common shares 75,000 Net income $450,000 Preferred share dividends $50,000 Common shareholders’ equity $3,500,000 Dividends declared per share $2.50 Market price per share $30.00

2017 73,500 $410,500 $34,500 $3,300,000 $2.40 $32.50

Instructions Calculate the following ratios for 2018 and 2017 respectively: (a) Basic earnings per share (b) Return on common shareholders’ equity (assume 2016 common shareholders’ equity of $3,250,000) (c) Dividend yield (d) Payout ratio Solution 164

(a) Basic earnings per share =

Return on common shareholders’ equity =

2018

2017

($450,000 – $50,000) 75,000 = $5.33

($410,500 – $34,500) 73,500 = $5.12

($450,000 – $50,000)

($410,500 – $34,500)

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($3,500,000 + $3,300,000)/2 = 11.8%

($3,300,000 + $3,250,000)/2 =11.5%

Dividend yield =

$2.50 $30.00 = 8.3%

$2.40 $32.50 = 7.4%

Payout ratio =

$2.50 $5.33 = 46.9%

$2.40 $5.12 = 46.9%

Ex. 165 Solutions Plus Inc. operates on a calendar year basis. During the year the company had the following transactions related to common shares: Jan 1 Issued 250,000 common shares for $2 per share. Feb 1 Issued 60,000 common shares for $2.25 per share. Mar 10 Issued 2,500 preferred shares for $50 per share. May 1 Issued 600,000 common shares for $2.50 per share. Sep 1 Reacquired 75,000 common shares for $1.95 per share. Nov 1 Reacquired 45,000 common shares for $1.75 per share. In addition, Solutions Plus reported net income of $1,433,625 and paid $55,000 in preferred dividends. Instructions (a) Calculate the weighted average number of shares. (b) Calculate the basic earnings per share. Solution 165 (a) Jan 1 250,000 x 12/12 = Feb 1 60,000 x 11/12 = May 1 600,000 x 8/12 = Sep 1 (75,000) x 4/12 = Nov 1 (45,000) x 2/12 = Weighted Average # of Shares (b) Basic earnings per share =

250,000 55,000 400,000 (25,000) (7,500) 672,500 ($1,433,625 – $55,000) = $2.05 672,500

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MATCHING QUESTIONS 166. 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 net income distributed in the form of dividends to common shareholders

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ANSWERS TO MATCHING 1.

10. C

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SHORT-ANSWER ESSAY QUESTIONS S-A E 167 (a) Explain the difference between comprehensive income, other comprehensive income (OCI) and accumulated other comprehensive income (AOCI). (b) Which type of companies report other comprehensive income? (c) Which financial statements are prepared for reporting purposes? Solution 167 (a) Comprehensive income is the sum of net income and other comprehensive income. Comprehensive income; therefore, includes: (1) the revenues, expenses, gains, and losses included in net income, and (2) the gains and losses that are reported in OCI. Other comprehensive income reflects certain gains and losses (e.g. gains on revaluing property, plant & equipment) that bypass net income. Accumulated other comprehensive income reflects the accumulation of other comprehensive income. AOCI is increased by other comprehensive income and decreased by other comprehensive losses. (b) Only companies using IFRS have to report other comprehensive income. Companies using ASPE do not, because OCI is not used under these standards. Of course, not all companies using IFRS will have transactions affecting other comprehensive income. (c) Comprehensive income is reported on the Statement of Comprehensive Income, while accumulated other comprehensive income is reported in the shareholders’ equity section of the statement of financial position and the statement of changes in shareholders’ equity.

S-A E 168 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.

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Solution 168 (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 long-standing dividend than it gains by a large purchase of its own shares.

S-A E 169 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? (d) Would the impact on the share price be any different if the company declared a 10% stock dividend instead? Explain. Solution 169 (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. (d) A stock dividend is a distribution of shares to shareholders that affects share capital because common or preferred shares is increased when the new shares are issued for the dividend. Similar to a stock split, marketability also increases with the issue of the stock dividend. The share price decreases as a result of the increased number of available shares. However, a stock split is usually much larger than a stock dividend so a drop in share price would likely be greater with a stock split than a stock dividend.

S-A E 170 Why must a corporation meet a two-part solvency test before it may declare cash dividends?

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Solution 170 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 171 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 171 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.

S-A E 172 Your friend Antonia is studying accounting ratios, and asks you to explain the difference between basic 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 net income available to common shareholders.” Instructions Explain to your friend the difference between these two ratios. Solution 172 You are right, Antonia, in that both of these ratios use net income available to common shareholders (i.e., net income less preferred dividends) as the numerator. However, they have different denominators because they measure two different things. Basic earnings per share (EPS) uses the weighted average of common shares outstanding during the year, and when you divide the net income available to common shareholders by this figure, the result is the amount of net income 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

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average common shareholders’ equity from the statement of financial position, and when you divide the net income 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 173 “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 173 The payout ratio is calculated by dividing the total cash dividends paid during the year by the net income for the year, i.e., it uses figures from the corporation records. It measures the percentage of net income distributed as cash dividends (if any). A high ratio means that the company is paying out a lot of its net income 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 net income 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 net income and not retaining it for future growth. Therefore again, for a growth oriented company, one would expect a low (or zero) dividend yield.

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OBJECTIVE FORMAT QUESTIONS

174. Juan Rodriquez is the president and CEO of Balsam Industries Ltd, and owns 100% of the common shares of this private corporation. He is considering taking the company public in order to raise much needed capital. Of the following comments made below, which are correct? (a) The new public corporation will have an unlimited life and may exist past Juan’s own life expectancy. (b) If the company becomes public, Juan will probably have limited liability for corporate obligations. (c) If the company becomes public, Juan will lose control of the company. (d) Since a public corporation is a separate legal entity, Juan by himself will no longer be able to make key decisions such as decisions related to buying property, borrowing money, or entering into contracts. (e) When the company goes public, many of the shares will now trade on a public stock exchange so Juan will not be able to influence those buying or selling the company’s shares. (f) The reporting requirements for Balsam Industries will vary depending on the stock exchange its shares are listed on. Solution 174 (a), (e), and (f) are correct (b) The company most likely, already has limited liability as a privately held corporation, although sometimes there can be exceptions if creditors like banks require personal guarantees from shareholders so the comment made in the question is not always correct. (c) This is not necessarily correct. Juan can still own the majority of shares (50% + 1 share or more), which will enable him to retain control. (d) If Juan maintains majority ownership and continues to work as an officer of the company, going public will not change his ability to make decisions. However, if he only maintains a minority ownership, the board of directors could potentially vote to remove him from the board and from his position as an officer of the company. Even if this does not occur, the board could override his decisions.

175. Choose whether the corporation is likely following IFRS or ASPE from the following statements: (a) Issue (sale) of share capital is shown on the statement of changes in equity. (b) The changes to contributed surplus that arises from the retirement of shares are shown in the notes to the financial statements only. (c) Net income is reported on the statement of retained earnings. (d) Share capital, retained earnings, and accumulated other comprehensive income, if any, must be reported separately. (e) An issue of common shares is disclosed in the notes to the financial statements. (f) The disclosure of basic earnings per share is required.

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(g) The company is a public corporation. (h) When shares are issued for noncash goods or services, the transaction is recorded at the fair value of the goods or services or the fair value of the shares, whichever is more reliable. Solution 175 (a) IFRS. A statement of changes in equity is prepared by companies following IFRS only. ASPE companies prepare a statement of retained earnings. (b) ASPE. Changes to contributed surplus are disclosed in the notes under ASPE because changes in this account are not shown in the statement of retained earnings. (c) ASPE. Companies following ASPE prepare a statement of retained earnings, not a statement of changes in equity and because net income affects retained earnings it will be reported on this statement. (d) IFRS. Only companies following IFRS report accumulated other comprehensive income. (e) ASPE. Companies following ASPE prepare a statement of retained earnings. Consequently, changes in other equity accounts such as the issue of common shares are not shown on this statement. Therefore, information about share issues will be shown in the notes to the financial statements. (f) IFRS. The disclosure of basic earnings per share is only a requirement under IFRS. (g) IFRS. All public companies must follow IFRS if there shares are listed only on Canadian stock exchanges. Private corporations have the choice of following IFRS or ASPE. (h) ASPE. 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. IFRS therefore has a preference for recording such transactions based on the value of consideration received. For a private company following ASPE, the more reliable of the two fair values should be used.

176. The following is a selection of journal entries related to share transactions. Indicate all of the entries that are correctly recorded. (a)

(b)

(c)

Cash Common Shares To record issuance of 26,000 common shares at $3.00 per share.

78,000

Common Shares Cash Reacquired and retired 3,000 common shares at $2.00. Average cost of shares is $3.00.

6,000

Cash Common Shares, Preferred

12,600

78,000

6,000

12,600

Reporting and Analyzing Shareholders’ Equity

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To record issuance of 1,800 preferred shares at $7.00 per share. (d)

(e)

(f)

(g)

Common Shares Contributed Surplus Retained Earnings Cash Reacquired and retired 5,000 common shares at $4.00. Average cost of shares is $3.00. Balance in Contributed Surplus account was $3,000 prior to this entry.

15,000 3,000 2,000

Land Common Shares Issued 80,000 common shares in exchange for land valued at $240,000. This is a reliable value. Share price at the time of exchange is $3.50.

240,000

Common Shares Cash Contributed Surplus Reacquired and retired 10,000 common shares at $4.00. Average cost of shares is $5.50.

55,000

Vehicles Common Shares Issued 10,000 common shares in exchange for a new bus valued at $44,000. Share price at date of exchange was $4.00.

40,000

20,000

240,000

40,000 15,000

40,000

Solution 176 Journal entries (a), (d), (e), and (f) are correctly prepared (b) When shares are reacquired and retired at a price that is below the average carrying amount of the shares, the entry should be Common Shares ................................................. 9,000 Cash .......................................................... 6,000 Contributed Surplus.................................... 3,000 The difference between the average cost of the shares and repurchase price is credited to the Contributed Surplus account to reflect the gain that was made on reacquisition. (c) The correct journal entry to record the issue of preferred shares should have a credit to Preferred Shares, not Common Shares as follows: Cash.................................................................... 12,600 Preferred Shares ........................................ 12,600 (g) The share issuance should be recorded at the fair value of the bus, rather than at the current share price (the item given up) as long as the value of the bus is a fair value. The correct journal entry to record the issue of common shares for the automobile is Vehicles .............................................................. 44,000 Common Shares ........................................ 44,000

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

177. For each event indicate the effect (+/-) on retained earnings and share capital: (a) Dividends of $0.75 per share are declared on 50,000 common shares. (b) Dividends of $35,700 are paid to common shareholders. (c) A total of 15,000 new common shares are issued at $5.00 per share. (d) Existing shareholders sell 1,500 shares for a total of $9,000 on the open market. (e) A 10% stock dividend is declared to common shareholders. (f) A 10% stock dividend is distributed after it was declared. (g) A stock split of 2-for-1 is declared on the 50,000 common shares trading. Solution 177 a) Dividends of $0.75 per share are declared on 50,000 common shares.

Retained earnings –

When dividends are declared, Dividends Declared is debited and Dividend Payable is credited. Dividends Declared is closed into Retained Earnings (it decreases retained earnings). There is no effect on share capital.

(b) Dividends of $35,700 are paid to common shareholders.

No effect

When dividends are paid, the Dividends Payable account is debited and Cash is credited. There is no effect on retained earnings or share capital.

Share capital +

When new common shares are issued, Cash is debited and Common Shares is credited. Therefore, share capital increases. There is no effect on retained earnings.

(d) Existing shareholders sell 1,500 shares for a total of $9,000 on the open market.

No effect

This does not affect the company’s financial records. Resale of existing shares on the open market occur externally to the company and do not affect the company’s accounting records because such a transaction occurs between shareholders, so the company is not involved,

(e) A 10% stock dividend is declared to common shareholders.

Retained earnings –

When a stock dividend is declared, Dividends Declared is debited and Stock Dividends Distributable is credited. Dividends Declared is closed into Retained Earnings (it decreases Retained Earnings). There is no effect on share capital until the stock dividend is distributed.

Reporting and Analyzing Shareholders’ Equity

(f)

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A 10% stock dividend is distributed after it was declared.

Share capital +

When a stock dividend is declared, stock dividends distributable is debited and common shares is credited. Therefore, share capital increases. There is no effect on retained earnings.

(g) A stock split of 2-for1 is declared on the 50,000 common shares trading.

No effect

When a stock split is declared, there is no change in the value of retained earnings or share capital. Only the number of shares outstanding increases but this does not affect the balance of any accounts on the financial statements.

178. The following information was provided for Linker Corporation which reports under IFRS for 2018: January 1, 2018 account balances: Retained earnings Common shares (23,850 shares) Contributed surplus Accumulated other comprehensive income

$127,000 $56,700 $4,500 $670 credit

Events that took place during 2018: • A 10% stock dividend was declared on July 31. Fair value of each share was $3.00. • Cash dividends of $0.20 per share were declared March 1. • Total revenue earned by the company during the year was $126,000. • Total expenses incurred by the company during the year were $87,000. • 25,000 new common shares were issued in exchange for land on October 1. The fair value of the land was $50,000. The fair value of each common share was $2.75. Using the above information, prepare a statement of changes in equity. Using this statement, indicate all of the following statements that are correct: (a) Shareholders’ equity on December 31, 2018 totaled $273,100. (b) The balance of common shares on December 31, 2018 is $106,700. (c) The balance of retained earnings at December 31, 2018 is $154,075. (d) Shareholders’ equity on December 31, 2018 totaled $277,200. (e) The balance retained earnings at December 31, 2018 is $158,845. (f) The balance of common shares on December 31, 2018 is $113,855. (g) The total change in retained earnings during the year is $39,000. (h) Shareholders’ equity on January 1, 2018 totaled $188,200. Solution 178 (a), (c), and (f) are correct The following statement of changes in equity for Linker Corporation shows the correct calculations. Linker Corporation Statement of Changes in Equity

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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian

Year Ended December 31, 2018 Contributed Capital Common Shares

Contributed Surplus

Balance, January 1 $56,700 Issued common shares 50,000 Cash dividends declared Stock dividends 7,155 Comprehensive income Net income Other comprehensive income Balance, December 31 $113,855

$4,500

Retained Earnings $127,000

Accumulated Other Comprehensive Income $670

(4,770) (7,155)

$4,500

39,000 0 $154,045

0 $670

Total $188,870 50,000 (4,770)

39,000 0 $273,100

Calculations: Cash dividends and stock dividends: Cash dividends = $0.20 x 23,850 shares = $4,770 Stock dividends = 10% x $3.00 x 23,850 shares = $7,155 Net income = $126,000 – $87,000 = $39,000 The common shares issued on October 1, in exchange for the land, were recorded at the fair value of the land because Linker Corporation follows IFRS.

CHAPTER 12 REPORTING AND ANALYZING INVESTMENTS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 M C F AN 12. 2 E K F AN 23. 4 M K F AN 2. 1 M K F AN 13. 2 M K F AN 24. 4 M K F AN 3. 1 M K F AN 14. 2 M C F AN 25. 4 H C F AN F AN F AN F AN 4. 1 M C 15. 3 E K *26. 5 E C 5. 1 E K F AN 16. 3 E C F AN *27. 5 M C F AN 6. 1 M K F AN 17. 3 E K F AN *28. 5 M K F AN 7. 1 M K F AN 18. 3 M C F AN *29. 5 M C F AN 8. 1 M K F AN 19. 3 M K F AN *30. 5 H C F AN 9. 2 E K F AN 20. 4 M K F AN *31. 5 M K F AN 10. 2 H C F AN 21. 4 M K F AN 11. 2 M C F AN 22. 4 M K F AN Multiple Choice Questions 32. 1 M C F AN 60. 3 M C F AN 88. 4 M K F AN 33. 1 M K F AN 61. 3 E K F AN 89. 4 M C F AN 34. 1 M K F AN 62. 3 H C F AN 90. 4 M C F AN 35. 1 E K F AN 63. 3 M C F AN 91. 4 M AP F AN 36. 1 M K F AN 64. 3 E K F AN 92. 4 H AP F AN 37. 1 E K F AN 65. 3 E C F AN 93. 4 E K F AN 38. 1 E K F AN 66. 3 E C F AN 94. 4 H C F AN 39. 1 M K F AN 67. 3 M AP F AN *95. 5 M C F AN 40. 1 M K F AN 68. 3 H AP F AN *96. 5 M K F AN 41. 1 E K F AN 69. 3 H AP F AN *97. 5 H C F AN 42. 1 E K F AN 70. 3 H AP F AN *98. 5 H C F AN 43. 2 M C F AN 71. 3 H AP F AN *99. 5 E AP F AN 44. 2 H K F AN 72. 3 E C F AN *100. 5 E AP F AN 45. 2 E K F AN 73. 3 M K F AN *101. 5 E AP F AN 46. 2 E K F AN 74. 3 H K F AN *102. 5 M AP F AN 47. 2 H C F AN 75. 3 H C F AN *103. 5 H AP F AN 48. 2 M AP F AN 76. 3 M C F AN *104. 5 E AP F AN 49. 2 M AP F AN 77. 3 E C F AN *105. 5 E AP F AN 50. 2 M AP F AN 78. 3 M C F AN *106. 5 H AP F AN 51. 2 E C F AN 79. 3 M C F AN *107. 5 E C F AN 52. 2 E C F AN 80. 3 E C F AN *108. 5 M C F AN 53. 2 E C F AN 81. 3 E K F AN *109. 5 M C F AN 54. 2 H C F AN 82. 3 E K F AN *110. 5 M AP F AN 55. 2 M C F AN 83. 3 M C F AN *111. 5 M AP F AN 56. 2 M AP F AN 84. 3 M C F AN *112. 5 M AP F AN 57. 3 M C F AN 85. 4 H C F AN *113. 5 M AP F AN 58. 3 H C F AN 86. 4 M C F AN 59. 3 E K F AN 87. 4 M C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension K = Knowledge CPA: F = Financial Reporting AACSB: AN = Analytic *This topic is dealt with in an Appendix to the chapter. Copyright © 2017 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, Seventh Canadian Edition

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO

114. 1 115. 1–3 116. 2 117. 2 118. 2 119. 2,3 120. 2,3

LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB

E M E M E M M

133. 1–4 E,M,H

K C AP AP AP AP AP

F F F F F F F

AN AN AN AN AN AN AN

134. 1 E 135. 2,3,4 M

C C

139. 140.

C C

2 3

M M

Exercises 121. 2,3 H AP 122. 2,4 M AP 123. 2,4 M AP 124. 2,4 M AP 125. 2,4 M AP 126. 2,5 H AP 127. 3 E AP Matching

F F F F F F F

AN AN AN AN AN AN AN

128. 3 E 129. 3,4 E *130. 5 M *131. 5 M *132. 5 M

Short-Answer Essay F AN 136. 2,4 M C F AN 138. 3,4 E F,E AN, E 137. 2,4 M C F,C AN,C CPA Questions F AN 141. 4 M K F AN *143. 5 M F AN *142. 5 H AN F AN

AP AP AP AP AP

F F F F F

AN AN AN AN AN

LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge CPA: C = Communication E = Professional and Ethical Behaviour F = Financial Reporting AACSB: AN = Analytic C = Communication E = Ethics *This topic is dealt with in an Appendix to the chapter.

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SUMMARY OF LEARNING 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

32. 33. 34. 35.

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

TF TF TF TF TF TF

43. 44. 45. 46. 47. 48.

MC MC MC MC MC MC

49. 50. 51. 52. 53. 54.

15. 16. 17. 18. 19. 57. 58.

TF TF TF TF TF MC MC

59. 60. 61. 62. 63. 64. 65.

MC MC MC MC MC MC MC

66. 67. 68. 69. 70. 71. 72.

20. 21. 22. 23.

TF TF TF TF

24. 25. 85. 86.

TF TF MC MC

87. 88. 89. 90.

*26. *27. *28. *29. *30.

TF TF TF TF TF

*31. *95. *96. *97. *98.

TF MC MC MC MC

*99. *100. *101. *102. *103.

Note:

TF = True-False Ex = Exercise

Item

Type

Item

Type

115. 133. 134.

Ex Ma SAE

125. 126. 133. 135. 136. 137.

Ex Ex Ma SAE SAE SAE

139.

120. 121. 127. 128. 129. 133. 135.

Ex Ex Ex Ex Ex Ma SAE

138. 140.

SAE CP

Learning Objective 1 MC 36. MC 40. MC MC 37. MC 41. MC MC 38. MC 42. MC MC 39. MC 114. Ex Learning Objective 2 MC 55. MC 119. Ex MC 56. MC 120. Ex MC 115. Ex 121. Ex MC 116. Ex 122. Ex MC 117. Ex 123. Ex MC 118. Ex 124. Ex Learning Objective 3 MC 73. MC 80. MC MC 74. MC 81. MC MC 75. MC 82. MC MC 76. MC 83. MC MC 77. MC 84. MC MC 78. MC 115. Ex MC 79. MC 119. Ex Learning Objective 4 MC 91. MC 122. Ex MC 92. MC 123. Ex MC 93. MC 124. Ex MC 94. MC 125. Ex *Learning Objective 5 MC *104. MC *109. MC MC *105. MC *110. MC MC *106. MC *111. MC MC *107. MC *112. MC MC *108. MC *113. MC

129. 133. 135. 136.

Ex Ma SAE SAE

137. 138. 141.

SAE SAE CP

*126. *130. *131. *132. *142.

Ex Ex Ex Ex CP

*143.

MC = Multiple Choice SAE = Short-Answer Essay

Ma = Matching CP = CPA Questions

*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, Seventh Canadian Edition

CHAPTER LEARNING 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 or a strategic reason in order to influence or control the operations of another company. Alternatively, an investment may be made for non-strategic reasons. Non-strategic debt investments may be purchased for trading purposes or to receive interest payments until maturity. 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. (1) 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. (2) The fair value through other comprehensive income model is very similar to the above except that both unrealized gains and losses are reported in other comprehensive income rather than on the income statement. Depending on whether the investment is a debt or equity security, the treatment of realized gains and losses and previously recorded unrealized gains and losses can be accounted for in different ways under this model that are covered in more advanced accounting courses. (3) 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. (4) The cost model is identical to the amortized cost model but would be used on an equity investment rather than a debt investment.

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. However, qualitative factors (board representation, participation in investee’s decisions, material transactions with investee, interchange of managerial personnel, and provision of technical information) are the major criteria used 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, the equity method can be used. The equity method records investment income 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 investee’s equity has fallen. When the investor obtains control (usually more than 50% of the shares) of the investee, the investee is referred to as a subsidiary whose financial statements are normally consolidated into those of the parent company.

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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 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. The second exception applies to investments accounted for under the fair value through OCI model, where gains and losses are not shown in the income statement but are instead reported in OCI. (Realized gains and losses are then reclassified out of OCI, but this treatment goes beyond the scope of this textbook.) 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 and can be accounted for using the fair value through OCI model under IFRS (an option to use fair value through profit or loss is available), but because ASPE does not use other comprehensive income, use of the fair value through OCI model 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 if the investment is also held for trading purposes. Under ASPE or IFRS, 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 method or fair value through profit or loss method. If fair value is not known, they can be accounted for using the equity method or cost model. Under IFRS, when a company has a strategic investment in a subsidiary where control has been obtained, the preparation of consolidated financial statements is required. 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, if the fair value of the investment is known, the investment can be accounted for using the fair value through profit or loss model or the equity method. If the fair value of the investment is not known, then in addition to consolidating financial statements, the investment can be accounted for using either the cost model or the equity method. 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 or loss model.

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

TRUE-FALSE STATEMENTS 1. Corporations purchase investments in debt or equity securities for the income tax write-off.

2. Strategic investments are debt or equity securities that are usually purchased to generate investment income.

3. Non-strategic investments can be classified as short or long-term investments.

4. 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.

5. Non-strategic investments that are held for the purpose of earning capital gains are called Held for Trading Investments.

6. The degree of influence determines how a strategic investment is classified.

7. Preferred shares are often purchased as strategic investments.

8. Equity securities are always classified as long-term investments.

9. At acquisition, non-strategic investments are recorded at their purchase cost.

10. 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.

11. No unrealized gains and losses are recorded when using the amortized cost model.

12. Using the fair value through profit or loss model, both unrealized and realized gains and losses would be reported in the income statement.

13. Only debt investments can be accounted for using the fair value through other comprehensive income model.

14. If the fair value through other comprehensive income model is used, then unrealized gains and losses are not used to evaluate management.

Reporting and Analyzing Investments

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15. When an investee can be significantly influenced, it is known as an associate.

16. 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.

17. 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.

18. 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.

19. 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.

20. Under both IFRS and ASPE, investors can use either the cost model or the equity method for significantly influenced investments.

21. Investments in associates are reported as current assets on the statement of financial position at their fair value.

22. Both equity and debt investments are reported as current assets on the statement of financial position at their fair value.

23. Realized gains and losses are always reported in the income statement.

24. Debt investments held to earn interest revenue are reported at amortized cost in the statement of financial position.

25. Consolidated financial statements are appropriate when one company has significant influence over another company.

*26. 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.

*27. Premiums and discounts must be amortized on all bond investments.

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

*28. Short-term investments in bonds are accounted for using the fair value through profit or loss model.

*29. 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.

*30. 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.

*31. 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.

Ans. F F T T T T F

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. T F T T T F F

Item 22. 23. 24. 25. 26. 27. 28.

Ans. F F T F F F T

Item 29. 30. 31.

Ans. T T F

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

MULTIPLE CHOICE QUESTIONS 32. Securities that can be purchased for strategic purposes (a) include only equity securities to influence relationships between companies. (b) include only debt investments. (c) include both equity securities and debt investments. (d) exclude both equity securities and debt investments.

33. When investing excess cash for short periods of time, (a) corporations generally invest in equity securities. (b) corporations generally invest in debt securities that have both high liquidity and high risk. (c) corporations generally invest in debt securities that have high risk and low liquidity. (d) corporations generally invest in debt securities that have low risk and high liquidity.

34. 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.

35. 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.

36. Which of the following would never be classified as a long-term investment? (a) strategic investments (b) held for trading investments (c) investments in associates (d) bonds with a ten-year maturity

37. Debt investments include all of the following except (a) common shares. (b) guaranteed investment certificates. (c) treasury bills. (d) bonds.

38. 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) held for trading investments

Reporting and Analyzing Investments

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(d) long-term bonds

39. Held for Trading Investments are all of the following except (a) debt or equity securities. (b) securities purchased to generate a net income from short-term price fluctuations. (c) securities held for the purpose of earning capital gains. (d) strategic investments.

40. All of the following statements concerning strategic investments are true, except (a) they include held for trading investments. (b) they are purchased for the strategic purpose of influencing relationships between companies. (c) they are generally long-term investments. (d) they are equity securities.

41. Debt investments are all of the following except (a) low risk. (b) classified according to maturity. (c) equity securities. (d) debt securities.

42. 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.

43. Which of the following is false? (a) The cost model is used only for equity investments. (b) The cost model reports realized gains and losses on the income statement. (c) The cost model is used to account for equity investments where there is significant influence. (d) The cost model is very similar to the amortized cost model.

44. 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.

45. All of the following investments are generally shown at their fair value except (a) short-term debt investments. (b) held for trading investments. (c) bond investments intended to be held to maturity.

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

(d) shares purchased with the intention of achieving a capital gain on sale.

46. Which of the following is not true about the accounting for Held 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.

47. 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.

48. Hankers Corporation buys 1,500 shares of Viggo Ltd.'s common shares as a trading investment. The shares are purchased for $45 a share. At year end the shares are trading at $48. The adjusting entry at year end is (a) Cash ............................................................................................. 4,500 Investment Revenue .............................................................. 4,500 (b) Held for Trading Investments ........................................................ 4,500 Unrealized Gain on Held for Trading Investments .................. 4,500 (c) Held for Trading Investments ........................................................ 4,500 Realized Gain on Held for Trading Investments ..................... 4,500 (d) No entry is required. Solution: ($48 x 1,500) – ($45 x 1,500) =$4,500 unrealized gain

49. On September 15, 2018, Alonso Ltd. sells 150 common shares of Bandi Corp., which were being held as a trading investment. The shares were acquired six months ago at $75 a share. Alonso sells the shares for $60 a share. The entry to record the sale is (a) Cash ............................................................................................. 9,000 Realized Losses on Held for Trading Investments......................... 2,250 Held for Trading Investments.................................................. 11,250 (b) Cash ............................................................................................. 11,250 Realized Gain on Held for Trading Investments ..................... 2,250 Held for Trading Investments.................................................. 9,000 (c) Cash ............................................................................................. 9,000 Held for Trading Investments.................................................. 9,000 (d) Held for Trading Investments ........................................................ 9,000 Realized Losses on Held for Trading Investments......................... 2,250 Cash....................................................................................... 11,250 Solution: ($60 – $75) x 150 = ($2,250) realized loss

50. On June 1, 2018, Mango Corp. purchased Papaya Corp. common shares for $12,100 as a trading investment. Three months later, Mango sold these shares for $13,000. The entry to record the sale would include a

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(a) debit to Cash of $12,100. (b) credit to Interest Revenue of $900. (c) credit to Held for Trading Investments of $13,000. (d) credit to Realized Gain on Held for Trading Investments of $900. Solution: ($13,000 – $12,100) = $900 realized gain

Use the following information to answer questions 51–54. Wells Inc. reported these transactions relating to marketable Held for Trading Investments intended to generate net income 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.

51. The entry to record the purchase of the Taylor shares on Feb 1 would include a (a) debit to Long-Term Held for Trading Investments. (b) debit to Held for Trading Investments. (c) debit to Strategic Investments. (d) debit to Investment in Associates.

52. The entry to record the receipt of the dividends on Jun 1 would include a (a) debit to Held for 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. Solution: ($3 x 500) = $1,500

53. The entry to record the sale of the shares on Oct 1 would include a (a) credit to Held for 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. Solution: ($7,500 / 500) = $15; $3,800 – ($15 x 200) = $800 realized gain

54. The entry, if any is required, to record the value of the investment on December 31 would include a debit to (a) Realized Losses for $450. (b) Unrealized Loss for $750. (c) No entry is required. (d) Unrealized Losses of $450. Solution: ($7,500 / 500) = $15; ($13.50 – $15.00) x 300 shares = ($450) unrealized loss

55. 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.

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

(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.

56. On October 1 of last year, Hand Tools Corp. purchased 1,500 shares of the Bindo Bank for $72,000 as a trading investment. At year end, December 31, the fair value of these shares was $75,000. On February 1 of this year, Hand Tools sold all these shares for $73,000. The realized gain (loss) that Hand Tools will report this year is (a) a gain of $2,000. (b) a gain of $1,000. (c) a loss of $1,000. (d) a loss of $2,000. Solution: ($73,000 – $75,000 = ($2,000) loss

57. Which one of the following statements is false? (a) Under the equity method, revenue is recognized when net income is earned by the associate. (b) 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. (c) Under the equity method, the investment account is adjusted annually for a portion of associate’s net income and for dividends received. (d) Under the equity method, revenue is recognized when net income is earned by the investor which may not be when it is earned by the investee.

58. Under the equity method, (a) the receipt of dividends from the investee results in an increase in the investment account. (b) the receipt of dividends from the investee results in a credit to the Dividend Revenue account. (c) the receipt of dividends from the investee results in an increase in the investment account and a credit to the Dividend Revenue account. (d) the receipt of dividends from the investee reduces the carrying amount of the investment account.

59. When an investee can be significantly influenced, it is known as a(n) (a) subsidiary. (b) associate. (c) trading investment. (d) parent.

60. 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 net income. (c) the Investment account is credited when the investee reports net income. (d) the Investment account is credited when dividends are received.

61. If 30% of the common shares of an investee are purchased as a long-term investment, the

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appropriate classification for this investment is most likely (a) held for trading investments. (b) equity investments. (c) non-strategic investments. (d) investment in associates.

62. When the cost method is used to account for an equity investment, the carrying amount of the investment is affected by (a) the net income of the investee. (b) dividend distributions of the investee. (c) both the net income and the dividend distributions of the investee. (d) neither the net income nor the dividend distributions of the investee.

63. 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.

64. 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.

65. 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.

66. 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

67. Aroma Limited owns a 25% interest in the shares of Baltic Corporation. During the year, Baltic pays $10,000 in dividends to Aroma and reports $100,000 net income. Aroma’s investment in Baltic will increase Aroma’s net income by (a) $25,000.

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

(b) $27,500. (c) $10,000. (d) $ 2,500. Solution: ($.25 x $100,000) = $25,000

68. Republic Corp. owns a 15% interest in the common shares of Wholesome Ltd. During this year, Wholesome pays a total of $25,000 in dividends and reports $160,000 net income. Republic’s investment in Wholesome will increase Republic’s net income by (a) $25,000. (b) $24,000. (c) $27,750. (d) $ 3,750. Solution: (.15 x $25,000) = $3,750

69. Frisbee Inc. owns a 30% interest in the shares of California Corp. During the year, California pays $10,000 in dividends to Frisbee and reports a net loss of $80,000. Frisbee’s investment in California will affect Frisbee’s net income by (a) $10,000 increase. (b) $3,000 increase. (c) $24,000 decrease. (d) $21,000 decrease. Solution: ($.30 x $80,000) = $24,000 decrease

70. Eurythmics Ltd. owns 20% interest in the shares of Sydney Corporation. During the year, Sydney pays $10,000 in dividends to Eurythmic and reports a net loss of $50,000. Eurythmic’s investment in Sydney will affect Eurythmics’s net income by (a) $2,000 increase. (b) $10,000 decrease. (c) $10,000 increase. (d) $12,000 decrease. Solution: (.20 x $50,000) = $10,000 decrease

71. On January 1, 2018, Coastal Corp. purchased 30% of the common shares of Mansbridge Corp. for $600,000. During 2018, Mansbridge Corp. reported net income of $75,000 and paid total cash dividends of $15,000. The balance in the Investment in Associates (Mansbridge) account on Coastal’s books at December 31, 2018 is (a) $675,000. (b) $622,500. (c) $618,000. (d) $600,000. Solution: $600,000 + (.30 x $75,000) – (.30 x $15,000) = $618,000

72. Under the equity method, the Investment in Associates account is increased when the (a) associate reports net income. (b) associate pays a dividend. (c) associate reports a loss.

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(d) investment is sold at a gain.

73. 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

74. 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

75. 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) net income of the investee are ignored by the investor. (c) net income 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.

76. 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.

77. 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 net income 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 Income from Associates account.

78. If the equity method is being used, the Income from Associates account is (a) another name for a Dividend Revenue account. (b) credited when dividends are declared by the investee. (c) credited when net income is reported by the investee. (d) debited when net income is reported by the investee.

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

79. Under the equity method, the Investment in Associates account is credited when the (a) associate reports net income. (b) associate reports a net loss. (c) associate is originally acquired. (d) both when the investee reports net income and when the investment is originally acquired.

80. 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.

81. 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.

82. 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.

83. 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.

84. 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.

85. Held for trading investment(s) (a) may be a source of comprehensive income when unrealized gains and losses are recorded. (b) are always classified as current assets. (c) are not a source of comprehensive income but a source of always classified as long-term assets. (d) unrealized gains and losses are recorded differently under the fair value through profit or loss model as realized gains and losses.

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86. Other comprehensive income (loss) (a) has no impact on shareholders’ equity. (b) increases (decreases) accumulated other comprehensive income. (c) increases (decreases) retained earnings. (d) increases (decreases) net income.

87. 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.

88. 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.

89. 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. 90. “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 held for trading investments. (d) unrealized gains and losses on held for trading investments.

91. Laski Corp. holds two held for 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 held for 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. Solution: $2,000 – $4,500 = ($2,500) in the income statement

92. During its first year of operation, Snapper Limited (a public company) acquired three securities

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

as trading investments held for. Investment A cost $75,000 and had a year-end fair value of $80,000. Investment B cost $42,000 and had a year-end fair value of $26,000. Investment C cost $32,000 and had a year-end fair value of $30,000. What amount should be reported as an unrealized loss in Snapper’s income statement for the first year of operation? (a) $0 (b) $13,000 (c) $18,000 (d) $23,000 Solution: ($80,000 – $75,000 + $26,000 – $42,000 + $30,000 – $32,000) = ($13,000) unrealized loss

93. Held for Trading Investments are listed on the statement of financial position immediately below (a) cash. (b) inventory. (c) accounts receivable. (d) prepaid expenses.

94. 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.

*95. The amortization of a bond investment is recorded in (a) an Interest Expense account. (b) an Interest Revenue account. (c) neither an Interest Expense or an Interest revenue account. (d) either an Interest Expense account or an Interest Revenue account.

*96. 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.

*97. 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.

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*98. 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 *99–*101. On January 1, 2017, 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.

*99. The entry for the receipt of interest on July 1, 2017, is (a) Cash ............................................................................................... Interest Revenue .................................................................... (b) Cash ............................................................................................. Interest Revenue .................................................................... (c) Interest Receivable ....................................................................... Interest Revenue .................................................................... (d) Interest Receivable ....................................................................... Interest Revenue .................................................................... Solution: ($5,000 x.05 x 6/12) = $125

*100. The adjusting entry on December 31, 2017, is (a) No entry required. (b) Cash ............................................................................................. Interest Revenue .................................................................... (c) Interest Receivable ....................................................................... Interest Revenue .................................................................... (d) Long-Term Investments ................................................................ Interest Revenue .................................................................... Solution: ($5,000 x.05 x 6/12) = $125

*101. The entry for the receipt of interest on January 1, 2018 is (a) Cash ............................................................................................. Interest Revenue .................................................................... (b) Cash ............................................................................................. Interest Receivable................................................................. (c) Cash ............................................................................................. Interest Revenue .................................................................... (d) Cash ............................................................................................. Interest Receivable................................................................. Solution: ($5,000 x.05 x 6/12) = $125

125 125 250 250 125 125 250 250

125 125 125 125 125 125

250 250 250 250 125 125 125 125

Use the following information for questions *102–*106.

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

On January 1, 2017, 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, 2017 was $48,500. Marianne sold the bonds on January 2, 2018 for $48,500.

*102. The entry for the receipt of interest on July 1, 2017 is (a) Cash ............................................................................................. 1,080 Long-Term Investments.......................................................... 80 Interest Revenue .................................................................... 1,000 (b) Cash .................................................................................. 1,000 Long-Term Investments ................................................................ 80 Interest Revenue .................................................................... 1,080 (c) Cash .................................................................................. 1,000 Interest Revenue .................................................................... 1,000 (d) Cash .................................................................................. 1,080 Interest Revenue .................................................................... 1,080 Solution: ($48,000 x.045 x 6/12) = $1,080 interest Revenue; ($50,000 x.04 x 6/12) = $1,000 Cash; $1,080 – $1,000 = $80 Long-Term Investments

*103. The adjusting entry for interest on December 31, 2017, is (a) No entry required. (b) Interest Receivable ....................................................................... 1,000 Long-Term Investments ................................................................ 80 Interest Revenue .................................................................... 1,080 (c) Interest Receivable ....................................................................... 1,000 Long-Term Investments ................................................................ 82 Interest Revenue .................................................................... 1,082 (d) Cash ............................................................................................. 1,000 Long-Term Investments ................................................................ 82 Interest Revenue .................................................................... 1,082 Solution: (($48,000 + $80) x.045 x 6/12) = $1,082 interest Revenue; ($50,000 x.04 x 6/12) = $1,000 Cash; $1,082 – $1,000 = $82 Long-Term Investments

*104. The entry to adjust to fair value on December 31, 2017 is (a) No entry required. (b) Long-Term Investments ................................................................ 500 Unrealized Gain on Long-Term Investments .......................... (c) Long-Term-Investments ................................................................ 338 Unrealized Gain on Long-term Investments............................ (d) Long-Term Investments ................................................................ 500 Realized Gain on Long-Term Investments.............................. Solution: No entry required. No adjustment to FV if the amortized cost method is used.

*105. The entry for the receipt of interest on January 1, 2018 is (a) Cash .............................................................................................

500 338 500

1,080

Reporting and Analyzing Investments

Interest Receivable................................................................. (b) Cash ............................................................................................. Interest Receivable................................................................. (c) Cash ............................................................................................. Interest Revenue .................................................................... (d) Cash ............................................................................................. Interest Revenue .................................................................... Solution: ($50,000 x.04 x 6/12) = $1,000

*106. The entry for the sale of the bonds on January 2, 2018 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.......................................................... Solution: ($48,500 – ($48,000 + $80 + $82)) = $338

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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 *107–*109. On January 1, 2018, 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 held for trading investments. The bonds were sold on July 2, 2018 for $53,000. *107. Warner’s entry to record the purchase would include a debit to (a) Held for Trading Investments for $50,000. (b) Cash for $50,000. (c) Bonds Payable for $50,000. (d) Long-Term Investments for $50,000. *108. 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 Held for Trading Investments for $875. Solution: ($50,000 x.035 x 6/12) = $875 *109. 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.

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

(c) credit to Realized Gain on Held for Trading Investments for $3,000. (d) credit to Held for Trading Investments for $53,000. Solution: $53,000 – $50,000 = $3,000 realized gain

*110. 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 Held for Trading Investments.................................................. 1,060 (b) Cash ............................................................................................. 1,100 Held for Trading Investments.................................................. 1,060 Realized Gain on Held for Trading Investments ..................... 40 (c) Cash ............................................................................................. 1,100 Held for Trading Investments.................................................. 1,060 Unrealized Gain on Held for Trading Investments .................. 40 (d) Cash ............................................................................................. 1,100 Held for Trading Investments.................................................. 1,100 Solution: $1,100 – $1,060 = $40 realized gain

Use the following information for questions *111–*113. On January 1, 2018, 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, 2018, the fair value of the bonds was $23,950.

*111. 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 ................................................................ Interest Revenue .................................................................... Cash.......................................................................................

21,595 21,595 21,595 3,405 25,000 25,000 3,405 21,595 25,000

*112. What is the entry to record the receipt of the interest on July 1, 2018? (a) Cash ............................................................................................. Long-Term Investments.......................................................... (b) Cash ............................................................................................. Interest Revenue .................................................................... (c) Cash ............................................................................................. Interest Revenue .................................................................... (d) Cash .............................................................................................

3,405 21,595

625 625 756 756 625 625 625

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Long-Term Investments ................................................................ 131 Interest Revenue .................................................................... 756 Solution: ($21,595 x.07 x 6/12) = $756 Interest Revenue; ($25,000 x.05 x 6/12) = $625 Cash; $756 – $625 = $131 Long-Term Investments

*113. What is the entry (if any) to record the fair value adjustment on December 31, 2018? 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 Solution: Long-term investments are accounted for using the amortized cost model so no entry is required.

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

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45.

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

Item 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59.

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

Item 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73.

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

Item 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87.

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

Item 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101.

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

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

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

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EXERCISES Ex. 114 Identify which of the following are true or false. 1. _____ Investments that are held for the purpose of earning interest are called strategic investments. 2. _____ Non-strategic investments can be classified as either short-term or long-term. 3. _____ Both debt and equity securities can be purchased for the strategic purpose of influencing relationships between companies. 4. _____ It is best to invest excess short-term cash in equity securities as share prices fluctuate significantly over the short term. 5. _____ Both debt and equity securities can be purchased as a non-strategic investment. Solution 114 1. False 2.

True

False

True

Ex. 115 Identify whether each of the following investments for JCL Incorporated is a non-strategic (NS) or strategic investment (S) and a debt (D) or equity (E) investment: (a) investment in guaranteed investment certificates (b) 25% of the common shares in Fragile Ltd. for the purpose of influencing its relationship with Fragile Ltd. (c) investment in 10-year corporate bonds held for the purpose of earning interest (d) 10% investment in Alibaba Inc. common shares for the purpose of earning capital gains (e) 75% of the common shares of Windows Inc. for control purposes Solution 115 (a) NS, D (b) S, E (c) NS, D (d) NS, E (e) S, E

Ex. 116 On January 1, Kensington Corporation, as a trading investment, purchased a three month, 3%,

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

$20,000 term deposit. Instructions Prepare entries for the purchase and maturity of the term deposit. Solution 116 (2–4 min.) Jan 1 Held for Trading Investments ............................................. Cash ...........................................................................

20,000

Mar 31

20,150

Cash .................................................................................. Held for Trading Investment ........................................ Interest Revenue ($20,000 x 3% x 3/12) .....................

20,000

20,000 150

Ex. 117 Glover Corporation reported the following transactions relating to its held for 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 117 (10–15 min.) (a) Jan 1 Held for Trading Investments ............................................. Cash ........................................................................... Jul

(b) Dec 31

104,000 104,000

Cash ($100,000 × 6% × 6/12) ............................................ Interest Revenue.........................................................

3,000

Cash .................................................................................. Held for Trading Investments ($104,000 x ½) ............. Realized Gain on Held for Trading Investments ..........

53,000

Interest Receivable ............................................................ Interest Revenue......................................................... ($50,000 × 6% × 6/12)

1,500

3,000

52,000 1,000

1,500

Ex. 118 The following transactions regarding their held for trading investments were made by Amarillo Limited: Jun 2 Purchased 200 Clark Corporation common shares for $45 per share. Jul 1 Purchased 100 Lewis Corporation bonds for $110,000. 31 Received a cash dividend of $2 per share from Clark Corporation.

Reporting and Analyzing Investments

Sep 15 Dec 31 31 31

12 - 29

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 118 (10–15 min.) Jun 2 Held for Trading Investments ............................................. Cash (200 x $45) ........................................................ Jul

Sep 15

Dec 31

9,000 9,000

Held for Trading Investments ............................................. Cash ...........................................................................

110,000

Cash .................................................................................. Dividend Revenue .......................................................

400

Cash (80 × $50) ................................................................. Held for Trading Investments (80 × $45) ..................... Realized Gain on Held for Trading Investments ..........

4,000

Cash .................................................................................. Interest Revenue.........................................................

5,500

Cash (120 × $2) ................................................................. Dividend Revenue .......................................................

240

Held for Trading Investments (120 × ($48 – $45) ............... Held for Trading Investments ($113,500 – $110,000) ........ Unrealized Gain on Held for Trading Investments .......

360 3,500

110,000

400

3,600 400

5,500

240

3,860

Ex. 119 Lion Limited purchased 40,000 common shares of Tiger Corp. for $800,000, as a long-term investment. During the year, Tiger Corp. reported net income 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 held for 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? (b) Repeat requirement (a) above except assume that the 40,000 shares represent a 40% interest in Tiger Corp. Solution 119 (15–20 min.) (a) Fair value through profit or loss model

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

Held for Trading Investments.................................................. Cash ................................................................................

800,000

Cash ($90,000 x 10%) ............................................................ Dividend Revenue ........................................................... Held for Trading Investments.................................................. Unrealized Gain on Held for Trading Investments............

9,000

9,000 20,000 20,000

The Held for 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) ........................... Income from 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. 120 Information relating to equity investments made in 2018 by Mahdi Corporation follows: 1. On January 1, 2018, 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, 2018, Webster declared and paid a cash dividend of $1.50 per share. On December 31, Webster's reported net income was $280,000, and their shares were trading at $25.50. 2. On March 1, 2018, as a trading investment, Mahdi acquired 12% of the 250,000 issued common shares of Noah Limited at $8 per share. On July 1, 2018, Noah declared and paid a cash dividend of $2 per share. On December 31, 2018, Noah's reported net income 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 2018 for Mahdi Corporation. Solution 120 (15–20 min.) Jan 1 Investment in Associates ................................................... Cash (30% × 120,000 × $24) ......................................

864,000

Mar 1

Held for Trading Investments ............................................. Cash (250,000 × 12% × $8) ........................................

240,000

Cash (36,000 × $1.50) ....................................................... Investment in Associates ............................................

54,000

Cash (30,000 × $2) ............................................................

60,000

Jun 15

Jul

864,000

240,000

54,000

Reporting and Analyzing Investments

Dividend Revenue ....................................................... Dec 31

12 - 31

60,000

Investment in Associates ................................................... Income from Associates. ............................................. ($280,000 × 30%)

84,000

Unrealized Losses on Held for Trading Investments .......... Held for Trading Investments ...................................... (30,000 × ($8.00 – $7.50)

15,000

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. 121 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 net income 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 121 (25–35 min.)

(a) 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 (b) 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 (c) Equity method: 12,500 ÷ 50,000 = 25% ownership

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

Cost = 12,500 × $20 = $250,000 Carrying amount at sale = $296,000 [$250,000 + ($234,000 net income × 25%) – (12,500 × $1 dividends)] Proceeds = $300,000 (12,500 × $24) – $296,000 carrying amount = $4,000 gain (d) 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 net income × 25%) – (25,000 × $2.50 dividends) Cost = $1,758,750 ÷ 25,000 shares = $70.35 cost/share (e) 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. 122 Ainsworth Corporation, a publicly-traded company, had the following transactions during 2018 to be held for trading investments: Feb 1 Mar 1 Apr 1 Jun 1 Aug 1 Sep 1 Oct 1 Nov 1

Purchased 1,000 common shares of Circle Adventures for $22,500 Purchased 500 common shares of Benji Corp. for $15,000. Purchased 80 $1,000, 6% Franklin bonds for $82,500. Interest is receivable semi-annually on April 1 and October 1. Received a cash dividend of $0.50 per share on the Circle Adventures common shares. Sold 200 shares of Circle Adventures common shares at $20.50 per share. Received $2 per share cash dividend on the Benji common shares. Received the semi-annual interest on the Franklin bonds. Sold the Franklin bonds for $86,000.

At December 31, Ainsworth’s fiscal year end, the fair values of the Circle Adventures and Benji common shares were $18.50 and $32 per share, respectively. Instructions Record the above transactions, including required adjusting journal entries (if any). Solution 122 Date

Account Titles and Explanation

Debit

Feb 1

Held for Trading Investments Cash

22,500

Held for Trading Investments Cash

15,000

Mar 1

Credit 22,500

15,000

Reporting and Analyzing Investments

Apr 1

Jun 1

Aug 1

Sep 1

Oct 1

Nov 1

Dec 31

Held for Trading Investments Cash

82,500 82,500

Cash (1,000 x $0.50) Dividend Revenue

500 500

Cash (200 x $20.50) Realized Loss on Held for Trading Investments Held for Trading Investments [($22,500 ÷ 1,000) x 200]

4,100 400

Cash (500 x $2) Dividend Revenue

1,000

Cash (80 x $1,000 x 6% x 6/12) Interest Revenue

2,400

Cash Realized Gain on Held for Trading Investments ($86,000 – $82,500) Held for Trading Investments

86,000

Cost $18,000* 15,000 $33,000

4,500

1,000

2,400

Unrealized Loss on Held for Trading Investments ($33,000 – $30,800)1 Held for Trading Investments Security Circle Adv. Benji

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Fair Value $14,800 16,000 $30,800

3,500 82,500

2,200 2,200

(800 x $18.50) (500 x $32)

*$22,500 – $4,500 = $18,000

Ex. 123 Platinum Corporation reported the following transactions relating to its held for trading investments. Platinum Corporation follows IFRS and has elected to report held for 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.

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Dec 31

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

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 123 (15 min.) (a) Jan. 1 Held for Trading Investments ............................................. Cash (1,200 x $20) ..................................................... Jun

Sep 15

Dec 1

Dec 31

24,000 24,000

Cash (1,200 x $0.50) ......................................................... Dividend Revenue .......................................................

600

Cash .................................................................................. Realized Gain on Held for Trading Investments .......... Held for Trading Investments (600 × $20) ...................

13,800

Cash (600 × $0.75) ............................................................ Dividend Revenue .......................................................

450

600

1,800 12,000

450

Held for Trading Investments ............................................. 4,200 Unrealized Gain on Held for Trading Investments (600 × ($27–$20)

4,200

(b) Since the fair value through profit or loss model is used for held for trading investments, dividend revenue and both realized and unrealized gains are reported under Other Revenues and Gains on the income statement.

Ex. 124 Ontario Corporation (a private corporation) reported the following transactions relating to its held for 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 124 (10–15 min.) (a) Jan 1 Held for Trading Investments ............................................. Cash ...........................................................................

45,000 45,000

Reporting and Analyzing Investments

Jun

Sep 15

(b) Dec 31

Cash (1,000 × $0.50) ......................................................... Dividend Revenue .......................................................

500

Cash .................................................................................. Realized Losses on Held for Trading Investments ............. Held for Trading Investments ($45,000 x 40%) ...........

14,875 3,125

Unrealized Losses on Held for Trading Investments .......... (600 × ($45 – $42) Held for Trading Investments ......................................

1,800

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500

18,000

1,800

(c) Since the fair value through profit or loss model is used for held 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. 125 Metro Corporation reported the following transactions relating to its held for trading investments: Jan 1 Purchased 1,000 shares of London Ltd. shares for $64,000 cash. Jun 1 Received cash dividends of $5 per share on the London shares. Sep 15 Sold 250 London shares for $15,500. Dec 31 The fair value of the London shares was $49,250. 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 125 (10–15 min.) (a) Jan 1 Held for Trading Investments ............................................. Cash ........................................................................... Jun

Sep 15

Dec 31

64,000 64,000

Cash (1,000 × $5) .............................................................. Dividend Revenue .......................................................

5,000

15,500 500

Held for Trading Investments ............................................. Unrealized Gain on Held for Trading Investments .......

1,250

5,000

16,000

1,250

(b) Since the fair value through profit or loss model is used for held 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. 126

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

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On January 1, 2018, Alfalfa Ltd. paid $457,876.36 for 4% bonds with a maturity value of $500,000. The purchase price was based on a market interest rate of 6%. The bonds were issued by Spanky Inc. on January 1, 2018, and mature on January 1, 2023, with interest receivable on December 31 of each year. Alfalfa classifies the bonds as a non-strategic debt investment held to earn interest revenue. Instructions Prepare the following for Alfalfa Ltd. (record all journal entry amounts to the nearest cent): (a) Prepare the journal entry to record the bond purchase. (b) Prepare a bond amortization schedule. (c) Prepare the journal entry to record the receipt of interest on December 31, 2018. (d) Prepare the journal entry to record the receipt of interest on December 31, 2019. (e) Prepare the journal entry to record the disposal of the bond at maturity. *Solution 126 (a) Date Account Titles and Explanation Jan 1/18

Debit

Long-Term Investments Cash

Credit

457,876.36 457,876.36

(b) Schedule of Interest Revenue and Bond Discount Amortization Effective-Interest Method 4% Bonds Sold to Yield 6% (annual interest period) Date

(4%) Cash Interest Received

01/01/18 — 12/31/18 $20,000 12/31/19 20,000 12/31/20 20,000 12/31/21 20,000 12/31/22 20,000 *Adjusted due to rounding (c) Date

(6%) Interest Revenue

Discount Amortization

— $27,472.58 27,920.94 28,396.19 28,899.96 29,433.97*

– $7,472.58 7,920.94 8,396.19 8,899.96 9,433.97*

Account Titles and Explanation

Dec 31/18

Cash Long-Term Investments Interest Revenue

Carrying Amount of Bonds $457,876.36 465,348.94 473,269.88 481,666.07 490,566.03 500,000.00

Debit

Credit

20,000.00 7,472.58 27,472.58

(d)

Reporting and Analyzing Investments

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Date

Account Titles and Explanation

Dec 31/19

Cash Long-Term Investments Interest Revenue

20,000.00 7,920.94

Account Titles and Explanation

Debit

(e) Date Jan 1/23

Debit

Credit

27,920.94

Cash Long-Term Investments

Credit

500,000.00 500,000.00

Ex. 127 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 127 (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 Associates ($120,000 × 40%) ............................ Investment in Associates ............................................

48,000

(b) Purchase price ........................................................... Less dividend received ............................................... Less loss from investment .......................................... Balance, December 31 ...............................................

8,000

48,000

$600,000 (8,000) (48,000) $544,000

Ex. 128 On January 1, 2018, Henderson Corp. purchased 10,000 Alpha Inc. shares for $825,000. This investment represents 30% of the total issued common shares of Alpha Inc. During 2018, Alpha paid total dividends of $60,000 and reported net income of $325,000. At December 31, 2018, the fair value of the Alpha Inc. shares was $950,000. Instructions (a) Calculate the revenue that Henderson reports for 2018 related to this investment. (b) Determine the amount to be reported on the statement of financial position under “Investment in Associates” at December 31, 2018.

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

Solution 128 (10 min.) (a) Revenue for 2018 ($325,000 × 30%) .........................

$97,500

(b) Investment in Associates: Purchase price ................................................... Less dividend received ($60,000 × 30%) ............. Plus investment income ($325,000 × 30%) ......... Ending balance, December 31, 2018 .........................

$825,000 (18,000) 97,500 $904,500

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. 129 On January 1, 2017, 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, 2017, Marvel pays a total dividend of $38,000. At year end, December 31, 2017, a fair value of the Marvel shares is not available, but Samantha estimates the fair value is $11.50. On November 1, 2018, 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 129 (15 min.) 2017 Jan 1 Long-Term Investments ..................................................... Cash (2,000 x $10) ..................................................... Jul

Dec 31 2018 Nov 1

Cash ($38,000 x 50%) ....................................................... Dividend Revenue .......................................................

20,000 20,000 19,000 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. 130 On January 1, 2017, 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, 2017, the fair value of these bonds was $48,400. On January 2, 2018, Marianne sold the bonds for $48,400.

Reporting and Analyzing Investments

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Instructions Prepare the required entries to record the above transactions and events. Round all values to the nearest dollar. *Solution 130 (20–25 min.) 2017 Jan 1 Cash .................................................................................. Long-Term Investment ................................................ Jul

Dec 31

Dec 31 2018 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. 131 On January 1, 2017, 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, 2017 was $51,500. On January 2, 2018, Palermo sold the bonds for $51,000. Instructions Prepare the required entries to record the above transactions and events. Round all values to the nearest dollar. *Solution 131 (20–25 min.) 2017 Jan 1 Long-Term Investment ....................................................... Cash ........................................................................... Jul

Dec 31

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 ................................................

1,250

205 1,045

209

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

Interest Revenue ($52,045 × 4% × 6/12)..................... Dec 31 2018 Jan 1

Jan

1,041

No entry required to adjust investment to fair value (amortized cost model being used).

Cash .................................................................................. Interest Receivable .....................................................

1,250

Cash .................................................................................. Realized Losses on Long-Term Investment ....................... Long-Term Investment ($52,250 – $205 – $209) ........

51,000 836

1,250

51,836

*Ex. 132 On January 1, 2018, Mickey Ltd. paid $543,294.77 for 7% bonds with a maturity value of $500,000. The purchase price was based on a market interest rate of 5%. The bonds were issued by Minnie Inc. on January 1, 2018, and mature on January 1, 2023, with interest receivable on December 31 of each year. Mickey classifies the bonds as a non-strategic debt investment held to earn interest revenue. Instructions (a) Prepare the journal entry to record the bond purchase. (b) Prepare a bond amortization schedule using the effective-interest method. (c) Prepare the journal entry to record the receipt of interest on December 31, 2018. (d) Prepare the journal entry to record the receipt of interest on December 31, 2019. (e) Prepare the journal entry to record the disposal of the bond at maturity. *Solution 132 (a) Date

Account Titles and Explanation

Jan 1/18

Long-Term Investments Cash

Debit

Credit

543,294.77 543,294.77

(b) Schedule of Interest Revenue and Bond Premium Amortization Effective-Interest Method 7% Bonds Sold to Yield 5% (annual interest period) Date 01/01/18 12/31/18

(7%) Cash Interest Received

(5%) Interest Revenue

Premium Amortization

— $35,000

— $27,164.74

– $7,835.26

Carrying Amount of Bonds $543,294.77 535,459.51

Reporting and Analyzing Investments

12/31/19 35,000 12/31/20 35,000 12/31/21 35,000 12/31/22 35,000 *Adjusted due to rounding

26,772.98 26,361.16 25,929.71 25,476.18*

8,227.02 8,638.38 9,070.29 9,523.82*

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527,232.49 518,594.11 509,523.82 500,000.00

Account Titles and Explanation

Dec 31/18

Cash Long-Term Investments Interest Revenue

Debit

Credit

35,000.00 7,835.26 27,164.74

(d) Date

Account Titles and Explanation

Debit

Dec 31/19

Cash Long-Term Investments Interest Revenue

35,000.00

Date

Account Titles and Explanation

Debit

Jan 1/23

Cash Long-Term Investments

Credit 8,227.02 26,772.98

(e) Credit

500,000.00 500,000.00

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

MATCHING QUESTIONS 133. 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 net income 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

Reporting and Analyzing Investments

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ANSWERS TO MATCHING 1.

10.

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

SHORT-ANSWER ESSAY QUESTIONS S-A E 134 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. Instructions (a) Is this investment considered to be a non-strategic or strategic investment? Explain your reasoning. (b) How would your answer change if they purchased an 18% interest instead? (c) How would your answer change if they purchased a 50% interest instead? (d) What other factors, outside of percentage ownership, should be considered when determining significant influence? Solution 134 (a) 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. (b) This would be a non-strategic investment. With such a comparatively small block of shares, Gigantico would probably not be able to elect the directors they want or significantly influence Smalltown’s policies. However, if a highly respected investor with 18% ownership has board membership and plays a key role in forming company strategy, then significant influence could exist in which case it would be a strategic investment. (c) This would be a strategic investment. It is assumed that the investor controls the investee if the investor has more than 50% of the investee’s voting shares. (d) Among the questions that should be considered in determining an investor’s influence are the following: 1. Does the investor have representation on the investee’s board of directors? 2. Does the investor participate in the investee’s policy-making process? 3. Are there material transactions between the investor and the investee? 4. Are the investor and investee exchanging managerial personnel? 5. Is the investor providing key technical information to the investee?

S-A E 135 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 held for 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

Reporting and Analyzing Investments

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classify the investment as held for 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 135 (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 held for 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 136 When a year-end adjustment is made to reduce the held for 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 136 (a) The Unrealized Losses on Held for Trading Investments would be reported in the Other Expenses and Losses section of the income statement. The Held for Trading Investments account would be reduced to fair value on the statement of financial position. (b) The Unrealized Losses on Held for Trading Investments would be reported on the statement of other comprehensive income. The Held for Trading Investments account would be reduced to fair value on the statement of financial position.

S-A E 137 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 held for 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 137

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

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 held for 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 138 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: (a) the initial investment is made? (b) it receives a dividend from the investee? (c) when the associate reports net income/ (loss)? Solution 138 (a) The investment is initially recorded at cost with an increase in the Investment in Associates account and a decrease in Cash. Both accounts are reported on the statement of financial position. (b) 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. (c) When the associate reports net income, the investor records its share of that net income by increasing (debiting) the Investment in Associates account and increasing (crediting) a revenue account called Income from Associate. Conversely, when the associate has a net loss, the investor increases (debits) a Loss from Associate account and decreases (credits) the Investment in Associates account for its share of the associate’s loss. The Investment in Associates account is reported on the statement of financial position and the Income/ (Loss) from Associate is reported on the income statement.

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OBJECTIVE FORMAT QUESTIONS 139. Identify all of the following statements that are correct with regards to the valuation of nonstrategic investments: (a) When purchased, all debt and equity investments are recorded at their purchase cost. (b) When non-strategic investments are valued using the fair value through profit and loss model, unrealized gains and losses are recorded in other comprehensive income (OCI). (c) The amortized cost model only applies to debt investments. (d) Both the amortized cost model and the cost model can potentially be applicable to equity investments. (e) Dividend revenues are not a consideration under the amortized cost model. (f) Realized gains and losses when investments are sold are always reported on the income statement. (g) The fair value through profit and loss model and the fair value through other comprehensive income model can used for either debt or equity investments. (h) The only model for which interest revenue is not applicable is the fair value through other comprehensive income model. Solution 139 (a), (c), (e), (g), and (h) are correct (b) Unrealized gains and losses are only recorded in other comprehensive income when the fair value through other comprehensive income model is used. Under the fair value through profit or loss model, unrealized gains and losses are recorded on the income statement along with any interest or dividend revenue. (d) Only the cost model is used for equity investments. (e) Is correct. Dividends are not applicable for debt investments and the amortized cost model applies only to debt investments. (f) For the fair value through other comprehensive income model, realized gains and losses are recorded to other comprehensive income for equity investments.

140. The following is a selection of journal entries related to recording strategic investments for Green Corporation. Green Corporation holds 45% of the common shares in BCG Company Inc., over whom they are considered to have significant influence. Green Corporation also holds 10% of the common shares in Bonnet Corporation, over whom they do not have significant influence. The

Bonnet Corporation shares are held for trading purposes with no intent to hold them for more than one year. Indicate all of the entries that are correctly recorded. Item Journal Entry (a) Held for Trading Investments Cash To record the purchase of common shares in Bonnet Corporation (20,000 shares at $4 per share)

80,000 80,000

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

(b)

(c)

(d)

(e)

(f)

(g)

Investment in Associates Cash To record the purchase of common shares in BCG Company Inc. (120,000 shares at $3.00 per share)

360,000

Held for Trading Investments Unrealized Gain on Held for Trading Investments To record an unrealized gain on the investment in BCG Company Inc. 120,000 shares were originally purchased for $3.00 per share and now have a fair value of $3.10 per share

12,000

Cash Investment in Associates Dividends of $8,000 are received from Bonnet Corporation for the year

8,000

Income from Associates Investment in Associates BCG reports net income of $100,000 for year

45,000

Held for Trading Investments Unrealized Gain on Held for Trading Investments To record the adjustment to fair value for common shares held in Bonnet Corporation. 20,000 shares were originally purchased at $4 per share. The present fair value for each share is $5.50

30,000

Cash Investment in Associates Dividends of $15,000 are received from BCG for the year

15,000

360,000

12,000

8,000

45,000

30,000

15,000

Solution 140 (a), (b), (f), and (g) are correct (c) When the equity method is used for the investment in BCG Company Inc. because Green Corporation has significant influence over this investment. Consequently, unrealized gains are not recorded as an adjustment to fair value under the equity method so no entry is required. (d) When dividends are earned and received on an investment that is accounted for using the fair value through profit and loss model (i.e., an investment where the investor does not have significant influence), the journal entry should be: Cash 8,000 Dividend Revenue

8,000

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(e) The journal entry to record Green Corporation’s share of BCG’s net income for the year should be: Investment in Associates 45,000 Income from Associates

45,000

141. Identify all of the following statements that are correct with regards to reporting investments: (a) Adjustments to comprehensive income are reported net of income tax on the statement of comprehensive income. (b) Under ASPE, the fair value through OCI model is only used for investments where there is no intention of trading them frequently. (c) In determining the ending balance of retained earnings on the statement of changes in equity, dividends are subtracted from, and net income is added to, the opening retained earnings balance. (d) If the purpose of an investment is to hold the investment for sale only, it should be accounted for using the fair value through OCI model and recorded under current assets as Held for Trading Investments. (e) The statement of changes in equity shows the accumulated comprehensive income or loss, not just the comprehensive income or loss from the current period. (f) Closing entries include closing revenue and expenses to the Retained Earnings account and comprehensive income or loss to the Accumulated Other Comprehensive Income (Loss) account. (g) IFRS requires a company to prepare consolidated financial statements if it has significant influence over the investee. (h) When reporting investments, the order in which statements are prepared is (1) statement of comprehensive income, (2) income statement, (3) statements of changes in equity, and (4) statement of financial position. Solution 141 Statements (a), (c), (e), and (f) are correct. (b) The fair value through OCI model is not used under ASPE. It is only an election under IFRS. (d) If the purpose of an investment is to hold the investment for sale only, it should be accounted for using the fair value through profit or loss model and recorded under current assets as Held for Trading Investments. (g) IFRS requires a company to prepare consolidated financial statements if it has control over the investee (known as a subsidiary). If the investor has significant influence but no control over the investee (known as an associate), the investment is accounted for using the equity method. (h) When reporting investments, the order in which statements are prepared is (1) income statement, (2) statement of comprehensive income, (3) statements of changes in equity, and (4) statement of financial position. The income statement is prepared first and the net income (loss) reported on the income statement is transcribed to the statement of comprehensive income, unless the statements of income and the statement of comprehensive income are combined into one financial statement.

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

*142. The following journal entries relate to a long-term bond investment made by JRC Company Inc. The bond issuer is PRT Company Ltd. JRC purchased $100,000 of PRT 5-year, 8% bonds on January 1, 2018, for $97,000 at a market rate of 8.75369%. The bonds pay interest semi-annually, on June 30 and December 31. The following is a list of journal entries recorded by both JRC and PRT (all rounded to the nearest dollar). On December 31, 2018, JRC sold the bonds for $101,000, after the bond interest had been received, on the open market. Identify whether each journal entry is correctly recorded. For incorrect entries, provide the correct entries. For the correct entries, indicate whether the journal entry was recorded by the investee (PRT) or investor (JRC). Correct (Y/N) (a) Jan 1

(b) Jan 1

(c)

Jun 30

(d) Jun 30

(e) Dec 31

(f)

Dec 31

(g) Dec 31

(h) Dec 31

Long-Term Investments Cash

100,000

Cash Bonds Payable

97,000

Cash Long-Term Investments Interest Revenue

4,000 246

Interest Expense Cash

4,000

Cash Long-Term Investments Interest Revenue

4,000 256

Cash Long-Term Investments Realized Gain on Long-Term Investments Interest Expense Bonds Payable Cash Bonds Payable Cash

Investee or Investor

100,000

97,000

4,246

4,000

4,256 101,000 97,502 3,498

4,256 256 4,000 101,000 101,000

*Solution 142 Journal entries (b), (c), (e), (f), and (g) are correctly prepared (a) The entry was incorrectly prepared by JRC Company Ltd. Since they purchased the bond at a discount for $97,000, JRC, the investor, should have made the following entry. Long-Term Investments 97,000 Cash 97,000

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(b) This entry to record the issuance of the bond to JRC was correctly prepared by PRT Company Ltd, the investee. (c) This entry to record the receipt of interest on the bond on June 30 was correctly prepared by JRC Company Ltd., the investor and is calculated as follows for the amount of the amortization of the discount: Carrying amount x yield rate or effective rate compared to cash collected ($97,000 x 8.75369% x 6/12) – ($100,000 x 8% x 6/12) = 4,246 - $4,000 = $246 (d) This entry to record the payment of interest to JRC was incorrectly prepared by PRT Company Ltd., the investee. The correct entry should be: Refer to calculations in (c) above: Interest Expense 4,246 Bonds Payable 246 Cash 4,000 (e) This entry to record the payment on interest on the bond on December 31was correctly prepared by JRC Company Ltd., the investor and is calculated as follows for the amount of the amortization of the discount: Carrying amount x yield rate or effective rate compared to cash collected [($97,000 + $246) x 8.75369% x 6/12] – ($100,000 x 8% x 6/12) = 4,256 - $4,000 = $256

(f) This entry to record sale of the bond on the open market was correctly prepared by JRC Company Ltd., the investor. (Realized gain = $101,000 - $97,502 (bond carrying value at December 31, 2018) = $3,498. The carrying amount at the date of sale is calculated as $97,000 + amortization of $246, refer to (d) and amortization of $256, refer to (e) = $97,502 (g) This entry was correctly prepared by PRT Company Ltd., the investee, to record the payment on interest on the bond on December 31. Refer to (e) for the amounts. (h) This entry was incorrectly prepared. It is the entry that would be recorded by the party that purchased the bond from JRC but it is not an entry that would be made either by JRC or PRT.

*143. Identify all of the following statements that are correct with regards to recording bond investments: (a) When bonds purchased as a long-term investment are purchased at a premium, the Interest Revenue account and carrying amount of the investment are reduced by the amortization amount to reflect the effect of the additional cost of the bond premium over the term of the bond. (b) Companies have the choice of amortizing premiums and discounts using a straight-line basis or the effective-interest method. (c) The interest expense recorded by the investee and the interest revenue recorded by the investor are always the same if both the investor and investee use the effective interest method. (d) When bonds purchased as a long-term investment are issued at a discount, the carrying amount of the investment is reduced by the amortization amount recorded. (e) When bonds are sold on the open market, the investee does not need to prepare any journal entries to reflect the change in ownership.

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

(f) If a $40,000 bond is purchased as a long-term investment at a discount for $37,000, the $3,000 discount will be debited to the Long-Term Investments account over the term of the bond, for its amortization. (g) As the premium on a bond investment is amortized, the interest revenue recorded in each payment period will increase. (h) Over time, an investment in a bond with a discount will have increasing amounts interest revenue even though the interest received in cash each period will remain constant. *Solution 143 (a), (e), (f), and (h) are correct. (b) Only companies that follow ASPE have the choice of amortizing premiums and discounts on a straight-line basis or the effective-interest method. A company reporting under IFRS must use the effective-interest method. (c) Would be correct if the original investor of the bond held that investment to maturity which is not always the case. If the original investor of the bond sold it to a subsequent investor, it is likely that it would sold at a different price than it was originally purchased at. The second owner of the bond may have paid a different premium or discount amount and because of this, the interest revenue for this investor may not be equal to the interest expense of the bond issuer (the investee). (d) When bonds purchased as a long-term investment are issued at a discount, the carrying amount of the investment is increased by the amortization recorded. In this way, the carrying amount of the bond moves toward its maturity amount over time (g) As a premium is amortized, the carrying amount of the investment will fall and because of this the related interest revenue will also fall..

CHAPTER 13 STATEMENT OF CASH FLOWS SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 E K F AN 12. 1 M K F AN 23. 3 M K F AN 2. 1 M K F AN 13. 1 M K F AN 24. 3 E K F AN 3. 1 M K F AN 14. 1 E K F AN 25. 3 E K F AN 4. 1 E K F AN 15. 1 E K F AN 26. 4 M C F AN 5. 1 E K F AN 16. 1 E K F AN *27. 5 M K F AN 6. 1 M K F AN 17. 1 M K F AN *28. 5 H C F AN 7. 1 M K F AN 18. 2 E C F AN *29. 5 M AP F AN F AN F AN F AN 8. 1 M K 19. 2 H K *30. 5 E K 9. 1 E K F AN 20. 2 M C F AN *31. 5 M C F AN 10. 1 M K F AN 21. 3 E K F AN *32. 5 M C F AN 11. 1 M K F AN 22. 3 E K F AN *33. 5 M C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

*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, Seventh Canadian Edition

SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’sCPA AACSB Item LO LOD Bloom’sCPA AACSB Multiple Choice Questions 34. 1 M C F AN 63. 2 H C F AN 92. 3 M AP F AN 35. 1 E K F AN 64. 2 M C F AN 93. 3 M AP F AN 36. 1 E K F AN 65. 2 M C F AN 94. 3 E C F AN 37. 1 E C F AN 66. 2 M AP F AN 95. 3 M K F AN F AN F AN F AN 38. 1 E K 67. 2 M C 96. 3 M K F AN F AN F AN 39. 1 E C 68. 2 M C 97. 3 M C F AN F AN F AN 40. 1 E K 69. 2 M C 98. 4 M C F AN F AN F AN 41. 1 E K 70. 2 M AP 99. 4 M K F AN F AN F AN 42. 1 M K 71. 2 H AP 100. 4 M C F AN F AN F AN 43. 1 M C 72. 2 E K 101. 4 M K F AN F AN F AN 44. 1 M K 73. 2 E C 102. 4 M AP F AN F AN F AN 45. 1 M K 74. 2 E C 103. 4 E K F AN F AN *104. 5 M F AN 46. 1 E C 75. 2 M C AP F AN F AN *105. 5 M F AN 47. 1 E K 76. 2 H C AP 48. 1 E C F AN 77. 2 H C F AN *106. 5 M AP F AN 49. 1 H C F AN 78. 2 M C F AN *107. 5 M AP F AN 50. 1 M K F AN 79. 2 H C F AN *108. 5 M AP F AN 51. 1 M K F AN 80. 2 H C F AN *109. 5 M AP F AN 52. 1 E K F AN 81. 2 H C F AN *110. 5 M C F AN 53. 1 M K F AN 82. 2 M C F AN *111. 5 M AP F AN 54. 1 M C F AN 83. 2 H AP F AN *112. 5 E C F AN 55. 1 M C F AN 84. 2 H AP F AN *113. 5 M AP F AN 56. 1 E K F AN 85. 2 H AP F AN *114. 5 M AP F AN 57. 2 E K F AN 86. 2 M C F AN *115. 5 E C F AN 58. 2 M K F AN 87. 2 M C F AN *116. 5 M AP F AN 59. 2 H C F AN 88. 3 E C F AN *117. 5 M C F AN 60. 2 E C F AN 89. 3 M C F AN *118. 5 M AP F AN 61. 2 E C F AN 90. 3 E C F AN *119. 5 M K F AN 62. 2 H C F AN 91. 3 M AP F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

*This topic is dealt with in an Appendix to the chapter.

Statement of Cash Flows

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item

120. 121. 122. 123. 124. 125. 126. 127. 128. 129.

1 1 1 2 2 2 2 2 2 2

M M E E E M M H M M

C C C C AP AP AP AP AP C

F F F F F F F F F F

AN AN AN AN AN AN AN AN AN AN

150.

152. 1 M *153. 1,2,5 M 154. 2 M

C C C

F F F

AN AN AN

161. 1–3 M 162. 2 M

C C

F F

AN AN

LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Exercises 130. 2 H AP F AN 140. 4 M AP F AN 131. 2 H AP F AN 141. 4 M AP F AN 132. 2 M AP F AN 142. 4 M AP F AN 133. 2,3 M AP F AN *143. 5 E AP F AN 134. 2,3 H AP F AN *144. 5 E AP F AN *135. 2,3,5 M AP F AN *145. 5 E AP F AN *136. 3,5 H AP F AN *146. 5 M AP F AN *137. 3,5 H AP F AN *147. 5 M AP F AN *138. 3,5 M AP F AN *148. 5 M AP F AN *139. 3,5 M AP F AN *149. 5 H AP F AN Matching *151. 5 M C F AN Short-Answer Essay *155. 2,5 E K F AN 158. 4 M C F,E AN,E *156. 2,5 M C F AN 159. 4 H K F AN *157. 2,5 E C F AN *160. 5 E C F AN CPA Questions 163. 2–4 M AN F AN *165. 5 M AN F AN *164. 5 M K F AN

LOD: E = Easy M = Medium H = Hard Bloom’s: AN = Analysis AP = Application CPA: E = Professional and Ethical Behaviour AACSB: AN = Analytic E = Ethics

C = Comprehension K = Knowledge F = Financial Reporting

*This topic is dealt with in an Appendix to the chapter.

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

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SUMMARY OF LEARNING 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. 16. 17. 34. 35. 36. 37.

18. 19. 20. 57. 58. 59. 60. 61.

TF TF TF MC MC MC MC MC

62. 63. 64. 65. 66. 67. 68. 69.

MC MC MC MC MC MC MC MC

70. 71. 72. 73. 74. 75. 76. 77.

21. 22. 23. 24.

TF TF TF TF

25. 88. 89. 90.

TF MC MC MC

91. 92. 93. 94.

26. 98.

TF MC

99. 100.

MC MC

101. 102.

*27. *28. *29. *30. *31. *32. *33.

TF TF TF TF TF TF TF

*104. *105. *106. *107. *108. *109. *110.

MC MC MC MC MC MC MC

*111. *112. *113. *114. *115. *116. *117.

Note:

TF = True-False Ex = Exercise

Type Item Type Item Learning Objective 1 TF 38. MC 45. TF 39. MC 46. TF 40. MC 47. MC 41. MC 48. MC 42. MC 49. MC 43. MC 50. MC 44. MC 51. Learning Objective 2 MC 78. MC 86. MC 79. MC 87. MC 80. MC 123. MC 81. MC 124. MC 82. MC 125. MC 83. MC 126. MC 84. MC 127. MC 85. MC 128. Learning Objective 3 MC 95. MC 134. MC 96. MC 135. MC 97. MC 136. MC 133. Ex 137. Learning Objective 4 MC 103. MC 141. MC 140. Ex 142. *Learning Objective 5 MC *118. MC *143. MC *119. MC *144. MC *135. Ex *145. MC *136. Ex *146. MC *137. Ex *147. MC *138. Ex *148. MC *139. Ex *149. MC = Multiple Choice SAE = Short-Answer Essay

Type

Item

Type

Item

Type

MC MC MC MC MC MC MC

52. 53. 54. 55. 56. 120. 121.

MC MC MC MC MC Ex Ex

122. 152. 153. 161.

Ex SAE SAE CP

MC MC Ex Ex Ex Ex Ex Ex

129. 130. 131. 132. 133. 134. 135. 150.

Ex Ex Ex Ex Ex Ex Ex Ma

153. 154. 155. 156. 157. 161. 162. 163.

SAE SAE SAE SAE SAE CP CP CP

Ex Ex Ex Ex

138. 139. 161. 163.

Ex Ex CP CP

Ex Ex

158. 159.

SAE SAE

163.

Ex Ex Ex Ex Ex Ex Ex

*151. *153. *155. *156. *157. *160. *164.

Ma *165. SAE SAE SAE SAE SAE CP

Ma = Matching CP = CPA Questions

*This topic is dealt with in an Appendix to the chapter.

Statement of Cash Flows

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CHAPTER LEARNING OBJECTIVES 1. Describe the content and format 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 net income. Operating activities are affected by noncash items in the income statement and changes in certain 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 changes in noncurrent liabilities and shareholders’ equity items. These are general guidelines, to which there are a few exceptions. The statement of cash flows begins with the operating activities section, which can be prepared using either the indirect or direct method. Both end up with the same net cash provided or used by operating activities but differ in the detail provided in this section. Investing and financing activities follow. The statement concludes by reporting the net change in cash for the period, and reconciles it to the beginning and ending cash (or cash and cash equivalents) balances reported on the statement of financial position. Significant noncash transactions are reported in a note to the financial statements.

2. Prepare the operating activities section of a statement of cash flows using the indirect method. The first step in the preparation of a statement of cash flows is to determine the net cash provided (used) by operating activities. In the indirect method, net income is converted from an accrual basis to a cash basis. To do this, noncash expenses and losses, decreases in certain current asset accounts, and increases in certain current liability accounts are added back to net income. Noncash revenues and gains, increases in certain current asset accounts, and decreases in certain current liability accounts are deducted from net income..

3. Prepare the investing and financing activities sections and complete the statement of cash flows. The second step in the preparation of a statement of cash flows is to analyze the changes in certain non-current asset accounts and record them as investing activities, or disclose them as significant noncash transactions. The third step is to analyze the changes in non-current liability (and any related current portions) and equity accounts and record them as financing activities, or disclose them as significant noncash transactions. In addition to this, changes in the Dividends Payable account should be considered in determining the amount of dividends paid. The fourth and final step in the preparation of a statement of cash flows is to determine the overall net cash flow for the year and add it to the opening amount of cash (and cash equivalents) to determine the ending amount. This result should agree to the cash (and cash equivalents) reported on the statement of financial position.

4. Use the statement of cash flows to evaluate a company. When using the statement of cash flows to appreciate the nature of a company, we must understand what phase of its corporate life cycle a company is in. In the introductory and growth phases, financing cash flows are needed to offset the cash used in operating and investing activities. However, by the time a company enters the maturity phase, operating cash flows are usually sufficient to cover cash

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

used in investing activities and to begin to pay down debt and use cash for financing activities. When the company is in the decline phase, this trend continues but, as cash from operating activities declines, so does the amount of cash used in investing and financing activities. Free cash flow (net cash provided or used by operating activities minus net capital expenditures minus dividends paid) is a measure of solvency. It indicates the amount of cash a company generated during the period that is available for increases in the payment of dividends, expansion, or the reduction of debt.

5. Prepare the operating activities section of a statement of cash flows using the direct method (Appendix 13A). In the direct method of determining net cash provided or used by operating activities, each individual revenue and expense account is converted from an accrual basis to a cash basis. These cash flows are then combined into the major classes of cash receipts and cash payments and reported in the operating activities section.

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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. Cash equivalents can include both short-term and long-term investments.

4. Operating activities include the cash effects of transactions that create revenues and expenses.

5. 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.

6. Noncash investing and financing activities must be reported in the body of a statement of cash flows.

7. 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.

8. 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.

9. The statement of cash flows classifies cash receipts and payments as operating, nonoperating, and financial activities.

10. The sale of land for cash would be classified as a cash receipt from an investing activity.

11. 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 net income.

12. Under IFRS, the receipt of dividends from equity investments may be classified as a cash receipt provided (used) by investing activities.

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13. Under ASPE, the payment of interest on a mortgage payable may be classified as a cash payment from financing activities.

14. The statement of cash flows is a required statement for both public and private corporations.

15. Like the other financial statements, the statement of cash flows is prepared from an adjusted trial balance.

16. 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.

17. 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.

18. Cash provided by operating activities is generally the same as the net income reported on the income statement.

19 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 net income is not emphasized.

20. Under the indirect method, an increase in accounts payable during a period is deducted from net income in calculating cash provided by operating activities.

21. Investing activities affect non-current asset accounts.

22. 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.

23. A loss on sale of equipment is included in the investing activities on the statement of cash flows.

24. 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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25. If accumulated other comprehensive income increases or decreases during the year, the change must be reported in the financing activities section.

26. 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.

*27. The direct method is considered to be more informative and easier to compare with the other financial statements.

*28. Cost of goods sold + an increase in inventory + an increase in accounts payable = cash paid to suppliers during a period.

*29. 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. Solution: $(22,000) + $3,000 = $(19,000)

*30. 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.

*31. Under the direct method, an increase in inventory would be added to cost of goods sold to determine net purchases for the period.

*32. 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.

*33. 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.

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

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

Ans. T F F T F

Item 6. 7. 8. 9. 10.

Ans. F T T F T

Item 11. 12. 13. 14. 15.

Ans. F T F T F

Item 16. 17. 18. 19. 20.

Ans. F T F F F

Item 21. 22. 23. 24. 25.

Ans. T F F T F

Item 26. 27. 28. 29. 30.

Ans. T T F T T

Item 31. 32. 33.

Ans. T F F

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MULTIPLE CHOICE QUESTIONS 34. Which one of the following is false? (a) The statement of cash flows can be prepared using cash and cash equivalents rather than just cash, as its base. (b) The statement of cash flows reports the sources and uses of cash during a specific period. (c) The statement of cash flows shows the effects on net income of a company’s operating, investing, and financing activities for an accounting period. (d) The statement of cash flows explains the difference between net income, as shown on the income statement, and the net cash flows generated from operating activities.

35. 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.

36. 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 net income. (c) provide information about cash receipts and cash payments during a period. (d) report to Canada Revenue Agency.

37. 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.

38. 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.

39. 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.

40. The order of presentation of activities on the statement of cash flows is (a) operating, investing, and financing.

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(b) operating, financing, and investing. (c) financing, operating, and investing. (d) financing, investing, and operating.

41. 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.

42. 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.

43. 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.

44. 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.

45. 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. (c) investing activities section. (d) shareholders' equity section.

46. 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

47. Which one of the following items is not generally used in preparing a statement of cash

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flows? (a) adjusted trial balance (b) comparative statements of financial position (c) current income statement (d) additional information

48. 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.

49. In preparing a statement of cash flows, (a) an increase in the Common Shares account during a period would be classified as an investing activity. (b) the issue of debt should be reported separately from the retirement of debt. (c) the net movement of loans and repayments are reported as a financing activity. (d) the issue of shares to acquire land are reported as financing and investing, respectively.

Use the following information for questions 50–55. 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.

50. 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

51. 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

52. 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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53. 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

54. 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

55. 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

56. 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.

57. 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.

58. 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.

59. Which of the following statements are false when using the indirect method? (a) A loss on the sale of equipment is added to net income in calculating cash provided by operating activities. (b) An increase in accounts receivable during a period is deducted from net income in calculating cash provided by operating activities. (c) An increase in accounts payable during a period is added to net income in calculating cash provided by operating activities.

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(d) A decrease in accumulated depreciation during a period is added to net income in calculating cash provided by operating activities.

60. 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 in the (a) operating activities section. (b) investing activities section. (c) financing activities section. (d) does not represent a cash flow.

61. 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 an increase in inventory in the (a) operating activities section. (b) investing activities section. (c) financing activities section. (d) does not represent a cash flow.

62. 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 payment of interest on a long-term bank loan in the (a) operating activities section. (b) investing activities section. (c) financing activities section. (d) does not represent a cash flow.

63. 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 receipt of dividends on held for trading investments in the (a) operating activities section. (b) investing activities section. (c) financing activities section. (d) does not represent a cash flow.

64. Cash flows provided (used) by operating activities, prepared using the indirect method, would include (a) receipts from the sale of investments. (b) net income. (c) payments for dividends. (d) receipts from the issue of preferred shares.

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65. If accounts receivable have increased during a period, (a) revenues on an accrual basis are less than revenues on a cash basis. (b) revenues on an accrual basis are greater than revenues on a cash basis. (c) revenues on an accrual basis are the same as revenues on a cash basis. (d) expenses on an accrual basis are greater than expenses on a cash basis.

66. Accounts receivable arising from sales to customers amounted to $35,000 and $40,000 at the beginning and end of the year, respectively. Net income 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. Solution: $120,000 – $5,000 = $115,000

67. 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.

68. In calculating cash flows provided (used) by operating activities using the indirect method, a gain on the sale of equipment is (a) added to net income. (b) deducted from net income. (c) ignored because it does not affect cash. (d) not reported on a statement of cash flows.

69. In calculating cash flows provided (used) by operating activities using the indirect method, a loss on the sale of equipment is (a) added to net income. (b) deducted from net income. (c) ignored because it does not affect cash. (d) not reported on a statement of cash flows.

70. Galaxy Corporation reported net income of $75,000 for the year. During the year, accounts receivable increased by $6,000, accounts payable decreased by $3,000 and depreciation expense of $5,000 was recorded. Using the indirect method, cash provided by operating activities for the year is (a) $80,000. (b) $78,000. (c) $70,000. (d) $71,000. Solution: $75,000 – $6,000 – $3,000 + $5,000 = $71,000

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71. Applegate Ltd. reported a loss of $10,000 for the year. During the year, accounts receivable decreased $3,000, inventory increased $5,000, accounts payable increased by $11,000, and depreciation expense of $6,000 was recorded. Using the indirect method, operating activities (a) used net cash of $23,000. (b) used net cash of $17,000. (c) provided net cash of $5,000. (d) provided net cash of $15,000. Solution: $(10,000) + $3,000 – $5,000 + $11,000 + $6,000 = net cash provided of $5,000

72. Starting with net income and adjusting it for items that affected reported net income but not cash is called the (a) direct method. (b) indirect method. (c) working capital method. (d) cost-benefit method.

73. In calculating net cash provided by operating activities using the indirect method, an increase in prepaid expenses during a period is (a) deducted from net income. (b) added to net income. (c) ignored because it does not affect net income. (d) ignored because it does not affect expenses.

74. Using the indirect method, depreciation expense for the period (a) is deducted from net income. (b) is ignored. (c) causes cash to decrease. (d) is added to net income.

75. Using the indirect method, which of the following would be subtracted from net income? (a) depreciation expense (b) increase in accounts receivable (c) increase in accounts payable (d) decrease in prepaid expenses

76. Using the indirect method, which of the following would be added to net income? (a) increase in accounts receivable (b) increase in prepaid expenses (c) depreciation expense (d) decrease in accounts payable

77. Using the indirect method, which of the following would not be an adjustment to net income? (a) depreciation expense

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(b) an increase in prepaid insurance (c) an increase in inventories (d) an increase in Land

78. 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 net income. (b) addition to net income. (c) addition to cash flow from investing activities. (d) subtraction from cash flow from investing activities.

79. Using the indirect method, which of the following adjustments to convert net income to net cash provided by operating activities is correct? Add to Net income Deduct from Net income (a) Accounts Receivable increase decrease (b) Prepaid Expenses increase decrease (c) Inventory decrease increase (d) Income Tax Payable decrease increase

80. Using the indirect method, which of the following adjustments to convert net income to net cash provided by operating activities is incorrect? Add to Net income Deduct from Net income (a) Accounts Receivable decrease increase (b) Prepaid Expenses increase decrease (c) Inventory decrease increase (d) Accounts Payable increase decrease

81. Using the indirect method, which of the following adjustments to convert net income to net cash provided by operating activities is not added to net income? (a) gain on Sale of Equipment (b) Depreciation Expense (c) loss on Sale of Equipment (d) amortization of Bond Discount

82. 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.

83. Net income reported for the current year was $200,000. Depreciation expense was $35,000. During the year, Accounts Receivable and 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?

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(a) $182,000 (b) $192,000 (c) $210,000 (d) $244,000 Solution: $200,000 + $35,000 – $18,000 – $26,000 + $4,000 – $9,000 + $6,000 = $192,000

84. Net income 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 Solution: $222,000 + $35,000 – $4,000 – $7,000 + $3,000 – $9,000 = $240,000

85. Net income 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 Solution: $100,000 + $25,000 + $5,000 + $15,000 – $500 + $4,000 = $148,500

86. On a statement of cash flows using the indirect method, depreciation expense will (a) be added to net income in the operating activities section. (b) be deducted from net income in the operating activities section. (c) appear a cash receipt in the investing activities section. (d) be ignored.

87. 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

88. 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

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89. 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.

90. 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.

91. If a gain of $30,000 is incurred in selling (for cash) office equipment that cost $120,000 and 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. Solution: $30,000 + $120,000 – $40,000 = $110,000

92. 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. Solution: $90,000 – $20,000 – $22,500 = $47,500

93. 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 Solution: $125,000 proceeds from sale

94. 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) net income for the period only (c) both cash dividends paid and net income for the period (d) neither cash dividends paid nor net income for the period

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95. Financing activities involve (a) lending money. (b) acquiring investments. (c) issuing debt. (d) acquiring long-lived assets.

96. Investing activities include (a) repayment of debts. (b) obtaining cash from creditors. (c) obtaining capital from investors. (d) collecting the principal on loans receivable.

97. 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. 98. 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.

99. 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 basic earnings per share figures on a cash basis in the body of the statement.

100. 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. Free cash flow (a) is not a solvency-based measure that helps creditors and investors understand how much discretionary cash flow a company has left from operating activities. (b) is calculated as cash provided (used) by operating activities plus net capital expenditures and dividends paid. (c) helps creditors and investors understand how much discretionary cash flow a company has left from its operating activities. (d) helps to understand how much discretionary cash flow a company has left from its operating activities that can be used to expand operations, increase debt, or pay additional dividends.

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101. The statement of cash flows will not provide insight into (a) why dividends were not increased. (b) whether cash flow is greater than net income. (c) the number of shares issued in a stock split. (d) how the retirement of debt was accomplished. 102. Kate’s Fashions Ltd. produces and sells high fashion merchandise. For the year ended June 30, 2018, 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 2018 was (a) $95,000. (b) $63,000. (c) $50,000. (d) $28,000. Solution: $85,000 – $22,000 – $35,000 = $28,000

103. Free cash flow is a measure of (a) solvency. (b) profitability. (c) liquidity. (d) creativity.

*104. 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. (c) $10,000. (d) $1,520. Solution: $11,520 – $1,520 = $10,000

*105. During the year, Tristan Inc. reported a $6,000 increase in Inventory and a $4,000 increase in Accounts Payable. Cost of goods sold for the year was $125,000. What were the cash payments made to suppliers during the year? (a) $135,000 (b) $127,000 (c) $115,000 (d) $123,000 Solution: $6,000 – $4,000 + $125,000 = $127,000

*106. During the year, Cost of Goods Sold was $65,000, Inventory decreased by $4,000, and Accounts Payable decreased by $2,000. What were the cash payments for merchandise during the year?

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(a) $63,000 (b) $65,000 (c) $67,000 (d) $71,000 Solution: $65,000 – $4,000 + $2,000 = $63,000

*107. During the year, Omega Limited reported credit sales of $600,000. Beginning Accounts Receivable was $70,000 and ending Accounts Receivable was $160,000. What were the cash collections from customers during the year? (a) $830,000 (b) $690,000 (c) $510,000 (d) $370,000 Solution: $600,000 – ($160,000 – $70,000) = $510,000

*108. During the year, Rinks Corp. reported $510,000 in cash sales and $2,350,000 in credit sales. Beginning Accounts Receivable was $360,000 and ending Accounts Receivable was $475,000. What was the total cash collected from all customers during the year? (a) $3,695,000 (b) $2,975,000 (c) $2,675,000 (d) $2,745,000 Solution: $510,000 + $2,350,000 – ($475,000 – $360,000) = $2,745,000

*109. The following information relates to Fenelon Corporation: Prepaid insurance, December 31, 2017 ..................... $142,000 Prepaid insurance, December 31, 2018 ..................... 180,000 Insurance expense for 2018 ....................................... 620,000 What was the amount of cash paid for insurance during 2018? (a) $942,000 (b) $658,000 (c) $582,000 (d) $298,000 Solution: $620,000 + ($180,000 – $142,000) = $658,000

*110. 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.

*111. During the year, Kawartha Corp. reported an increase in Inventory of $40,000. Cost of Goods Sold for the year was $125,000, and there was an $6,000 decrease in Accounts Payable. What were the cash payments to suppliers during the year? (a) $79,000 (b) $91,000

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*112. 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

*113. During the year, Flapps Inc. reported other operating expenses of $102,000. The Prepaid Expenses decreased $8,500 during the year, and Accrued Liabilities increased by $11,000. What were Oak's cash payments for operating expenses for the year? (a) $121,500 (b) $ 99,500 (c) $ 104,500 (d) $ 82,500 Solution: $102,000 – $8,500 – $11,000 = $82,500

*114. During the year, Holistic Corp. reported Income Tax Expense of $36,000. There was a $3,000 decrease in federal income tax payable and a $2,000 increase in provincial income tax payable during the year. What were Holistic's cash payments for income tax for the year? (a) $41,000 (b) $37,000 (c) $35,000 (d) $31,000 Solution: $36,000 + $3,000 – $2,000 = $37,000

*115. 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

*116. Dock Inc. reports the following: End of Year Beginning of Year Inventory $24,000 $38,000 Accounts Payable 27,000 20,000 If cost of goods sold for the year is $128,000, the amount of cash paid to suppliers is (a) $113,000. (b) $121,000. (c) $149,000. (d) $107,000. Solution: $128,000 – ($38,000 – $24,000) – ($27,000 – $20,000) = $107,000

Statement of Cash Flows

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*117. 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.

*118. 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. Solution: $155,000 + $9,000 = $164,000

*119. 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. (b) If the direct method is used, gains and losses on sale of equipment are not shown. (c) The statement of cash flows reports basic earnings per share. (d) The statement of cash flows is an optional financial statement for external reporting purposes.

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

ANSWERS TO MULTIPLE CHOICE QUESTIONS Item 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46.

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

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

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

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

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

Item 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

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

Item 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98.

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

Item 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. 111.

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

Item Ans. 112. c 113. d 114. b 115. c 116. d 117. d 118. b 119. b

Statement of Cash Flows

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EXERCISES Ex. 120 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 held for trading investment. 9. Land is sold for cash at the carrying amount. 10. Recorded an increase in the fair value of the held for 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 120 (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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Test Bank for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian Edition

Ex. 121 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 121 (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. 122 (a) Identify how significant noncash activities are presented in the financial statements. (b) Give three examples of significant noncash transactions. Solution 122 (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. (b) 1.

Issue of common shares to purchase assets

Statement of Cash Flows

2. 3. 4.

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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. 123 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 net income 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 net income Deduct from net income

Code A D

1. Increase in accounts receivable 2. Increase in inventory 3. Decrease in prepaid expenses 4. Decrease in accounts payable 5. Decrease in accrued liabilities 6. Increase in income tax payable 7. Depreciation expense 8. Unrealized loss on held for trading investments 9. Gain on disposal of equipment 10. Patent amortization expense

____ ____ ____ ____ ____ ____ ____ ____ ____ ____

Solution 123 (10 min.) 1. D 2.

10. A

Ex. 124 Using the indirect method, calculate the amount of cash flows provided (used) by operating

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

activities from the following data: Net income ................................................................. Beginning accounts receivable ................................... Ending accounts receivable ....................................... Beginning prepaid expenses ...................................... Ending prepaid expenses ........................................... Beginning accounts payable....................................... Ending accounts payable ........................................... Depreciation expense ................................................

$392,000 54,000 43,000 8,000 2,000 27,000 17,000 46,000

Solution 124 (15 min.) Net income........................................................................ + 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. 125 Tabele Limited reported a net income of $545,000 for the year ended December 31, 2018. 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 Inventory 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. Solution 125 (15 min.) TABELE LIMITED Statement of Cash Flows (partial) Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income............................................................................................................. $545,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ..................................................................................... 182,000 Decrease in accounts receivable ..................................................................... 6,000 Decrease in inventory ..................................................................................... 5,000 Increase in prepaid expenses.......................................................................... (4,500)

Statement of Cash Flows

Decrease in accounts payable ........................................................................ Increase in income tax payable ....................................................................... Net cash provided by operating activities ........................................................

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(4,000) 300 $729,800

Ex. 126 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, 2018: Net income............................................................................................................. $250,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense, $40,000 ..................................................................... ______ Increase in accounts receivable, $65,000 ..................................................... ______ Decrease in inventory, $12,500 ..................................................................... ______ Share of net income 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 126 (15 min.) Net income............................................................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ..................................................................................... Increase in accounts receivable ...................................................................... Decrease in inventory ..................................................................................... Share of net income from an investment in associate ..................................... Increase in accounts payable .......................................................................... Decrease in interest receivable ....................................................................... Increase in prepaid expenses.......................................................................... Decrease in income tax payable ..................................................................... Gain on sale of land ........................................................................................ Net cash provided by operating activities .................................................

$250,000 40,000 (65,000) 12,500 (5,250) 7,500 3,500 (5,000) (1,250) (4,000) $233,000

Ex. 127 Presented below are Maginot Inc.’s operating activities section, prepared using the indirect method, of their 2018 statement of cash flows, and the current assets and liabilities sections of the statement of financial position for 2017. The company is using its overdraft facility at June 30, 2018. MAGINOT INC. Statement of Cash Flows (partial) Year Ended June 30, 2018

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

––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income .................................................................................... $34,000 Adjustments to reconcile net income 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 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 2018 Cash .................................................................................................... Accounts receivable ............................................................................. Inventory ........................................................................................ Prepaid expenses ................................................................................ Total assets Liabilities Bank overdraft...................................................................................... Accounts payable................................................................................. Accrued expenses payable .................................................................. Total liabilities

2017 $ 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 2018 statement of financial position. Solution 127 (20 min.) MAGINOT INC. Comparative Statements of Financial Position June 30 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2018 2017 Cash ................................................................................. $ –– $ 8,000 Accounts receivable .......................................................... 10,000 18,500 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

Statement of Cash Flows

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Ex. 128 Condensed financial data of McKillop Corporation appear below: MCKILLOP CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2018 Cash ........................................................................................... $ 74,700 Accounts receivable .................................................................... 104,000 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

2017 $ 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 Total ..................................................................................... $561,700

$ 75,000 24,000 160,000 91,000 81,000 $431,000

MCKILLOP CORPORATION Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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 Income before income tax ........................................................... 102,000 Income tax expense .................................................................... 15,300 Net income.................................................................................. $ 86,700 Additional information regarding fiscal 2018: 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.

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4. 5.

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

Cash dividends were declared and paid during the year. Accounts payable pertain to merchandise purchases.

Instructions Using the indirect method, prepare a statement of cash flows for the year ended December 31, 2018. Solution 128 MCKILLOP CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income ............................................................................... $86,700 Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation expense ............................................................ $ 17,000 Loss on sale of old equipment ................................................ 3,000 Increase in accounts receivable ............................................. (37,000) Decrease in inventory ............................................................. 12,000 Decrease in prepaid expenses ............................................... 4,000 Increase in accounts payable ................................................. 18,000 Increase in accrued expense payable .................................... 5,000 _22,000 Net cash provided by operating activities ......................... 108,700 Investing activities Purchase of long-term investments ......................................$(15,000) (1) Purchase of equipment ........................................................ (85,000) Sale of equipment ................................................................ 10,000 Net cash used by investing activities ......................

(90,000)

Financing activities Issue of common shares ...................................................... $124,000 (2) 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) $81,000 - 66,000 = 15,000 (2) $240,000 – 91,000 + 25,000 = 124,000 (3) $81,000 + 86,700 – 64,700 = 103,000

Ex. 129 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

Statement of Cash Flows

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category under which the item would appear: Code Operating Activities OA Add to net income + Deduct from net income – Investing Activities IA Financing Activities FA

1. Common shares are issued for cash. 2. Inventory increased during the period. 3. Depreciation expense is recorded for the period. 4. Building is purchased for cash. 5. Bonds payable are purchased and retired at their carrying value. 6. Accounts payable decreased during the period. 7. Prepaid expenses decreased during the period. 8. Common shares are reacquired for cash. 9. Land is sold for cash at an amount equal to carrying amount. 10. Cash dividends are paid.

Category _____ _____ _____ _____ _____ _____ _____ _____ _____ _____

Solution 129 (10 min.) 1.

Common shares are issued for cash.

Category FA

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. 130 Comparative statements of financial position for Anderson Inc. appear below:

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

ANDERSON INC. Comparative Statements of Financial Position ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Dec. 31, 2018 Dec. 31, 2017 Cash ................................................................................. $ 29,000 $10,000 Accounts receivable .......................................................... 28,000 19,000 Prepaid expenses ............................................................. 9,000 12,000 Inventory ........................................................................... 37,000 54,000 Long-term investments...................................................... 0 53,000 Equipment......................................................................... 110,000 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 Common shares................................................................ 40,000 Retained earnings ............................................................. 89,000 Total liabilities and shareholders' equity ..................... $187,000

$ 9,000 45,000 23,000 97,000 $174,000

Additional information regarding fiscal 2018: 1. Net income for the year was $27,000. 2. Cash dividends of $35,000 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, 2018. Solution 130 (25–30 min.) ANDERSON INC. Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income........................................................................................... $27,000 Adjustments to reconcile Net income 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 Decrease in inventory ............................................................. 17,000 Increase in accounts payable ................................................. 12,000 32,000 Net cash provided by operating activities ......................... 59,000 Investing activities Sale of long-term investments ....................................................... Purchase of equipment .................................................................

$48,000 (62,000)

Statement of Cash Flows

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 .............................................................................

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(14,000)

$ 17,000 (8,000) (35,000) (26,000) 19,000 10,000 $29,000

Ex. 131 Comparative statements of financial position for Canford Corporation appear below: CANFORD CORPORATION Comparative Statements of Financial Position ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets Dec 31, 2018 Dec 31, 2017 Cash ................................................................................. $ 78,000 $ 62,000 Accounts receivable .......................................................... 146,000 120,000 Prepaid insurance ............................................................. 38,000 34,000 Land.................................................................................. 36,000 80,000 Equipment......................................................................... 140,000 120,000 Accumulated depreciation—equipment ............................. (40,000) (26,000) Total assets................................................................ $398,000 $390,000 Liabilities and Shareholders' Equity Accounts payable.............................................................. Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total liabilities and shareholders' equity .....................

$ 22,000 54,000 280,000 42,000 $398,000

12,000 38,000 230,000 110,000 $390,000

Additional information regarding fiscal 2018 1. A loss of $50,000 was reported for the year. 2. Cash dividends were declared and paid. 3. Land was sold for cash at a loss of $20,000. This was the only land transaction during the year. 4. Equipment with a cost of $30,000 and accumulated depreciation of $20,000 was sold for $10,000 cash. 5. The bonds were originally issued at face value. $24,000 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 $50,000. Instructions Using the indirect method, prepare a statement of cash flows for the year ended December 31,

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

2018. Solution 131 (30 min.) CANFORD CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Loss .............................................................................................. $(50,000) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation expense (a) ....................................................... $ 34,000 Loss on sale of land ............................................................... 20,000 Increase in accounts receivable ............................................. (26,000) Increase in prepaid expenses ................................................. (4,000) Increase in accounts payable ................................................. 10,000 34,000 Net cash used by operating activities............................... (16,000) Investing activities Proceeds from the sale of land (b) ................................................ Proceeds from the sale of equipment ............................................ Net cash provided by investing activities .........................

$24,000 10,000 34,000

Financing activities Retirement of bonds payable......................................................... $(24,000) Issue of bonds payable (c) ............................................................ 40,000 Payment of dividends (d)............................................................... (18,000) Net cash used by financing activities ............................... (2,000) Increase in cash ................................................................................... 16,000 Cash, January 1 ................................................................................... 62,000 Cash, December 31 ............................................................................. $ 78,000 Noncash investing and financing activities Purchase of equipment through issue of common shares ...........

$50,000

(a) Accumulated depreciation, Dec 31, 2017 ...................................... Accumulated depreciation, Dec 31, 2018 ...................................... Difference...................................................................................... Add: accumulated depreciation on equipment sold ....................... Depreciation expense ...................................................................

$26,000 40,000 14,000 20,000 $34,000

(b) Cost of land sold ........................................................................... Less loss on sale of land ............................................................... Proceeds from sale of land ............................................................

$44,000 (20,000) $24,000

(c) Bonds payable, Dec 31, 2017 ....................................................... Bonds payable, Dec 31, 2018 ....................................................... Increase ........................................................................................ Add retirement of bonds ................................................................ New bonds issued .........................................................................

$38,000 54,000 16,000 24,000 $40,000

Statement of Cash Flows

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(d) Retained earnings, Dec 31, 2017 .................................................. $110,000 Less loss for year .......................................................................... (50,000) Less retained earnings, Dec 31, 2018 ........................................... (42,000) Dividends declared........................................................................ $ 18,000

Ex. 132 The following information is available for Bulls Bay Corporation for the year ended December 31, 2018: Collection of principal on long-term loan to a supplier ................... $50,000 Purchase of equipment for cash .................................................... 24,000 Proceeds from the sale of long-term investment at carrying amount 56,000 Issue of common shares for cash.................................................. 47,000 Depreciation expense ................................................................... 38,000 Redemption of bonds payable at their carrying amount ................. 66,000 Payment of cash dividends ........................................................... 28,500 Net income .................................................................................... 103,500 Purchase of land by issuing mortgage payable ............................. 70,000 In addition, the following information is available from the comparative statements of financial position for Bulls Bay at the end of 2018 and 2017: Dec 31,2018 Dec 31, 2017 Cash .......................................................................... $ 191,800 $32,000 Accounts receivable ................................................... 49,000 42,500 Prepaid insurance ...................................................... 27,000 18,000 Total current assets.................................................... $267,800 $92,500 Accounts payable ....................................................... Salaries payable......................................................... Total current liabilities ................................................

$72,500 10,200 $82,700

$67,000 16,400 $83,400

Instructions Using the indirect method, prepare a statement of cash flows for the year ended December 31, 2018. Solution 132 (30 min.) BULLS BAY CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income .................................................................................... $103,500 Adjustments to reconcile net income to net cash provided by operating activities ........................................................................ Depreciation .................................................................................. $38,000 Increase in accounts receivable .................................................... (6,500) Increase in prepaid insurance ....................................................... (9,000) Increase in accounts payable ........................................................ 5,500

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

Decrease in salaries payable ........................................................ Net cash provided by operating activities ............................... Investing activities Collection of long-term loan ........................................................... Proceeds from the sale of investment ........................................... Purchase of equipment ................................................................. Net cash provided by investing activities ................................ 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 .............................................................................

(6,200)

21,800 125,300

$ 50,000 56,000 (24,000) 82,000

$47,000 (66,000) (28,500) (47,500) 159,800 32,000 $191,800

Noncash investing and financing activities Purchase of land by issuing mortgage payable .............................

$70,000

Ex. 133 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: Net income 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. Solution 133 (20 min.) (a) Operating activities Net income ....................................................................................

$ 24,000 41,000 525,000 145,000 80,000 140,000 93,500 28,000

______________ ______________ ______________ ______________ ______________

$475,000

Statement of Cash Flows

Depreciation expense ................................................................... Increase in accounts receivable .................................................... Increase in inventory ..................................................................... Decrease in prepaid expenses ...................................................... Increase in accounts payable ........................................................ Cash flows provided (used) by operating activities ........................

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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. 134 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 2018 2017 Cash ................................................................................. $ 34,000 $ 18,000 Accounts receivable .......................................................... A 32,000 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 ..................................................................

$ F 10,000 130,000

$ 34,000 12,000 100,000

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

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

50,000 136,000 $364,000

75,000 G $292,000

PRIMAVERA CORPORATION Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales .................................................................................................... $500,000 Expenses Cost of goods sold ........................................................................ $290,000 Operating expenses (excluding depreciation) ................................ H Depreciation expense ................................................................... I Interest expense............................................................................ 9,000 Loss on sale of property, plant, and equipment ............................. J 408,000 Income before income tax .................................................................... 92,000 Income tax expense ............................................................................. 17,000 Net income........................................................................................... K

PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income ...................................................................................................... $75,000 Adjustments to reconcile net income 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 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

Statement of Cash Flows

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Additional information regarding fiscal 2018: 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). Solution 134 (45 min.) PRIMAVERA CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ................................................................................. Accounts receivable .......................................................... Inventory ........................................................................... Prepaid expenses ............................................................. Long-term investments...................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total assets................................................................

2018 $ 34,000 48,500 90,000 2,500 15,000 224,000 (50,000) $364,000

2017 $ 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, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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 Income before income tax .................................................................... 92,000

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

Income tax expense ............................................................................. Net income...........................................................................................

17,000 $ 75,000

PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Net income........................................................................................... Adjustments to reconcile net income 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 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)

$75,000

$ (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

Statement of Cash Flows

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*Ex. 135 The comparative statements of financial position for Malcolm Heights Inc. are presented below: MALCOLM HEIGHTS INC. Comparative Statements of Financial Position ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ................................................................................. Accounts receivable .......................................................... Inventory ........................................................................... Prepaid expenses ............................................................. Investments ...................................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total ............................................................................

2018 $ 68,000 97,000 180,000 5,000 30,000 448,000 (100,000) $728,000

2017 $ 36,000 64,000 140,000 4,000 20,000 400,000 (80,000) $584,000

Liabilities and Shareholders' Equity Accounts payable.............................................................. Accrued expenses payable ............................................... Bonds payable .................................................................. Common shares................................................................ Retained earnings ............................................................. Total ............................................................................

$ 76,000 20,000 260,000 100,000 272,000 $728,000

$ 68,000 24,000 200,000 150,000 142,000 $584,000

MALCOLM HEIGHTS CORPORATION Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ................................................................................. $1,000,000 Expenses Cost of goods sold ..................................................... $580,000 Operating expenses (excluding depreciation) ............. 180,000 Depreciation expense ................................................ 30,000 Interest expense......................................................... 18,000 Loss on sale of property, plant, and equipment .......... 8,000 816,000 Income before income tax ................................................. 184,000 Income tax expense .......................................................... 34,000 Net income........................................................................ $ 150,000 Additional information regarding fiscal 2018: 1. New property, plant, and equipment costing $66,000 was purchased for cash. 2. Old property, plant, and equipment costing $18,000 was scrapped when the carrying amount was $8,000. 3. A cash dividend of $20,000 was declared and paid during the year. 4. Accounts payable pertain to merchandise purchases. 5. Accrued expenses pertain to operating expenses.

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

The bonds were originally issued at face value.

Instructions Prepare the operating activities section of the cash flow statement using the: (a) indirect method (b) direct method *Solution 135 (a) MALCOLM HEIGHTS INC. Statement of Cash Flows (partial indirect method) Year Ended December 31, 2018 Operating activities Net income ............................................................................... Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation expense ............................................................ Loss on disposal of old equipment ......................................... Increase in accounts receivable ............................................. Increase in inventory .............................................................. Increase in prepaid expenses ................................................. Increase in accounts payable ................................................. Decrease in accrued expense payable ................................... Net cash provided by operating activities .........................

$150,000

$ 30,000 8,000 (33,000) (40,000) (1,000) 8,000 (4,000)

(32,000) 118,000

(b) MALCOLM HEIGHTS INC. Statement of Cash Flows (partial direct method) Year Ended December 31, 2018 Operating activities Cash receipts from customers ($1,000,000 – $33,000) ........ Cash payments To suppliers ($580,000 + $40,000 – $8,000) ................. $612,000 For operating expenses ($180,000 + $4,000 + $1,000) . 185,000 For income tax .............................................................. 34,000 For interest expense...................................................... 18,000 Net cash provided by operating activities

$967,000

(849,000) 118,000

*Ex. 136 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 –––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––

Statement of Cash Flows

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Assets

Cash ................................................................................. Accounts receivable .......................................................... Inventory ........................................................................... Prepaid expenses ............................................................. Investments ...................................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total assets................................................................

2018 $ 34,000 A B 2,500 D 224,000 (50,000) $ E

2017 $ 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

PRIMAVERA CORPORATION Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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 Income before income tax ................................................. 92,000 Income tax expense .......................................................... 17,000 Net income........................................................................ $ J

PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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

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

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)

(38,000)

(5,000)

Net increase in cash ......................................................... Cash, January 1 ................................................................ Cash, December 31 ..........................................................

16,000 18,000 $34,000

Additional information regarding fiscal 2018: 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. Accounts payable pertain to merchandise purchases. 5. Accrued expenses pertain to operating expenses. 6. The bonds were originally issued at face value. Instructions Solve for the missing amounts (note the letter O is not used). *Solution 136 (45 min.) PRIMAVERA CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ................................................................................. Accounts receivable .......................................................... Inventory ........................................................................... Prepaid expenses ............................................................. Investments ...................................................................... Property, plant, and equipment ......................................... Accumulated depreciation ................................................. Total ............................................................................

2018 $ 34,000 48,500 90,000 2,500 15,000 224,000 (50,000) $364,000

2017 $ 18,000 32,000 70,000 2,000 10,000 200,000 (40,000) $292,000

$ 38,000 10,000 130,000 50,000

$ 34,000 12,000 100,000 75,000

Statement of Cash Flows

Retained earnings ............................................................. Total ............................................................................

136,000 $364,000

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71,000 $292,000

PRIMAVERA CORPORATION Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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 Income before income tax ................................................. 92,000 Income tax expense .......................................................... 17,000 Net income........................................................................ $ 75,000

PRIMAVERA CORPORATION Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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

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

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 K = $92,500 L = $(424,500) M = $59,000

*Ex. 137 Presented below is the comparative trial balance and additional information for Hipsters Inc., which has a calendar year end. Credit balances are shown in brackets. 2018 2017 Cash .................................................................................... $ 19,800 $ (10,000) Accounts Receivable ............................................................ 48,200 40,000 Inventory .............................................................................. 10,000 14,000 Prepaid Expenses ................................................................ 2,000 1,000 Equipment ............................................................................ 84,000 70,000 Accumulated Depreciation ................................................... (20,000) (14,000) Accounts Payable ................................................................ (34,000) (20,000) Salaries Payable .................................................................. (6,000) 0 Income Tax Payable ............................................................ (2,000) 0 Bank Loan Payable .............................................................. (20,000) (24,000) Common Shares .................................................................. (10,000) (8,000) Retained Earnings................................................................ (49,000) (29,800) Dividends ............................................................................. 10,000 10,000 Revenue .............................................................................. (354,000) (290,000) Cost of Goods Sold .............................................................. 116,000 86,000 Salaries Expense ................................................................. 138,000 110,000 Operating Expenses............................................................. 52,000 53,000 Depreciation Expense .......................................................... 10,000 5,000 Interest Expense .................................................................. 1,000 1,200

Statement of Cash Flows

Income Tax Expense ........................................................... Gain on Disposal of Equipment ............................................

6,000 (2,000)

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5,600 0

Additional information regarding fiscal 2018: 1. New equipment costing $20,000 was purchased for cash. 2. Old equipment costing $6,000 was sold for $4,000 cash when the carrying amount was $2,000. 3. A cash dividend of $10,000 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, 2018. *Solution 137 (35 min.) HIPSTERS INC. Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers [$354,000 – ($48,200 – $40,000)] $345,800 Cash payments To suppliers ($116,000 + ($10,000 – $14,000) – ($34,000 – $20,000)) .................................................. $98,000 For operating expenses ($52,000 + ($2,000 – $1,000) .. 53,000 For salaries ($138,000 – $6,000)................................... 132,000 For income tax ($6,000 – $2,000) .................................. 4,000 For interest expense...................................................... 1,000 288,000 Net cash provided by operating activities ................ 57,800 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 ....................................................................

$ 4,000 (20,000) (16,000)

$2,000 (4,000) (10,000) (12,000) 29,800 (10,000) $ 19,800

*Ex. 138 The financial statements of Weighting Limited appear below: WEIGHTING LIMITED Comparative Statements of Financial Position

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

December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2018 2017 Cash ........................................................................................... $ 118,000 $ 46,000 Accounts receivable .................................................................... 62,000 68,000 Inventory ..................................................................................... 40,000 30,000 Property, plant, and equipment ................................................... 100,000 156,000 Accumulated depreciation ........................................................... (40,000) (48,000) Total ..................................................................................... $280,000 $252,000 Liabilities and Shareholders' Equity Accounts payable........................................................................ $ 30,000 Income tax payable ..................................................................... 26,000 Mortgage payable ....................................................................... 18,000 Common shares.......................................................................... 78,000 Retained earnings ....................................................................... 128,000 Total ..................................................................................... $280,000

$ 46,000 16,000 66,000 48,000 76,000 $252,000

WEIGHTING LIMITED Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Sales ...................................................................................................................... $760,000 Cost of goods sold ................................................................................................. 580,000 Gross profit ............................................................................................................ 180,000 Operating expenses ............................................................................................... 72,000 Interest expense .................................................................................................... 8,000 Income before income tax ...................................................................................... 100,000 Income tax expense ............................................................................................... 20,000 Net income............................................................................................................. $ 80,000 Additional information regarding fiscal 2018: 1. Dividends declared and paid were $28,000. 2. During the year, equipment was sold for $24,000 cash. This equipment cost $56,000 originally and had a carrying amount of $24,000 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, 2018. *Solution 138 (30 min.) WEIGHTING LIMITED

Statement of Cash Flows

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Statement of Cash Flows Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers ($760,000 + $6,000) ............. $766,000 Cash payments: To suppliers................................................................... $606,000 (1) For operating expenses ................................................. 48,000 (2) For interest expense...................................................... 8,000 For income tax ($20,000 – $10,000) .............................. 10,000 672,000 Net cash provided by operating activities ................ 94,000 Investing activities Sale of equipment ................................................................ Net cash provided by investing activities .......................

$24,000 24,000

Financing activities Repayment of mortgage ....................................................... $(48,000) Issue of common shares ...................................................... 30,000 Payment of cash dividend .................................................... (28,000) Net cash used by financing activities ............................. Net increase in cash ................................................................... Cash, January 1 .......................................................................... Cash, December 31 ....................................................................

(46,000) 72,000 46,000 $ 118,000

(1) Cost of goods sold ............................................................... $580,000 Add: Increase in inventory ................................................... 10,000 Purchases ............................................................................ 590,000 Add: Decrease in accounts payable .................................... 16,000 Cash payments to suppliers ................................................. $606,000 (2) Operating expenses ............................................................. Less: Depreciation expense ................................................ Cash payments for operating expenses ...............................

$72,000 (24,000)* $48,000

*$48,000 – $32,000 = $16,000 balance in accumulated depreciation after sale. Ending balance, $40,000 – $16,000 = $24,000 depreciation expense.

*Ex. 139 Condensed financial data of McKillop Corporation appear below: MCKILLOP CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets

Cash ........................................................................................... Accounts receivable ....................................................................

2018 $ 74,700 104,000

2017 $ 35,000 67,000

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

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

112,000 36,000 66,000 175,000 (60,000) $431,000

$ 75,000 24,000 160,000 91,000 81,000 $431,000

Statement of Cash Flows

Operating activities Cash receipts from customers ($500,000 – $37,000) .................. Cash payments: To suppliers................................................................... $265,000 (1) For operating expenses ................................................. 56,000 (2) For income tax .............................................................. 15,300 For interest .................................................................... 18,000 Net cash provided by operating activities ................

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$463,000

354,300 108,700

Investing activities Purchase of long-term investments ...................................... $(15,000) Purchase of equipment ........................................................ (85,000) Sale of equipment ................................................................ 10,000 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 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, 2017 ......................................... $ 81,000 Add: Net income for 2018..................................................... 86,700 Less: Retained earnings, Dec 31, 2018................................ (64,700) Dividends declared............................................................... $ 103,000

Ex. 140 Select data for the following two companies is identified below: Wizards Corp. Profit $21,575 Cash provided/(used) by operating activities (9,820) Cash provided/(used) by investing activities* 14,385 Cash provided/(used) by financing activities (2,400) Dividends paid 0

Blazer Inc. $10,200 6,490 (1,195) (6,058) 2,500

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

*Assume cash provided/(used) by investing activities reflects net capital expenditures. Instructions (a) Calculate the free cash flow for each company. (b) Which company is in a stronger financial position? Solution 140 (a) Free cash flow = Cash provided by operating activities – Net capital expenditures – Dividends paid Wizards = $(9,820) + $14,385 – $0 = $4,565; Blazer = $6,490 – $1,195 – $2,500 = $2,795 (b) Wizards Corp. has more free cash flow to finance new investments, reduce debt or pay more dividends in the future relative to Blazer Inc. Wizards Corp. has cash provided rather than used by investing activities, which indicates that the company may be selling some of its longlived assets to offset cash used by operating activities. In addition, Wizards did not pay out any dividends. Blazer Inc., on the other hand, had cash used by investing activities in addition to paying out dividends, which are the primary reasons why its free cash flow was lower than Wizards Corp.

Ex. 141 Healthy Eater Inc. reported the following selected information: 2018

2017

2016

Net cash provided/(used) by operating

$14,650

$(2,100)

$ (8,500)

Net cash used by investing activities activities Net cash provided by financing

(5,100)

(11,200)

(8,400)

2,000

7,000

5,500

Dividends activities

4,500

Instructions (a) In each of the years shown above, what phase of the corporate life cycle do you think the company is in? (b) Calculate the company’s free cash flow for 2018 and 2017. Use net cash used by investing activities as a proxy for capital expenditures. Solution 141 (a) Healthy Eater appears to be in the introductory stage in Years 2016 and 2017as evidenced by the negative cash from operating activities, cash used by investing activities and positive cash generated in financing activities. This is indicated by the issuance of debt and equity to pay for investments and cover the operating activities shortfall. In 2018 they appear to be moving into the growth stage given the positive cash from operating activities and lower cash used in investing activities. (b) Free cash flow = Cash provided by operating activities – Net capital expenditures – Dividends paid 2018 = $14,650 – $5,100 – $4,500 = $5,050; 2017 = $–2,100 – $11,200 – $0 = $(13,300)

Statement of Cash Flows

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Ex. 142 Merlin Marketing Ltd. produces the following information from their latest financial statements: Net income ........................................................................... $ 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. Solution 142 (10 min.) (a) Free cash flow = Cash provided by operating activities – Net capital expenditures – Dividends paid = $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.

*Ex. 143 Greenbriar Sales Inc. reported total operating expenses of $320,000 in 2018, which included depreciation expense of $75,000. Also, during 2018, 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 2018 *Solution 143 (5–8 min.) Operating expenses .......................................................... Less: Depreciation expense .............................................. Add: Increase in prepaid expenses ................................... Add: Decrease in accrued liabilities................................... Cash payments for operating expenses ............................

$320,000 (75,000) 17,000 16,500 $278,500

*Ex. 144 For all instances below, assume the direct method of preparing the operating activities section of the statement of cash flows is used.

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

(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 144 (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. 145 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 145 (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) (d) $209,050 (272,000 – 41,200 – 15,750 – 6,000)

*Ex. 146 The general ledger of Argyle Limited provides the following information: End of Year Beginning of Year Accounts Receivable ............................ $ 142,000 $ 206,000 Inventory .............................................. 686,000 524,000

Statement of Cash Flows

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

90,000

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132,000

The company's net sales for the year were $4,600,000 and cost of goods sold was $3,275,000. 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 146 (8–12 min.) (a) Cash receipts from customers Sales + decrease in Accounts Receivable $4,600,000 + $64,000 = $4,664,000 (b) Cash payments to suppliers Cost of Goods Sold + increase in Inventory + decrease in Accounts Payable $3,275,000 + $162,000 + 42,000 = $3,479,000

*Ex. 147 The income statement of Packer Inc. for the year ended December 31, 2018, reported the following condensed information: Revenue from fees ................................... $585,000 Operating expenses ................................. 340,000 Income from operations............................ 245,000 Income tax expense ................................. 61,250 Net income ............................................... $183,750 Packer's statement of financial position contained the following comparative data at December 31: 2018 2017 Accounts receivable ................................. $52,500 $45,000 Accounts payable ..................................... 34,000 41,000 Income taxes payable .............................. 5,500 3,000 The corporation has no depreciable assets. Accounts payable pertain to operating expenses. Instructions Using the direct method, prepare the operating activities of the statement of cash flows for the year ended December 31, 2018. *Solution 147 (15 min.) PACKER INC. Statement of Cash Flows (partial) Year Ending December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Operating activities Cash receipts from customers ($585,000 – $7,500) ............. $577,500 Cash payments:

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For operating expenses ($340,000 + $7,000) ................ $347,000 For income taxes ($61,250 – $2,500) ............................ 58,750 Net cash provided by operating activities ......................

405,750 $171,750

*Ex. 148 The income statement of Northumberland Corporation is shown below: NORTHUMBERLAND CORPORATION Income Statement Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 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 Net income.................................................................................. $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, 2018. *Solution 148 (15–20 min.) NORTHUMBERLAND CORPORATION Statement of Cash Flows (partial) Year Ended December 31, 2018 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Cash flows provided (used) by operating activities Cash receipts from customers ............................................... $8,080,000 (1) 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 ....................................................

$5,200,000 250,000

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Purchases ............................................................................ Deduct: Increase in accounts payable .................................. Cash payments to suppliers .................................................

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. 149 Below is select information from Houston Enterprise: 2018 2017 Dividends payable $36,000 $30,000 Retained earnings 391,500 171,000 Net Income 295,500 Instructions (a) Calculate cash dividends declared. (b) Calculate cash payments for dividends. *Solution 149 (a) Cash dividends declared = 2018 retained earnings – net income – 2017 retained earnings : $391,500 – $295,500 – $171,000 = $75,000 (b) Cash payments for dividends = Cash dividends declared – increase in dividends payable: $75,000 – $6,000 = $69,000

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MATCHING QUESTIONS SET 1 150. 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 net income Deducted from net income 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 inventory during a period

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ANSWERS TO MATCHING SET 1 1.

10. A

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MATCHING QUESTIONS SET 2 *151. 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 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

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ANSWERS TO MATCHING SET 2 1.

10. J

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SHORT-ANSWER ESSAY QUESTIONS S-A E 152 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 152 • 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 net income 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 153 (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 153 (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 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, net income 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 154 When preparing a statement of cash flows using the indirect method explain the following. (a) Why is depreciation added back to net income in the operating activities section? (b) Why are gains/(losses) deducted/added back to net income in the operating activities

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section? (c) Why are the proceeds from sale reported in the investing activities section rather than the operating activities section? Solution 154 (a) The indirect method begins with net income based on accrual accounting, which includes depreciation expense. However, depreciation expense does not represent a cash payment and thus, to convert accrual-based net income to cash-based net income, it must be added back to net income to “cancel” the expense. As a result, depreciation will not be included in the calculation of cash flows provided (used) by operating activities. (b) The indirect method begins with net income based on accrual accounting, which includes gains/(losses). However, gains/(losses) do not represent a cash receipt or cash payment and thus, to convert accrual-based net income to cash-based net income, gains must be deducted from net income to “cancel” the income and losses must be added to net income to “cancel” the loss. As a result, gains/(losses) will not be included in the calculation of cash flows provided/(used) by operating activities. (c) The proceeds from sale are reported in the investing activities section as selling equipment is not part of the company’s primary activities. There is therefore no cash receipt or payment from operating activities.

*S-A E 155 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 155 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 156 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 156 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 net income or loss.

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*S-A E 157 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 157 The indirect method starts with net income 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 net income and an increase in accounts payable is added to net income. Similarly, noncash expenses such as depreciation expense are added back to net income. The adjustments are the difference between net income 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 net income is adjusted or individual revenues and expenses are adjusted. Therefore, both methods arrive at the same result.

S-A E 158 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 158 (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

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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 159 The corporate life cycle consists of four phases: introductory, growth, maturity, and decline. Each phase helps to understand what to expect for a company’s cash flow from its operating, investing, and financing activities. Instructions (a) During which phase(s) and within which activity(ies) should a company not expect to generate positive cash flows and why? (b) During which phase(s) and within which activity(ies) should a company expect to generate positive cash flows and why? (c) When might a company not experience the traditional phases of a corporate life cycle? Solution 159 (a) In the introductory and growth phases, we don’t usually expect to see a company generate positive cash from its operating activities. Because the company is making significant investments in its long-lived assets, cash will be used by investing activities. As companies move to the maturity phase they can start to declare and pay dividends, retire debt, and/or buy back shares, so their cash flows from financing activities move toward the negative. In the decline phase, cash from operating activities decreases. (b) In the introductory and growth phases, cash generated by financing activities is usually positive because debt and equity are issued to pay for the investments and cover the operating activities shortfall. Companies are usually able to generate positive cash from operating activities as they reach maturity which is used to cover investing activities. Cash from investing activities is positive as the company sells off its excess assets before starting to decline. Cash is used for financing activities as the company continues to pay off its debt. (c) When a company is undergoing financial difficulties cash provided by operating activities is usually declining (or negative with cash used by operating activities) because cash needs to be used for, rather than provided by, financing activities. This is because lenders require repayments of loans and provide no new financing to the company. At times like this, a company may need to sell off non-current assets to obtain the cash to make these payments to lenders.

*S-A E 160 When preparing a statement of cash flows using the direct method, why must the sales revenue

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figure be adjusted to arrive at cash receipts from sales? *Solution 160 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.

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OBJECTIVE FORMAT QUESTIONS 161. Choose whether the item would be shown in the operating (O), investing (I), or financing (F) activities on the statement of cash flows, or if the transaction would not be shown (NS) on the statement of cash flows. The company reports under ASPE and uses the indirect method to prepare the operating activities section of the statement of cash flows. (a) Depreciation expense totalling $35,000 (b) Interest received from bond investments totalling $4,000 (c) Interest paid totalling $6,500 on long-term debt (d) An increase of $32,000 in income tax payable (e) Reacquired common shares for $44,000 (f) Declared and distributed a stock dividend (g) Proceeds from the sale of land totalled $35,000 (h) A gain on the sale of land totalling $4,500 Solution 161 (a) Operating. Depreciation expense is a noncash expense but it is shown on the statement as an addition to net income because it was deducted in arriving at net income. By adding it back to net income we negate its effect on cash flows.. (b) Operating. Under ASPE, interest earned is recorded as an operating activity. It is not shown as a separate item but is included in net income which is the first amount shown under operating activities. If a company reports under IFRS, they have the option to record this as an operating activity or an investing activity. (c) Operating. Under ASPE, interest paid is recorded as an operating activity. It is not shown as a separate item but is included in net income which is the first amount shown under operating activities. If a company reports under IFRS, they have the option to record this as an investing activity or an operating activity. (d) Operating. An increase in income tax payable during the year indicates a difference between the income tax expense incurred and the income tax actually paid during the year. It means that income tax expense was not fully paid in cash so cash provided by operating activities is higher than net income with regard to this effect. Therefore, when net income is adjusted to the operating cash flow, the increase in income tax payable is added to net income. (e) Financing. If a company reacquires shares, the amount of cash paid to reacquire the shares would be reported as a cash payment in the financing activities section of the statement of cash flows. (f) Not Shown. Stock dividends do not require a cash payment and are not shown on the statement of cash flows. (g) Investing. The cash proceeds received from the disposal of land are shown in their entirety in the investing activities section. Any gain or loss on the disposal of land would be reported under operating activities. These gains and losses are not cash flows but were included in net income which is the first amount shown in the operating activities section. Because they

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are not cash flows we deduct the gains or add the losses back to net income so that their effect is excluded from operating activities (h) Operating. Since the gain on sale the land will impact the net income reported on the income statement but does not reflect an increase in cash, it is deducted from net income in the operating activities section of the statement. .

162. Identify all of the following statements that are correct with regard to the indirect method of preparing the operating activities section of the statement of cash flows. (a) There is an in inverse relationship between the impact of changes in current assets and current liabilities on cash flows. (b) The reason depreciation and amortization are added to net income is because they were subtracted from revenue to calculate net income. They are noncash expenses and must be added back to net income to reverse the effect. (c) When accounts receivable increase during the year, cash collected from customers is greater than the amount of sales to those customers and the change in accounts receivable should be subtracted from net income. (d) Unrealized losses on investments (i.e. losses that are recorded when the carrying amount of an investment is adjusted to fair value but it is not sold) are added back to net income. (e) Changes in all working capital accounts need to be either added back to net income or subtracted from net income. (f) An increase in the unearned revenue account is subtracted from net income and a decrease in the unearned revenue account is added to net income. (g) A loss or gain on the sale of a long-term asset is added to or subtracted from net income, respectively. This is because the full cash proceeds from the sale are recorded under investing activities on the statement of cash flows. (h) If the amount of income tax payable increases during a year, the increase is added to net income to show that the cash paid during the period for income tax is higher than the income tax expense deducted on the accrual-based income statement. Solution 162 (a), (b), (d), and (g) are correct. (c) When accounts receivable increase during the year, cash collected from customers is less than the amount of sales to those customers and the change in accounts receivable should be subtracted from net income. (e) Changes in some non-cash working capital accounts need to be added back or subtracted from net income. However, some working capital accounts affect the investing or financing activities on the statement of cash flows and would not be shown in the determination of operating cash flows. For instance, changes in working capital accounts relating to loans, notes, and dividends payable are not included in the operating activities section. The issue and repayment of loans or notes for investment purposes are shown in the investing section of the statement of cash flows. Similarly, the receipt and repayment of short-term loans or notes payable that have been used for borrowing purposes are shown in the financing section of the statement of cash flows. Payments of dividends, which can affect the dividends payable account, are shown in the financing section of the statement of cash flows.

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(f) An increase in the unearned revenue account is added to net income because it represents cash received from customers not yet shown in sales on the income statement. A decrease in the unearned revenue account is subtracted from net income as it represents a portion of revenue that was not received in cash in a prior period, not the current one. (h) If the amount of income tax payable increases during a year, the increase is added to net income but not for the reason specified in the question. This is done to show that the income tax expense deducted on the accrual-based income statement is higher than the cash paid during the period for income tax.

163. Dragon Light Company Inc. prepared the following statement of cash flows for 2018:

Dragon Light Company Inc. Statement of Cash Flows Year Ended December 31, 2018 Operating activities Net income Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense Loss on disposal of equipment Increase in accounts receivable Decrease in inventory Increase in accounts payable Increase in income tax payable Net cash provided by operating activities Investing activities Purchase of equipment Proceeds from disposal of equipment Net cash used by investing activities Financing activities Repayment of mortgage payable Payment of cash dividend Net cash used by financing activities Net decrease in cash Cash, January 1 Cash, December 31

$78,000

$ 8,500 (1,245) (4,500) 1,785 (780) (7,450)

(3,690) 74,310

(57,840) 6,750 (51,090) (34,580) 6,575 (28,005) (4,785) 4,250 $(535)

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As a consultant for Dragon Light, you have been asked to review the statement of cash flows for any errors and make corrections. Once you have completed this, indicate all of the following statements that are correct: (a) Dragon Light has free cash flow of $29,795. (b) Net cash provided from operations should be $93,260. (c) Net cash used by investing activities is correctly stated. (d) Dragon Light is likely in the introductory/growth phase of the corporate life cycle. (e) Net cash used by financing activities should be $41,155. (f) Cash, December 31 should be $5,265. (g) The net decrease in cash should be $17,935. (h) Overall, cash flows have declined from January 2018 to December 2018. Solution 163 The following is the corrected statement of cash flows for Dragon Light Company Inc.

$78,000

$8,500 1,245 (4,500) 1,785 780 7,450

(57,840) 6,750

Net cash used by investing activities Financing activities Repayment of mortgage payable Payment of cash dividend Net cash used by financing activities Net increase in cash Cash, January 1 Cash, December 31

15,260 93,260

(51,090) (34,580) (6,575) (41,155) 1,015 4,250 $5,265

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Based on the above, statements (b), (c), (e), and (f) are correct. (a) The free cash flow should be $35,595. 𝐹𝑟𝑒𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 = 𝐶𝑎𝑠ℎ 𝑝𝑟𝑜𝑣𝑖𝑑𝑒𝑑 𝑏𝑦 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑖𝑒𝑠 − 𝑛𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒𝑠 − 𝑐𝑎𝑠ℎ 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝐹𝑟𝑒𝑒 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 = $93,260 − $51,090 − $6,575 = $35,595 (d) Dragon Light is not likely in the introductory/growth phase. During this phase, cash from operations is generally negative. Dragon Light is more likely in the maturity phase as they are experiencing positive cash flows from operations and are paying dividends. (g) As shown above, the net increase in cash should be $1,015. (h) Overall the cash flows have increased in January.

*164. Choose all statements that describe the direct method of preparing cash flows from operating activities on the statement of cash flows: (a) Adjustments will include adjusting individual revenue and expense balances on the income statement from an accrual to a cash basis. (b) Increases in accounts receivable are subtracted from cash flows on the statement of cash flows. (c) Depreciation expense must be added to cash flows as it is a noncash expense. (d) Most companies find this the more difficult method to apply in practice. (e) Cash receipts from customers are determined by adjusting sales for changes in accounts receivable and unearned revenues. (f) May include noncash expenses or revenues. (g) Net income is reported in the operating activities section of the statement of cash flows. (h) In the operating section of the statement of cash flows, cash flows are combined into the major classes of cash receipts and cash payments. *Solution 164 Statements (a), (d), (e), and (h) describe the direct method; (b), (c), (f), and (g) do not describe the direct method. (b) For the direct method, changes in accounts receivable are not shown on the statement of cash flows. Rather, changes in accounts receivable are used to adjust the sales figure on the income statement to determine cash receipts from customers. (c) Depreciation expense is simply excluded from the cash payments on the statement of cash flows, unlike the indirect method where it is added back to net income to reflect the noncash nature of depreciation. When using the direct method, we do not begin to prepare the statement by listing net income so there is no need to add back to this amount, non-cash items like depreciation. (f) Noncash expenses and revenues are simply excluded from the statement of cash flows when the direct method is used.

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(g) Net income is not reported under the operating activities section when the direct method is used. The direct method adjusts each individual revenue and expense item in the income statement so that the result looks like a cash basis income statement rather than a list of adjustments to net income.

*165. Aircon Ltd. Reported the following net income on its income statement for the month ended April 30, 2018:

Aircon Ltd. Income Statement Month Ended April 30, 2018 Sales revenue Cost of goods sold Gross profit Operating expenses Salaries expense Administrative expenses Depreciation expense Income from operations Interest expense Income before income tax Income tax expense Net income

$ 35,700 12,500 23,200 $

5,200 890 1,200

7,290 15,910 545 15,365 3,025 $ 12,340

During the month, Aircon’s accounts receivable increased by $1,350 and accounts payable increased by $245. The company also received payments for unearned revenue of $250. Merchandise inventory decreased by $1,345. Administrative costs reported on the income statement do not include prepaid expenses of $450. Income taxes payable increased in total by $3,025. The company has no other accrued liabilities. Aircon uses the direct method when preparing the statement of cash flows. Based on the above information, identify all of the following statements that are correct: (a) Net cash provided by operating activities is $16,605. (b) Cash receipts from customers is $34,350. (c) Cash payments for interest are $545. (d) Cash payments for operating expenses are $6,090. (e) Cash payments to suppliers is $11,360. (f) Cash payments to suppliers is $10,910. (g) Cash payments for income tax are zero. (h) Net cash provided by operating activities is $16,355.

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*Solution 165 Statements (a), (c), (f), and (g) are correct In order to answer this question, students will want to prepare a partial statement of cash flows for the month ended April 30, 2018 using the direct method.

Aircon Ltd. Statement of Cash Flows (partial) Month Ended April 30, 2018 Operating activities Cash receipts from customers Cash payments To suppliers

$ 34,600

$10,910

For operating expenses For interest For income tax Net cash provided by operating activities

6,540 545 ________

17,995 $16,605

Calculations: Cash receipts from customers = $35,700 – $1,350 + 250 = $34,600 Cash payments to suppliers = $12,500 – $1,345 – $245 = $10,910 Cash payments for operating expenses = $5,200 + $890 + 450 = $6,450 Cash payments for interest = $545 Cash payments for income tax = $3,025 – $3,025 = 0 Students could also check their work by preparing a statement of cash flows using the indirect method as follows:

Aircon Ltd. Statement of Cash Flows (partial) Month Ended April 30, 2018 Net income

$12,340

Adjustments to reconcile net income to net cash provided (used) by operating activities Depreciation expense Increase in accounts receivable Decrease in inventory Increase in prepaid expenses Increase in accounts payable Increase in unearned revenue

$1,200 (1,350) 1,345 (450) 245 250

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Increase in income tax payable Net cash provided by operating activities

3,025

4,265 $16,605

CHAPTER 14 PERFORMANCE MEASUREMENT SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB True-False Statements 1. 1 M K F AN 13. 2 E K F AN 25. 4 M AP F AN 2. 1 M AP F AN 14. 2 E C F AN 26. 4 M C F AN 3. 1 M AP F AN 15. 3 E K F AN 27. 4 M K F AN 4. 1 M K F AN 16. 3 M C F AN 28. 5 E K F AN 5. 1 M K F AN 17. 3 M C F AN 29. 5 E K F AN 6. 1 M K F AN 18. 3 M K F AN 30. 5 M K F AN 7. 1 M K F AN 19. 3 M C F AN 31. 5 M K F AN 1 M K F AN K F AN F AN 8. 20. 4 E 32. 5 E K 9. 1 M C F AN 21. 4 M K F AN 33. 5 M K F AN 10. 1 E K F AN 22. 4 H K F AN 34. 5 E K F AN 11. 2 E K F AN 23. 4 H C F AN 35. 5 E C F AN 12. 2 M K F AN 24. 4 M K F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

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SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE, LEVEL OF DIFFICULTY, BLOOM’S TAXONOMY, CPA CODES, AND AACSB CODES (CONT’D) Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Item LO LOD Bloom’s CPA AACSB Multiple Choice Questions 36. 1 M K F AN 67. 2 H AP F AN 98. 4 M C F AN 37. 1 E K F AN 68. 2 M AP F AN 99. 4 M C F AN 38. 1 M C F AN 69. 2 M AP F AN 100. 4 E K F AN 39. 1 E C F AN 70. 2 M AP F AN 101. 4 M K F AN K F AN K F AN 102. 4 M K F AN 40. 1 E 71. 2 M 1 K F AN 2 K F AN 4 AP F AN 41. M 72. M 103. M K F AN C F AN 104. 4 M AP F AN 42. 1 E 73. 2 M AP F AN C F AN 105. 4 M AP F AN 43. 1 M 74. 2 M AP F AN C F AN 106. 4 M AP F AN 44. 1 M 75. 2 H K F AN K F AN 107. 4 M C F AN 45. 1 E 76. 2 E 1 C F AN 2 C F AN 4 AP F AN 46. M 77. E 108. M C F AN AP F AN 109. 4 E C F AN 47. 1 M 78. 2 E K F AN AP F AN 110. 4 M AP F AN 48. 1 E 79. 2 M K F AN C F AN 111. 4 M AP F AN 49. 1 E 80. 2 H 50. 1 E K F AN 81. 2 H K F AN 112. 4 M AP F AN 51. 1 M K F AN 82. 2 M AP F AN 113. 4 M AP F AN 52. 1 E K F AN 83. 2 H C F AN 114. 4 M AP F AN 53. 1 E K F AN 84. 2 H AP F AN 115. 4 M AP F AN 54. 1 H C F AN 85. 2 H AP F AN 116. 4 M AP F AN 55. 1 M K F AN 86. 2 M AP F AN 117. 5 M C F AN 56. 1 M AP F AN 87. 3 H K F AN 118. 5 E K F AN 57. 1 E AP F AN 88. 3 H C F AN 119. 5 M C F AN 58. 1 M C F AN 89. 3 H C F AN 120. 5 M K F AN 59. 2 M C F AN 90. 3 M AP F AN 121. 5 E K F AN 60. 2 E K F AN 91. 3 M K F AN 122. 5 M K F AN 61. 2 M K F AN 92. 4 E C F AN 123. 5 M C F AN 62. 2 M K F AN 93. 4 M C F AN 124. 5 M K F AN 63. 2 E K F AN 94. 4 E C F AN 125. 5 M C F AN 64. 2 M C F AN 95. 4 M C F AN 126. 5 E C F AN 65. 2 E K F AN 96. 4 E C F AN 127. 5 E C F AN 66. 2 E C F AN 97. 4 E C F AN LOD: E = Easy M = Medium H = Hard Bloom’s: AP = Application C = Comprehension CPA: F = Financial Reporting AACSB: AN = Analytic

K = Knowledge

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K = Knowledge F = Financial Reporting

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

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE Item Type Item Type Item Type Item Type Item Type 1. 2. 3. 4. 5. 6. 7.

TF TF TF TF TF TF TF

8. 9. 10. 36. 37. 38. 39.

TF TF TF MC MC MC MC

40. 41. 42. 43. 44. 45. 46.

11. 12. 13. 14. 59. 60. 61.

TF TF TF TF MC MC MC

62. 63. 64. 65. 66. 67. 68.

MC MC MC MC MC MC MC

69. 70. 71. 72. 73. 74. 75.

15. 16. 17.

TF 18. TF 19. TF 87.

TF 89. TF 90. MC 91.

20. 21. 22. 23. 24. 25. 26.

TF TF TF TF TF TF TF

27. 92. 93. 94. 95. 96. 97.

TF MC MC MC MC MC MC

28. 29. 30. 31.

TF TF TF TF

32. 33. 34. 35.

TF 117. TF 118. TF 119. TF 120.

Note:

98. 99. 100. 101. 102. 103. 104.

TF = True-False Ex = Exercise

Learning Objective 1 MC 47. MC 54. MC MC 48. MC 55. MC MC 49. MC 56. MC MC 50. MC 57. MC MC 51. MC 58. MC MC 52. MC 128. Ex MC 53. MC 129. Ex Learning Objective 2 MC 76. MC 83. MC MC 77. MC 84. MC MC 78. MC 85. MC MC 79. MC 86. MC MC 80. MC 137. Ex MC 81. MC 138. Ex MC 82. MC 139. Ex Learning Objective 3 MC 143. Ex 147. Ex MC 144. Ex 148. Ex MC 145. Ex 149. Ex Learning Objective 4 MC 105. MC 112. MC MC 106. MC 113. MC MC 107. MC 114. MC MC 108. MC 115. MC MC 109. MC 116. MC MC 110. MC 144. Ex MC 111. MC 145. Ex Learning Objective 5 MC 121. MC 125. MC MC 122. MC 126. MC MC 123. MC 127. MC MC 124. MC 154. Ex

Item

Type

Item

Type

130. 131. 132. 133. 134. 135. 136.

Ex Ex Ex Ex Ex Ex Ex

159. 166.

SAE CP

140. 141. 142. 143. 144. 145. 146.

Ex Ex Ex Ex Ex Ex Ex

157. 158. 160. 167. 168.

Ma Ma SAE CP CP

157. 158. 160.

Ma Ma SAE

169.

146. 148. 149. 150. 151. 152. 153.

Ex Ex Ex Ex Ex Ex Ex

157. 158. 160. 161. 169. 170.

Ma Ma SAE SAE CP CP

155. 156. 161. 162.

Ex Ex SAE SAE

163. 164. 165.

SAE SAE SAE

MC = Multiple Choice SAE = Short-Answer Essay

Ma = Matching CP = CPA Questions

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CHAPTER LEARNING OBJECTIVES 1.

Explain and apply comparative 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. 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.

Calculate and interpret ratios that are used to analyze liquidity. Liquidity ratios include working capital, the current ratio, receivables turnover and average collection period, and inventory turnover and days in inventory. The formula, what it measures, and desired result of each liquidity ratio are presented in Illustration 14-10.

Calculate and interpret ratios that are used to analyze solvency. Solvency ratios include debt to total assets, times interest earned, and free cash flow. The formula, what it measures, and desired result of each solvency ratio are presented in Illustration 14-11.

Calculate and interpret 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, basic earnings per share, price-earnings, payout, and dividend yield. The formula, what it measures, and desired result of each profitability ratio are presented in Illustration 14-13.

Understand the limitations of financial analysis. The comparability of a company’s financial results with those of its peers can be affected by the level of diversification undertaken by the company, the accounting policies it has chosen from acceptable alternatives, and management’s professional judgement when determining estimated amounts in financial statements. Companies using IFRS may report significant amounts of other comprehensive income in their financial statements while those using ASPE do not. Furthermore, accounting policy choices within IFRS may lead to differences in how or if other comprehensive income is reported. Consequently, if other comprehensive income is significant, it should be taken into consideration when performing financial analysis. Gains or losses from discontinued operations are presented separately from continuing operations on the income statement, net of income tax, to highlight their infrequent nature. Assets and

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liabilities pertaining to these operations are also segregated on the statement of financial position. Normally, the effects of discontinued operations are ignored when undertaking financial analysis because they are not expected to be present in the future. When management believes that accounting standards do not produce effective amounts to measure performance or financial position, they will provide adjusted measures of selected financial statement items such as net income. These are called non-GAAP measures and will often exclude items that management believes are nonrecurring or not relevant.

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TRUE-FALSE STATEMENTS 1. Comparisons of company data with industry averages provide information about a company's relative position within the industry.

2. If a company has sales of $100 in 2017 (the base period) and $560 in 2018 (the analysis period), the percentage of the base period is 460%.

3. If a company has sales of $220 in 2017 and $560 in 2018, the percentage increase in sales from 2017 to 2018 is 155%. Solution: ($560 – $220) / 220 = 155%

4. 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%.

5. When preparing a vertical analysis on an income statement, net sales are represented by 100%.

6. On an income statement analyzed vertically, each item is expressed as a percentage of net income.

7. On a statement of financial position analyzed vertically, total assets are represented by 100%.

8. In the vertical analysis of a statement of financial position, the base for current liabilities is total liabilities.

9. Using vertical analysis on the income statement, a company's net income as a percentage of net sales is 15%; therefore, the cost of goods sold as a percentage of net sales must be 85%.

10. The first step in any comprehensive analysis is to perform a horizontal and vertical analysis.

11. Liquidity ratios measure the ability of the company to survive over a long period of time.

12. The current ratio should not be interpreted on its own without also looking at the receivables turnover and inventory turnover ratios.

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13. The receivables turnover ratio is useful in assessing the profitability of receivables.

14. An assessment of liquidity can be done based on only one ratio, such as the current ratio or the receivables ratio.

15. A solvency ratio measures the net income or operating success of a company for a given period of time.

16. 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.

17. Earnings before interest and tax (EBIT) is a proxy for the amount available to cover interest payments.

18. Free cash flow is the cash available after a company pays dividends.

19. 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.

20. Profitability ratios are frequently used as a basis for evaluating management's operating effectiveness. 21. Both the profit margin ratio and the asset turnover ratio affect a company’s return on assets. 22. Leveraging and return on common shareholders’ equity are closely related. 23. The return on common shareholders’ equity is affected by both the return on assets and debt to total assets ratios.

24. Comparisons of basic earnings per share with other companies and the industry averages are usually not very meaningful. 25. The price-earnings ratio reflects investors’ expectations about the future profitability of the company. 26. 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.

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27. Dividend yield measures net income generated by each share, based on the market price per share.

28. One objective of the income statement is to separate the results of continuing operations from those of discontinued operations.

29. When there is a disposal of a component of an entity, the income statement should report both income from continuing operations and income (loss) from discontinued operations.

30. A component of an entity represents a separate major line of business.

31. Identifying discontinued items is important if a potential investor is going to use reported net income to estimate a company’s value.

32. The gain (loss) on disposal of a discontinued operation is not reported on the income statement.

33. Basic earnings per share must be reported separately for continuing operations and discontinued operations.

34. Many firms today are so diversified that they cannot be classified by industry.

35. 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. F 3. T 4. T 5. T

Item 6. 7. 8. 9. 10.

Ans. F T F F T

Item 11. 12. 13. 14. 15.

Ans. F T F F F

Item 16. 17. 18. 19. 20.

Ans. F T F T T

Item 21. 22. 23. 24. 25.

Ans. T T T T T

Item 26. 27. 28. 29. 30.

Ans. T F T T T

Item 31. 32. 33. 34. 35.

Ans. T F T T T

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MULTIPLE CHOICE QUESTIONS 36. Comparisons of financial data made within a company are called (a) intracompany comparisons. (b) interior comparisons. (c) intercompany comparisons. (d) intramural comparisons.

37. Horizontal analysis is also called (a) percentage analysis. (b) trend analysis. (c) vertical analysis. (d) economic analysis.

38. 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.

39. 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.

40. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time (a) that has been arranged from the highest number to the lowest number. (b) that has been arranged from the lowest number to the highest number. (c) to determine which items are in error. (d) to determine the amount and/or percentage increase or decrease that has taken place.

41. 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.

42. Horizontal analysis is a technique for evaluating financial statement data (a) within a period of time.

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(b) over a period of time. (c) on a certain date. (d) as it may appear in the future.

43. A horizontal analysis is being conducted with year one as the base year. If year one equals $900, year two equals $960, and year three equals $995, the percentage of the base period for year three is (a) 89%. (b) 100%. (c) 106%. (d) 111%. Solution: ($995 / $900) = 111% 44. Assume the following sales data for a company: 2018 ....................................... $2,800,000 2017 ....................................... 2,500,000 2016 ....................................... 2,100,000 2015 ....................................... 1,900,000 What is the percentage increase in sales from 2017 to 2018? (a) 11% (b) 88% (c) 12% (d) 47% Solution: ($2,800,000 – $2,500,000) / $2,500,000 = 12%

45. In horizontal analysis, each item is expressed as a percentage of the (a) retained earnings amount. (b) total assets amount. (c) net income amount. (d) base year amount.

46. 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.

47. Vertical analysis (a) 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. (b) expresses each item in a financial statement as a percent of a base amount. (c) makes it more difficult to compare different companies. (d) is also called trend analysis.

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48. 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.

49. On financial statements that include vertical analysis, which of the following is set at 100%? (a) total liabilities (b) net income (c) total assets (d) cost of goods sold

50. In vertical analysis of an income statement, the 100% figure is (a) net income. (b) cost of goods sold. (c) gross profit. (d) net sales.

51. 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.

52. 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.

53. 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.

54. Horizontal analysis showed a 25% increase in accounts receivable in 2018 over 2017. 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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55. 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 56–57. Accounts receivable ............... $ 2,500 Cost of goods sold ................. 200,000 Net income ............................. 50,000 Net sales ................................ 450,000 Sales ...................................... 500,000 Total assets............................ 250,000 Total current assets................ 25,000

56. In performing a vertical analysis, the percentage for accounts receivable is (a) 0.5%. (b) 1.0%. (c) 5.0%. (d) 10.0%. Solution: ($2,500 / $250,000) = 1%

57. 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%. Solution: ($200,000 / $450,000) = 44.4%

58. Horizontal analysis (a) is also called trend analysis. (b) can be carried out on statement of financial position data but not on income statement data. (c) is a technique for evaluating a financial statement item in the current year with other items in the current year. (d) uses the base year as the most current year being examined.

59. An inventory turnover ratio (a) measures the number of times, on average, the inventory was sold during the period. (b) is a measure of solvency that focuses on efficient use of inventory. (c) that is significantly lower than the industry average usually indicates difficulty with selling that inventory and the likelihood of incurring lower than average storage costs. (d) that is significantly higher than the industry average may indicate that a company is maintaining inventory levels that are too high.

60. Short-term creditors are usually most interested in assessing

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(a) solvency. (b) liquidity. (c) marketability. (d) profitability.

61. A common measure of liquidity is (a) return on assets. (b) receivables turnover. (c) profit margin. (d) debt to total assets.

62. 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.

63. The current ratio is a (a) liquidity ratio. (b) profitability ratio. (c) solvency ratio. (d) cash flow ratio.

64. 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.

65. The receivables turnover and inventory turnover ratios are used to analyze (a) solvency. (b) profitability. (c) liquidity. (d) leverage.

66. 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.

67. Afrikana Inc. had a balance in the Accounts Receivable account of $820,000 at the beginning of the year and a balance of $880,000 at the end of the year. Net credit sales during the year

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were $5,920,000. The average collection period of the receivables was (a) 45 days. (b) 52 days. (c) 54 days. (d) 104 days. Solution: 365 / [$5,920,000 / ($820,000 + $880,000) / 2] = 52 days

68. Handles Corp. reported net credit sales of $6,500,000 and cost of goods sold of $3,400,000 for the year. The Accounts Receivable balances at the beginning and end of the year were $525,000 and $575,000, respectively. The receivables turnover ratio was (a) 6.2 times. (b) 11.3 times. (c) 11.8 times. (d) 5.9 times. Solution: $6,500,000 / ($525,000 + $575,000) / 2 = 11.8 times

Use the following information for questions 69–70. Nelly Inc. reported net credit sales of $24,000,000 and cost of goods sold of $18,000,000 for the year. The average inventory for the year was $6,000,000. 69. The inventory turnover ratio for the year was (a) 3.0 times. (b) 33.3 times. (c) 4.0 times. (d) 25.0 times. Solution: $18,000,000 / $6,000,000 = 3.0 times

70. The days in inventory during the year was (a) 15 days. (b) 11 days. (c) 91 days. (d) 122 days. Solution: 365 / 3.0 = 122 days

71. Which one of the following would not be considered a liquidity ratio? (a) current ratio (b) inventory turnover ratio (c) receivables turnover ratio (d) return on assets ratio

72. 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.

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73. 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.

74. 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.

75. 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. (c) The ratio increased. (d) Cannot be determined.

76. A liquidity ratio measures the (a) net income 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.

77. If a company has a current ratio of 1.3:1, what effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio? Short-term Borrowing Collection of Receivables (a) Increase No effect (b) Increase Increase (c) Decrease No effect (d) Decrease Decrease

78. 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. Solution: 12 x $360,000 = $4,320,000

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

79. 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 Solution: 365 / 45 = 8.1 times

80. 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.

81. 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.

82. 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? (a) $1,056,000 (b) $553,030 (c) $486,667 (d) $480,000 Solution: (365 / 26.4) x $40,000 = $553,030

83. 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 84–86. Green Thumb Garden Supplies reported the following information for 2017 and 2018. 2018 Assets Cash ........................................................ Accounts receivable ................................. Inventory .................................................. Property, plant, and equipment ................ Total assets..............................................

2017

$ 50,000 $ 45,000 35,000 25,000 25,000 20,000 240,000 210,000 $350,000 $300,000

Liabilities and Shareholders’ Equity

Performance Measurement

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 2018 Sales ........................................................ Cost of goods sold ................................... Gross profit .............................................. Operating expenses ................................. Income before income tax ........................ Income tax expense ................................. Net income ...............................................

$95,000 45,000 50,000 15,000 35,000 5,000 $30,000

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84. What is the current ratio for 2018? (a) 2.0:1 (b) 1.7:1 (c) 1.6:1 (d) 0.6:1 Solution: ($50,000 + $35,000 + $25,000) / $65,000 = 1.7:1

85. What is the receivables turnover ratio for 2018? (a) 2.7 times (b) 2.0 times (c) 3.2 times (d) 3.8 times Solution: $95,000 / ($35,000 + $25,000) / 2 = 3.2 times

86. What is the inventory turnover ratio for 2018? (a) 2.3 times (b) 2.0 times (c) 1.8 times (d) 0.5 times Solution: $45,000 / ($25,000 + $20,000) / 2 = 2.0 times

87. A common measure of solvency is (a) free cash flow. (b) current ratio. (c) asset turnover ratio. (d) inventory turnover ratio.

88. 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

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

89. Long-term creditors are usually most interested in evaluating (a) liquidity. (b) marketability. (c) profitability. (d) solvency.

90. Affluent Limited reported the following on its income statement: Income before income tax ...... $1,200,000 Income tax expense ............... 380,000 Net income ............................. $820,000 Interest expense was $150,000. Gifford's times interest earned was (a) 9 times. (b) 8 times. (c) 6.5 times. (d) 5.5 times. Solution: ($820,000 + $150,000 + $380,000) / $150,000 = 9 times

91. Free cash flow is calculated as (a) net income minus net capital expenditures minus dividends paid. (b) net income 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.

92. 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

93. The return on assets ratio is affected by the (a) profit margin and debt to total assets ratios. (b) profit margin and asset turnover ratios. (c) times interest earned and debt to total assets ratios. (d) profit margin and free cash flow. 94. 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.

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

96. 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.

97. A common measure of profitability is the (a) current ratio. (b) free cash flow. (c) return on common shareholders’ equity ratio. (d) debt to total assets ratio.

98. All of the following profitability ratios relate more to the needs of investors than corporations except for (a) basic earnings per share. (b) payout ratio. (c) profit margin. (d) dividend yield.

99. 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.

100. Asset turnover ratio is calculated as (a) net sales divided by net income. (b) average total assets divided by net income. (c) net sales divided by average total assets. (d) average total assets divided by net sales.

101. 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.

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

102. Profit margin is calculated by dividing (a) sales by cost of goods sold. (b) gross profit by net sales. (c) net income by shareholders' equity. (d) net income by net sales.

Use the following information for questions 103–106. During 2018, Amazing Corp. reported after-tax net income of $900,000 and paid $175,000 in common dividends. The weighted average number of common shares issued in 2018 was 200,000. There are no preferred shares issued. At year end, Amazing's common shares are selling for $81 per share on the Toronto Stock Exchange.

103. Amazing’s basic earnings per share for 2018 is (a) $22.22. (b) $3.63. (c) $4.50. (d) $5.14. Solution: $900,000 / 200,000 = $4.50 104. Amazing’s price-earnings ratio is (a) 180 times. (b) 12 times. (c) 18 times. (d) 6 times. Solution: $81.00 / $4.50 = 18 times

105. Amazing's payout ratio for 2018 is (a) $1.00. (b) 5.6%. (c) 22.2%. (d) 19.4%. Solution: $175,000 / $900,000 = 19.4% 106. Amazing’s dividend yield for 2018 is (a) $0.875. (b) 1.1%. (c) 6.0%. (d) 16.7%. Solution: ($175,000 / 200,000) / $81.00 = 1.1%

107. A company that is highly leveraged is one that (a) has a high basic earnings per share.

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(b) contains debt financing. (c) contains equity financing. (d) has a high current ratio.

108. Consider the following information: Beginning number of shares..................... Ending number of shares ......................... Dividend per share ................................... Market price per share ............................. Net income ...............................................

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%. Solution: $1.2 / $80.00 = 1.5%

109. 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) basic earnings per share and price-earnings (d) price-earnings and dividend yield

110. 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 Solution: ($2,700,000 / 3) x 2 – $750,000 = $1,050,000

Use the following information to answer questions 111–116. Green Thumb Garden Supplies reported the following information for 2017 and 2018: 2018

2017

Assets Cash ........................................................ Accounts receivable ................................. 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 ................................

$ 65,000 $ 60,000 110,000 90,000

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

Shareholders’ equity—common ............... Total liabilities and shareholders’ equity ...

175,000 150,000 $350,000 $300,000

$95,000 45,000 50,000 15,000 35,000 5,000 $30,000

Share data for 2018 Weighted average number of common shares Market price per common share ............... Dividends per share .................................

6,000 $40 $0.90

111. What is the return on assets for 2018? (a) 27.1% (b) 10.0% (c) 9.2% (d) 8.6% Solution: $30,000 / ($350,000 + $300,000) / 2 = 9.2%

112. What is the profit margin for 2018? (a) 8.6% (b) 10.0% (c) 17.1% (d) 31.6% Solution: ($30,000 / $95,000) = 31.6% 113. What is the return on common shareholders’ equity for 2018? (a) 4.5% (b) 17.1% (c) 18.5% (d) 20.0% Solution: $30,000 / ($175,000 + $150,000) / 2 = 18.5%

114. What are the basic earnings per share for 2018? (a) $15.83 (b) $5.00 (c) $2.50 (d) $0.90 Solution: $30,000 / 6,000 = $5.00

115. What is the price-earnings ratio?

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(a) 44.4 times (b) 16.0 times (c) 8.0 times (d) 2.5 times Solution: $40.00 / ($30,000 / 6,000) = 8 times

116. What is the dividend yield for 2018? (a) 2.3% (b) 4.4% (c) 9.0% (d) 12.5% Solution: $0.90 / $40.00 = 2.3%

117. Assets and liabilities of discontinued (a) items are always reported as non-current. (b) operations are reported on the statement of financial position at fair value. (c) are segregated on the statement of financial position and are usually shown as current items. (d) operations are reported on the statement of comprehensive income.

118. 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.

119. 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) net income (d) income from continuing operations

120. The discontinued operations section of the income statement refers to (a) discontinuance of a product line. (b) the net income 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.

121. 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.

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

122. Which of the following items appears on the income statement before income from continuing operations? (a) loss from discontinued operations (net of income tax) (b) income from discontinued operations (net of income tax) (c) income tax expense (d) gain on sale of discontinued operations (net of income tax)

123. 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.

124. 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.

125. 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.

126. Factors than can limit the usefulness of financial analysis do not include (a) professional judgement. (b) alternative accounting policies. (c) diversification. (d) accrual accounting.

127. 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 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49.

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

Item 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63.

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

Item Ans. Item 64. c 78. 65. c 79. 66. a 80. 67. b 81. 68. c 82. 69. a 83. 70. d 84. 71. d 85. 72. b 86. 73. c 87. 74. d 88. 75. c 89. 76. c 90. 77. c 91.

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

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

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

Item 106. 107. 108. 109. 110. 111. 112. 113. 114. 115. 116. 117. 118. 119.

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

Item 120. 121. 122. 123. 124. 125. 126. 127.

Ans. d d c d a c d b

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

EXERCISES Ex. 128 Comparative information taken from Water Works Corporation’s financial statements is shown below: 2018 2017 (a) Cash .......................................................................... $(60,000) $(80,000) (b) Accounts receivable ................................................... 135,000 175,000 (c) Inventory .................................................................... 195,000 115,000 (d) Notes receivable ........................................................ 30,000 -0Instructions Using horizontal analysis, calculate the percentage change from 2017 to 2018. Solution 128 (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. 129 The following items were taken from the financial statements of McGonigal Inc. over a four-year period: Item 2018 2017 2016 2015 Net sales $650,000 $580,000 $530,000 $500,000 Cost of goods sold 520,000 440,000 380,000 340,000 Gross profit $130,000 $140,000 $150,000 $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 129 (8–12 min.) Item 2018 Net sales 130% Cost of goods sold 153% Gross profit 81%

2017 116% 129% 88%

2016 106% 112% 94%

2015 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.

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Ex. 130 The following items were taken from the financial statements of Nesci Ltd. over a three-year period: Item 2018 2017 2016 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 2016 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 130 (8–12 min.) Item 2018 Net sales 116% Cost of goods sold 112% Gross profit 121%

2017 106% 107% 105%

2016 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. 131 The following items were taken from the financial statements of Cukor Corp. over a three-year period: Item 2018 2017 2016 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 Instructions Using horizontal analysis, calculate the following for each of the above items: (a) The amount and percentage change from 2017 to 2018. (b) The amount and percentage change from 2016 to 2017. Solution 131 (8–12 min.) Item Net sales Cost of goods sold Gross profit

(a) 2017–2018 $ Percent $16,120 5.0 7,004 4.0 $ 9,116 6.2

(b) 2016–2017 $ Percent $12,400 4.0 5,100 3.0 $7,300 5.2

Ex. 132 The comparative statements of financial position of Dolphin Corporation appear below:

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

DOLPHIN CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets .................................................................................................. 2018 2017 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 2018 amounts as percentages of the 2017 amounts. (b) Prepare a comparative statement of financial position using vertical analysis. Solution 132 (20 min.) (a) DOLPHIN CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2018 2017 Current assets...................................................................................... 139% 100% Property, plant, and equipment ............................................................ 127% 100% Total assets .................................................................................... 131% 100% Liabilities and shareholders' equity Current liabilities .................................................................................. Non-current liabilities............................................................................ Common shares................................................................................... Retained earnings ................................................................................ Total liabilities and shareholders' equity ........................................

167% 156% 106% 130% 131%

100% 100% 100% 100% 100%

(b) DOLPHIN CORPORATION Comparative Statements of Financial Position December 31 ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– Assets 2018 Percent 2017 Percent Current assets................................................. $ 390 37% $280 35% Property, plant, and equipment ....................... 660 63% 520 65% Total assets.............................................. $1,050 100% $800 100%

Performance Measurement

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

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15% 20% 40% 25% 100%

Ex. 133 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 base amount. December 31, 2018 December 31, 2017 Accounts receivable ........................... $ 520,000 $ 450,000 Inventory ............................................ 680,000 650,000 Total assets ....................................... 4,400,000 4,000,000 Solution 133 (8–10 min.)

Accounts receivable Inventory Total assets

HORIZONTAL ANALYSIS December 31, 2018 December 31, 2017 116% 100% 105% 100% 110% 100%

Accounts receivable Inventory Total assets

VERTICAL ANALYSIS December 31, 2018 December 31, 2017 12% 11% 15% 16% 100% 100%

Ex 134 Condensed data from the latest comparative income statement of Squash Corp. follow: 2018 2017 Net sales .................................................................. $1,240,000 $1,000,000 Cost of goods sold ................................................... 620,000 480,000 Gross profit .............................................................. 620,000 520,000 Operating expenses ................................................. 216,000 240,000 Income before income tax ........................................ 404,000 280,000 Income tax expense ................................................. 121,200 84,000 Net income............................................................... $ 282,800 $ 196,000 Instructions (a) Prepare a vertical analysis for each year. (b) Comment on the results. Solution 134 (15 min.) (a) Net sales ..................................................................

2018 100%

2017 100%

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

Cost of goods sold ................................................... Gross profit .............................................................. Operating expenses ................................................. Income before income tax ........................................ Income tax expense ................................................. Net income...............................................................

50% 50% 17% 33% 10% 23%

48% 52% 24% 28% 8% 20%

(b) Although the dollar amounts of sales and gross profit have increased from 2017 to 2018, 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 net income 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 2017 to 2018.

Ex. 135 The comparative statements of financial position of Hillside Corporation appear below: HILLSIDE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash ............................................................................................... $25,200 $86,000 Accounts receivable ........................................................................ 170,000 152,000 Inventory ......................................................................................... 344,000 320,000 Prepaid expenses ........................................................................... 10,000 15,000 Land................................................................................................ 250,000 150,000 Equipment....................................................................................... 650,000 380,000 Less: Accumulated depreciation ............................................... (136,500) (80,000) Total assets.............................................................................. $1,312,700 $1,023,000 Liabilities and shareholders' equity Accounts payable............................................................................ $86,000 Unearned revenue .......................................................................... 15,000 Income tax payable ......................................................................... 5,000 Bank loan payable .......................................................................... 250,000 Common shares.............................................................................. 434,000 Retained earnings ........................................................................... 522,700 Total liabilities and shareholders' equity .................................... $1,312,700

$76,000 10,000 12,000 160,000 334,000 431,000 $1,023,000

Instructions Using horizontal analysis, prepare a comparative statement of financial position, expressing the 2018 amounts as percentages of the 2017 amounts. Solution 135 HILLSIDE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Increase/(Decrease)

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Amount Percentage Assets Cash Accounts receivable Inventory Prepaid expenses Land Equipment Less: Accumulated depreciation Total assets

2018 2017 $25,200 $86,000 170,000 152,000 344,000 320,000 10,000 15,000 250,000 150,000 650,000 380,000 (136,500) (80,000) $1,312,700 $1,023,000

$60,800 18,000 24,000 (5,000) 100,000 270,000 (56,500) 289,700

(70.70)% 11.84% 7.50% (33.33)% 66.67% 71.05% 70.63% 28.32%

Liabilities and shareholders' equity Accounts payable Unearned revenue Income tax payable Bank loan payable Common shares Retained earnings Total liabilities and shareholders' equity

$86,000 $76,000 15,000 10,000 5,000 12,000 250,000 160,000 434,000 334,000 522,700 431,000 $1,312,700 $1,023,000

10,000 5,000 7,000 90,000 100,000 91,700 289,700

13.16% 50.00% 58.33% 56.25% 29.94% 21.28% 28.32%

Ex. 136 The comparative statements of financial position of Hillside Corporation appear below: HILLSIDE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash ............................................................................................... $25,200 $86,000 Accounts receivable ........................................................................ 170,000 152,000 Inventory ......................................................................................... 344,000 320,000 Prepaid expenses ........................................................................... 10,000 15,000 Land................................................................................................ 250,000 150,000 Equipment....................................................................................... 650,000 380,000 Less: Accumulated depreciation ............................................... (136,500) (80,000) Total assets ............................................................................... $1,312,700 $1,023,000 Liabilities and shareholders' equity Accounts payable............................................................................ $86,000 Unearned revenue .......................................................................... 15,000 Income tax payable ......................................................................... 5,000 Bank loan payable .......................................................................... 250,000 Common shares.............................................................................. 434,000 Retained earnings ........................................................................... 522,700 Total liabilities and shareholders' equity .................................... $1,312,700

$76,000 10,000 12,000 160,000 334,000 431,000 $1,023,000

Instructions Prepare a comparative statement of financial position using vertical analysis. Solution 136

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HILLSIDE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— 2018 2017 Amount Percentage Amount Percentage Assets Cash $25,200 1.92% $86,000 8.41% Accounts receivable 170,000 12.95% 152,000 14.86% Inventory 344,000 26.21% 320,000 31.28% Prepaid expenses 10,000 0.76% 15,000 1.47% Land 250,000 19.04% 150,000 14.66% Equipment 650,000 49.52% 380,000 37.15% Less: Accumulated depreciation (136,500) (10.40)% (80,000) (7.82)% Total assets $1,312,700 100.00% $1,023,000 100.00% Liabilities and shareholders' equity Accounts payable Unearned revenue Income tax payable Bank loan payable Common shares Retained earnings Total liabilities & shareholders' equity

$86,000 15,000 5,000 250,000 434,000 522,000 $1,312,700

6.55% 1.14% 0.38% 19.04% 33.06% 39.82% 100.00%

76,000 10,000 12,000 160,000 334,000 431,000 $1,023,000

7.43% 0.98% 1.17% 15.64% 32.65% 42.13% 100.00%

Ex. 137 Selected information from the comparative financial statements of Danton Doors Inc. for the year ended December 31 appears below: 2018 2017 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 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 Net income............................................................... 170,000 85,000 Total assets ............................................................. 1,000,000 800,000 Instructions Calculate the following ratios for 2018: (a) Inventory turnover (b) Receivables turnover

Performance Measurement

Solution 137 (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

Ex. 138 Selected data for Younge Yoga Shoppe appear below: Net sales .................................................................. Cost of goods sold ................................................... Inventory at end of year ........................................... Accounts receivable at end of year ..........................

2018 $745,000 375,000 50,000 35,000

2017 $660,000 250,000 40,000 25,000

Instructions Calculate the following ratios for 2018: (a) Inventory turnover (b) Days in inventory (c) Receivables turnover (d) Average collection period Solution 138 (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

= Net sales ÷ Average accounts receivable = $745,000 ÷ [($35,000 + $25,000) ÷ 2] = $745,000 ÷ $30,000 = 24.8 times

(d) Average collection period

= 365 days ÷ receivables turnover = 365 ÷ 24.8 = 15 days

Ex. 139 Omar Corporation reported the following comparative current assets and current liabilities: Dec. 31, 2018 Current assets Cash .................................................................

$ 30,000

Dec. 31, 2017 $ 25,000

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

Held for trading investments .............................. Accounts receivable .......................................... Inventory ........................................................... Prepaid expenses ............................................. Total current assets .................................... Current liabilities Accounts payable .............................................. Salaries payable................................................ Income tax payable ........................................... Total current liabilities .................................

40,000 65,000 120,000 35,000 $290,000

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 2018, credit sales and cost of goods sold were $480,000 and $288,000, respectively. Net cash provided by operating activities for 2018 was $94,000. Instructions Calculate the following ratios for 2018: (a) Current ratio (b) Receivables turnover (c) Inventory turnover Solution 139 (10–15 min.) (a) Current ratio = Current Assets ÷ Current Liabilities = $290,000 ÷ $185,000 = 1.6:1 (b) Receivables turnover = =

Net credit sales ÷ Average gross accounts receivable $480,000 ÷ $80,000 = 6.0 times

Cost of goods sold ÷ Average inventory $288,000 ÷ $105,000 = 2.7 times

= =

Ex. 140 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 140 (8 min.) (a) no effect (b) increase (c) increase

Performance Measurement

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(d) decrease (e) no effect (f) no effect

Ex. 141 The following data are taken from the financial statements of Hankers Corporation: 2018 2017 Average gross accounts receivable.......................... $ 800,000 $ 850,000 Net sales on account................................................ 8,360,000 6,970,000 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 141 (8–10 min.) (a) Receivables turnover

Average collection period

2018 $8,360,000 ————— $800,000

2017 $6,970,000 ————— $850,000

10.5 times

8.2 times

365 days ———— 10.5

365 days ———— 8.2

35 days

45 days

(b) The receivables are turning over much faster in 2018 than they did in 2017. There was a problem in 2017 since the normal credit period is 30 days, and the average collection period was 50% longer. The company showed vast improvement in the management of their receivables in 2018.

Ex. 142 The comparative statements of financial position of Hillside Corporation appear below: HILLSIDE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash ............................................................................................... $25,200 $86,000 Accounts receivable ........................................................................ 170,000 152,000 Inventory ......................................................................................... 344,000 320,000 Prepaid expenses ........................................................................... 10,000 15,000

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

Land................................................................................................ 250,000 Equipment....................................................................................... 650,000 Less: Accumulated depreciation ............................................... (136,500) Total assets.............................................................................. $1,312,700

150,000 380,000 (80,000) $1,023,000

Liabilities and shareholders' equity Accounts payable............................................................................ $86,000 Unearned revenue .......................................................................... 15,000 Income tax payable ......................................................................... 5,000 Bank loan payable .......................................................................... 250,000 Common shares.............................................................................. 434,000 Retained earnings ........................................................................... 522,700 Total liabilities and shareholders' equity ................................... $1,312,700

$76,000 10,000 12,000 160,000 334,000 431,000 $1,023,000

Additional information: Net credit sales and COGS for 2018 was $1,346,500 and $807,900, respectively. Instructions Calculate the following liquidity ratios for 2018 and 2017, unless otherwise noted, and where applicable, identify whether each ratio is better or worse in 2018: (a) Working capital (b) Current ratio (c) Receivables turnover (2018 only) (d) Average collection period (2018 only) (e) Inventory turnover (2018 only) (f) Days in inventory (2018 only) Solution 142 (a) Working capital: 2018 = ($25,200 + $170,000 + $344,000 + $10,000) – ($86,000 + $15,000 + $5,000) = $443,200 2017 = ($86,000 + $152,000 + $320,000 + $15,000) – ($76,000 + $10,000 + $12,000) = $475,000 Working capital is worse year-over-year by $31,800. (b) Current ratio: 2018 = ($25,200 + $170,000 + $344,000 + $10,000) / ($86,000 + $15,000 + $5,000) 5.18 2017 = ($86,000 + $152,000 + $320,000 + $15,000) / ($76,000 + $10,000 + $12,000) = 5.85 The current ratio is worse year-over-year from 5.85:1 to 5.18:1. (c) Receivables turnover: 2018 = $1,346,500 / [($170,000 + $152,000) / 2] = 8.36 times

Performance Measurement

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(d) Average collection period = 365 / 8.36 = 43.7 days (e) Inventory turnover: 2018 = $807,900 / [($344,000 + $320,000) / 2] = 2.43 times (f) Days in inventory = 365 / 2.43 = 150.2 days

Ex. 143 Presented below are liquidity and solvency ratios for Carmelo Industries, along with industry averages: Ratio 2018 2017 Industry Average Current ratio ........................................... 0.7:1 0.8:1 1.4:1 Debt to total assets................................. 55% 48% 35% Inventory turnover .................................. 7.0 11.0 15.2 Receivables turnover .............................. 6.2 8.1 10.4 Times interest earned ......................... 2.0 4.8 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 143 (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. Times interest earned has decreased and is well below the industry average.

Ex. 144 The financial statements of Belleville Corporation appear below: BELLEVILLE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash .................................................................................................... $ 35,250 $ 40,000 Held for trading investments................................................................. 15,000 60,000 Accounts receivable ............................................................................. 50,000 30,000 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................................................................................. Bank loan payable (due March 31).......................................................

$ 20,000 $ 30,000 40,000 90,000

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Bonds payable ..................................................................................... Common shares................................................................................... Retained earnings ................................................................................ Total liabilities and shareholders' equity ........................................

80,000 160,000 170,000 145,000 110,250 75,000 $400,250 $500,000

BELLEVILLE CORPORATION Income Statement Year Ended December 31, 2018 ————————————————————————————————————————— Net sales .............................................................................................. $400,000 Cost of goods sold ............................................................................... 190,000 Gross profit .......................................................................................... 210,000 Expenses Operating expenses ...................................................................... $85,000 Interest expense............................................................................ 18,000 Total expenses ......................................................................... 103,000 Income before income tax .................................................................... 107,000 Income tax expense ............................................................................. 26,750 Net income........................................................................................... $ 80,250 Additional information for 2018: 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 2018: (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) Dividend yield Solution 144 (25 min.) (a) Current ratio

$160,250 ————–– = 2.7 to 1 $60,000

Performance Measurement

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(b) Return on common shareholders' equity

$80,250 —————————––——– = 32.1% ($280,250 + $220,000) ÷ 2

$80,250 EPS = ———––— = $1.34; 60,000 $20 –––––– = 14.9 $1.34

(d) Receivables turnover

$400,000 ——————————––— = 10 times ($50,000 + $30,000) ÷ 2

(e) Times interest earned

$80,250 + $26,750 + $18,000 ————————————––— = 6.9 $18,000

(f) Profit margin

$80,250 ———––– = 20.1% $400,000

(g) Days in inventory

Inventory turnover = 2.9

$190,000 –––––––––––––––––––– = 2.9 ($60,000 + $70,000) ÷ 2 365 days ————– = 126 2.9

(h) Payout ratio

$45,000 ———–– = 56.1% $80,250

(i)

$80,250 ——————————––— = 17.4% ($420,250 + $500,000) ÷ 2

Return on assets

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(j)

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Dividend yield

($45,000 ÷ 60,000) —————————– = 3.8% $20

Ex. 145 The following ratios have been calculated for Rosco and Ramsey Limited for 2018: 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 2018 for Rosco and Ramsey Limited with missing information follows: ROSCO AND RAMSEY LIMITED Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash ........................................................................................... $ 25,000 $ 35,000 Held for trading investments........................................................ 15,000 15,000 Accounts receivable .................................................................... ? (6) 35,000 Inventory ..................................................................................... 30,000 20,000 Property, plant, and equipment ................................................... 200,000 160,000 Total assets $? (8) $265,000 Liabilities and shareholders' equity Accounts payable........................................................................ Bank loan payable (due March 31).............................................. Bonds payable ............................................................................ Common shares.......................................................................... Retained earnings ....................................................................... Accumulated other comprehensive income ................................. Total liabilities and shareholders' equity ...............................

$? (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, 2018 ——————————————————————————————————————–— 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

Performance Measurement

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

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? (4) ? (2) ? (3) ? (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 145 (35–40 min.) ROSCO AND RAMSEY LIMITED Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash $ 25,000 $ 35,000 Held for trading investments 15,000 15,000 Accounts receivable 27,500 (6) 35,000 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 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

ROSCO AND RAMSEY LIMITED Income Statement Year Ended December 31, 2018 ———————————————————————————————————————— 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) Income before income tax ........................................................... 31,500 (3) Income tax expense .................................................................... 12,750 (2) Net income.................................................................................. $18,750 (1) (1)

Net income = $18,750 ($75,000 × 25%)

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(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 ($18,750 – 250 – (250 x 23)

(3)

Income before income tax = $31,500 ($12,750 + $18,750)

(4)

Total expenses = $14,500 ($46,000 – $31,500)

(5)

Depreciation expense = $6,750 [$14,500 – ($7,500 + $250)]

(6)

Accounts receivable = $27,500 Let X = Average receivables $75,000 ————– = 2.4 times; 2.4X = $75,000; X = $31,250 X Let Y = Accounts Receivable at December 31, 2018 $35,000 + Y —————–— = $31,250; $35,000 + Y = $62,500; Y = $27,500 2

(7)

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 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. 146 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

Performance Measurement

Net income........................................................................ Sales (all on credit) ...........................................................

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280,000 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 146 (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 Days in Inventory = 365 days ÷ 9.2 times = 40 days (c) Return on common shareholders' equity

Net income ————————————————— Average common shareholders' equity

$280,000 ÷ $4,000,000 = 7.0%

Ex. 147 The comparative statements of financial position of Sumach Corporation appear below: SUMACH CORPORATION Comparative Statements of Financial Position December 31

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————————————————————————————————————————— 2018 2017 Total assets .................................................................................... $1,943,000 $1,854,000 Total liabilities ................................................................................. 1,088,500 979,500 Interest expense ............................................................................. 13,500 8,500 Income tax expense ........................................................................ 87,000 76,000 Net Income ..................................................................................... 203,000 187,500 Cash provided by operating activities .............................................. 462,500 290,000 Net capital expenditures.................................................................. 237,500 150,000 Dividends paid ................................................................................ 22,500 15,500 Instructions Calculate the following solvency ratios for 2018 and 2017 and for each ratio identify whether it is better or worse in 2018. (a) Debt to total assets (b) Times interest earned (c) Free cash flow Solution 147 (a) Debt to total assets: 2018 = $1,088,500 / $1,943,000 = 56.0% 2017 = $979,500 / $1,854,000 = 52.8% Debt to total asset ratio is worse year-over-year increasing from 52.8% to 56.0%. (b) Times interest earned: 2018 = ($203,000 + $87,000 + $13,500) / $13,500 = 22.5 times. 2017 = ($187,500 + $76,000 + $8,500) / $8,500 = 32.0 times. Times interest earned is worse year-over-year decreasing from 32.0 times to 22.5 times. (c) Free cash flow: 2018 = $462,500 - $237,500 - $22,500 = $202,500 2017 = $290,000 - $150,000 - $15,500 = $124,500 Free cash flow improved year-over-year increasing from $124,500 to $202,500.

Ex. 148 The statement of financial position for Crown Corporation at the end of the current year includes the following: Mortgage payable, 4% .................................................. $3,625,000 $5 noncumulative preferred shares ............................... 1,200,000 Common shares (500,000 shares issued) ..................... 5,000,000 Income before income tax was $2,425,000, and income tax expense for the current year was $720,945. Cash dividends paid on common shares were $250,000 and $150,000 was paid on preferred shares. The common shares were selling for $105.00 per share at the end of the year. There were no ownership changes during the year.

Performance Measurement

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Instructions Calculate the following ratios: (a) times interest earned (b) basic earnings per share (c) price-earnings ratio (d) dividend yield Solution 148 (10 min.) (a) Times interest earned

•

Income before income tax and interest expense ———————————————————— Interest expense

($2,425,000 + $145,000) ———————––––——– = 17.7 times $145,000*

Interest expense: $3,625,000 * 4% = $145,000

(b) Basic earnings per share =

Net income – Preferred dividends ———————————————— Average number of common shares

(($2,425,000-$720,945) – $150,000) —————————–––––––––––––– = $3.11 500,000 shares

Price-earnings ratio

Market price per share —————————–––– = Basic earnings per share

(d) Dividend per share

($250,000 ÷ 500,000) = $0.50

Dividend per share —————————— Market price per share

(c)

Dividend yield

$105.00 ———–– = 33.8 times $3.11

$0.50 = ————— = 0.5% $105.00

Ex. 149 The condensed income statement for Newberry Limited for the year ended December 31, 2018 appears below: Cost of goods sold ............................................................ $720,000 Expenses .......................................................................... *520,000 Gross profit ....................................................................... 880,000 Net income........................................................................ 360,000 Sales ................................................................................. $1,600,000 *Includes $90,000 of interest expense and $100,000 of income tax expense Additional information:

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1. 2. 3.

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Average number of common shares in 2018 was 110,000 shares. The market price of Newberry’s shares was $50 per share at the end of 2018. Total cash dividends of $72,000 were paid, $12,000 of which were paid to preferred shareholders.

Instructions Calculate the following ratios for 2018: (a) Basic earnings per share (b) Price-earnings ratio (c) Times interest earned Solution 149 (8 min.) (a) Basic earnings per share ($360,000 – $12,000) ——————––—— = 110,000

$348,000 ———––— = $3.16 110,000

(b) Price-earnings ratio $50.00 ——–— = 15.8 $3.16 (c) Times interest earned ($360,000 + $100,000 + $90,000) ———————————––––—— = 6.1 times $90,000

Ex. 150 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 Net sales ....................................................................... 6,000,000 Net income.................................................................... 950,000 Total assets .................................................................. 7,400,000 Instructions Calculate all of the profitability ratios that can be determined from the above information. Solution 150 (10–15 min.) With the information provided, the profitability ratios that can be calculated are as follows:

Return on common shareholders' equity

Net income = ————————————————— Average common shareholders' equity = $950,000 ÷ $4,500,000 = 21.1%

Performance Measurement

Return on assets

Profit margin

Asset turnover

Gross profit margin

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= Net income ÷ Average assets = $950,000 ÷ $7,200,000 = 13.2%

= Net income ÷ 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. 151 The following information was taken from the financial statements of Marjory Corporation: 2018 2017 Gross profit ................................................................................. $3,400,000 $1,400,000 Net income.................................................................................. 280,000 325,000 Income before income tax ........................................................... 230,000 221,000 Profit margin ............................................................................... 5% 13% 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 151 (12–15 min.) (a) To calculate net sales, divide net income by the profit margin: 2018 2017 Net Sales $280,000 ÷ 5% = $5,600,000 $325,000 ÷ 13% = $2,500,000 (b)

Using the net sales information from (a) and the gross profit given, it is possible to calculate the cost of goods sold.

Net sales Less: Gross profit Cost of goods sold % of net sales

2018 $5,600,000 3,400,000 $ 2,200,000 39%

2017 $2,500,000 1,400,000 $1,100,000 44%

Ex. 152 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

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Average total liabilities ...................................................... Average total shareholders’ equity .................................... Cash dividends paid .......................................................... Gross profit ....................................................................... Payout ratio....................................................................... Preferred dividends paid ................................................... Price-earnings ratio ........................................................... Profit margin .....................................................................

$38,000 $36,000 $400 $12,000 20% $80 18 8%

Instructions Using the above information, calculate the following: (a) Net income (b) Return on common shareholders' equity (c) Asset turnover (d) Return on assets (e) Gross profit margin (f) Basic earnings per share (g) Market price per share Solution 152 (20 min.) (a) Net income = Cash dividends ÷ payout ratio = $400 ÷ 0.20 = $2,000

(b) Return on common shareholders' equity

= =

Net income – 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 = Net income ÷ 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 = Net income ÷ average total assets = $2,000 ÷ $74,000 = 2.7% (e) Gross profit margin = gross profit ÷ net sales = $12,000 ÷ $25,000 = 48%

(f) Basic earnings per share = =

Net income – preferred dividends ———————————–—–––—– Average number of common shares ($2,000 – $80) ÷ 320 = $6.00

Performance Measurement

Average number of common shares =

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Average common shareholders' equity ————————————————— Average issue price $32,000 ÷ $100 = 320

(g) price per share = Basic earnings per share × Price-earnings ratio = $6.00 × 18 = $108.00

Ex. 153 The comparative statements of financial position of Hillside Corporation appear below: HILLSIDE CORPORATION Comparative Statements of Financial Position December 31 ————————————————————————————————————————— Assets 2018 2017 Cash ............................................................................................... $25,200 $86,000 Accounts receivable ........................................................................ 170,000 152,000 Inventory ......................................................................................... 344,000 320,000 Prepaid expenses ........................................................................... 10,000 15,000 Land................................................................................................ 250,000 150,000 Equipment....................................................................................... 650,000 380,000 Less: Accumulated depreciation ............................................... (136,500) (80,000) Total assets.............................................................................. $1,312,700 $1,023,000 Liabilities and shareholders' equity Accounts payable............................................................................ $86,000 Unearned revenue .......................................................................... 15,000 Income tax payable ......................................................................... 5,000 Bank loan payable .......................................................................... 250,000 Common shares.............................................................................. 434,000 Retained earnings ........................................................................... 522,700 Total liabilities and shareholders' equity .................................... $1,312,700

$76,000 10,000 12,000 160,000 334,000 431,000 $1,023,000

Additional information: Net credit sales and net income for 2018 was $1,346,500 and $216,000, respectively. Instructions Calculate the following profitability ratios for 2018. (a) Asset turnover (b) Return on assets (c) Return on common shareholders’ equity Solution 153 (a) Asset turnover: 2018 = $1,346,500 / [($1,312,000 + $1,023,000) / 2] = 1.15 times

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(b) Return on assets: 2018 = $216,000 / [($1,312,000 + $1,023,000) / 2] = 18.5% (c) Return on common shareholders’ equity: 2018 = $216,000 / [($956,700 + $765,000) / 2] = 25.1%

Ex. 154 For the year ended December 31, 2018, Master Moving Corp. reports pre-tax net income from continuing operations of $520,000. Other items relating to 2018 are: 1. $160,000 net income from discontinued operations, net of income tax. 2. Dividends of $35,000 were declared. 3. Retained earnings, January 1, 2018, were $980,000. Its income tax rate is 30%. Instructions (a) Calculate the net income for 2018. (b) Calculate the retained earnings at December 31, 2018. Solution 154 (10 min.) (a) Profit before taxes from continuing operations .............................. Less: Income tax at 30% ............................................................... Income from continuing operations................................................ Income from discontinued operations, net of income tax ............... Net income ....................................................................................

$520,000 156,000 364,000 160,000 $524,000

Dividends declared do not impact the calculation of net income for 2018. (b) Retained earnings, beginning ........................................................ $980,000 Add: Net income............................................................................ 524,000 Less: Dividends ............................................................................. (35,000) Retained earnings, ending ............................................................ $1,469,000

Ex. 155 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

____

Net income

____

Income before income tax

____

Discontinued operations

Performance Measurement

____

Revenue

____

Income from continuing operations

____

Operating expenses

____

Income tax expense

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Solution 155 (5 min.) __2__ Cost of goods sold __8__ Net income __4__ Income before income tax __7__ Discontinued operations __1__ Revenue __6__ Income from continuing operations __3__ Operating expenses __5__ Income tax expense

Ex. 156 Sports Pick Corporation reported net income of $1,750,000 in 2016. Using 2016 as the base year, net income decreased by 60% in 2017 and increased by 130% in 2018. Instructions Calculate the net income reported by Sports Pick Corporation for 2017 and 2018. Solution 156 (2–3 min.) 2017: $1,750,000 × (100% – 60%) = $700,000 2018: $1,750,000 × 130% = $2,275,000

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MATCHING QUESTIONS SET 1 157. 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. Inventory turnover ____ 3. Debt to total assets ____ 4. Free cash flow ____ 5. Times interest earned ____ 6. Return on assets ____ 7. Basic earnings per share ____ 8. Payout ratio ____ 9. Dividend yield

Performance Measurement

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ANSWERS TO MATCHING SET 1 1.

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

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MATCHING QUESTIONS SET 2 158. 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 Income before income tax and interest expense ____ 5. ——————————————————————— Interest expense Net income ____ 6. —————— Net sales Cash dividends ____ 7. ——————— Net income Net sales ____ 8. ——————— Average assets Market price per share ____ 9. —————————— Basic earnings per share

Performance Measurement

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Dividend per share ____ 10. —————————— Market price per share

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ANSWERS TO MATCHING SET 2 1.

10. B

Performance Measurement

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SHORT-ANSWER ESSAY QUESTIONS S-A E 159 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 159 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 net income.

S-A E 160 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. • Net income this year is $2.1 million. Last year's net income 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 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 160 Fast Express released its financial statements today, disclosing a 17% increase in net income, 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.

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S-A E 161 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 161 Any of the profitability ratios that involve net income 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 straight-line method had been used. Therefore, because of the different costs, net income will also be different. Thus, the choice of depreciation method affects net income, 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 162 When companies have significant operations in different lines of business, they are required to report additional disclosures in a segmented information note to their financial statements. Instructions (a) Under IFRS, how does a company determine if it is required to report segmented information and what information must be disclosed if required? (b) Explain the reporting requirements under ASPE. Solution 162 (a) IFRS has specific revenue, income, and asset tests to determine if a company is required to report segmented information or not. If a company has reportable operating segments, it must disclose relevant information about revenues, operating income, and/or identifiable assets by products and services, by geographic area, and by major customer. (b) Segments are not as common in private companies as they are in large public companies and consequently there are no requirements for the disclosure of segments in ASPE.

S-A E 163 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 net income. 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 net income that is in accordance with GAAP can be anything other than exact. Instructions

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Prepare the explanation you would give Sidney. Include two examples of where estimates are made. Solution 163 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. 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 164 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 164 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.

S-A E 165 Management-defined measures of financial performance that are not included in accounting standards are referred to as non-GAAP measures. (a) Explain why management might provide adjusted measures of selected financial statement items and the disclosure requirements. (b) Discuss two examples. Solution 165 (a) When management believes that accounting standards define key measures of performance such as net income too rigidly, they will disclose non-GAAP measures. When management uses non-GAAP measures they must provide an explanation as to how these measures differ from well-defined IFRS terms like net income and must also provide a reconciliation between the two amounts. (b) Two examples include adjusting net income for items that management believes are nonrecurring referred to as normalized net earnings, and measuring performance using adjusted earnings before income tax and depreciation (adjusted EBITDA) to exclude the

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

effects of tax refunds and depreciation (because it is based on estimates and has no effect on cash flows).

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OBJECTIVE FORMAT QUESTIONS 166. Identify all of the following statements that are correct regarding horizontal analysis: (a) Horizontal analysis is also called trend analysis. (b) An income statement prepared using horizontal analysis is also called a common size income statement. (c) All values on an income statement prepared using horizontal analysis are expressed as a percentage of sales. (d) When calculating the percentage change, the denominator is the prior period amount or base period amount. (e) The increase or decrease reported in a horizontal analysis can be expressed as a dollar amount or a percentage. (f) Horizontal analysis is applied only to the income statement. (g) A large percentage change of an item identified in a horizontal analysis always requires further investigation. (h) Horizontal analysis is considered a up to down analysis. Solution 166 (a), (d), and (e) are correct (b) Common size analysis applies to vertical analysis, not horizontal analysis. Common size analysis is a technique that expresses each item in a financial statement as a percentage of a base amount within the same financial statement. For example, a common size income statement expresses each item as a percentage of net sales. (c) When performing horizontal analysis, the period over period change in an account balance are expressed as a percentage from a base period. For example, the percentage or dollar value change from last year to this year for each item would be reported on a horizontal analysis. When items are expressed as a percentage of sales, this would apply to vertical analysis. Vertical analysis compares data within the same year and horizontal analysis compares data across years. (f) Horizontal analysis can be applied to more than just the income statement. It can also be used to look at trends in the statement of financial position. (g) A large percentage change may not require further investigation if the values being compared are not material. For instance, if miscellaneous expenses increased from $1,000 in 2017 to $2,500 in 2018, this would show a 150% increase on a horizontal analysis. Even through the increase is significant in percentage terms; it would not be material if the company had total expenses of $500,000, for example. Furthermore, if a material change is expected, it may not have to be investigated. For example, if another business was acquired that doubled revenues; this is a significant but expected change requiring no investigation. (h) Vertical analysis is considered a up to down analysis as it compares items on one financial report to a base item on the report. For instance, on the income statement items are expressed as percentage of sales. Horizontal analysis is more of a sideways analysis as it looks at changes from period to period for the same financial statement item.

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167. Identify all the following that are correct regarding liquidity ratio analysis: (a) Working capital is the total dollar value difference between current assets and current liabilities. (b) A company wants both the average collection period ratio and receivables turnover ratio to be higher than industry. (c) The correct formula for receivables turnover is: 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐺𝑟𝑜𝑠𝑠 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 (d) The days in inventory ratio and the inventory turnover ratio are inversely related. (e) Liquidity ratios are often reviewed by both lenders and suppliers. (f) If the cash or receivables balance rises due to increased sales and inventory has been reduced, the current ratio will decrease. (g) A high current ratio is an indication of strong liquidity. (h) Since companies do not generally disclose their credit sales on their income statement, it is acceptable to assume that all sales on are credit for analyzing liquidity. Solution 167 (a), (d), (e), and (h) are correct. (b) There is an inverse relationship between the average collection period and the receivables turnover ratio. It is preferable that the average collection period is lower than industry average for this ratio, although not too much lower since this may indicate an overly strict collection policy. Furthermore, the receivables turnover ratio should be somewhat higher than industry average for this ratio but not too high as this may indicate that credit policies are too tight. (c) The denominator in the formula for receivables turnover should be average accounts receivable. Average accounts receivable is an average of the current year’s accounts receivable balance at the end of the current year and corresponding balance at the end of the previous year. (f) If the cash or receivables balance rises due to increased sales and inventory has been reduced, the current ratio will increase. The question does not mention any change to current liabilities. Typically, inventory is sold for a price that exceeds its cost so if sales rise causing an increase in cash or accounts receivable, this increase will be greater the decrease in inventory arising from these increased sales. Consequently, current assets will rise, and if, as stated above, current liabilities remain unchanged, the current ratio will rise. For example, assume the current assets are $10,000 and current liabilities are $5,000, a current ratio of 2:1 ($10,000 / $5,000). If sales increase by $2,500, accounts receivable or cash will increase by the same amount. Inventory will also decrease but not by $2,500 since the inventory is valued at cost. If the cost of inventory was $1,500, the new balance of current assets would be $11,000 ($10,000+$2,500-$1,500). The current ratio would increase to 2.2:1 ($11,000 / $5,000). (g) A high current ratio is not necessarily an indication of liquidity. In cases where the increase in the company’s current assets are resulting from increases in accounts receivable due to collection difficulties) or increases in inventory (due to obsolete or unpopular merchandise),

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and not cash, a company may not be truly liquid. That is why it is also important to assess a company’s inventory turnover and receivables turnover before making a judgement about liquidity.

168. The following data is for two cosmetic companies: Natural Glow Ltd. And Healthy Radiance Inc. Select financial data Natural Glow Ltd.

Healthy Radiance Inc.

2018

2017

2018

2017

$15,400

$ 13,090

$ 1,750

$ 1,550

Held for trading investments

7,500

6,225

4,580

3,450

Accounts receivable

42,800

33,384

2,150

3,200

Prepaid insurance

1,450

943

350

910

Supplies

4,950

5,940

500

425

Inventory

74,500

65,560

Notes receivable, 60-day

16,000

3,200

6,950 -

5,120 -

1,250,000

1,412,500

185,000

175,000

Accounts payable

65,200

59,984

1,450

2,100

Unearned revenues

15,400

2,310

1,520

2,450

Current portion of bank loan payable

23,740

2,000

Bank loan payable

192,093

215,833

14,500

16,500

Net sales

785,000

667,250

69,000

58,500

Cost of goods sold

333,625

283,581

35,880

28,080

Operating expenses

94,200

80,070

10,350

7,605

Cash

Property, plant, and equipment

Select all the statements that are correct. Note: ratios are rounded to the one decimal. (a) The current ratio for 2017 for Natural Glow is 1.5. (b) Natural Glow has more current assets relative to its current liabilities than Healthy Radiance. (c) The current ratio for Healthy Radiance for 2018 has improved over 2017 by 1.1. (d) Investors will likely be encouraged by the liquidity of Healthy Radiance over Natural Glow. (e) As a larger company, it is difficult for Natural Glow to outperform Healthy Radiance in terms of liquidity. (f) The days in inventory for Natural Glow and Healthy Radiance for 2018 are 76.0 and 61.9, respectively. (g) The average collection period for 2018 for Natural Glow and Healthy Radiance are 19.9 and 11.4, respectively. (h) Inventory turnover ratios for 2018 for Natural Glow and Healthy Radiance are 4.8 and 5.9, respectively.

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Solution 168 (a), (c), (d), (f), and (h) are incorrect (b) Healthy Radiance can pay their current obligations easier than Natural Glow. Healthy Radiance’s current ratio for 2017 and 2018 is higher than Natural Glow’s. (e) Healthy Radiance outperforms Natural Glow on all liquidity ratios but this is not due to the size of the company. Liquidity is not a factor of size but rather a factor of a company’s ability to collect receivables quickly, turn over inventory quickly and maintain liquid assets. (g) The average collection period for 2018 for Natural Glow and Healthy Radiance are 17.7 and 14.1, respectively. The denominator used to determine the receivables turnover; therefore, the average collection period should an average of the accounts receivable balances for 2017 and 2018. Liquidity Ratios December 31, 2018 Natural Glow Ltd.

Healthy Radiance Inc.

2018 $ 162,600 104,340

2017 $ 128,342 86,034

2018 $ 16,280 4,970

2017 $ 14,655 6,550

Current Ratio

1.6

1.5

3.3

2.2

Receivables Turnover

20.6

25.8

Average Collection Period

17.7

14.1

Inventory Turnover

4.8

5.9

Days in Inventory

76.0

61.9

Total current assets Total current liabilities

Calculations: Total current assets: Natural Glow: 2018 = $15,400 + $7,500 + $42,800 + $1,450 + $4,950 +$ 74,500 + $16,000 = $162,600 2017 = $13,090 + $6,225 + $33,384 + $943 + $5,940 + $65,560 + $3,200 = $128,342 Healthy Radiance: 2018 = $1,750 + $4,580 + $2,150 + $350 + $500 + $6,950 = $16,280 2017 = $1,550 + $3,450 + $3,200 + $910 +$ 425 + $5,120 = $14,655 Total current liabilities: Natural Glow: 2018 = $65,200 + $15,400 +$ 23,740 = $104,340 2017 = $59,984 +$ 2,310 + $23,740 = $86,034 Healthy Radiance: 2018 = $1,450 + $1,520 + $2,000 = $4,970 2017 = $2,100 + $2,450 + $2,000 = $6,550 Current Ratio: Natural Glow:

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2018 = $162,600 / $104,340 = 1.6 2017 = $128,342 / $86,034 = 1.5 Healthy Radiance: 2018 = $16,280 / $4,970 = 3.3 2017 = $14,655 / $6,550 = 2.2 Receivables Turnover (2018): Natural Glow = $785,000 / (($42,800 + $33,384) / 2) = 20.6 Healthy Radiance = 69,000 / (($2,150 + $3,200) / 2) = 25.8 Average Collection Period (2018): Natural Glow = 365 / 20.6 = 17.7 days Healthy Radiance = 365 / 25.8 = 14.1 days Inventory Turnover (2018): Natural Glow = $333,625 / (($74,500 + $65,560) / 2) = 4.8 Healthy Radiance = $35,880 / (($6,950 + $5,120) / 2) = 5.9 Days in Inventory (2018): Natural Glow = 365 / 4.8 = 76.0 days Healthy Radiance = 365 / 5.9 = 61.9 days

169. The following data is provided for Foster Inc. and Bryant Ltd. Two companies in the same industry, for 2018. Select financial data December 31, 2018

Total assets, beginning of year Total assets, end of year Total liabilities, beginning of year Total liabilities, end of year Total common shareholders’ equity, beginning of year Total common shareholders’ equity, end of year Net sales Gross profit Net income Interest Expense EBIT Cash dividends

Foster $254,000 285,000 68,900 64,200 185,100 220,800 287,000 115,000 42,500 4,800 55,800 4,700

Bryant $124,000 127,000 57,500 65,600 66,500 61,400 179,500 85,700 22,400 4,100 22,530 1,250

Select all the statements that are correct. Note: all ratios are rounded to two decimal places. (a) Foster’s and Bryant’s debt to total assets for 2018 are 22.5% and 51.7%, respectively.

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(b) Although Bryant’s return on assets and return on common shareholder’s equity are higher than those of Foster, creditors may prefer to lend money to Foster as they have better solvency. (c) The asset turnover ratio for Foster and Bryant is 1.1 and 1.4, respectively. (d) The dividend payout ratio is 904.3% for Foster. (e) Foster Inc. has a higher gross profit as a percentage of net sales than Bryant. (f) Bryant has better profitability and Foster has the better solvency. (g) For every dollar of assets, Bryant has $143 in sales. (h) The return on assets for Foster and Bryant are 14.9% and 17.6%, respectively. Solution 169 (a), (b), (e), and (f) are correct (c) As shown below, the asset turnover is 1.1 and 1.4 times, respectively, for Foster and Bryant. The denominator should be based on the average assets for the year, not the ending balance of assets. (d) The dividend payout ratio is the percentage of net income that is distributed in dividends. It is 8.4% and 5.5%, respectively, for Foster and Bryant. (g) For every dollar in assets, Bryant has $1.43 dollars in sales, as evidenced by the following asset turnover ratio. (h) The return on assets for Foster and Bryant are 15.8% and 17.8% as shown below. The denominator should be based on the average assets for the year, not the ending balance of assets. The following ratios are for Foster and Bryant for 2018: Ratios December 31, 2018

Foster Debt to total assets Gross profit margin Asset turnover Return on assets Return on common shareholders' equity Times interest earned Dividend payout

22.5% 59.9% 1.1 15.8% 20.9% 11.6 8.4%

Bryant 51.7% 52.3% 1.4 17.8% 35.0% 5.5 5.5%

Calculations: Debt to Total Assets: Foster = $64,200 / $285,000 = 22.5% Bryant = $65,600 / $127,000 = 51.7%

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Gross Profit Margin: Foster = ($287,000-$115000) / $287,000 = 59.9% Bryant = ($179,500-$85,700) / $179,500 = 52.3% Asset Turnover: Foster = $287,000 / (($254,000+$285,000) / 2) = 1.1 times Bryant = $179,500 / (($124,000+$127,000) / 2) = 1.4 times Return on Assets: Foster = $42,500 / (($254,000+$285,000) / 2) = 15.87% Bryant = $22,400 / (($124,000+$127,000) / 2) = 17.8% Return on Common Shareholders’ Equity: Foster = $42,500 / (($185,100+$220,800) / 2) = 20.9% Bryant = $22,400 / (($66,500+$61,400) / 2) = 35.0% Times Interest Earned: Foster = $55,800 / $4,800 = 11.6 times Bryant = $22,530 / $4,100 = 5.5 times Dividend Payout: Foster = $4,700 / $55,800 = 8.4% Bryant = $1,250 / $22,530 = 5.5%

170. Identify all the following that are correct regarding profitability ratio analysis: (a) The following are all examples of profitability ratios: return on common shareholders’ equity, asset turnover and price-earnings. (b) The payout ratio measures the number of times net income covers the cash dividends that were distributed. (c) The dividend yield shows the amount shareholders earned from dividends during the year as a percentage of the share price. (d) For companies following IFRS, the basic earnings per share must be presented on the income statement or statement of comprehensive income. (e) The numerator when calculating the return on common shareholders’ equity ratio is net income less dividends declared and paid on common shares. (f) When analyzing profitability ratios, one must consider the change in the ratios over the years rather than the ratio in and by itself. (g) The main difference between profit margin and gross profit margin is that the latter is based on gross sales. (h) If a company’s asset turnover is over 1, this means that they are using their assets efficiently. Solution 170 (a), (c), (d), and (f) are correct (b) The payout ratio measures the percentage of net income that is distributed as cash dividends. It is calculated as follows:

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𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑖𝑜 =

𝐶𝑎𝑠ℎ 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

(e) The numerator for the return on common shareholders’ equity ratio is net income less dividends declared on preferred shares. (g) The main difference between profit margin and gross profit margin is that the latter is based on gross profit. For the profit margin ratio, the numerator is net income; whereas, for the gross profit margin ratio the numerator is gross profit (h) If a company’s asset turnover is over 1, this simply means that the company generated at least $1 in sales for each dollar it has invested in assets. Having an asset turnover over 1 doesn’t necessarily mean the company is using their assets efficiently. Some industries are more capital intensive and will have lower asset turnovers. One needs to review the asset turnover trend. If it is increasing, you can usually assume the company is more efficient than in previous periods. Sometimes, a rising asset turnover ratio can also be caused from ageing assets that are not replaced as this causes the denominator of this ratio to fall.

Part 2 Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 01 Shuffle: No

Question type: True/False

1) Internal users of accounting information include a company's shareholders. Answer: False

2) The issue of shares and the distribution of dividends do not affect net income. Answer: True

3) Proprietorships and partnerships are taxable entities. Answer: False

4) The notes to the financial statements are not required. Answer: False

5) Interest expense is classified as an operating activity. Answer: True

Question type: Multiple Choice

6) Which of the following is not an external user of accounting data? a) labour unions b) customers c) economic planners d) finance directors Answer: d

7) Which of the following type of companies must adopt International Financial Reporting Standards? a) proprietorship b) publicly-traded corporations c) partnerships d) private corporations Answer: b

8) Internal users want answers to all of the following questions except a) what is the cost of manufacturing each unit of the product? b) which product line is more profitable? c) is the company earning enough to give me a return on my investment? d) is cash sufficient to pay the bills? Answer: c

9) The statement of financial position and the statement of changes in equity are interrelated because a) the beginning amount of retained earnings on the statement of changes in equity is reported on the statement of financial position. b) the amount of assets on the statement of financial position is reported on the statement of changes in equity. c) the ending amount of each of the components of shareholders’ equity on the statement of changes in equity is reported on the statement of financial position. d) the amount of liabilities on the statement of financial position is reported on the statement of changes in equity. Answer: c

10) Easy transfer of ownership is a characteristic of which form of business organization? a) proprietorship b) partnership c) publicly-traded corporation d) all of the above Answer: c

11) The statement of financial position reports a) assets owned by the business. b) claims to assets by creditors. c) claims to assets by shareholders. d) all of the above Answer: d

12) The statement that is dated at a specific point in time is the a) statement of cash flows. b) statement of financial position. c) statement of changes in equity. d) Both b) and c) are correct. Answer: b

13) Which of the following would be considered an investing activity? a) the recording of depreciation expense b) the retirement of outstanding debt c) the purchase of inventory for resale d) the construction of a new factory Answer: d 14) To determine how much of a company’s cumulative profits has been distributed to its shareholders, one would refer to the a) statement of financial position. b) notes to the financial statements. c) statement of cash flows. d) statement of changes in equity. Answer: d

15) Cost of goods sold is classified as a(n) a) asset. b) expense.

c) liability. d) revenue. Answer: b

16) The financial statements are usually prepared in which of the following sequence? a) Income statement, Statement of financial position, Statement of changes in equity, Statement of cash flows b) Statement of financial position, Statement of changes in equity, Statement of cash flows, Income statement c) Statement of financial position, Statement of cash flows, Income statement, Statement of changes in equity d) Income statement, Statement of changes in equity, Statement of financial position, Statement of cash flows Answer: d 17) Which of the following financial statements would you use to determine a company’s source(s) of financing? a) statement of financial position b) income statement c) statement of changes in equity d) bank statement Answer: a

18) Which of the following would not appear on the income statement? a) service revenue b) interest expense c) net income d) dividends declared Answer: d

19) Which of the following would not appear directly on the statement of changes in equity? a) beginning retained earnings balance b) dividends declared c) service revenue

d) net income Answer: c 20) Saira’s Maid Service Ltd. began the year with total assets of $120,000 and shareholders’ equity of $40,000. During the year, the company earned $90,000 in net income and paid $20,000 in dividends. Total assets at the end of the year were $215,000. Shareholders’ equity at the end of the year was a) $130,000. b) $110,000. c) $150,000. d) $135,000. Answer: b

21) Repayment of non-current notes payable is an example of a (an) a) operating activity. b) financing activity. c) investing activity. d) delivery activity. Answer: b

22) Financial statements are prepared to provide information to which users? a) regulators b) bond holders c) investors d) all of the above Answer: d

23) The statement of changes in equity is dependent on the results of the a) income statement. b) statement of financial position. c) statement of cash flow. d) statement of assets and liabilities. Answer: a

24) Which of the following would appear on the statement of financial position? a) service revenue b) interest expense c) net income d) accounts receivable Answer: d

25) Purchasing a new building is an example of a(n) a) operating activity. b) financing activity. c) investing activity. d) delivery activity. Answer: c

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 02 Shuffle: No

Question type: True/False

1) Understandability is the enhancing qualitative characteristic of accounting information that allows a statement reader to compare a company’s performance from one year to the next. Answer: False

2) Comparability means that a company uses the same accounting principles and methods as the rest of the companies in the same industry. Answer: False

3) Current assets are assets that are expected to be converted to cash or used in the business within two years. Answer: False

4) The fair value basis of accounting can result in a more relevant measure of the elements of financial statements than the cost basis of accounting. Answer: True

5). Completeness means the absence of bias. Answer: False

6) The debt to total assets ratio is an overall measure of profitability. Answer: False

7) The profit margin is an overall measure of profitability. Answer: True

Question type: Multiple Choice

8) Which of the following is a characteristic of relevant accounting information? a) cost constraint b) predictive value c) cost basis of accounting d) neutral Answer: b

9) Which of the following is not a characteristic of faithful representation? a) free from material error b) confirmatory value c) neutrality d) completeness Answer: b

10) ___ of information indicates that the information is reasonably free of material error and bias. a) Relevance b) Comparability c) Understandability d) Faithful representation Answer: d

11) Which of the following would best resemble an example of the reverse order of liquidity asset presentation of the statement of financial position? a) Goodwill; Property, Plant and Equipment; Prepaid Insurance; Cash b) Property, Plant and Equipment; Goodwill; Accounts Receivable; Inventory; Cash c) Goodwill; Property, Plant and Equipment; Long-term Investments; Cash; Inventory d) Property, Plant and Equipment; Long-term Investments; Accounts Receivable; Prepaid Insurance; Cash Answer: a

12) Which basic assumption states that a business will remain in operation for the foreseeable future? a) time period assumption b) monetary unit assumption c) economic entity assumption d) going concern assumption Answer: d

13) Which of the following would not be classified as a current asset? a) prepaid expenses b) accounts receivable c) patents d) inventory Answer: c

14) Which of the following is the usual order for current assets to be listed on a Canadian statement of financial position? a) Cash, Accounts Receivable, Prepaid Expenses, Inventories, Trading Investments b) Cash, Trading Investments, Inventories, Prepaid Expenses, Accounts Receivable c) Cash, Accounts Receivable, Inventories, Trading Investments, Prepaid Expenses d) Cash, Trading Investments, Accounts Receivable, Inventories, Prepaid Expenses Answer: d

15) Which of the following is an example of an intangible asset? a) accounts receivable b) trademarks c) prepaid expenses d) trading investments Answer: b

16) Which of the following is not a type of useful comparison in ratio analysis?

a) intracompany comparisons b) intercompany comparisons c) industry average comparisons d) inter-industry comparisons Answer: d

17) The purpose of the earnings per share ratio is a) to measure the net income for each common share. b) to measure the revenue earned for each common share. c) to compare the profitability of low-turnover businesses with high-turnover businesses. d) to provide a measure of gross profit to sales. Answer: a

18) Which of the following ratios measures the ability of the company to survive over a long period of time? a) current ratios b) liquidity ratios c) profitability ratios d) solvency ratios Answer: d

19) The current ratio is calculated by dividing current assets by a) total assets. b) non-current liabilities. c) current liabilities. d) the number of common shares. Answer: c

20) Which of the following statements about the current ratio is true? a) One limitation of the current ratio is that it does not take into account the composition of the current assets. b) The working capital ratio is a more reliable indicator of liquidity than the current ratio. c) The current ratio will reflect a decline in sales and cause inventories to rise. d) The current ratio should be similar for all types of organizations.

Answer: a

21) While IFRS uses the term depreciation for tangible assets, ASPE uses the term a) depletion. b) capital cost allowance. c) amortization. d) any of the above. Answer: c

22) Which of the following ratios measures the ability of the company to satisfy immediate cash requirements? a) asset efficiency ratios b) liquidity ratios c) profitability ratios d) solvency ratios Answer: b

23) Which of the following asset classification(s) are generally contained on a classified balance sheet? a) Current liabilities b) Non-current liabilities c) Shareholders’ equity d) all of the above Answer: d

24) Which of the following should be classified as current liabilities? a) Cash, Prepaid Expenses, And Income Tax Payable b) Accounts Receivable, Cash, And Prepaid Expenses c) Accounts Payable, Income Tax Payable, And Accrued Liabilities d) Prepaid Expenses, Equipment, And Long-Term Investments Answer: c

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 03 Shuffle: No

Question type: True/False

1) Every transaction affects at least two accounts. Answer: True

2) Every account has a left or credit side and a right or debit side. Answer: False

3) Assets are increased with credits. Answer: False

4) Transactions are recorded in chronological order in the general journal. Answer: True

5) Expenses decrease retained earnings and should only be recorded whenever the expense is incurred. Answer: True

6) Expenses decrease retained earnings and should only be recorded whenever cash is paid out. Answer: False

Question type: Multiple Choice

7) Which component of the recording process discloses the complete effect of a transaction in one place?

a) Source documents b) Chart of accounts c) General ledger d) General journal Answer: d

8) The primary purpose of a trial balance is to a) prove that the correct accounts have been used in recording transactions. b) list all of the account titles. c) prove the mathematical equality of debits and credits after posting. d) find all errors. Answer: c

9) If cash is received in advance from a customer, then a) assets will decrease. b) retained earnings will increase. c) liabilities will increase. d) shareholders’ equity will decrease. Answer: c

10) Which accounts are affected when a cash dividend is declared and paid? a) Accounts Receivable is debited and the Dividends Payable account is credited. b) Cash is debited and the Dividends Payable account is credited. c) The Dividends Declared account is debited and the Cash account is credited. d) The Dividends Declared account is debited and Dividends Payable is credited. Answer: c

11) Accounts with normal debit balances include a) assets and liabilities. b) liabilities and expenses. c) shareholders’ equity and revenues. d) expenses and assets. Answer: d

12) Retained earnings are decreased by a) revenues. b) liabilities. c) expenses. d) common shares. Answer: c

13) Accounts with credit balances normally include a) assets and liabilities. b) revenues and expenses. c) liabilities and shareholders’ equity. d) revenues and assets. Answer: c

14) Issuing shares to investors for cash would result in a) a debit to Common Shares and a credit to Cash. b) a debit to Cash and a credit to Common Shares. c) a debit to Investments in Common Shares and a credit to Cash. d) a debit to Cash and a credit to Sales. Answer: b

15) Which of the following is not a part of a complete journal entry? a) the balance of each account affected b) the accounts and amounts to be debited and credited c) the date of the transaction d) a brief explanation of the transaction Answer: a

16) The process of transferring entries from the journal to the ledger is called a) journalizing. b) transferring.

c) posting. d) balancing. Answer: c

17) The first place every transaction is recorded in the recording process is the a) ledger. b) account. c) trial balance. d) journal. Answer: d

18) When a trial balance balances, it is an indication that a) all journal entries have been posted. b) the account balances are correct. c) debits equal credits. d) all transactions have been journalized. Answer: c

19) Accounts are normally listed on the trial balance in a) chronological order. b) the order that they appear in the ledger. c) alphabetical order. d) the order in which they are posted. Answer: b

20). One purpose of a trial balance is to a) prove that the correct accounts have been used in recording transactions. b) prove that the correct amounts have been used in recording transactions. c) uncover errors in journalizing and posting. d) prove that all transactions have been recorded. Answer: c

21) If supplies are purchased but not paid for immediately, then a) liabilities will increase. b) retained earnings will increase. c) assets will decrease. d) expenses will decrease. Answer: a

22) Collecting cash in advance from customers for a service to be performed later would result in a) a debit to Cash and a credit to Service Revenue. b) a debit to Cash and a credit to Unearned Revenue. c) a debit to Prepaid Services and a credit to Cash. d) no journal entry recorded until the service was performed. Answer: b

23) Which of the following statements is true? a) The normal balance for asset accounts is on the debit side. b) The normal balance for liability accounts is on the credit side. c) The normal balance for revenue accounts is on the credit side. d) all of the above Answer: d

24) Accounts with normal credit balances include a) assets and liabilities. b) liabilities and expenses. c) shareholders’ equity and revenues. d) expenses and assets. Answer: c

25) Collecting an accounts receivable would result in a) a debit to Cash and credit to Accounts Receivable. b) a debit to Accounts Receivable and credit to Cash. c) a debit to Cash and a credit to Revenue. d) none of the above

Answer: a

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 4 Shuffle: No

Question type: True/False

1) Revenue recognition guidelines dictate that revenue is recognized in the period in which the cash is received. Answer: False

2) Expense recognition guidelines require that expenses be recognized in the same period that they are paid. Answer: False

3) The cash basis of accounting is in accordance with generally accepted accounting principles. Answer: False

4) The carrying amount of a depreciable asset is equal to its cost less its accumulated depreciation. Answer: True

5) Accrued expenses are expenses that have already been paid. Answer: False

Question type: Multiple Choice

6) Which of the following is not a type of adjusting entry? a) prepaid expenses b) prepaid revenues c) accrued revenues d) accrued expenses

Answer: b

7) Closing entries a) are prepared after the post-closing trial balance is prepared. b) are prepared at the same time adjusting entries are prepared. c) close off all revenue, expense, and dividends declared accounts to a zero balance. d) close off all accounts in the books to a zero balance. Answer: c

8) The cash basis of accounting does not satisfy generally accepted accounting principles because a) it fails to record revenue that has been earned but not collected, thus violating revenue recognition guidelines. b) cash is more important than revenues not received in cash. c) some companies may use different accounting standards, so it does not matter whether revenue is recognized or not unless it is received in cash. d) it does not make sense to record expenses unless cash has been paid to support the expense. Answer: a

9) If revenues are recognized only when a customer pays for the goods or services it has received, what method of accounting is being used? a) accrual basis b) recognition basis c) cash basis d) matching basis Answer: c

10) Which of the following is not a typical example of a prepaid expense? a) supplies b) insurance c) rent d) salaries Answer: d

11) Payments received in advance of services provided are recorded as a) revenues. b) shareholders’ equity. c) expenses. d) liabilities. Answer: d

12) If the adjusting entry is not made to recognize unearned revenues in the period in which they are earned, the result will be to a) overstate assets and understate liabilities. b) overstate liabilities and understate revenues. c) understate net income and overstate retained earnings. d) understate retained earnings and overstate revenues. Answer: b

13) On September 1, the Mini-Mite Store paid $12,000 to the Maxi-Mall for three months rent beginning September 1. The Prepaid Rent account was debited for the entire amount of the payment. If financial statements are prepared on September 30, the appropriate adjusting journal entry to be made on September 30 would be to: a) debit Rent Expense $4,000; credit Prepaid Rent $4,000. b) debit Prepaid Rent $8,000; credit Rent Expense $8,000. c) debit Rent Expense $8,000; credit Prepaid Rent $8,000. d) debit Prepaid Rent $4,000; credit Rent Expense $4,000. Answer: a

14) A company receives its electricity bill on May 20. It sent a cheque in payment of the bill on June 5 and confirmed that the electric company received the cheque on June 11. The expense should be recognized on a) May 20. b) May 31. c) June 5. d) June 11. Answer: a

15) Which of the following is not an example of an accrued expense? a) depreciation b) salaries c) interest d) income tax Answer: a

16) Medina Corporation purchased office supplies costing $5,000 and debited Supplies for the full amount. Supplies on hand at the end of the accounting period were $1,300. The appropriate adjusting journal entry to be made would be to a) debit Supplies $3,700; credit Supplies Expense $3,700. b) debit Supplies Expense $1,300; credit Supplies $1,300. c) debit Supplies Expense $3,700; credit Supplies $3,700. d) debit Supplies $1,300; credit Supplies Expense $4,000. Answer: c

17) On August 1, Hacienda Corporation signed a $30,000, 14%, 1-year bank loan payable, with interest payable at maturity, to help finance some renovations it was making to its corporate headquarters. Assuming that interest is accrued at fiscal year-end on December 31, the appropriate journal entry to be made would be to a) debit Interest Expense $1,750; credit Interest Payable $1,750. b) debit Interest Expense $4,200; credit Bank Loan Payable $4,200. c) debit Interest Expense $1,750; credit Bank Loan Payable $1,750. d) debit Interest Expense $4,200; credit Interest Payable $4,200. Answer: a

18) Which of the following is the correct sequencing of selected steps in the accounting cycle? a) Prepare: (1) general journal entries, (2) closing journal entries, and (3) adjusting journal entries. b) Prepare: (1) general journal entries, (2) post-closing trial balance, and (3) financial statements. c) Prepare: (1) financial statements, (2) adjusted trial balance, and (3) closing journal entries. d) Prepare: (1) general journal entries, (2) adjusting journal entries, and (3) closing journal entries.

Answer: d

19) Which of the following statements is correct? a) Dividends declared as well as all revenue and expense accounts are always closed directly to Retained Earnings. b) Dividends declared as well as all revenue and expense accounts are closed first to Income Summary and then to Retained Earnings. c) Only revenue and expense accounts are closed to Income Summary before being closed to Retained Earnings. d) Only Dividends declared are closed to Income Summary before being closed to Retained Earnings. Answer: c

20) Which of the following statements is true? a) With prepaid expenses, accounts before adjustment include assets that are overstated and expenses that are understated. b) With unearned revenues, accounts before adjustment include liabilities that are understated and revenues that are overstated. c) With accrued revenues, accounts before adjustment result in assets that are overstated and revenues that are understated. d) With accrued expenses, accounts before adjustment result in liabilities that are overstated and expenses that are overstated. Answer: a

21) Which of the following statement(s) is/are true? a) A contra asset account normally has a credit balance. b) A contra asset account is offset against an asset account. c) Accumulated Depreciation—Office Equipment is a contra account to the Office Equipment account. d) All of the above. Answer: d

22) John The Tailor, Inc. signed an 18-month, 5% bank loan payable in the amount of $10,000 on September 1, 2018. Interest is due at maturity. The adjusting journal entry on December 31, 2018, assuming adjusting entries were not previously made, would consist of:

a) a debit to Interest Expense for $750 and a credit to Interest Payable for $750. b) a debit to Interest Expense for $167 and a credit to Cash for $167. c) a debit to Interest Expense for $167 and a credit to Interest Payable for $167. d) a debit to Interest Expense for $167 and a credit to Bank Loan Payable for $167. Answer: c

23) Which one of the following accounts would appear in the financial statements if revenue was recognized before cash was received from the customer? a) a credit to Accounts Receivable b) a credit to Unearned Revenue c) a credit to Revenue d) a debit to Unearned Revenue Answer: c

24) Which one of the following accounts would appear in the financial statements if revenue was recognized after cash was received from the customer? a) a credit to Accounts Receivable b) a credit to Unearned Revenue c) a credit to Revenue d) a debit to Unearned Revenue Answer: d

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 05 Shuffle: No

Question type: True/False

1) The operating cycle of a merchandising company is ordinarily shorter than that of a service company. Answer: False

2) Credit terms of 2/10, n/30 means that a 10% cash discount is available if payment is made within 30 days. Answer: False

3) Gross profit is the difference between net sales and cost of goods sold. Answer: True

4) Sales Returns and Allowances is a contra-revenue account. Answer: True

5) If the gross profit margin is 35% and the cost of goods sold is $1,300,000, the net sales are $2,000,000. Answer: True

Question type: Multiple Choice

6) Which of the following would appear on both a single-step and a multiple-step income statement? a) Gross profit b) Profit from operations c) Cost of goods sold

d) Other expenses and losses Answer: c

7) An inventory system that does not keep detailed inventory records of the goods on hand on a continuous basis is called a a) just-in-time inventory system. b) periodic inventory system. c) perpetual inventory system. d) temporary inventory system. Answer: b

8) Which of the following statements about a merchandising company is not true? a) The operating cycle for a merchandising company includes buying and selling inventory. b) The cost of goods sold is the total cost of merchandise and supplies sold during the period. c) The primary source of revenue for merchandising companies is the sale of merchandise. d) Operating expenses are expenses that are incurred in the process of earning sales revenue. Answer: b

9) Audio Wholesalers Ltd. recently returned 500 clock radios to its supplier because they were defective. The company uses a perpetual inventory system and had not yet paid for the merchandise. Which of the following journal entries would have to be made to correctly record the return of the merchandise? a) a debit to Inventory and a credit to Accounts Payable b) a debit to Inventory and a credit to Purchase Allowances c) a debit to Accounts Payable and a credit to Merchandise Inventory d) a debit to Accounts Payable and a credit to Cash Answer: c

10) Which of the following statements about a perpetual inventory system is correct? a) Freight costs for goods sold, terms FOB shipping point, would appear on the seller’s income statement as an addition to its cost of goods sold. b) Freight costs for goods purchased, terms FOB destination, would appear on the buyer’s income statement as an operating expense. c) Freight costs for goods purchased, terms FOB shipping point, would appear on the buyer’s

statement of financial position as a cost of its merchandise inventory. d) Freight costs for goods sold, terms FOB destination, would appear on the seller’s statement of financial position as a cost of its inventory. Answer: c

11) When the buyer incurs freight costs, a) the costs are considered part of the cost of purchasing inventory. b) the account Freight Out is debited. c) the cost of goods sold is higher. d) the account Inventory is credited. Answer: a

12) Freight costs incurred by the seller are recorded in the a) Sales account. b) Cost of Goods Sold account. c) Inventory account. d) Freight Out expense account. Answer: d

13) With respect to freight terms, which of the following statements is correct? a) If terms are FOB destination, it is the seller’s responsibility to ensure that the goods reach their intended destination. b) If terms are FOB shipping point, it is the seller’s responsibility to ensure that the goods reach their intended destination. c) FOB terms do not determine which party is responsible for shipping costs. d) If terms are FOB destination, it is the buyer’s responsibility to ensure that the goods reach their intended destination. Answer: a

14) A customer returns undamaged goods to Magna Stereos Inc. that were sold originally for $200 on account. Magna Stereos uses a perpetual inventory system. Assuming the cost of the goods was $125, the journal entry for Magna’s Stereos to record the return would be a) Accounts Receivable .................................... Sales Returns and Allowances ..............

200 200

Inventory ...................................................... Cost of Goods Sold ............................... b) Inventory ...................................................... Sales Returns and Allowances .............. Accounts Receivable .................................... Cost of Goods Sold ............................... c) Sales Returns and Allowances ..................... Accounts Receivable ............................. Inventory ...................................................... Cost of Goods Sold ............................... d) Accounts Receivable .................................... Sales Returns and Allowances .............. Cost of Goods Sold ...................................... Inventory ...............................................

125 125 200 200 125 125 200 200 125 125 200 200 125 125

Answer: c

15) In a multiple-step income statement, a) sales less cost of goods sold results in profit from operations. b) interest revenue is included in operating expenses. c) income tax expense is subtracted just prior to determining net income. d) gross profit less cost of goods sold expense equals net income. Answer: c

16) A multiple-step income statement is often considered more useful than a single-step income statement because a) a multiple-step income statement is simpler and easier to read than a single-step income statement. b) a multiple-step income statement highlights the components of profit and is therefore more useful to the reader. c) a multiple-step income statement is required for reporting income tax expense. d) a multiple-step income statement is more accurate because it lists total expenses before showing any kind of income for the company. Answer: b

17) Which of the following would have no effect on the profit margin? a) an increase in net income b) a decrease in cost of goods sold

c) a decrease in average inventory d) an increase in sales discounts Answer: c

18) Beer Barrel Pickle Corporation recently suffered a $15,000 loss when a main water pipe burst in its warehouse, damaging a significant amount of pickle inventory. The $15,000 loss would be classified as ___ on the company’s year-end financial statements. a) an operating loss b) a non-operating loss c) cost of goods sold d) an operating expense Answer: b

19) Sales taxes collected in Canada a) can include GST, HST, PST, and/or QST. b) are revenues to the company. c) are long-term liabilities to the company. d) are optional for the company. Answer: a

20) Under a periodic inventory system, a) a purchase of goods on account results in a debit to Purchases and a credit to Accounts Payable. b) a record of cost of goods sold is kept. c) a count of physical inventory is not taken. d) sales of merchandise are recorded in the Purchases account. Answer: a

21) Gross profit margin primarily measures a) the ability to generate revenue while holding assets steady. b) the ability to generate sufficient profit on total assets. c) the ability to earn income for the common shareholders. d) the ability to generate profit on each sale.

Answer: d

22) Which of the following would have no effect on the gross profit margin? a) an increase in selling price b) a decrease in cost of inventory purchased and sold c) a decrease in insurance costs d) an increase in sales discounts Answer: c

23) A company with merchandise that has a low unit value and high volume turnover would probably use a a) perpetual inventory system. b) double entry inventory system. c) periodic inventory system. d) single entry inventory system. Answer: c

24) Martin Corporation purchases $5,000 of merchandise on March 1, with credit terms of 3/10, n/30. If Martin pays on March 10, what is the cost of this purchase? a) $5,000 b) $4,750 c) $4,850 d) $3,864 Answer: c

25) Which of the following items should appear on an invoice from a supplier? a) quantity of goods shipped b) credit terms c) sales taxes paid d) all of the above Answer: d

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 06 Shuffle: No

Question type: True/False

1) When the terms of a sale are FOB destination, legal title to the goods passes to the buyer when they reach the buyer’s place of business. Answer: True

2) FOB shipping point means ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller. Answer: True

3) Under FIFO, the cost of goods sold consists of the units with the oldest costs. Answer: True

4) The FIFO and average cost formulas can be used in the perpetual inventory system, but not the periodic inventory system. Answer: False

5) The days in inventory is calculated by dividing the inventory turnover ratio by 365 days. Answer: False

6) The weighted average unit cost in the average cost formula is calculated by dividing the cost of the goods sold by the number of goods available for sale. Answer: False

Question type: Multiple Choice

7) Which of the following would most likely employ the specific identification formula of inventory costing? a) a grocery store b) a hardware store c) a gasoline station d) a jewellery store Answer: d

8) Which of the following statements is true? a) IFRS and ASPE both allow the use of both the perpetual and periodic inventory systems. b) IFRS and ASPE both allow specific identification, FIFO, and average cost formulas for determination. c) IFRS and ASPE both require that inventory be carried at the lower of cost and net realizable value. d) All of the above statements are true. Answer: d

9) Goods on consignment are a) included in the inventory of the consignor. b) not included in the inventory of the consignor. c) included in the inventory of the consignee. d) are included in the inventory of both the consignor and the consignee. Answer: a

10) Which cost formula conforms to actual physical inventory flow? a) first-in, first-out b) average cost c) specific identification d) all of the above Answer: c

11) Which of the following statements is (are) true? a) Whether a periodic or perpetual inventory system is used, FIFO will always result in the same

cost of goods sold and ending inventory amounts. b) Whether a periodic or perpetual inventory system is used, average will always result in the same cost of goods sold and ending inventory amounts. c) Under FIFO, the cost of the goods most recently purchased before each sale is allocated to the cost of goods sold. d) None of the above statements are correct. Answer: a

12) An overstatement of the ending inventory balance would affect which account? a) Purchase Discounts b) Sales c) Sales Returns and Allowances d) Retained Earnings Answer: d

13) The ML Corporation undertook a 2018 year-end physical inventory count. It was subsequently discovered that inventory totalling $50,000 was not counted or recorded. The impact of this error on the cost of goods sold and profit, respectively, for 2018 is a) overstated, understated. b) understated, overstated. c) overstated, overstated. d) understated, understated. Answer: a

14) The ML Corporation undertook a 2018 year-end physical inventory count. It was subsequently discovered that inventory totalling $50,000 was not counted or recorded. Assuming the inventory was purchased for cash, the impact of this error on the assets, liabilities, and shareholders’ equity accounts, respectively, for 2018 is a) overstated, no effect, understated. b) understated, no effect, understated. c) overstated, no effect, overstated. d) understated, understated, overstated. Answer: b

15) A company just starting business made inventory purchases in August at a time when the

prices were rising. The inventory cost formula that would produce the higher gross profit for August is a) average in the periodic inventory system. b) average in the perpetual inventory system. c) FIFO. d) not determinable. Answer: c

16) Which of the following financial statements are affected when an error in inventory occurs? a) income statement only b) statement of financial position only c) income statement and statement of financial position d) statement of cash flows Answer: c

17) Which of the following does not need to be disclosed in the financial statements or accompanying notes relating to inventory? a) the cost formula b) the basis of inventory valuation c) the name of the suppliers owed for the inventory d) the amount of any write-down to net realizable value or reversals of previous write-downs, including the reason why the write-down was reversed Answer: c

18) Low inventory turnover would indicate that a) sales have exceeded expectations. b) the company may have excessive carrying costs or obsolete inventory. c) the company does not stock enough inventory. d) the company manages inventory effectively. Answer: b

19) The cost of goods sold equals $150,000 and ending inventory equals $135,000. The cost of goods available for sale in a periodic inventory system would be

a) $285,000. b) $235,000. c) $150,000. d) $280,000. Answer: a

20) The beginning inventory equals $200,000, purchases were $125,000, and ending inventory equals $150,000. The cost of goods sold in a periodic inventory system would be a) $250,000. b) $175,000. c) $150,000. d) $200,000. Answer: b

21) Which of the following statement(s) is (are) correct? a) Net Sales – Cost of Goods Sold = Gross Profit b) Income + Income Tax Expense + Operating Expenses = Net Sales c) Income from Operations + Cost of Goods Sold = Net Sales d) Both a and c are correct. Answer: a

22) Alpha Co. has accumulated the following cost and net realizable value (NRV) data on December 31: Cost NRV Data Data Steel Plates $27,000 $25,000 Iron Rods 25,000 28,000 Sheet Metal 18,000 17,000 $70,000 $70,000 Using the lower of cost and NRV as applied on an item-by-item basis, calculate the LCNRV of the ending inventory. a) $70,000 b) $67,000 c) $68,000 d) $69,000

Answer: b

23) Which of the following factors do not apply to the lower of cost and NRV of inventory? a) acquisition cost b) replacement cost c) net realizable value d) All of the above apply. Answer: b

24) Which inventory cost formula shows the lowest reported ending inventory amount in a period of rising prices? a) FIFO in a perpetual inventory system b) FIFO in a periodic inventory system c) Average cost d) Both a and b Answer: c

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 07 Shuffle: No

Question type: True/False

1) Good internal control systems have five primary components. Answer: True

2) Segregation of duties reduces the risk of errors and irregularities. Answer: True

3) Collusion is when two or more people are responsible for a single task. Answer: False

4) All payments, even for incidental amounts, must be paid by cheque. Answer: False

5) Deposits in transit are added to the cash balance per books on a bank reconciliation. Answer: False

6) Storing cash in limited access areas, such as safes or cash registers, is a control activity over cash receipts. Answer: True

Question type: Multiple Choice

7) Which of the following is not a control activity over cash receipts? a) Individuals who receive cash do not also record cash receipts.

b) Serial numbers on bills are recorded and maintained. c) Only designated personnel are authorized to handle cash. d) Cash is stored in limited access areas, such as safes or cash registers. Answer: b

8) Which of the following is not a control activity? a) segregation of duties b) documentation c) collusion between employees d) review and reconciliation Answer: c

9) Computer programs that limit unauthorized access to certain files are examples of a) assignment of responsibility b) independent checks of performance. c) documentation. d) physical controls. Answer: d

10) Reasonable assurance rests on the premise that a) the cost of internal controls does not exceed their benefit. b) bonding will prevent employees from stealing. c) employees are basically honest people. d) a system of internal control will prevent errors. Answer: a

11) Generally, control activities over cash payments are more effective when a) payments are made in cash rather than by other means. b) payments are made each week by the same employees at regularly scheduled times. c) payments are authorized by any personnel. d) payments are made by cheque rather than by cash. Answer: d

12) The following items were found in the cash drawer on May 31. Which item is not considered cash on that date? a) debit card slips from sales to customers b) bank credit card slips from sales to customers c) a customer cheque dated may 30 d) a customer cheque dated June 1 Answer: d

13) Springer Corporation had outstanding cheques totalling $4,500 on its September bank reconciliation. In October, the company issued cheques totalling $45,700. The October bank statement shows that cheques totalling $39,800 cleared the bank. In addition, a cheque from one of Springer’s customers in the amount of $500 was returned as NSF. The outstanding cheques on the October bank reconciliation should total a) $5,900. b) $9,900. c) $10,400. d) $1,400. Answer: c

14) Jones Limited collected the following information to prepare its May bank reconciliation: Cash balance per books, May 31 $5,300 Deposits in transit 510 Notes receivable with interest collected by bank 580 Bank service charges 30 Outstanding cheques 1,800 NSF cheque 150 The adjusted cash balance per books on May 31 is a) $5,700. b) $5,810. c) $6,210. d) $5,660. Answer: a

15) Barker Corp. collected the following information to prepare its November bank reconciliation:

Unadjusted cash balance per bank, November 30 Electronic collection of account receivable Outstanding cheques Deposits in transit Bank service charges NSF cheque

$21,000 9,000 6,000 5,400 85 2,000

The adjusted cash balance per bank at November 30 is a) $20,400. b) $27,315. c) $21,000. d) $27,915. Answer: a

16) An adjusting entry is required for a) outstanding cheques. b) deposits in transit. c) bank errors. d) NSF cheques. Answer: d

17) Which of the following is not an example of a basic principle of cash management? a) Keep inventory levels high. b) Delay the payment of liabilities. c) Prepare a cash budget. d) Plan the timing of major expenditures. Answer: a

18) Which of the following would be accounted for in the bank reconciliation as a deduction from the cash balance per the accounting records? a) a bank service fee b) an outstanding deposit c) the collection of an accounts receivable d) an outstanding cheque Answer: a

19) Cash consists of all of the following except a) coins. b) postage stamps. c) debit card receipts. d) bank credit card receipts. Answer: b

20) An adjusting entry is not required for a) bank collection of accounts receivable. b) deposits in transit. c) NSF cheques. d) service charges. Answer: b

21) Restricted cash is normally reported a) as an asset on the statement of financial position. b) in the notes to the financial statements. c) as an investing activity in the statement of cash flow. d) as a non-operating item in the income statement. Answer: a

22) When the cashier is able to override their own errors on the cash register, which internal control activity is violated? a) physical controls b) assignment of responsibility c) segregation of duties d) documentation Answer: b

23) Which of the following is not a control activity? a) segregation of duties

b) assignment of responsibility c) physical controls d) management control Answer: d

24) Cash equivalents can include a) cash in the bank account. b) short-term, highly liquid trading investments. c) bank overdrafts. d) all of the above. Answer: b 25) Cash receipts come by way of all except: a) Mailed receipts b) Electronic receipts c) Cheque receipts d) Over-the-counter receipts Answer: a 26) Control activities over cash payments are least effective when payments are made by: a) Credit card b) Electronic funds transfer c) Cash d) Cheque Answer: c

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 08 Shuffle: No

Question type: True/False

1) Accounts receivable are amounts due from individuals and other companies that are supported by formal instruments of credit—a written promise to repay. Answer: False

2) The Allowance for Doubtful Accounts is written off at the end of the fiscal year. Answer: False

3) Under the allowance method, the write-off of an account receivable leaves the carrying value of the accounts receivable unchanged. Answer: True

4) Journal entries to an accounts receivable subsidiary ledger are normally posted daily, while entries to the general ledger are normally posted monthly. Answer: True

5) Cash sales are normally excluded from the receivables turnover ratio. Answer: True

6) The aged trial balance of accounts receivable is an effective document in estimating bad debt expense. Answer: True

Question type: Multiple Choice

7) Accounts receivable are reported on the Statement of Financial Position at their a) fair value. b) present value. c) carrying value. d) maturity value. Answer: c

8) A short-term note receivable is recorded at its a) carrying value. b) fair value. c) present value. d) maturity value. Answer: a 9) Which of the following would be classified as “other receivables?” a) trade accounts receivable b) interest receivable c) accounts receivable d) notes receivable Answer: b

10) When an account is written off under the allowance method a) Bad Debts Expense is debited. b) Accounts Receivable is debited. c) Allowance for Doubtful Accounts is debited. d) Loss on Accounts Receivable is debited. Answer: c

11) The use of an Allowance for Doubtful Accounts complies with a) full disclosure principle. b) expense recognition. c) the cost model. d) revenue recognition.

Answer: b

12) A business estimates that $9,000 of its credit sales will prove uncollectible. The adjusting entry to record this estimate is a) a debit to Bad Debts Expense for $9,000 and a credit to Allowance for Doubtful Accounts for $9,000. b) a debit to Allowance for Doubtful Accounts for $9,000 and a credit to Bad Debts Expense for $9,000. c) a debit to Accounts Receivable for $9,000 and a credit to Bad Debts Expense for $9,000. d) a debit to Accounts Receivable for $9,000 and a credit to Bad Debts Expense for $9,000. Answer: a

13) Reporting Accounts Receivable on the financial statements is often problematic because a) Accounts Receivable can be very large. b) determining the amount to report is difficult because some receivables will prove to be uncollectible. c) Accounts Receivables as a percentage of assets could be too small to disclose to the users of information. d) there are no accounts receivable. Answer: b

14) A schedule in which customer balances are classified by the length of time they have been unpaid is called a(n) a) estimation schedule. b) allowance for doubtful accounts schedule. c) aging schedule. d) bad debts schedule. Answer: c

15) Using the percentage of receivables basis, the amount of the bad debts adjusting entry is a) the difference between the sales and the estimated bad debts. b) the difference between the required balance and the existing balance in the accounts receivable account. c) the amount of the estimated bad debts matched to the sales.

d) the difference between the required balance and the existing balance in the allowance account. Answer: d

16) Wainwright Corporation receives a $3,000, 4-month, 10% note from Fulton Limited as payment of its account receivable. What entry will Wainwright make when it receives the note, assuming interest is paid at maturity and no adjusting entries have previously been made? a) Notes Receivable .......................................... Accounts Receivable—Fulton .............. b) Notes Receivable .......................................... Accounts Receivable—Fulton .............. Interest Revenue .................................... c) Notes Receivable .......................................... Interest Receivable ....................................... Accounts Receivable—Fulton .............. Interest Revenue .................................... d) Notes Receivable .......................................... Accounts Receivable—Fulton ..............

3,100 3,100 3,100 3,000 100 3,000 100 3,000 100 3,000 3,000

Answer: d

17) The maturity value of a 9%, 4-month note receivable is $25,750, and interest is due at maturity. What is the principal (or face value) of the note receivable? a) $25,250 b) $25,563 c) $25,000 d) $27,750 Answer: c

18) An executive of the Lite Way Corporation signed a six-month promissory note for $8,000 bearing interest at 7%. Interest is due at maturity. At the end of the six months, the amount of interest paid would have been a) $280. b) $8,280. c) $560. d) $8,560. Answer: a

19) On the Statement of Financial Position a) Bad Debts Expense is shown as a contra account to Accounts Receivable. b) Accounts Receivable is shown as a contra account to Bad Debts Expense. c) Allowance for Doubtful Accounts is shown as a contra account to Accounts Receivable. d) Accounts Receivable is shown as a contra account to Allowance for Doubtful Accounts. Answer: c

20) Managing accounts receivable involves all of the following except a) establishing a payment period. b) monitoring collection. c) deciding who to extend credit to. d) accelerating payments to suppliers. Answer: d

21) Which of the following is not true regarding the receivables turnover ratio? a) It is used to assess the liquidity of receivables. b) It measures the number of times, on average, receivables are collected during a period. c) It is calculated by dividing the average gross accounts receivable by the net credit sales. d) It has a popular variant called the average collection period. Answer: c

22) Recording bad debt expenses as they become known is a violation of a) full disclosure principle. b) expense recognition. c) the cost model. d) revenue recognition. Answer: b

23) On the Income Statement a) Bad Debts Expense is shown as a contra account to Revenues. b) Bad Debts Expense is included in the gross margin calculation. c) Bad Debt Expense is shown as a separate line item in Operating Expenses.

d) Accounts Receivable is shown as a contra account to Allowance for Doubtful Accounts. Answer: c

24) The total interest on a $10,000, 4%, 9-month note receivable is: a) $150. b) $200. c) $300. d) $250. Answer: c

25) The balances in its Accounts Receivable and Allowance for Doubtful Accounts on December 31, 2015 were $55,000 and $10,000 (Credit) respectively. An aging schedule indicated that $16,000 of the receivables would prove uncollectible. The amount of bad debts expense that had to be recorded was a) $55,000. b) $16,000. c) $6,000. d) $10,000. Answer: c

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 09 Shuffle: No

Question type: True/False

1) Land improvements are not a depreciable asset. Answer: False

2) Amortization is about valuation rather than allocation. Answer: False

3) Carrying amount is always the same as fair value. Answer: False

4) Operating expenditures are expensed as incurred. Answer: True

5) Research costs are an example of intangible assets. Answer: False

6) An asset is always sold for its residual value at the end of the asset's useful life. Answer: False

7) In a lease, the party paying to use the asset is known as the lessee. Answer: True

Question type: Multiple Choice

8) The concept of depreciation is best explained by which accounting principle or assumption? a) cost principle b) going concern assumption c) expense recognition d) economic entity assumption Answer: c

9) All of the following are examples of intangible assets except a) franchises. b) copyrights. c) research costs. d) trademarks. Answer: c

10) Which of the following costs would normally not be included in the cost of equipment? a) insurance for equipment after it has started being used b) installation of equipment c) testing of equipment d) freight paid by buyer to have equipment shipped Answer: a

11) Which of the following is not a factor affecting the calculation of straight-line depreciation? a) useful life b) residual value c) carrying amount d) cost Answer: c

12) AA Shrubs owns machinery for moving and delivering plants to its customers. The recorded cost of the machinery is $38,000. It is estimated that the machinery will be able to move 120,000 plants over its life. The company depreciates the machinery using straight-line depreciation over a useful life of twelve years and an estimated residual value of $2,000. The amount that will be charged annually as depreciation will be

a) $3,167. b) $3,000. c) $3,800. d) $3,600. Answer: b 13) Corrine’s Courier Service recently purchased a new delivery van for $29,000. The van is estimated to have a useful life of 8 years or 250,000 kilometres. The van will have a residual value of $1,000. The company uses the units-of-production method of depreciation. Assuming the van travelled 36,000 km during the first year, what is the depreciation expense for the van in year 1? a) $3,625 b) $3,500 c) $4,032 d) $4,176 Answer: c

14) On September 1, 2018, Dulzura Limited purchased an asset for $9,000, with a $1,500 estimated residual value, and a 4-year useful life. The 2018 depreciation expense using the single diminishing-balance method would be a) $625. b) $750. c) $1,875. d) $2,250. Answer: b

15) The amortization of finite life intangibles is recorded as a) a debit to Cost of Goods Sold and a credit to Accumulated Amortization. b) a credit to Accumulated Amortization and a debit to the Asset account. c) a credit to Accumulated Amortization and a debit to Amortization Expense. d) a debit to Accumulated Amortization and a credit to Amortization Expense. Answer: c

16) When a depreciable asset is sold, the amount of the gain is equal to

a) the asset’s carrying amount. b) the difference between the carrying amount and the proceeds. c) the accumulated depreciation. d) the amount of cash received. Answer: b

17) On April 1, 2018, Cricket Company sold equipment for $11,400 cash. The equipment had originally been purchased at a cost of $24,000 on January 1, 2014. The equipment was expected to have a useful life of 8 years with no residual value. As of January 1, 2018, the equipment had accumulated depreciation of $12,000. The entry to record the sale of the equipment was a) Cash .............................................................. Accumulated Depreciation ........................... Gain on Sale of Machine ....................... Machine ................................................. b) Cash .............................................................. Accumulated Depreciation ........................... Loss on Sale of Machine .............................. Machine ................................................. c) Cash .............................................................. Depreciation Expense ................................... Gain on Sale of Machine ....................... Machine ................................................. d) Cash .............................................................. Loss on Sale of Machine .............................. Machine .................................................

11,400 12,750 150 24,000 11,400 12,000 600 24,000 11,400 750 150 12,000 11,400 600 12,000

Answer: a

18) On January 1, 2018, Moreno Corporation purchased a patent from another company for $190,000. The estimated useful life of the patent is 10 years, and its remaining legal life is 15 years. The Amortization Expense for 2018 is a) $19,000. b) $12,667. c) $85,000. d) $68,000. Answer: a

19) All of the following statements are true, except

a) copyrights extend for the life of the creator plus 10 years. b) a copyright is amortized over its useful life. c) a copyright gives the owner the exclusive right to reproduce and sell an artistic or published work. d) the cost of a copyright consists of the cost of acquiring and defending it. Answer: a

20) The advantages of leasing an asset include all of the following except a) income tax advantages. b) increased risk of obsolescence. c) 100% financing. d) off-balance sheet financing. Answer: b

21) Return on assets is calculated as a) net assets divided by average profit. b) average total assets divided by profit. c) average total profit divided by net assets. d) profit divided by average total assets. Answer: d 22) ABC Inc. typically has a gross profit margin of 25%. The company’s cost of goods sold for the year was $72,000. The company had other expenses (including income tax) of $15,000. Assuming that the company’s average total assets amounted to $50,000 for the year, what was ABC’s return on assets for the year? a) 18 % b) 12% c) 9% d) 20% Answer: a

23) An asset being depreciated using the straight-line method has a residual value of $20,000 and depreciation expense of $25,000 in its second year. What was the original cost of the asset if its useful life was 10 years?

a) $185,000 b) $200,000 c) $250,000 d) $270,000 Answer: d

24) The depreciable amount is a) the original cost less the accumulated depreciation. b) the original cost less the residual value. c) the accumulated depreciation less residual value. d) net present value. Answer: b

25) Dusty Doughnuts Ltd. has an asset with an original cost of $16,000 and a carrying amount today of $4,400. The company no longer needs the asset and has decided to sell it today for $3,000 cash. The journal entry Dusty will use to record the sale includes a) a credit to the Asset account for $4,400. b) a debit to the Asset account for $4,400. c) a debit to Accumulated Depreciation for $11,600. d) none of the above Answer: c

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 10 Shuffle: No

Question type: True/False

1) Sales taxes are an expense to the retailer. Answer: False

2) Employment Insurance Premiums are paid by both the employer and the employee. Answer: True

3) Unearned revenue is a current liability. Answer: True

4) An operating line of credit can result in bank indebtedness being reported as a current liability on the statement of financial position. Answer: True

Question type: Multiple Choice

5) Assume that you borrow $5,000 at an annual interest rate of 5%. Your loan agreement calls for monthly payments of $94, which include both interest and principal. Your first payment is made one month after you received the loan. The amount of interest and principal (rounded to the nearest dollar) applied to your first instalment, respectively, would be a) $21 and $73. b) $21 and $83. c) $250 and $905. d) $250 and $250. Answer: a

6) Which of the following is not a typical current liability? a) sales taxes payable b) bonds payable c) unearned revenue d) income tax payable Answer: b

7) An employee receives a bi-weekly gross salary of $2,000. Income tax is $218, CPP is $99, EI is $36, and union dues are $50. What is the amount of the employee's take home pay (net pay) on a bi-weekly basis? a) $1,597 b) $1,732 c) $1,782 d) $2,000 Answer: a

8) On September 1, Banner Corp. borrowed $70,000 from the City Bank for five months at 9%. Interest is payable at maturity. The entry Banner must make on December 31, its year-end, assuming no prior accruals is a) Interest Expense Notes Payable

6,300

b) Interest Expense Interest Payable

1,575

c) Interest Expense Notes Payable

2,625

d) Interest Expense Interest Payable

2,100

6,300

1,575

2,625

2,100

Answer: d

9) A 9% six-month note for $10,000 was recorded on October 1. What journal entry would be recorded at the year end of December 31 if interest is payable at maturity?

a) Note Payable Interest Payable Interest Expense

900

b) Interest Expense Interest Payable

900

c) Interest Expense Interest Payable

225

d) Interest Expense Notes Payable

450

450 450

900

225

450

Answer: c

10) On September 1, Banner Corp. borrowed $70,000 from the City Bank for five months at 9%. Interest is due at maturity. The company’s year-end is December 31, at which time any outstanding interest was accrued. The entry to record payment of the note and accrued interest on February 1, the due date, is a) Notes Payable Interest Payable Interest Expense Cash

70,000 2,100 525

b) Notes Payable Cash

72,625

c) Notes Payable Interest Payable Cash

70,000 2,625

d) Notes Payable Interest Expense Cash

70,000 2,625

72,625

Answer: a

11) On January 1, 2018, Mars Ltd. issued a 20 year, $950,000 instalment note payable with 6% interest, with monthly fixed principal payments of $3,958, plus interest. The outstanding principal (rounded to the nearest dollar) after the second payment is a) $855,000. b) $942,884.

c) $942,084. d) $950,000. Answer: c

12) Which company reporting the following results could be said to have the best solvency position? a) high debt to total assets, low times interest earned, BBB credit rating. b) high debt to total assets, high times interest earned, D credit rating. c) low debt to total assets, high times interest earned, AAA credit rating. d) low debt to total assets, high times interest earned, significant amount of operating leases. Answer: c

13) At the end of 2017, 123 Inc. had share capital of $120,000 and retained earnings of $140,000, respectively. During 2018, the company reported net income of $60,000 and dividends declared in the amount of $20,000. The company reported a total assets amount of $500,000 at the end of 2018 on its statement of financial position. What was the company’s debt to total assets ratio for 2018? a) 100% b) 40% c) 60% d) 67% Answer: b

14) Which of the following statements is not true? a) The times interest earned ratio gives an indication of a company’s ability to meet interest payments as they come due. b) The times interest earned ratio is calculated by dividing the sum of net income, interest expense, and income tax expense, by interest expense. c) EBIT can be calculated by adding interest expense and income tax expense to net income. d) The higher a company’s debt to total assets ratio, the lower the company’s times interest earned ratio will be. Answer: d

15) Which of the following methods of ordering is normally used to present current liabilities on the statement of financial position?

a) in order of magnitude b) in order of liquidity (due date) c) in alphabetical order d) in order of reverse liquidity Answer: b

16) HST of 13% collected on taxable sales of $1,000 will result in a journal entry that includes a) a debit to Sales Tax Receivable for $130. b) a debit to Sales Tax Payable for $130. c) a credit to Sales for $130. d) a credit to Sales Tax Payable for $130. Answer: d

17) When the bond liability reported on the statement of financial position increases each year, this indicates that the bond was a) issued at face value. b) issued at a discount. c) issued at a premium. d) issued at net realizable value. Answer: b

18) Bonds issued at a premium reduce a) the perceived risk to the bondholder. b) the cost of borrowing. c) the bond value to be shown on the statement of financial position. d) the interest payments to be made to the bondholder. Answer: b

19) Amortizing a bond discount a) decreases bond interest expense. b) increases the carrying amount of the bond. c) has no effect on the bond interest expense. d) decreases the maturity value of the bond.

Answer: b

20) A company issued $100,000 face value of bonds at $80,000 with interest payable annually. The company pays annual interest to its bondholders in the amount of $5,000. The company reported annual interest expense in the first year in the amount of $6,000. What is the company's market rate of interest? a) 5% b) 8% c) 4.2% d) 7.5% Answer: d

21) A 5%, 5-year, $100,000 bond that sells when the market rate of interest is 6% will sell at a) face value. b) a premium. c) a discount. d) future value. Answer: c

22) A $500,000 bond is retired at 97 when the carrying amount of the bond is $490,000. The entry to record the retirement would include a a) $20,000 gain. b) $15,000 loss. c) $5,000 gain. d) $2,000 loss. Answer: c

23) A 4.5%, 5-year, $100,000 bond that sells when the market rate of interest is 4% will sell at a) face value. b) a premium. c) a discount. d) present value. Answer: b

24) A 5.5%, 10-year, $80,000 bond that sells when the market rate of interest is 5.5% will sell at a) face value. b) a premium. c) a discount. d) the redeemable value. Answer: a

25) Amortizing a bond premium a) decreases bond interest expense. b) increases the carrying amount of the bond. c) has no effect on the bond interest expense. d) decreases the maturity value of the bond. Answer: a

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 11 Shuffle: No

Question type: True/False

1) The shareholders of a corporation have unlimited liability. Answer: False 2) The amount the shares sell for represents a corporation’s legal capital. Answer: True

3) Preferred shareholders typically have the right to share in the distribution of dividends before common shareholders. Answer: True 4) Stock dividends increase total shareholders’ equity. Answer: False

5) No journal entry is required on the dividend record date. Answer: True

6) Proprietorships and partnerships both do not pay income taxes as separate entities. Answer: True

Question type: Multiple Choice

7) All of the following can be characteristics of preferred shares except a) dividend preference.

b) liquidation preference. c) voting privileges. d) conversion features. Answer: c

8) Retained earnings represents which of the following? a) cash earned in the business b) reacquired share capital c) contributed capital d) profit retained in the business Answer: d

9) Which of the following is not a characteristic of a corporation? a) separate legal existence b) unlimited liability for shareholders c) easy transferability of ownership interests d) ability to acquire capital easily Answer: b

10) Which of the following is not a disadvantage of the corporate business form? a) additional reporting requirements b) government regulation c) continuous life d) additional legal requirements Answer: c

11) Which of the following statements is not true? a) Most companies have a limited amount of authorized shares. b) The number of shares authorized will always be equal to or higher than the number of shares issued. c) When shares trade on the secondary market, they do not affect the financial position of the company. d) The amount paid for no par value shares is equal to the legal capital.

Answer: a

12) If 1,000 common shares are sold for $4 each, the journal entry to record the issue would include a a) credit to Common Shares for $4,000. b) debit to Investment in Common Shares for $4,000. c) credit to Shares Payable for $4,000. d) debit to Retained Earnings for $4,000. Answer: a

13) If preferred shares are issued for $6,000, the journal entry to record the issue would include a) a debit to Cash for $6,000. b) a credit to Retained Earnings for $6,000. c) a credit to Common Shares for $6,000. d) a debit to Retained Earnings $6,000. Answer: a

14) Which of the following is not a shareholder right? a) the right to share in the company’s assets at liquidation b) the right to share in dividends c) the right to vote in the election of the board of directors d) the right to personally manage the company Answer: d

15) Metallic Steel Ltd. has 1,000,000 common shares authorized and 400,000 shares issued. The shares are currently selling for $9 each. The balance in the retained earnings account is $4,400,000. If the board of directors declares and issues a 20% stock dividend, what would be the balances after the stock dividend in # Shares Issued Retained Earnings a) b) c) d)

1,500,000 480,000 480,000 266,667

Answer: b

$6,200,000 $3,680,000 $6,200,000 $4,400,000

16) Finish Cement Inc. is a publicly-traded company with 800,000 authorized common shares. The company has 100,000 common shares issued. On June 15, 2018, when the fair value of the shares was $4, the company declared and issued a 2-for-1 stock split. What is the journal entry that should be made by the company on June 15, 2018? a) Cash .............................................................. 400,000 Common Shares .................................... 400,000 b) Cash .............................................................. 3,200,000 Common Shares .................................... 3,200,000 c) Stock Split .................................................... 800,000 Common Shares .................................... 800,000 d) No journal entry is necessary. Answer: d

17) Dividends declared and payable are reported in the financial statements as a(n) a) liability. b) expense. c) note. d) equity item. Answer: a

18) Where would accumulated other comprehensive income appear on a publicly-traded company’s financial statements? a) as a separate component of shareholders’ equity on the statement of financial position b) as a non-operating item on the income statement c) in the notes to the financial statements d) Accumulated other comprehensive income does not appear on the financial statements. Answer: a

19) During the year ended December 31, 2018, Saturn Ltd. had net income of $25,000. The company had 15,000 common shares issued for the entire year, along with 1,000 $2 cumulative preferred shares. The company paid the preferred shareholders their annual dividend in 2015 but did not pay any dividend to the common shareholders. Saturn’s earnings per share is a) $1.44 per share. b) $1.53 per share.

c) $1.67 per share. d) $25 per share. Answer: b

20) Which of the following is not a common objective of a company repurchasing its own shares? a) to increase trading of the company’s shares b) to increase the number of shares issued c) to have shares available to meet employee bonus programs d) to aid in eliminating hostile shareholders Answer: b

21) Corporations issue stock dividends in order to a) satisfy shareholders’ dividend expectations by issuing cash. b) increase the marketability of the shares by decreasing the number of shares. c) show that a portion of shareholders’ equity is unavailable for cash dividends. d) increase the market price per share. Answer: c

22) During the year ended December 31, 2018, Proline Corp. reported net income of $5,575, and paid out cash dividends of $775. The average dividend payout ratio for Proline’s industry is 10%. Which of the following is true? a) Proline earns more income than the industry average. b) Proline earns less income than the industry average. c) Proline pays a larger percentage of their income as cash dividends than the industry average. d) Proline pays a smaller percentage of their income as cash dividends than the industry average. Answer: c

23) Which of the following will allow an investor to determine whether a corporation's net income is increasing or decreasing on a per-share basis? a) comprehensive income b) earnings per share c) price-earnings ratio d) dividend payout

Answer: b

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 12 Shuffle: No

Question type: True/False

1) Securities accounted for with the amortized cost model should be adjusted to reflect fluctuations in fair value. Answer: False

2) Only equity securities (normally common shares) can be purchased for the strategic purpose of influencing relationships between companies, and not debt securities. Answer: True

3) There is no requirement to amortize any premium or discount on investments in bonds that are accounted for with the fair value model through profit or loss. Answer: True

4) The determination of whether a held for trading investment is short- or long-term depends on whether the investment can be promptly liquidated. Answer: False

5) One of the factors in considering whether an investor can exercise influence over an investee is whether the common shares held by other shareholders are concentrated or dispersed. Answer: True

6) Strategic investments are made with the purpose of influencing the control of another company’s operations. Answer: True

Question type: Multiple Choice

7) Which of the following statements is correct? a) Securities accounted for with the amortized cost model are normally reported in the current assets section of the statement of financial position. b) Unrealized gains held on held for trading securities are reported as other comprehensive income. c) Accumulated other comprehensive income is reported on the statement of changes in equity and the statement of financial position. d) Accumulated other comprehensive income is reported on the statement of comprehensive income. Answer: c

8) Which of the following would not indicate the existence of significant influence over an investee? a) an ownership interest of more than 20% b) representation on the investee’s board of directors c) the ability to influence the investee’s decision-making d) The investor signed a $20,000 short-term interest-bearing note payable to the investee. The companies do not frequently lend money to one another. Answer: d

9) Which of the following statements pertaining to held for trading investments is correct? a) Both realized and unrealized gains and losses appear on the income statement. b) Unrealized gains and losses appear as other comprehensive income components on the statement of comprehensive income while realized gains and losses securities appear on the income statement. c) Unrealized gains and losses appear on the income statement while realized gains and losses appear as other comprehensive income components on the statement of comprehensive income. d) Both realized and unrealized gains and losses appear as other comprehensive income components on the statement of comprehensive income. Answer: a

10) On October 31, 2018, Black Corp. sold 10,000 common shares that it was holding as a held for trading investment for $50 a share. Black Corp. originally bought the shares for $45 each. The shares were trading at $43 a share on December 31, 2018, White’s fiscal year-end. The entry to record the sale is

a) Cash ................................................................................. Realized Gain on Held for trading Investment ........ Held for trading Investments .................................... b) Cash ................................................................................. Realized Gain on Held for trading Investment ........ Unrealized Loss—(OCI) .......................................... Held for trading Investments .................................... c) Cash ................................................................................. Realized Gain on Held for trading Investment ........ Held for trading Investments .................................... d) Cash ................................................................................. Realized Gain on Held for trading Investment ........ Unrealized Loss—(OCI) .......................................... Held for trading Investments ....................................

500,000 70,000 430,000 500,000 50,000 20,000 430,000 500,000 50,000 450,000 500,000 20,000 50,000 430,000

Answer: a 11) When an investor company owns more than 20% of the investee company’s common shares, the investment is usually accounted using the a) equity method. b) par value method. c) cost model. d) consolidated method. Answer: a

12) When the equity method is used to account for an equity investment in common shares, the receipt of a dividend a) increases the Investment in Associates account. b) decreases the Investment in Associates account. c) increases the Investment Income account. d) decreases the Investment Income account. Answer: b

13) A company that holds less than 10% of the common shares of another company would account for the receipt of a dividend by recording a) a debit to Held for trading Investments. b) a debit to Dividend Revenue.

c) a credit to Dividend Revenue. d) a credit to Realized Loss on Sale of Held for trading Investments. Answer: c

14) Which of the following statements is true? a) Investments accounted for with the fair value through profit or loss model can be classified as current assets. b) No distinction is usually made between debt and equity securities for financial reporting purposes. c) Investments accounted for using the amortized cost model would usually be classified as longterm assets. d) All of the above statements are correct. Answer: d

15) Accumulated other comprehensive income is reported on which of the following statements? a) Income statement b) Statement of financial position c) Statement of changes in equity d) Both b) and c) Answer: d

16) Combe Corp. which reports under IFRS purchased 65% of the common shares of Leeway Inc. Combe will account for this investment using a) consolidated financial statements. b) the equity method. c) the cost model. d) the fair value through profit or loss model. Answer: a

17) When a company reporting under IFRS owns more than 50% of the common shares of another company, which of the following statements is not true? a) The company that owns the shares is known as the parent company. b) The company whose shares are owned is called the subsidiary company. c) The subsidiary has a controlling interest in the parent company.

d) Consolidated financial statements are prepared for financial reporting purposes. Answer: c

18) In recording a bond for an investor and an investee, the recording of interest and amortization of a bond discount would affect which accounts? a) Interest Revenue for the investor and Interest Expense for the investee b) Interest Expense for the investor and Interest Revenue for the investee c) Held for trading Investment for the investee and Bonds Payable for the investor d) Realized Gain for the investor and Realized Loss for the investee Answer: a

19) Which of the following statements pertaining to consolidated financial statements under IFRS is correct? a) When consolidated financial statements are prepared, the parent company need not prepare its own set of unconsolidated financial statements. b) When consolidated financial statements are prepared, the subsidiary company(ies) need not prepare its(their) own set of financial statements. c) The preparation of consolidated financial statements is required in addition to the financial statements of the parent company and its subsidiaries when a controlling interest exists. d) Publicly-traded companies are not required to prepare consolidated financial statements. Answer: c 20) On January 1, 2018, Karl Corporation acquires $100,000 of Castle Corporation’s 10-year, 6percent bonds for $98,000. Karl Corporation classifies the investment as long-term investment because it intends to hold it until maturity. The entry to record the acquisition of this investment is a) Long-term Investment ..................................................... Cash .......................................................................... b) Long-term Investment ..................................................... Unrealized Gain on Long-term Investment.............. Cash .......................................................................... c) Long-term Investment ..................................................... Cash .......................................................................... d) Long-term Investment ..................................................... Cash .......................................................................... Interest Revenue .......................................................

100,000 100,000 100,000 2,000 98,000 98,000 98,000 106,000 100,000 6,000

Answer: c

21) When a security accounted for with the fair value model through profit or loss is sold, all of the following components of a journal entry are possible, except a) a credit to the Held for trading Investments account. b) a debit to Realized Loss on Held for trading Investments. c) a credit to Realized Gain on Held forTrading Investments. d) a credit to Cash. Answer: d 22) The investor’s ownership interest in the investee’s common shares determines a) the accounting method to apply to equity investments. b) the presumed influence to apply the correct accounting guidelines. c) control planning. d) the amount of income tax to pay. Answer: b

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 13 Shuffle: No

Question type: True/False

1) The statement of cash flows classifies cash receipts and payments into four activity categories. Answer: False

2) Noncash activities are a part of the body of the statement of cash flows. Answer: False

3) Under the indirect method, noncash expenses and losses are added to net income to determine cash provided (used) by operating activities. Answer: True

4) Conversion of bonds to common shares is an example of a noncash activity. Answer: True

5) Cash receipts from customers, under the direct method, are equal to sales plus the increase in accounts receivable. Answer: False

6) Dividends declared always represent a cash payment in the period. Answer: False

7) Revenues always represent a cash receipt in the period. Answer: False

Question type: Multiple Choice

8) Land purchased through the issue of common shares should be disclosed on the statement of cash flows as a(n) a) operating activity. b) financing activity. c) investing activity. d) noncash investing and financing activity. Answer: d

9) The differences in the indirect method and the direct method of the statement of cash flows are evident in which section? a) Operating activities b) Investing activities c) Financing activities d) Cash reconciliation section Answer: a

10) Short-term highly liquid investments that are readily convertible to cash within a very short period of time are known as a) accounts payable. b) current assets. c) cash equivalents. d) current liabilities. Answer: c

11) The information in a current statement of cash flows should help investors, lenders, and other creditors evaluate a) the company’s ability to generate past cash flows. b) the company’s ability to collect dividends and pay obligations. c) the reasons for the difference between net liabilities and net cash provided or used by operating activities. d) the investing and financing transactions during the period. Answer: d

12) The primary purpose of a statement of cash flows is a) to report on the sources of cash during a period. b) to report on the uses of cash during a period. c) to report on the change in the cash balance during the period. d) all of the above Answer: d

13) Which of the following statements regarding the statement of cash flows is not true? a) The statement of cash flows covers the same period of time as the income statement. b) The operating activities section always appears first. c) The net increase or decrease in cash for the period is added or subtracted from the end-ofperiod cash balance to obtain the beginning-of-period cash balance. d) The cash receipt from the issue of debt securities is reported separately from the cash payment for the retirement of debt. Answer: c

14) Which of the following would be classified as an operating activity by a private company following ASPE? a) payment of a cash dividend b) sale of equipment c) making a loan to another company d) payment of interest Answer: d

15) Which of the following is not an operating activity for a company? a) payment of accounts payable b) purchase of a trading investment c) payment of a bank loan d) collection of accounts receivable Answer: c

16) Under the indirect method of preparing the operating activities section of a statement of cash flows, an increase in accounts payable is

a) added to cost of goods sold. b) deducted from cost of goods sold. c) added to net income. d) deducted from net income. Answer: c

17) Under the indirect method of preparing the statement of cash flows, which of the following is added to profit in the operating activities section? a) gain on sale of equipment b) depreciation expense c) increase in accounts receivable d) decrease in accounts payable Answer: b

18) Which of the following would not appear on the statement of cash flows prepared under the direct method? a) collection of accounts receivable b) sale of equipment c) gain on sale of land d) issue of common shares Answer: c

19) In what phase of the corporate life cycle do you expect to see positive cash flows from operating activities? a) introductory b) growth c) maturity d) decline Answer: c

20) Free cash flow is defined as cash provided (used) by operating activities minus net capital expenditures minus a) profit.

b) debt repayments. c) dividends. d) retained earnings. Answer: c

21) A summary of the statement of cash flows for Fernando, Inc. for the years ended December 31 appears below: FERNANDO, INC. Statement of Cash Flows Years Ended December 31 2018 2017 Net cash provided by operating activities $250,000 $320,000 Net cash used by investing activities (80,000) (60,000) Net cash used by financing activities (30,000) (10,000) Net increase (decrease) in cash 140,000 250,000 Cash, January 1 270,000 20,000 Cash, December 31 $410,000 $270,000 Additional information: Net capital expenditures Dividends paid What is the free cash flow for 2018?

$100,000 $30,000

$50,000 $25,000

a) $120,000 b) $150,000 c) $220,000 d) $280,000 Answer: a

22) Free cash flows are defined as cash provided (used) by operating activities minus dividends paid minus a) net income b) debt repayments c) net capital expenditures d) retained earnings Answer: c

23) Which of the following is an operating activity?

a) issue of shares for cash b) purchase of intangible assets for cash c) cash receipts from customers d) sale of long-term investment Answer: c

24) Thread & Beads Ltd. has sales revenue in 2018 of $1,700,000. Accounts receivable were $180,000 on January 1, 2015 and $150,000 on December 31, 2018. During 2018, cash receipts from customers were a) $1,730,000. b) $1,700,000. c) $1,670,000. d) cannot be determined from the information provided (need to know the total sales on account). Answer: a

25) A building that is purchased with a long-term mortgage should be disclosed on the statement of cash flows as a(n) a) operating activity. b) financing activity. c) investing activity. d) noncash investing and financing activity. Answer: d

Package Title: Clicker Questions Course Title: Kimmel, Financial Accounting, Seventh Canadian Edition Chapter Number: 14 Shuffle: No

Question type: True/False

1) Sustainable income is equal to actual net income. Answer: False

2) Horizontal analysis is a technique for evaluating several companies over time. Answer: False

3) Vertical analysis is a technique for evaluating financial statement data by expressing each item in a financial statement as a percent of a total (base) amount. Answer: True

4) The usefulness of financial analysis can be limited by the use of alternative accounting policies. Answer: True 5) Solvency ratios measure a company’s ability to pay its currently maturing obligations. Answer: False 6) Financial ratios are used to evaluate the accuracy of a company’s financial statements. Answer: False 7) Taking out a bank loan, while holding profit constant, will generally make a company’s times interest earned ratio decrease. Answer: True

Question type: Multiple Choice

8) Solvency is of most interest to a) short-term lenders and creditors. b) customers. c) competitors. d) long-term lenders and creditors. Answer: d

9) The ratio that is calculated by dividing cash dividends by profit is called the a) dividend yield ratio. b) earnings per share ratio. c) price-earnings ratio. d) payout ratio. Answer: d

10) When the disposal of a significant business component occurs, the income statement should report the income (or loss) from this event as a) other revenue or expense. b) cost of goods sold. c) discontinued operations, before income tax. d) discontinued operations, net of income tax. Answer: d

11) Which of the following statements apply to discontinued operations? 1. The operations and cash flows have been (or will be) eliminated from the ongoing operations of the company as a result of the disposal transaction. 2. The company will have no continuing involvement after the disposal transaction. 3. Assets that are held for sale as discontinued operations are valued and reported on the Statement of Financial Position at the lower of their carrying amount and fair value (less any anticipated costs of selling). a) 1 and 2 b) 1 and 3 c) 2 and 3

d) all of the above Answer: d

12) Assume the following cost of goods sold data for a company: 2021 $2,000,000 2020 1,500,000 2019 1,200,000 2018 900,000 If 2018 is the base year, what is the percentage of the base-year amount for cost of goods sold in 2021? a) 22% b) 122% c) 222% d) 5% Answer: c

13) Horizontal analysis is also called a) vertical analysis. b) trend analysis. c) ratio analysis. d) intracompany analysis. Answer: b

14) The percent increase or decrease of liabilities of the current year compared to those of the previous year is an example of a) percentage analysis. b) horizontal analysis. c) vertical analysis. d) ratio analysis. Answer: b

15) Given the following data for a company: Current liabilities Non-current liabilities Common shares

$ 360 480 640

Retained earnings 520 Total liabilities and shareholders’ equity $2,000 What is the percentage of common shares found in a vertical analysis of the Statement of Financial Position? a) 75.0% b) 55.1% c) 32.0% d) Cannot be determined from the data given. Answer: c

16) Which of the following is a technique for evaluating financial statement data that expresses each item as a percentage of a total (base) amount? a) horizontal analysis b) diagonal analysis c) ratio analysis d) vertical analysis Answer: d

17) When the dollar amount of non-current assets is calculated as a percentage of the total assets, this is an example of a) percentage analysis. b) horizontal analysis. c) vertical analysis. d) ratio analysis. Answer: c

18) The following information is available for Farley Corporation: 2018 2017 Accounts receivable $ 360,000 $ 400,000 Inventory 280,000 320,000 Net credit sales 3,000,000 1,400,000 Cost of goods sold 1,200,000 1,060,000 Net Income 300,000 170,000 The receivables turnover ratio for 2018 is a) 8.3 times. b) 3.9 times.

c) 7.9 times. d) 10.0 times. Answer: c

19) The following information is available for Farley Corporation: 2018 2017 Accounts receivable $ 360,000 $ 400,000 Inventory 280,000 320,000 Net credit sales 3,000,000 1,400,000 Cost of goods sold 1,200,000 1,060,000 Net Income 300,000 170,000 The inventory turnover ratio for 2018 is a) 4.3 times. b) 4.0 times. c) 2.0 times. d) 2.4 times. Answer: b

20) The following amounts were taken from the financial statements of Friendly Corporation: 2018 2017 Current liabilities $ 280,000 $ 220,000 Non-current liabilities 800,000 600,000 Interest expense 100,000 50,000 Income tax expense 120,000 58,000 Net Income 300,000 170,000 Net cash provided by operating activities 480,000 270,000 The times interest earned ratio for 2018 is a) 3.0 times. b) 4.8 times. c) 4.0 times. d) 5.2 times. Answer: d

21) Including segmented information in financial statements addresses which of the following weaknesses of financial analysis? a) use of professional judgment b) use of alternative accounting policies

c) diversification of companies d) not adjusting financial statements for inflation Answer: c 22) The return on common shareholders’ equity, a widely used measure of profitability from the common shareholders’ viewpoint, is calculated by a) dividing profit by average total assets. b) dividing profit by sales. c) dividing profit available to common shareholders by the weighted average number of common shares. d) dividing profit available to common shareholders by average common shareholders’ equity. Answer: d 23) Which of the following would never affect a company’s profit margin? a) profit b) gross sales c) dividends declared d) sales returns and allowances Answer: c

24) Users of financial information are interested in the earning power of a company without irregular items. One type of irregular item reported in the income statement is a) sales returns. b) dividend income. c) discontinued operations. d) interest income. Answer: c

25) Which of the following is a technique for evaluating financial statement data across companies of different sizes? a) horizontal analysis b) diagonal analysis c) ratio analysis d) time-series analysis

Answer: c