SOLUTIONS MANUAL for Understanding Financial Accounting, 3rd Canadian Edition, by Christopher D. Bur by StudyGuide

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT 1. 2. 3. 4. 5. 1. 2. 3. 1. 1. 2. 1. 2. 1.

Discussion Questions 1 K 6. 2 C 11. 5 C 16. 4 C 21. 5 3 K 7. 2 C 12. 4 C 17. 4 C 22. 5 3 C 8. 2 C 13. 4 C 18. 5 C 23 5 3 C 9. 2 C 14. 4 C 19. 5 C 2 C 10. 4 C 15. 4 C 20. 5 C Application Problems 4 C 4. 5 C 7. 5 AP 10. 5 AP 13. 5 4 C 5. 5 AP 8. 5 AP 11. 5 AP 14. 5 4 AP 6. 5 AP 9. 5 AP 12. 5 AP 15. 5 User Perspective Problems 2 C 2. 2 C 3. 3 C 4. 2 C 5. 2 Work in Process 5 C 3. 5 C 5. 5 C 5 C 4. 5 C 6. 5 C Reading and Interpreting Published Financial Statements 5 AN 3. 5 AN 5. 2,5 C 5 AN 4. 5 AN 6. 5 AN Cases 2 C

C C C

AP AP AP C

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Learning objective Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty E Easy M Medium H Hard Estimated time to complete in minutes Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Tech. Technology Diversity Diversity Reflec. Thinking Reflective Thinking CPA Canada Competency Map Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ1-1

Accounting, as an information system, provides economic information to users to allow them to determine whether the entity is operating effectively and efficiently. In addition, accounting facilitates the making of important decisions in the management of the entity, such as whether new assets should be purchased or leased, or whether equity financing should be used as opposed to debt financing. LO 1 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-2

The owner’s legal liability is as follows for each form of business: Proprietorship: The owner (or proprietor) is responsible for the debts of the business. His or her personal assets are at risk in the event of legal action. Partnership: The owners (or partners) are responsible for the debts of the business. Their personal assets are at risk in event of legal action. Corporation: The owners (or shareholders) are only responsible for the debts of the corporation to the extent of their investment in the company’s shares. Any debts in excess of this amount are not their responsibility. The taxation of income is as follows for each form of business: Proprietorship: The income of a proprietorship is taxed in the hands of the owner (i.e. the proprietor). Partnership: The income of a partnership is taxed in the hands of the owners (i.e. the partners). Corporation: The income of a corporation is taxed separately (i.e. the corporation files its own tax return). Any income distributed to the shareholders (i.e. dividends) is then taxed in the hands of the owners (i.e. the shareholders). LO 3 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ 1-3

If an entrepreneur has a relatively simple business with low liability risk, it may be better to operate the business as a proprietorship. If the entrepreneur is not looking to borrow any money he or she will not assume the personal risk. Proprietorships are easy to form and do not have any organizational costs. If the entrepreneur has no intention of expanding the business or selling the business, a proprietorship makes sense. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-4

A private corporation is one whose shares are held by a small number of individuals. This makes the transfer of ownership more difficult, as the shares do not trade on a public stock exchange. A public corporation has shares held by a larger number of individuals or entities and these shares are bought and sold on a public stock exchange (such as the Toronto Stock Exchange). LO 3 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-5

Public companies have their shares traded on a public stock exchange. The federal and provincial governments have regulations related to how public companies report their financial statements and are interested in ensuring that these regulations are followed. The stock exchanges also have regulations about the timing and format of information that companies must convey to them and to investors. LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-6

Shareholders – These users are interested in the performance of their investment in the company. They will use the financial statements to evaluate how well management is handling their investment. Individual shareholders may also use the financial statements in assessing whether to continue to hold the shares, purchases more or sell the shares they have. Creditors (i.e. Financial Institutions) – These users are interested in evaluating the company to decide whether to lend money to it. They will use the statements to evaluate the risk that will be taken in making the loan. This includes assessing the company’s ability to service the debt (i.e. pay interest and repay principal).

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ1-6 (Continued) Taxing Authorities – These users establish the rules for how taxable income will be measured. They are interested in the fair measurement of the financial performance of the company so that the appropriate tax will be paid. Note, however, that income taxes are not paid based on the net earnings reported in the financial statements; rather, income taxes are based on taxable income. In preparing the tax return, the financial statements’ net income is the starting point and is then adjusted to arrive at taxable income. Financial Analysts – These users provide investment advice to their customers. They are interested in evaluating the investment potential of various companies. They will want to evaluate not only individual companies, but also make comparisons between companies, likely in the same industry. (Note: there are other users discussed in the chapter that would be equally acceptable answers to this question.) LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-7

Shareholders invest in the shares of a company. They may expect to receive dividends, which are a distribution of past profits to shareholders. They also expect to eventually sell their shares at a higher price than they paid for them, due to capital appreciation. LO 2 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-8

Capital appreciation is an increase in the market value of the shares of a company. Investors realize this type of return by purchasing shares in a company, and then later selling the shares at a higher market price than they had originally paid. Capital appreciation often results from a company’s growth (i.e. increased revenues and increased profits). LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ 1-9

When creditors loan money to a company, they expect to receive their money back. That is one cash stream, called return of principal. The other cash stream is periodic interest that creditors receive for time they have allowed the company to use their money. LO 2 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-10

The three major types of activities in which all companies engage are financing, investing, and operating activities. Financing refers to the activity of obtaining funds for the company to operate. Two primary sources of funds are owners and creditors. Some typical financing activities are: short- and long-term borrowing, repayment of debt, dividend payments, and the issuance of additional shares. Investing refers to the activity of using funds generated by financing activities to acquire assets that will generate profits in the future. Investments include the purchase of property, plant, and equipment and the purchase and sale of investments in other companies. Operating activities are associated with developing, producing, marketing, and selling the products and/or services of the company. Operating activities are mainly concerned with the day-to-day activities of the company.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-11

The three major categories of items that appear in a typical statement of financial position (balance sheet) are assets, liabilities, and shareholders’ equity.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ1-11 (Continued) Assets are resources owned by a company that will be used or sold for its the future economic benefit. In order to have an asset, the event that gave the company the control of the resource must have already happened. The company is able to perform its activities and thereby generate profits with the help of its assets. This means that they are income earning. Assets may be current or non-current. Current assets will be used or converted into cash within the next year or operating cycle. Examples include cash, inventory, and accounts receivable. Noncurrent assets are those assets whose benefits may be realized over a period longer than one year or operating cycle. Examples include property, plant, and equipment, patents, trademarks, etc. Liabilities are the amounts that the company owes to others and which require a probable future outflow or sacrifice of resources to settle an obligation that exists as a result of a transaction that has already taken place. Liabilities may be classified as current and non-current. Current liabilities include notes payable due within one year, accounts payable, accrued expenses, and dividends payable. Non-current liabilities include long-term debt, long-term warranties payable, and pension liabilities. Shareholders’ Equity represents the wealth or the ownership interest of the owners. Shareholders’ equity may also be defined as the difference between the assets and liabilities of a company: Shareholders’ Equity = Assets – Liabilities There are two major shareholders’ equity accounts: share capital and retained earnings. Share capital represents the amount that investors originally paid for the shares that the company issued. Retained earnings consist of the cumulative earnings of the company less the dividends distributed to shareholders. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ 1-12 Operating activities relate to the day-to-day activities of a company. This includes generating revenues and incurring expenses, which are the most crucial activities in relation to the long-term sustainability of a company. Investing activities occur on a more sporadic basis and include the purchase or disposal of property, plant, and equipment as well as the purchase and resale of shares in other companies. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ 1-13 Operating activities relate to the day-to-day activities of a company. This includes generating revenue and incurring expenses, which are the most crucial to the long-term sustainability of a company. Financing activities are those actions taken by a company to obtain the funding necessary to purchase assets such as buildings and equipment and investments. Financing activities also include the repayment of loan principal and payment of dividends. Financing activities are required in order to start a business. Without financing, most businesses would not be able to begin to engage in operating activities. Financing needs generally continue throughout the life of a company as it grows and expands. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-14

Costs relating to hiring and training a company’s employees are considered an operating activity. The employees will perform and maintain operations so all costs related to them will be operating activities. Investing activities are related to the purchase or sale of property, plant, and equipment and shares in other companies. LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-15

We would normally expect a company to have an overall inflow of cash from its operating activities. Unless a company is successful at generating positive cash inflows from its operations, it will ultimately run out of cash. Financing sources will dry up because the company will be unable to attract new investors or lenders. Eventually it will have to sell the property, plant, and equipment it uses to generate revenue. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ1-16

We would normally expect a company to have an overall cash outflow from its investing activities. These activities include the purchase of property, plant, and equipment that are purchased to generate operating revenue. Cash inflows from investing activities require the sale of investments or property, plant and equipment. Companies that are financially healthy and growing typically spend more cash on acquiring new assets than the proceeds they generate from selling the property, plant and equipment they have finished using. LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-17

The statement of income describes the results of the operating activities from the beginning of the current period to its end. Net income is defined as revenues less expenses. Revenues are cash or resources that flow into the company from operating activities. Expenses are cash or resources that flow out of company from operating activities. Investing and financing activities are typically depicted on statement of financial position. LO 4 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-18

The purpose of the statement of income is to measure the company’s performance by the results of its operating activities for a month, a quarter, or a year. The sum of these operating activities is known as the company’s profit, which is revenue less expenses. The purpose of a statement of cash flows is to present the cash related to the three categories of business activities and its objective is to enable financial statement users to assess the company’s inflows and outflows relative to each of these activities. The statement of income allows users to assess how well management has operated its business and if it is profitable where as the statement of cash flows allows users to assess how well management has managed its cash and whether they will have enough cash in the future to run the business effectively. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ 1-19

The statement of changes in equity provides details on how each component of shareholders’ equity changed during the period. Retained earnings, a component of shareholders’ equity, changes each period by the net income reported on the statement of income, less any dividends that were declared by the board of directors during the period. As a result, the statement of income must be prepared first.

LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-20

The accounting equation is Assets = Liabilities + Shareholders’ Equity. Shareholders’ Equity does represent the interests of the owners or residual value left in the business after the external claims or liabilities have been paid. This is supported by the reorganization of the accounting equation: Shareholders’ Equity = Assets – Liabilities. LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-21

The four main financial statements contained in all annual reports are the statement of income, the statement of changes in equity, the statement of financial position, and the statement of cash flows. Statement of Income: The statement of income records the inflow of revenues and gains and the outflow of expenses and losses over the year (or specified period). The statement helps investors evaluate the performance of the company during the period and it is useful in forecasting the future results of the company. Statement of Changes in Equity: The statement of changes in equity provides details on how each component of shareholders’ equity changed during the period. This includes any changes in share capital, and any income generated by the company less amounts distributed to shareholders as dividends. Statement of Financial Position: The statement of financial position gives the financial status of the company at a particular point in time. Since it presents the details of assets, liabilities, and shareholders’ equity, it gives users a fair idea of the riskiness of the mix of assets and liabilities of the company.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ1-21 (Continued) Statement of Cash Flows: This statement measures the inflow and outflow of cash during a specific period of time. It is very useful in measuring the performance of the company as well as predicting future cash flows since it gives details about the inflow and outflow of cash broken down into operating, investing, and financing activities. It explains the change in cash between the beginning and the end of the period. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-22

The notes to the financial statements provide more detailed information on items in the financial statements and are cross-referenced. The first, second or sometimes third note to the financial statements often discusses the Summary of Significant Accounting Policies, which describes the choices made by management from among the possible choices and judgments acceptable under accounting standards. The notes help keep the financial statements free of excessive detail, while providing meaningful information to financial statement users. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ1-23

The management discussion and analysis (MD&A) section of the annual report provides an overview of the previous year, a discussion of the risks facing the company, and some information about business plans for the future. Many companies use this part of the report to make more extensive, detailed comments on the company and its operating results. Often the information is presented from the company's perspective. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP1-1A

Examples of Canadian Tire’s financing transactions: 1. Share issuance to raise capital for purchasing property, plant & equipment 2. Issuance of long-term debt to raise capital Examples of Canadian Tire’s investing transactions: 1. Purchase of buildings to house their retail stores 2. Purchase of shelving racks and other displays Examples of Canadian Tire’s operating transactions: 1. Purchase of inventory from suppliers 2. Sale of goods and services

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-2A

Examples of Bank of Nova Scotia’s financing transactions: 1. Issuance of shares to investors to raise capital to lend money to customers 2. Issuance of long-term debt to raise necessary capital to have funds available to lend money (provide mortgages and loans) to customers Examples of Bank of Nova Scotia's investing transactions: 1. Purchase of buildings and equipment for in branch operations 2. Purchase of information technology equipment and software to maintain the banking transactions and provide online access for customers Examples of Bank of Nova Scotia's operating transactions: 1. Sale of services (interest revenue, service charges, etc.) to customers 2. Payment of wages to employees

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-3A a. I b. F c. O d. O e. O f. I g. O h. I LO 4 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-4A a. Sales revenue is found on the statement of income and represents the amounts charged to customers for the sale of goods and services. b. Accounts receivable appears on the statement of financial position and represents claims to cash, for the sale of goods and services, that have not yet been collected from the customer. Accounts receivable represents an asset of the company. c. The connection between these two accounts is that accounts receivable are created when sales have been made on credit. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-5A a. CL b. CA c. CL d. CA e. SCF f. SI g. SCE h. NCA i. NCL and SCF j. CL k. SC LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-6A a. NCA b. SI c. SCF d. SI e. RE and SCE f. SI g. SCE and SCF h. SCF i. SI j. NCA k. SCE and SCF LO 5 BT: AP Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-7A a. SFP b. SFP c. SFP d. SI e. SI f. N g. SI h. N i. N j. SFP LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-8A a. SFP b. N c. SFP d. SI e. SFP f. SFP g. SI h. N i. SI j. SI LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-9A Current Assets Non-current Assets Total Assets Current Liabilities Non-current Liabilities Shareholders’ Equity Total Liabilities and Shareholders’ Equity

A $570,0001 780,000 1,350,0004 375,000 337,0006 638,000 1,350,000

B $600,000 735,0002 1,335,000 345,000 330,000 660,0008 1,335,00010

C D $180,000 $990,000 390,000 660,0003 570,0005 1,650,000 135,000 390,000 105,0007 225,000 330,000 1,035,0009 570,00011 1,650,00012

$1,350,000 - $780,000 = $570,000 $1,335,000 - $600,000 = $735,000 3 $1,650,000 - $990,000 = $660,000 4 $1,350,000 = Total Liabilities and Shareholders’ Equity 5 $180,000 + $390,000 = $570,000 6 $1,350,000 - $638,000 -$375,000 = $337,000 7 $570,0005 - $330,000 -$135,000 = $105,000 8 $1,335,00010 (total assets) - $345,000 - $330,000 = $660,000 9 $1,650,00012 (total assets) - $390,000 - $225,000 = $1,035,000 10 $1,335,000 = Total Assets 11 $570,0005 = Total Assets 12 $1,650,000 = Total Assets 2

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: : Analytic CPA: cpa-t001 CM: Reporting

AP1-10A A Retained Earnings Dec. 31, 2023 Net Earnings Dividends declared and paid Retained Earnings Dec. 31, 2024

$100,000 40,000

$420,000 $1,475,0001 $930,000 160,0002 550,000 290,000

10,000

50,000

130,0004

530,000

225,000

140,0003

1,800,000 1,080,000

$1,800,000 - $550,000 + $225,000 = $1,475,000 $530,000 - $420,000 + $50,000 = $160,000 3 $930,000 + $290,000 - $1,080,000 = $140,000 4 $100,000 + $40,000 - $10,000 = $130,000 2

LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-11A A ($862,000 - $194,000) = $668,000 D ($300,000 - $100,000) = $200,000 B ($686,000 + $200,000 + $428,000) = $1,314,000 C ($3,426,000 - $815,000 - $300,000) = $2,311,000 LO 5 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-12A a.

Easy Peasy Ltd. Statement of Income For the month of January 31, 2xxx Service revenue Wages expense Advertising expense Operating expenses Supplies expense Utilities expense Total expenses Net income

$ 237,570 $ 35,791 10,000 6,450 16,465 1,465 70,171 $167,399

b. Other costs Friedrich might have incurred in January that were not listed above include: 1. Depreciation expense of vehicles 2. Income tax expenses 3. Interest expense on any outstanding loans 4. Insurance expense 5. Other employee benefit costs such as employer portion of CPP and EI LO 5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-13A a.

Call of the Wild Ltd. Statement of Income For the month of July, 2xxx Service revenue Wages expense Advertising expense Supplies expense Operating expenses Utilities expense Total expenses Net income

$ 171,430 $ 49,860 14,610 25,629 3,460 1,532 95,091 $ 76,339

b. Other costs Michelle might have incurred in July that were not listed above include: 1. Depreciation expense of tents and rafting equipment 2. Income tax expenses 3. Interest expense on any outstanding loans 4. Insurance expense 5. Other employee benefit costs such as employer portion of CPP and EI LO 5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-14A a.

Item Loan owed to bank Common shares Vehicles Ski equipment Amount prepaid by customers for February trips Retained earnings Prepaid Accommodations Cash in bank accounts

Classification Liability Shareholders’ equity Asset Asset Liability Shareholders’ equity Asset Asset

Easy Peasy Ltd. Statement of Financial Position January 31, 2xxx Cash $ 75,000 Prepaids 60,000 Ski equipment 22,000 Vehicles 65,000 Total Assets $222,000

Deferred revenue Bank loan payable Common shares Retained earnings Total Liabilities and Shareholders’ Equity

$ 95,000 60,000 41,000 26,000 $222,000

Inventory refers to products that have been purchased for resale to customers. Friedrich’s business does not have any products for resale to customers, but instead it provides a service, ski lessons and excursions. Thus, the real product is not inventory but a service.

Friedrich’s business does not produce a product for which customers would be extended credit. Friedrich would want his customers to pay in advance. Unlike a car dealership where the company can repossess the car if the customer does not pay, it would not be possible for Friedrich to repossess a skiing excursion once it is complete. Furthermore, the cost for the service is likely not too high for customers to pay right away. Thus, Friedrich’s business is not likely to have an accounts receivable account. If Friedrich provided skiing excursions to a company for several people, it is possible that he would invoice the customer and allow them to pay after the event. In this case, Friedrich would have an account receivable. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-15A a.

Item Loan owed to bank Supplies on hand Cash in bank accounts Common shares Cost of tents and rafts Retained earnings Amount prepaid by customers for August trips Vehicles

Classification Liability Asset Asset Shareholders’ equity Asset Shareholders’ equity Liability Asset

Call of the Wild Ltd. Statement of Financial Position As at July 31, 2xxx Cash Supplies

$33,670 13,420

Deferred revenue Bank loan payable

$19,140 24,000

Equipment Vehicles

34,100 38,400 $ 119,590

Common shares Retained earnings

20,000 56,450 $ 119,590

Inventory refers to products that have been purchased for resale to customers. Michelle’s business does not have any products for resale to customers, but instead it provides a service, rafting excursions. Thus, the real product is not inventory but a service.

Michelle’s business does not produce a product for which customers would be extended credit. Michelle would want her customers to pay in advance. Unlike a car dealership where the company can repossess the car if the customer does not pay, it would not be possible for Michelle to repossess a rafting excursion once it is complete. Furthermore, the cost for the service is likely not too high for customers to pay right away. Thus, Michelle’s business is not likely to have an accounts receivable account. If Michelle provided rafting excursions to a company for several people, it is possible that she would invoice the customer and allow them to pay after the event. In this case, Michelle would have an account receivable. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-1B

Examples of Aritzia Inc.’s financing transactions: 1. Issuance of shares to investors to raise capital for the purchasing of property, plant and equipment 2. Issuance of long-term debt to raise necessary capital to build new stores or invest in new retail technologies (such as online shopping) Examples of Aritzia Inc.’s investing transactions: 1. Purchase of buildings and equipment for retail operations 2. Purchase of building and vehicles for a distribution network to move inventory between warehouses and retail stores Examples of Aritzia Inc.’s operating transactions: 1. Sale of retail inventory to customers 2. Payment of wages to employees

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-2B

Examples of Telus Corporation’s financing transactions: 1. Issuance of shares to investors to raise capital for the purchasing of property, plant and equipment and research and development. 2. Issuance of long-term debt to raise necessary capital invest in new technologies (such as wifi calling and hot spots) Examples of Telus Corporation’s investing transactions: 1. Purchase of equipment for manufacturing operations 2. Selling of equipment used for manufacturing operations. Examples of Telus Corporation’s operating transactions: 1. Sale of inventory to customers 2. Payment of wages to employees

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-3B a. I b. I c. O d. F e. O f. I g. F LO 4 BT: AP Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-4B a. Wages payable is found on the statement of financial position and represents the amount that the company owes to the employees for time worked but not yet paid to the employees. b. Wages expense is found on the on the statement of income and represents the amount of wages incurred (earned by the employees) during the period, whether paid or unpaid. Wages payable represents a liability of the company and wages expense represents a use of the resources of the company. c. The connection between these two accounts is that wages payable is created from wages expense for time that has been worked by the employees but has not yet been paid. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-5B a. CL b. CA c. SI d. SCF e. CA f. SI and SCE g. SCF h. SCF i. SI j. SI k. SCE and SCF LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-6B a. NCA b. SI c. SCF d. CA e. CL and SCE f. SI g. CL h. SI i. SI j. CL and SCE k. SI LO 5 BT: AP Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-7B a. SFP b. SI c. SFP d. SFP e. SI f. SI g. N h. SFP i. SI j. SFP LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-8B a. SFP b. SI c. N d. SFP e. SI f. SFP g. SFP h. SFP i. SI j. SFP LO 5 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-9B A B Current Assets $ 650,000 $420,0001 Non-current Assets 1,150,0002 380,000 Total Assets 1,800,000 800,0004 Current Liabilities 750,000 170,000 Non-current Liab. 500,000 205,0006 Shareholders’ Equity 550,0008 425,000 Total Liabilities and Shareholders’ Equity 1,800,00010 800,000

C D $150,000 $ 320,000 210,0003 760,000 360,000 1,080,0005 50,000 410,000 120,000 270,0007 190,0009 400,000 360,00011 1,080,00012

$800,0004 - $380,000 = $420,000 2 $1,800,000 - $650,000 = $1,150,000 3 $360,000 - $150,000 = $210,000 4 $800,000 = Total Liabilities and Shareholders’ Equity 5 $320,000 + $760,000 = $1,080,000 6 $800,000 - $425,000 -$170,000 = $205,000 7 $1,080,0005 - $400,000 -$410,000 = $270,000 8 $1,800,00010 (total assets) - $750,000 - $500,000 = $550,000 9 $360,00011 (total assets) - $50,000 - $120,000 = $190,000 10 $1,800,000 = Total Assets 11 $360,000 = Total Assets 12 $1,080,0005 = Total Assets LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: : Analytic CPA: cpa-t001 CM: Reporting

AP1-10B A Retained Earnings Dec. 31, 2023 Net Earnings Dividends declared and paid Retained Earnings Dec. 31, 2024

$70,0001

$350,000 $2,400,000 $540,000

30,000

400,000

500,0002

190,000

5,000

150,0003

200,000

340,000

95,000

600,000 2,700,000

390,0004

$95,000 - $30,000 + $5,000 = $70,000 $2,700,000 - $2,400,000 + $200,000 = $500,000 3 $400,000 - $350,000 - $600,000 = $150,000 4 $540,000 + $190,000 - $340,000 = $390,000 2

LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-11B A ($2,687,000 + $792,000) = $3,479,000 D ($450,000 + $100,000) = $550,000 B ($2,564,000 + $1,775,000 + $550,000) = $4,889,000 C ($4,252,000 - $450,000 - $1,120,000) = $2,682,000 LO 5 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP1-12B a. Scents Unlimited Ltd. Statement of Income For the month of May, 2xxx Sales Revenue Cost of goods sold Wages expense Telephone expense Utilities expense Rent expense Operating expenses Total expenses Net income

$24,730 $10,733 7,000 160 370 1,500 329 20,092 $ 4,638

b. Other costs that Lydia might have incurred in May not listed above include: 1. Depreciation expense for vehicles and equipment 2. Income tax expense 3. Cost of advertising 4. Other employee benefit costs such as employer portion of CPP and EI 5. Interest expense on any bank loans owing 6. Insurance expense LO 5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-13B a.

Slip and Slide Ltd. Statement of Income For the month of July, 2xxx Service revenue Parking revenue Total revenues Wages expense Advertising expense Supplies expense Water expense Utilities expense Total expenses Net income

$ 200,650 6,000 206,650 $ 25,000 5,430 15,469 6,153 8,756 60,808 $ 145,842

b. Other costs Josephine might have incurred in July that were not listed above include: 1. Depreciation expense of water park equipment 2. Income tax expenses 3. Interest expense on any outstanding loans 4. Insurance expense 5. Other employee benefit costs such as employer portion of CPP and EI LO 5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-14B a.

Item Inventory Wages owed to employees Loan owed to the bank Cash held in chequing account Cost of refrigerator Prepaid rent for June Common shares Retained Earnings

Scents Unlimited Statement of financial position May 31, 2xxx Cash $ 8,361 Inventory 1,100 Prepaid rent 1,500 Equipment 18,695 Total Assets $ 29,656

Classification Asset Liability Liability Asset Asset Asset Shareholders’ equity Shareholders’ equity

Wages payable Bank loan payable

950 8,000

Common shares 18,000 Retained earnings 2,706 Total Liabilities and Shareholders’ Equity $29,656

It is unlikely that Lydia will have an account called ‘accounts receivable’ since most of her sales will be on a cash basis. If customers purchased flowers and other items on credit, then Lydia would have accounts receivable on her statement of financial position that would represent the amount that she is owed from her customers. However, florist shops sell products that are relatively inexpensive, therefore most customers, if not all, will have enough funds to pay cash for their purchase, which is why it is unlikely that Lydia will have an account called “accounts receivable”. It may be necessary for her to have an accounts receivable account if she has customers that purchase frequently and/or in large quantities, such as an event planner. In that case, it would be appropriate to ship a large order of flowers along with an invoice. Until the invoice is paid (by the event planner for example), the amount owing would be “accounts receivable”. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP1-15B a.

Item Cash in bank accounts Chemical supplies on hand Loans owed to an investor Retained earnings Spare parts Common shares Amount prepaid by customers to access park in August Cost of kayaks and pedal boats

Classification Asset Asset Liability Shareholders’ equity Asset Shareholders’ equity Liability Asset

Slip and Slide Ltd. Statement of Financial Position As at July 31, 2xxx Cash Supplies

$15,000 12,620

Deferred revenue Loan payable

$35,000 22,500

Spare parts Equipment

15,000 65,000 $ 107,620

Common shares Retained earnings

30,000 20,120 $107,620

c. Inventory refers to products that have been purchased for resale to customers. Josephine’s business does not have any products for resale to customers, but instead it provides a service, water park. d. Josephine’s business does not produce a product for which customers would be extended credit. Josephine would want her customers to pay in advance. Unlike a car dealership where the company can repossess the car if the customer does not pay, it would not be possible for Josephine to repossess a day at the water park once it is complete. Furthermore, the cost for the service is likely not too high for customers to pay right away. Thus, Josephine’s business is not likely to have an accounts receivable account. If Josephine provided water park usage to a company for several people, it is possible that she would invoice the customer and allow them to pay after the event. In this case, Josephine would have an accounts receivable. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP1-1 • • • • • • • • • •

Selling price of each model of laptop computer Cost of each model of laptop computer Selling price of assembly services Cost of assembly services Wages paid to any employees Costs of parts inventory that would be required Information on customers, as in name, model purchased, account balance Information on suppliers such as time to delivery and payment policy Warranty information on laptops sold Return policy for products sold

An accounting software package could reliably keep track of the above information, as well as other relevant information for running the business. A bank would want assurance that the loan will be repaid. This might include information about past sales and further sales prospects, as well as the cost of goods and services provided. A bank would also want to know about other current financial obligations of the business, and what the loan would be used for. It would be of particular interest whether the loan would be used to cover operating expenses or used for expansion. The bank would also be interested in any other assets you may have that could be used as security for the loan. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP1-2 a. The loan officer would be interested in your company’s ability to repay the loan and thus would look at net income and cash flows. The loan officer would also need to consider a backup plan in the event your company does not make the required loan payments. For example, which assets of your company could be given to the bank in lieu of repayment, or sold to provide cash for repayment? The loan officer would also look at your statement of financial position to identify the assets owned by your company, but would prefer up-to-date market values for these assets rather than the historical costs listed on the statement of financial position. Any other current or non-current liabilities would be of interest to the loan officer, as they may indicate previous obligations that could compromise the ability to repay a new loan. b. 1. Is your net income sufficient to repay a loan? 2. Is your net income sustainable? 3. Do you have assets that could be liquidated if your cash flows are insufficient? 4. Do you have currently existing debt that will make it difficult to repay new loans? *Other answers may also be accepted. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP1-3 a. The advantages of operating the business as a proprietorship are that it is simple and inexpensive to establish and maintain. b. The advantages of operating the business as a corporation are that Taylor’s personal assets would not be at risk in the event the company was unsuccessful. This form of business would also enable the company to raise funds by issuing shares, which is not an option if the business operated as a proprietorship. If the business proves to be success, there can be tax advantages from operating it as a corporation. c. Customers would likely prefer that he operates as a corporation. This gives the appearance that the business is more than a single individual. d. Creditors would likely prefer that he operate as a proprietorship as they would be able to access any personal assets Taylor might have in the event the business is not successful. They may be able to do this anyway, by requiring personal guarantees from Taylor for any debts of the corporation. e. The corporate form of business would be more advantageous if Taylor expects the business to grow rapidly. Rapid growth would require additional financing, and this is easier to obtain as a corporation. As the company grew, Taylor would see a related increase in the value of his shares in the company. Taylor would also have the option of selling some of his shares (for personal gain) or having the company issue additional shares to raise additional capital to fund the company’s growth. There may also be tax advantages associated with organizing the business as a corporation if profits increase as a result of the growth. LO 3 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP1-4

Funds can be raised from several sources, but the two primary sources are from lenders and shareholders. The advantage of borrowing from a lender is that your friend would retain complete ownership of the business and would not be required to share the decision-making and the profit of the company with anyone else. Bringing in another shareholder may result in a loss of control over the company and would also mean giving up some share of the future profits. The disadvantage of borrowing from a lender is that loan contracts require repayment of the amount on a set schedule. This increases the risk to the company that it will not be able to make payments on a timely basis. There could be significant consequences for not making payments, including losing ownership of the company. A new shareholder would not have this same type of contractual arrangement and would be at risk in the same way as your friend. However, the new shareholder would probably expect a higher return from her/his investment than would a lender. Your friend would be giving up more potential profit to a new shareholder than lender. Another disadvantage to borrowing is that interest must be paid on the loan. It is not optional but is tax deductible. Dividends, on the other hand, are optional and would normally only be declared by the company’s board if the company was profitable. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP1-5

The board should consider the number of shares outstanding and the proposed dividend per share, which will determine the total cash requirements. They must also consider whether the available cash in the company is sufficient to make the dividend payment without disturbing the overall liquidity of the business in its day-to-day operations. If not, they may have to delay payment of the dividend, or look for ways to generate additional cash. The dividend declaration will reduce retained earnings, so the retained earnings amount must be larger than the proposed dividend. The board should also consider the company’s future plans. The retained earnings account represents the cumulative profits of the business that are kept within the company to fund future expansion plans. Dividends are declared and paid when the company has no plans to use the accumulated profits to fund future expansion. Thus, the declaration and payment of dividends only makes sense if the company does not need the cash for future expansion plans. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK IN PROGRESS WIP1-1 Correct elements: • To determine if the dividends have been paid, we could review the statement of financial position, if they have been paid there will be no dividends payable account balance, if they still need to be paid there will be a dividends payable account in current liabilities. We could also look at the statement of cash flows to see if there are any dividend payments reported on under cash flows from financing activities. Incorrect elements: • Dividends declared are not found on the statement of income. Instead, they are found on the statement of changes in equity. • The amount of dividends declared are not equal to the company’s earnings per share (EPS). EPS is based on the net income, preferred dividends and the number of shares outstanding, whereas dividends declared is an amount determined by the Board of Directors, based on the profit for the year, cash available for the year and the strategic and operational goals of the organization. It would be very unusual for a company to distribute all of its earnings as dividends. Normally at least some portion of earnings is used to pay down liabilities or is reinvested in the company to purchase new property, plant, and equipment or other growth activities. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP1-2 Correct elements: • Dividends can be viewed as extra, or surplus cash flow as company boards do not declare dividends unless the company does not require these funds. Incorrect elements: • A company will not declare a dividend if they do not have cash to do so (cash available in their cash account) not an overall positive cash flow. • A company will also not declare dividends unless they are profitable or have retained earnings from prior periods. • To determine the amount of a dividend the company declared during the year, you should look at the statement of changes in shareholders’ equity for the year. LO 5 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP1-3 Correct elements: • The statement of income tells users how much profit the company makes after expenses. Incorrect elements: • The statement of income does not show dividends declared deducted from revenues earned during the period. • The dividends declared appear in the statement of changes in equity for the period, as a deduction from retained earnings. LO 5 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP1-4 Incorrect elements: • Shareholders’ equity is comprised of share capital (the amount of cash (or value of asset/service) received when a company issued the shares to the initial shareholders) and retained earnings (the net profits of the company from inception, less any dividends declared over the life of the company). The market price of the shares is not reflected in the shareholders’ equity section of the company’s statement of financial position. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP1-5 Correct elements: • Shareholders’ equity is comprised of two parts. The first part is the amounts contributed by the shareholders and the second is the company’s subsequent net earnings (net of dividends declared). • If the company reports a profit, the retained earnings (part of shareholders’ equity) will increase. Incorrect elements: • The increase to retained earnings for the year is made up of the profit for the year less of any dividends declared by the company during the year. Profit less dividends declared = the increase or decrease in retained earnings in shareholders’ equity. • Shareholders’ equity is reduced by dividends declared, not dividends paid. LO 5 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP1-6 Employees are human resources available to help companies earn a profit in exchange for a wage or salary. They are not owned and controlled by the company and nor are they recorded as assets on the statement of financial position. Consequently, the cost of hiring and training employees is not an asset but is an expense recorded on the income statement. LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI1-1 a.

Dividends declared in 2020 are $69,977. This amount is included in the consolidated statement of changes in shareholders’ equity. The actual amount paid for dividends was ($44,636) as shown on the consolidated statement of cash flows.

All amounts are in thousands of Canadian dollars. i. Revenues in 2020: $2,220,180. ii. Cost of sales in 2020: $1,236,258 iii. Gross profit in 2020: $983,922 or 44.3%. iv. Selling, general and administrative expenses in 2020: $750,951 v. Income tax expense in 2020: $47,235 vi. Net income in 2019: $106,929. vii. Trade receivables at the end of 2019: $140,535 viii. Inventories at the end of 2020: $332,072. ix. Trade payables and other payables at the beginning of 2020 fiscal year: $256,539. x. Retained earnings at the end of 2020: $842,604 (from the consolidated statement of changes in shareholders' equity or the statement of financial position). xi. Loans and borrowings at the beginning of 2020: $95,000 ($70,000 + $25,000) xii. Cash flows provided from operating activities in 2020: $511,424 xiii. Cash payments to purchase property, plant, and equipment in 2020: ($43,493). xiv. Cash payments for dividends in 2020: $(44,636). xv. Cash flows used for financing activities in 2019: ($192,457). xvi. Cash payments to repurchase common shares in 2020: ($48,202).

The largest sources of cash are $511,424 from operating activities, and $30,586 from the proceeds on sale of debt and equity instruments. The largest uses of cash are ($71,076) for the payment of lease liabilities and ($48,202) for the repurchase of common shares.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI1-1 (Continued) d.

To compute cash flow from operations, net earnings are increased by the non-cash items including depreciation and amortization expense, and further adjusted by changes in working capital items such as inventory and accounts payable. Also, cash was received from warranty plan sales, which would not have been included in revenue yet, since it has not been earned.

While revenues decreased by $63,231, gross profit only decreased by $14,663. This means that cost of goods sold decreased by a larger percentage than did the decrease in the revenues. Selling, general and administrative expenses decreased by $79,544. Together, this helps explain why net income for the year increased in spite of a decrease in revenues. LO 5 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI1-2 a.

The use of the term “consolidated” means that the company has, at a minimum, a parent company and a subsidiary – a company that is controlled by the parent company generally through holding voting shares. Since Waterloo Brewing’s financial statements do not include the word consolidated, this could mean that the company does not own (or control) any subsidiaries.

b. Year Current assets Current liabilities 2021 $24,944,817 $54,396,558 2020 16,246,586 30,999,384 Increase in working capital deficiency

Working capital $(29,451,741) (14,752,798) $ (14,698,943)

The working capital deficiency deteriorated from 2020 to 2021, it increased by $14,698,943. This represents an increase of 100%.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI-2 (Continued) c. All amounts are in Canadian dollars. i. Revenues in 2021: $86,699,345. ii. Cost of sales in 2021: $66,000,997. iii. Gross profit in 2021: $20,698,348 or 23.9% iv. Selling, marketing, and administrative expenses in 2020: $11,842,088. v. Income tax expense in 2020: $537,779. vi. Net income in 2021: $3,000,013. vii. Intangible assets at the end of 2021: $15,002,826. viii. Accounts receivable at the beginning of 2021: $4,976,226. ix. Share capital at the end of 2021: $39,546,216. x. Property, plant, and equipment at the end of 2021: $46,630,107. xi. Cash flows from in operating activities in 2021: $12,877,105. xii. Cash payments to purchase property, plant, and equipment in 2021: ($18,407,338). xiii. Cash used for the payment of dividends in 2021: $3,748,831. d.

In 2021, 70.8% ($81,769,324/$115,463,685) of Waterloo Brewing’s assets were financed with debt, while 29.2% ($33,694,361/$115,463,685) were financed by equity.

The two largest sources of cash were operating activities of $12,877,105 and the issuance of non-revolving demand loans of $14,505,315. The two largest uses of cash were the purchase of property, plant and equipment ($18,407,338) and dividends paid of ($3,748,831).

The income of $3,000,013 included non-cash depreciation and amortization of $7,810,676. This is the most significant difference between the net income on the statement of income and the cash flows from operations. LO 5 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI1-3 a.

All amounts in thousands of Canadian dollars: i. Total sales in 2021: $240,506. ii. Cost of goods sold in 2021: $100,767. iii. Selling, general and administrative expenses for 2020: $188,308. iv. Interest expense for 2020: $15,567. v. Income tax expense for 2021: $4,885. vi. Net income for 2021: $13,080. vii. Inventories at the end of 2021: $42,401. viii. Accounts payable and accrued liabilities at the beginning of 2021: $20,252. ix. Shareholders’ equity at the end of 2021: $164,180. x. Retained earnings (deficit) at the end of 2021: $(36,608). xi. Cash provided from operating activities in 2021: $50,922. xii. Cash payments to acquire fixed assets in 2021: $3,423. xiii. Cash used to repay long-term debt in 2021: $14,000. xiv. Cash used to pay dividends in 2021: $nil.

At January 30, 2021, Roots’ total assets of $390,323 were financed by liabilities of $226,143 and equity of $164,180. Approximately 42.1% of Roots’ assets were financed by shareholders, while 57.9% were financed using debt.

In 2021, Roots had a net cash outflow of $31,515 from financing activities (the company repaid debt and paid principal on lease liabilities) and a net cash outflow of $3,964 for investing activities (the company purchased fixed assets).

A classified statement of financial position presents information in order of liquidity. This is how Roots structures its consolidated statement of financial position, by separating current from non-current assets and liabilities. Current assets are reported according to liquidity, with least liquid last and most liquid first.

LO 5 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI-4 a.

All amounts are in thousands of U.S. dollars i. Net sales in 2020 - $1,981,276 ii Gross profit in 2020 - $249,059 iii. Total selling, general, and administrative expenses in 2019 – $340,487 iv. Net earnings (loss) in 2020 - $(225,282) v. Inventories in the beginning of 2020 - $1,052,052 vi. Trade accounts receivable at the end of 2020 - $196,480 vii. Retained earnings at the end of 2020 - $1,359,061 viii. Long-term debt at the end of 2019 - $845,000 ix. Cash flows from operating activities in 2020 - $415,030 x. Cash payments to acquire property, plant, and equipment in 2020 $50,670 xi. Dividends paid in 2020 - $30,553 xii. Cash used for investing activities in 2019 - $135,751

At January 3, 2021, Gildan’s total assets of $3,020,948 were financed by liabilities of $1,462,051 and equity of $1,558,897. Approximately 51.6% of Gildan’s assets were financed by shareholders, while only 48.4% were financed using debt.

The two largest sources of cash in 2020 were cash flows from operating activities of $415,030 and proceeds from issuance of a term loan for $400,000. The two largest uses of cash in 2020 were the purchase of property, plant and equipment of $50,670 and decrease (repayment) in amounts drawn under a revolving long-term bank credit facility, of $245,000.

Gildan Activewear prepared a classified statement of financial position that presents information in order of liquidity. The presence of sub-totals for current assets and current liabilities shows that the statement is a classified statement of financial position. Gildan separates current from non-current assets and liabilities. Current assets are reported according to liquidity, with most liquid first and least liquid last.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI-4 (Continued) e. Year Current assets Current liabilities Jan. 3, 2021 $1,544,473 $359,606 Dec. 29, 2019 1,514,173 422,404 Increase in working capital

Working capital $ 1,184,867 1,091,769 $ 93,098

Gildan’s working capital increased by $93,098,000 in fiscal year 2020. This is 8.5% higher than working capital in fiscal year 2019. LO 5 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI1-5 Answers to this question will depend on the company selected. LO 2,5 BT: C Difficulty: H Time: 120 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

RI1-6

Answers to this question will depend on the company selected. LO 5 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C1-1 Enticing Fashions Ltd. Memorandum To: CEO, Enticing Fashions Ltd. From: Accountant Re: Bank’s Use of Financial Statements As the company is seeking financing from its bank to support its expansion plans, it is understandable that the bank will be taking a greater interest in the company’s financial reporting. Prior to approving any loan, the bank will use Enticing’s financial statements to assess the following: (i)

The company’s ability to service a loan The bank will use the financial statements to determine if Enticing has the earnings and cash flow to service the loan (i.e. pay interest on the loan and repay the loan principal). Specifically, the bank will review the statement of income to assess the profitability of the company’s operations. If the company does not have a track record of profits, then it unlikely a loan will be granted. If the company is not profitable, it will not be able to pay interest or repay loan principal. The bank will use the statement of cash flows to evaluate the amount of cash the company is generating from its operating activities. It will be these cash flows that Enticing will use to pay interest and repay principal. While it will look at the company’s financing and investing cash flows, the bank’s primary focus will be on those generated from operations.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C1-1 (Continued) (ii)

The extent of assets that the company has available that could be provided as security in the event of loan default The bank will also want to ensure that it has adequate loan security. This will normally involve them taking a charge over some of the borrower’s assets. For example, they may want a charge over the Enticing’s accounts receivable and inventory, meaning these assets would revert to the bank for collection or sale to repay the loan if Enticing defaulted. They may also wish to use the property, plant and equipment of the company as security. This would involve the bank having a charge over Enticing’s equipment, buildings, land, etc. The bank could then seize and sell these assets to repay the loan in the event of default. The bank will use the statement of financial position to determine what assets the company could provide as security. The bank would know that, for many assets, the values on the statement of financial position represent their historic cost rather than their fair values. As such, the bank may ask Enticing to obtain appraisals for these assets prior to agreeing to accept the assets as loan security. I hope that this enhances your understanding of how the bank may use Enticing’s financial statements in the context of approving the company’s loan application. Please don’t hesitate to contact me if you wish to discuss this matter in greater detail. Sincerely, Accountant LO 2 BT: C Difficulty: M Time: 35 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Copyright © 2022 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved. The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd. MMXXI xii F1

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 2 Analyzing Transactions and Their Effects on Financial Statements Learning Objectives 1. Identify the accounting standards used by Canadian companies. 2. Identify and explain the qualitative characteristics of useful financial information and how the cost constraint affects these. 3. Explain the difference between the cash basis of accounting and the accrual basis of accounting. 4. Explain the accounting equation template approach to recording transactions. 5. Analyze basic transactions and record their effects on the accounting equation. 6. Summarize the effects of transactions on the accounting equation and prepare and interpret a simple set of financial statements. 7. Calculate and interpret three ratios used to assess the profitability of a company.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5 6.

1 2 2 2 2 2

1. 2. 3.

2 3 5

1. 2.

1 1

1. 2.

7 4,7

1. 5,6,7

Item

Discussion Questions C 7. 2 C 13. 5 C 19. 5 C 25. C 8. 3 C 14. 4 C 20. 5 C 26. C 9. 3 K 15. 5 C 21. 5 C 27. C 10. 3 C 16. 5 C 22. 6 C C 11. 3 C 17. 5 C 23. 6 K C 12. 3 C 18. 5 C 24. 6 K Application Problems K 4. 5 AP 7. 5 AP 10. 6 AP 13. AP 5. 5 AP 8. 5 AP 11. 6 AP 14. AP 6. 5 AP 9. 5 AP 12. 6 AP 15. User Perspective Problems C 3. 2 C 5. 3 C 7. 3 C 9. C 4. 3 C 6. 3 C 8. 6 C Work in Process C 2. 4 C 3. 4 C 4. 7 AN Reading and Interpreting Published Financial Statements AN 3. 7 AN 5. 7 AN 7. 7 AN AN 4. 4,7 AN 6. 4,7 AN Cases AN 2. 5,6 C 3. 7 AN 4. 5,6 C

6 6 6

K K C

6 5,6 5,6,7

AP AP AP

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file LO BT

Difficulty:

Time: AACSB

CPA CM

Learning objective Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to complete in minutes Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Tech. Technology Diversity Diversity Reflec. Thinking Reflective Thinking CPA Canada Competency Map Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS

DQ2-1

Advantages of using IFRS for interlisted public companies • Financial statement prepared using IFRS are accepted on many stock exchanges: NYSE, LSE, ASE, OMX Nordic Exchange and JSE. This saves these companies from having to prepare different financial statements for each exchange. • The SEC allows companies to submit IFRS statements rather than those prepared using US GAAP.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-2

The two fundamental qualitative characteristics are relevance and representational faithfulness. These fundamental characteristics ensure that information reported in financial statements is useful. The four enhancing qualitative characteristics are comparability, verifiability, timeliness, and understandability. These characteristics further enhance useful information; however, they cannot make useless information useful.

LO 2 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-3

The value of the land is reported at its original purchase price, or its historical cost. This is representationally faithful, verifiable, accurate and free from error. However, historical cost may not be relevant if the market value of the land has increased significantly since it was purchased. Some users may find it more useful to know the current market value of the land.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-4

The conceptual framework provides guidance by focusing the financial statement preparer on presenting information that is relevant and faithfully represented. Even in highly unique situations for which there is no specific accounting standard, accountants must think about accounting for a transaction in a manner that provides information that is predictive or enables users to confirm their previous assessments as well as provide information that is complete, neutral, and free from error. The conceptual framework also directs the accountant to consider qualities like comparability, verifiability, timeliness, and understandably. Finally, the conceptual framework considers the cost and benefit of reporting information, to ensure that the efforts spent obtaining information is warranted, considering the benefits the information provides to the financial statement users. In short, the conceptual framework provides accountants with a basis for determining how to treat the item or transaction in a way that results in useful financial information in the absence of any specific standard.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-5

Material information is information that is useful and matters to decision makers. Information is material when it influences the user of the information. Therefore, it is associated with the qualitative characteristic of relevance. It is information that, if known, would make a difference in the decisions that are made about investments in, or investments made by, a company. Normally, the greater the dollar value of an item, the more material it is. However, some small dollar items can be qualitatively material due to particular situations (i.e. even a small dollar fraud by senior management could be considered material).

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-6

The cost constraint is applied by companies when deciding what financial information should be reported. The benefits of reporting the information must exceed the cost involved in its preparation. If the benefit doesn’t exceed the cost, that information should not be captured and reported on the financial statements.

LO 2 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-7

The going concern assumption is a basic assumption in accounting that the business is going to continue to operate in the foreseeable future. A company can rely that it is going to realize its assets and discharge its liabilities through the normal course of operations. If this assumption were not present, the company would need to report its assets and liabilities at the amounts expected to result from the liquidation process.

LO 2 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-8

Under the accrual basis of accounting, transactions are recorded in the period in which they occur (i.e. revenues when earned and expenses when incurred) regardless of when the cash related to these transactions flowed into or out of the company. Under the cash basis of accounting, transactions are only recorded when the cash is actually received or paid by the company.

LO 3 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-9

Advantages of using the accrual basis: 1. Revenue is recognized when earned which is more meaningful to users. Under the cash basis, the revenue is recognized when the cash is received, even if the work associated with has been done previously or may not be completed for several periods. 2. It results in statements of income that reflect the revenues and expenses of the period more accurately. 3. It increases the comparability of financial statements from one period to another. Disadvantages of using the accrual basis: 1. It is more complicated for unsophisticated users to prepare or interpret. 2. Creates uncertainty regarding the collectability of future cash flows. Under the accrual basis, some of the revenues recognized may never be collected. This is a non-issue under the cash basis. 3. Net income determined under the accrual basis does not give a clear view of the amount of cash that an organization has generated in a given time period.

LO 3 BT: K Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-10

Since revenue is only recorded when cash is received, management could require customers to pay before providing the product or service to show revenue before it is earned and therefore increasing net income. Management could also delay paying for expenses to increase net income as well. The accrual basis of accounting prevents both these manipulations by only recording revenue when it is earned, when the product or service is provided to the customer and expenses are recorded when they are incurred.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-11

Under the accrual basis of accounting, revenues are recorded when they have been earned regardless of whether the related cash has been received by the company. When a university bookstore sells a textbook, it ‘earns’ the revenue when the textbook is sold and delivered to the student. In this case, most students pay for textbooks at the same time as receiving them, therefore the cash basis and the accrual basis would be the same for the sale of textbooks. The revenue earned from the parking would be recognized throughout the semester, as the student uses the parking space. The university would recognize a portion of the parking revenue each month throughout the semester. Under the cash basis of accounting, the full amount of the parking pass would have been recognized as revenue in the month the cash was received.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-12

Under accrual-basis accounting, a prepaid expense is recorded as an asset on the statement of financial position and expensed as the related benefits are realized. For example, if rent is paid for future months, no expense is recognized immediately even though cash is paid. The prepaid expense is then expensed over the months that benefit from the advance payment (i.e. rent expense would be recognized in each month covered by the prepaid rent).

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-13

Under accrual-basis accounting, an accrued expense (such as interest) is one that is recognized on the statement of income as an expense before any cash is paid out. In this case, a liability is also set up on the statement of financial position, that will be eliminated once the cash has been paid to settle the liability.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-14

When transactions are recorded in the accounting system, the equality of the basic accounting equation (or statement of financial position equation), Assets = Liabilities + Shareholders’ Equity, must be maintained. This implies that all transactions must affect at least two accounts in the financial statements to maintain the equality, although the effects may be within the same category of accounts. For example, the collection of cash on account from customers both increases an asset (Cash) and decreases another asset (Accounts Receivable).

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-15

Dividends are not expenses. They are a distribution of profits to shareholders and not an expense incurred to generate revenues. Dividend payments involve an outflow of cash and are therefore recorded on the statement of cash flows and the statement of changes in equity.

LO 5 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-16

Revenue is recorded as an increase to retained earnings in the template system as the template is based on the accounting equation: Assets = Liabilities + Shareholder’s Equity. Within Shareholder’s equity is Retained earnings, which captures net income and revenue is part of net income. Revenue increases net income and therefore, also increases retained earnings.

LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-17

At the date the loan is taken out, no interest has been incurred, but with each day that passes, interest expense is being incurred. Interest expense is based on the time the loan has been held and typically interest expense is recorded at the end of each month.

LO 5 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-18

Prepaid insurance is a benefit over the life of the policy and, since it has an economic benefit, it is considered an asset. Over time, this benefit is used up and should be expensed as time passes. Typically, insurance expense is recorded at the end of each month and the amount of prepaid insurance is reduced.

LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-19

Depreciation is a method of allocating the cost of property, plant and equipment to each of the years in which these assets are expected to help generate revenues (i.e. its estimated useful life). Using the straight-line method, depreciation is calculated as (the total cost of the asset less its estimated residual value, if any) divided by the estimated useful life. It results in an equal portion of the asset’s cost being allocated each period.

LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-20

Accrual accounting requires that revenue be recognized when it is earned, and that expenses be recognized in the period they are used to earn revenue. Buildings and equipment are often paid for when they are acquired, and then are used for generating revenue over many years. Depreciation enables the cost of the assets to be allocated to the periods in which they are used.

LO 5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-21

The estimated residual value of an asset is the amount the company estimates to recover from the disposal of the asset when the company is finished using it. The purpose of depreciation is to allocate the net cash spent on the asset to the periods of its use. Since some of the purchase price will be recovered through the eventual disposal of the asset, that portion of the cost should not be allocated as an expense during the period of use. Therefore, residual value is subtracted from the asset’s cost when calculating depreciation.

LO 5 BT: C Difficulty: C Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-22

The statement of changes in shareholders’ equity includes changes in retained earnings. Retained earnings are increased or decreased by the net income or loss for the period, therefore the statement of income must be completed first to know how much change to record in retained earnings. Then, the rest of the statement of changes in shareholders’ equity can be completed.

LO 6 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-23 The three major sections in the cash flow statement are: 1. Operating Activities: Includes transactions involving cash received from the sale of goods/services and cash paid for expenses incurred in generating the sales. 2. Investing Activities: Includes transactions involved with the buying and selling of assets such as property, plant, and equipment, long-term investments, etc. 3. Financing Activities: Includes transactions regarding the inflow and outflow of cash obtained from creditors or from shareholders necessary to finance the investment plans of the business. Financing activities include the issuance of shares, payment of dividends, proceeds from new loans and the repayment of loan principal, etc. LO 6 BT: K Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ2-24

The repayment of loan principal is an example of a cash outflow from financing activity. The sale of property, plant and equipment such as land or equipment held by a company for use is an example of a cash inflow from investing activity.

LO 6 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-25

The issuance of shares is an example of a cash inflow from financing activity. The purchase of property, plant, and equipment is an example of a cash outflow from investing activity.

LO 6 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-26

a. b. c. d. e. f. g. h.

T T F F F T F T

LO 3,5,6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ2-27

Operating activities are normally expected to have a positive net cash flow, as cash collected from sales is expected to be greater than the cash spent to generate the sales. Investing activities are normally expected to have a negative net cash flow, as more cash is spent on acquiring property, plant and equipment than is received from selling them once the company has finished using them. Financing activities normally result in net cash inflow because companies generally borrow money and issue shares to finance their growth.

LO 6 BT: C Difficulty: C Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP2-1A a. E b. F c. E d. E e. E f. F LO 2 BT: K Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP2-2A i. (a) No effect on the statement of income (b) No effect on the statement of income ii. (a) No effect on the statement of income (b) Revenue recorded $56,000 and an increase to net income of $56,000 iii. (a) Expenses recorded $18,000 and a decrease to net income of $18,000 (b)Expenses recorded $18,000 and a decrease to net income of $18,000 iv. (a) Revenue recorded $41,000 and an increase to net income of $41,000 (b) No effect on the statement of income v. (a) No effect on the statement of income (b) Expenses recorded $3,800 and a decrease to net income of $3,800 vi. (a) Expenses recorded $19,000 and a decrease to net income of $19,000 (b) No effect on the statement of income vii.(a) Revenue recorded $2,200 and an increase to net income of $2,200 (b) No effect on the statement of income Summary of results on the next page

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-2A (Continued) Summary of results: (a) Cash Basis Revenue Expenses i. ii. iii. iv. v. vi. vii.

$18,000 $41,000 19,000 2,200 $43,200

Net income

$37,000 $6,200

(b) Accrual Basis Revenue Expenses i. ii. iii. iv. v. vi. vii.

$56,000 $18,000 3,800

$56,000 Net income

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

$21,800 $34,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-3A a. Increase assets (cash) and increase shareholders’ equity (common shares) b. Decrease assets (cash) and increase assets (land) c. Increase assets (accounts receivable) and increase shareholders' equity (sales revenue increases, which increases retained earnings) d. Increase assets (cash) and decrease assets (accounts receivable) e. Decrease assets (cash) and decrease shareholders’ equity (dividends declared increases, which decreases retained earnings) f. Increase assets (cash) and increase liabilities (bank loan payable) g. Decrease assets (cash) and decrease shareholders’ equity (interest expense increases, which decreases retained earnings) h. Increase assets (inventory) and increase liabilities (accounts payable) i. Decrease assets (cash) and decrease liabilities (accounts payable) j. Decrease assets (cash) and decrease shareholders’ equity (delivery expense increases, which decreases retained earnings) k. Decrease assets (cash) and increase in assets (prepaid insurance) when payment is made. As insurance is used, decrease in assets (prepaid insurance) and a decrease shareholders’ equity (insurance expense increases, which decreases retained earnings) l. Decrease assets (increases accumulated depreciation, which is a contra asset) and decreases shareholders' equity (increases depreciation expense, which decreases retained earnings) LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-4A Account a. Cash (A) Common Shares (SE) b. Cash (A) Bank Loan Payable (L) c. Equipment (A) Accounts Payable (L) d. Inventory (A) Cash (A) Accounts Payable (L) e. Accounts Receivable (A) Sales Revenue (SE) Cost of Goods Sold (SE) Inventory (A) f. Accounts Payable (L) Cash (A) g. Cash (A) Accounts Receivable (A) h. Supplies (A) Cash (A) i. Dividends Declared (SE) Cash (A) j. Interest Expense (SE) Interest Payable (L) k. Accounts Payable (L) Cash (A) l. Supplies Expense (SE) Supplies (A)

Increase/Decrease Increase Increase* Increase Increase Increase Increase Increase Decrease Increase Increase Increase* Increase** Decrease Decrease Decrease Increase Decrease Increase Decrease Increase** Decrease Increase** Increase Decrease Decrease Increase** Decrease

* Increase in Shareholders’ Equity ** Decrease in Shareholders’ Equity LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-5A Assets Date Sept. 1 1 3 8 11 15:1

Cash

A/R

Inv.

260,000 160,000 (100,000) 6,600 2,500 4,300

Inflatable Equip.

140,000

A/P

Deferred Revenue

Loan Common Payable Shares 260,000 160,000

(1,700)

3,400

R/E

R/E/DD

40,000 6,600

4,300

8,600 (5,700)

S/H Equity

2,500

15:2

30:1 30:2

Liabilities

(5,700)

R E

(1,700) (3,400)

(3,000) (800)* *$160,000 x 6% x 1/12 = $800 Interest expense

(3,000)

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

(800)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-6A Assets Date Jan 1 1 4 10.1 10.2 19 27 29 30 30

Cash

A/R

Inv.

20,000 (3,300)

Liabilities Prepaid Ins.

Deferred Revenue

Loan Payable

R/E

R/E/DD

22,200 (15,600)

R E

(5,100)

(275) (50)

E E

20,000 3,300 36,000

11,100

A/P

S/H Equity

36,000

11,100 (15,600)

(5,000) (5,100) 5,000

(5,000) 5,000 (275)

(1,550)

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

(1,500)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-7A

Transaction i. ii. iii. vi.

v. vi. vii. viii. ix. x. xi.

(i) Effect on Net Earnings

(ii) Effect on cash flows

No effect No effect No effect Net increase of $200 (Sales of $500 less Cost of goods sold of $300) No effect No effect Decrease of $300 (Supplies expense) No effect No effect No effect Decrease of $500 (Depreciation expense)

Increase of $60,000 No effect Decrease of $500 No effect (sold on account, inventory already owned) Decrease of $10,000 Decrease of $1,000 No effect Increase of $700 No effect Decrease of $2,000 No effect

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-8A Assets # a b c d:1 d:2 e f g h i j

Cash 150,000 (25,000)

A/R

Inv.

Supplies

Equip. 50,000

45,000 52,000 (35,000) (1,000) 25,000 (1,200) (750) (250) (8,000)

Liabilities S/H Equity Loan Common Rev/Exp A/P Payable Shares R/E /DD 150,000 25,000 45,000 52,000 Rev (35,000) Exp (1,000) 25,000 (1,200) Exp

750

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

(250) (8,000)

Exp DD

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-9A Assets Liabilities S/H Equity Date Wages Loan Common Jan Cash A/R Inv. Equip. A/P Payable Payable Shares R/E 1a. 75,000 75,000 1b. 60,000 60,000 1c. (10,000) 10,000 d. 87,500 87,500 e. 17,500 130,000 147,500 f. (85,000) (85,000) g. (73,000) (73,000) h. 116,000 (116,000) i. (47,200) 1,200 (48,400) j. (3,600)* (3,600) k. (1,000) (1,000) l. (1,500)** (1,500) * 60,000 x 6% = 3,600 Interest expense **(10,000 -1,000)/6 = 1,500 Depreciation expense LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Rev/Exp/ DD

Rev Exp

Exp Exp DD Exp

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-10A Case 1 A Revenue – Expenses = Net Income, Revenue – $510,000 = $215,000, Revenue = $510,000 +$215,000 = $725,000 B Retained earnings, end of year = Retained earnings, beginning of the year + Net Income – Dividends declared = $850,000 + $215,000 – $100,000 = $965,000 C Total assets, end of the year = Total Liabilities, end of the year + Total Common Shares, beginning of the year + Total Retained Earnings, beginning of the year = $860,000 + $350,000 + $965,000 = $2,175,000 D Total Liabilities, beginning of year = Total Assets, beginning of year (given $1,890,000) – Total common shares, beginning of year (calculated in E) – Total retained earnings, beginning of year (calculated in B) = $1,890,000 $250,000 - $850,000 = $790,000 E Common shares, beginning of the year = Common shares, end of the year Additional common shares issued during the year = $350,000 - $100,000 = $250,000 Case 2 A Net Income = Revenue – Expenses = $850,000 - $550,000 = $300,000 B Total Retained Earnings, end of the year $965,000 - Retained Earnings, beginning of the year $780,000 (item C) less Net Income for the year $300,000 (item A) equals Dividends Declared of $115,000 C Total assets, beginning of year $1,880,000 - Total liabilities, beginning of year $850,000 - Total common shares, beginning of year $250,000 = Total retained earnings, beginning of year = $780,000 D Total liabilities, end of year = Total assets, end of year - Total common shares, end of year - Total retained earnings, end of year = $2,20,000 $350,000 - 965,000 = $885,000 E Proceeds from issuing Common shares during the year = Common shares, end of year – Common shares at beginning of the year = $350,000 – 250,000 = $100,000 LO 6 BT: AP Difficulty: C Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-11A a. Total revenues: $448,800 + $4,800 + $2,200 = $455,800 b. Total expenses: $272,000 + $63,300 + $38,800 + $1,200 + $26,400 = $401,700 c. Net earnings:

$455,800 - $401,700 = $54,100

d. Dividends declared: $96,000 + $54,100 - $105,600 = $44,500

Alternate: Beg. R/E + net income – dividends declared = End R/E $96,000 + $54,100 - ? (div. decl.) = $105,600 $150,100 - ? (div. decl.) = $105,600 ? (div. decl.) = $150,100 - $105,600 Therefore, dividends declared = $44,500 LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-12A a. i.

Sales revenue = $48,000 (#5)

ii. Cost of goods sold = $22,000 (#6) iii. Total expenses other than cost of good sold = $7,000 (#7) + $2,200 (#8) + $600 (#9) = $9,800 iv. Net income = $48,000 - $22,000 - $9,800 = $16,200 b. i.

Cash on hand: $100,000 (#1) + $22,000 (#2) - $25,000 (#3) $6,000 (#4) + $10,000 (#5) - $7,000 (#7) - $2,200 (#8) - $1,000 (#10) = $90,800

ii.

Total assets other than cash: $25,000 (#3) + $36,000 (#4) + $38,000 (#5) - $22,000 (#6) - $600 (#9= $76,400

Alternate: Equipment = $36,000 - $600 = $35,400 Inventory = $25,000 - $22,000 = $3,000 Accounts receivable = $38,000 (#5) Total assets other than cash = $35,400 + $3,000 + $38,000 = $76,400 iii. Total liabilities: $22,000 (#2) + $30,000 (#4) = $52,000 iv. Share capital: $100,000 v. Retained earnings: $0 + $16,200 - $1,000 (#10) = $15,200 LO 6 BT: AP Difficulty: C Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-13A a. The Wizard’s Corner Statement of Income For the year ended June 30, 2024 Sales revenue Less expenses: Cost of goods sold Wages expense Rent expense Advertising expense Depreciation expense Total expenses

$190,000

$103,000 36,000 12,000 6,000 2,000 159,000

Net income

$ 31,000

Retained earnings at July 1, 2023 Plus: Net income Less: dividends declared

$21,000 31,000 3,000

Retained earnings at June 30, 2024

$49,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-13A (Continued) c. The Wizard’s Corner Statement of Financial Position As at June 30, 2024 ASSETS Current assets Cash Accounts receivable Inventory Prepaid rent

$ 40,000 15,000 28,000 1,000 84,000

Non-current assets Equipment

11,000

Total Assets

$ 95,000

LIABILITIES & SHAREHOLDERS’ EQUITY Current liabilities Accounts payable $11,000 Wages payable 2,000 13,000 Total liabilities Shareholders’ equity Common shares Retained earnings Total Shareholders’ Equity Total Liabilities and Shareholders’ Equity

13,000 33,000 49,000 82,000

$ 95,000

LO 6 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14A a. Assets

Liabilities

Date/ Ref.

Cash

Jan.1

250,000

Jan.2

50,000

Jan.3

A/R

Buildings

Land

Wages Interest Payable Payable

140,000

Loan Payable

Common Shares

(115,000)

155,000

(55,000)

175,000

205,000

Rev

(120,000)

Exp

(57,000)

Exp

(3,000)

Exp

(4,000)

Exp

(7,000)

(115,000) (155,000) 2,000

3,000*

(4,000)**

Dec.15

7,000 115,000

Rev/Exp /DD

130,000

(120,000)

R/E

60,000

130,000

Totals

Dividends Payable

50,000

(200,000)

30,000

A/P

250,000

4 5

Inv.

S/H Equity

20,000

10,000

136,000

*$50,000 x 6% = $3,000 ** ($140,000 - $ 20,000) ÷ 30 = $4,000

60,000

15,000

2,000

3,000

7,000

50,000 250,000

14,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14A (Continued) b. Singh Company Statement of Income For the Year Ending December 31, 2024 Revenues Sales revenue Expenses Cost of goods sold Wages expense Interest expense Depreciation expense Net income

$205,000

$120,000 57,000 3,000 4,000

184,000 $ 21,000

Singh Company Statement of Changes in Equity For the year ended December 31, 2024 Number Share of Capital Retained Total Common Common Earnings Shares Shares Balance, Beginning of Year $0 $0 Net Income 21,000 21,000 Declaration of Dividends (7,000) (7,000) Issuance of Common Shares 10,000 $250,000 250,000 Balance, End of Year 10,000 $250,000 $14,000 $264,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14A (Continued) Singh Company Statement of Financial Position As at December 31, 2024 ASSETS Cash Accounts Receivable Inventory Land Buildings TOTAL ASSETS

$115,000 20,000 10,000 60,000 136,000 $341,000

LIABILITIES Accounts Payable Wages Payable Interest Payable Dividends Payable Loan Payable TOTAL LIABILITIES

$ 15,000 2,000 3,000 7,000 50,000 77,000

SHAREHOLDERS’ EQUITY Common Shares Retained Earnings TOTAL SHAREHOLDERS’ EQUITY

264,000

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$341,000

250,000 14,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14A (Continued) Singh Company Statement of Cash Flows For the Year Ending December 31, 2024 Cash Flow from Operating Activities: Cash collections from customers Cash payments to suppliers Cash payments for wages Cash flows from operating activities

$185,000 (115,000) (55,000) 15,000

Cash Flow from Investing Activities: Purchase of land and building Cash used in investing activities

(200,000) (200,000)

Cash Flow from Financing Activities: Cash proceeds from issuance of shares Cash proceeds from bank loan Cash from financing activities

$ 250,000 50,000 300,000

Increase in cash Cash, beginning of year Cash, end of year

115,000 0 $115,000

LO 5,6 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-15A a.

Date/ Ref. Oct. 1 Oct. 1 Oct. 1 3 4 5 6 7 8 9 10 11 12 13 14 Totals

Cash 175,000 225,000 (75,000)

A/R

Assets Prepaid Rent

Equipment

S/H Equity Common Shares R/E 175,000

(60,000)

Exp

800,000

Rev

(560,000) (86,500) (22,500)* (20,000)** (7,000) 44,000

Exp Exp Exp Exp DD

220,000 90,000 570,000

570,000

720,000 (650,000) (510,000) (560,000)

(82,500) (47,500)

4,000 (25,000) (20,000)

(7,000) 98,000

Rev/Exp/ DD

225,000 75,000 (60,000)

(220,000) (90,000) 80,000 650,000 (510,000)

Inv.

Liabilities Notes A/P Payable

70,000

15,000

100,000

*$225,000 x 10% = $22,500 ** ($220,000 - $20,000) ÷ 10 = $20,000

200,000

64,000

200,000

175,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-15A (Continued) b. Hughes Tools Company Statement of Income For the year ended September 30, 2024 Sales revenue Expenses Cost of goods sold Rent expense Depreciation expense Interest expense Selling and administrative Net income

$800,000 $560,000 60,000 20,000 22,500 86,500

The Hughes Tool Company Statement of Changes in Equity For the year ended September 30, 2024 Share Capital Number of Common Common Shares Shares Balance, Beginning of Year Net income Declaration of dividends 10,000 $175,000 Issuance of common shares 10,000 $175,000 Balance, End of Year

749,000 $ 51,000

Retained Earnings $0 51,000 (7,000) $44,000

Total $0 51,000 (7,000) 175,000 $219,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-15A (Continued) Hughes Tools Company Statement of Financial Position As at September 30, 2024 Assets Cash Accounts receivable Inventory Prepaid rent Equipment Total assets

$ 98,000 70,000 100,000 15,000 200,000 $483,000

Liabilities Accounts payable Notes payable Total liabilities

$ 64,000 200,000 264,000

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

175,000 44,000 * 219,000 $483,000

*Net income – dividends declared = $51,000 – $7,000 = $44,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-15A (Continued) Hughes Tools Company Statement of Cash Flows For the year ended September 30, 2024 Cash flows from operating activities Cash receipts from customers $730,000 Cash paid for inventory (600,000) Cash paid for interest (22,500) Cash paid for selling and administrative expenses (82,500) Cash paid for rent (75,000) Cash used in operating activities

$(50,000)

Cash flows from investing activities Purchase of equipment

(220,000)

Cash flows from financing activities Issuance of shares Issuance of note payable Repayment of note payable Payment of dividends Cash from financing activities Increase in cash Cash, beginning of the year Cash, end of the year

175,000 225,000 (25,000) (7,000) 368,000 98,000 0 $98,000

c. The results of the first year of operations are generally very good. The sales are excellent, with a healthy profit margin ($51,000/$800,000) 6.4%, and the business has a very substantial cash balance. However, cash flow from operations is negative, which may be a cause for concern. The company’s return on assets measures 10.6% ($51,000/$483,000) and their return on equity comes in at 23.3% ($51,000/$219,000). As it is their first year of operations, we will want to compare these results to industry averages to have a better understanding of this company’s performance. LO 5,6,7 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-1B a. R b. F c. F d. R e. R f. F LO 2 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP2-2B i. (a) No effect on the statement of income (b) No effect on the statement of income ii. (a) Revenue recorded $80,000 ($100,000 x 80%) and an increase to net income of $80,000 (b) Revenue recorded $100,000, Cost of Goods Sold recorded $60,000 and an increase to net income of $40,000 iii. (a) Revenue recorded $20,000 and an increase to net income of $20,000 (b) No effect on the statement of income iv. (a) Expenses recorded $13,000 and a decrease to net income of $13,000 (b) Expenses recorded $12,000 and a decrease to net income of $12,000 v. (a) Expenses recorded $5,500 and a decrease to net income of $5,500 (b) Expenses recorded $5,000 and a decrease to net income of $5,000 vi. (a) Expenses recorded $37,500 and a decrease to net income of $37,500 (b) Expenses recorded $38,000 and a decrease to net income of $38,000 Summary of results on the next page

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-2B (Continued) Summary of results: (a) Cash Basis Revenue i. ii. iii. iv. v. vi.

$80,000 20,000

$100,000 Net income

(b) Accrual Basis

Expenses

Revenue

$ 13,000 5,500 37,500 $56,000

i. ii. $100,000 iii. iv. v. vi. $100,000

$44,000

Loss

*($100,000 x 80%) = $80,000 LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Expenses $60,000 12,000 5,000 38,000 $115,000 ($15,000)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-3B

a. Increase assets (equipment) and decrease assets (cash) b. Increase assets (cash) and increase liabilities (bank loan payable) c. Increase assets (inventory) and increase liabilities (accounts payable) d. Increase assets (cash) and increase shareholders’ equity (sales revenue increases, which increases retained earnings) e. Decrease assets (cash) and decrease liabilities (accounts payable) f. Increase liabilities (wages payable) and decrease shareholders’ equity (wages expenses increases, which decreases retained earnings) g. Decrease assets (cash) and decrease shareholders’ equity (interest expense increases, which decreases retained earnings) h. Decrease assets (cash) and decrease liabilities (bank loan payable) i. Decrease assets (cash) and decrease liabilities (wages payable) j. Increase assets (inventory) and increase liabilities (accounts payable) k. Decrease assets (cash) and decrease in shareholders’ equity (utilities expense increases, which decreases retained earnings) l. Decrease assets (increases accumulated depreciation, which is a contra asset) and decrease shareholders' equity (increases depreciation expense, which decreases retained earnings)

LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-4B

Account a. Cash (A) Common Shares (SE) b. Land (A) Cash (A) c. Inventory (A) Accounts Payable (L) d. Equipment (A) Cash (A) e. Prepaid Insurance (A) Cash (A) f. Advertising Expense (SE) Accounts Payable (L) g. Accounts Receivable (A) Sales Revenue (SE) Cost of Goods Sold (SE) Inventory (A) h. Accounts payable (L) Cash (A) i. Accounts Payable (L) Cash (A) j. Cash (A) Accounts Receivable (A) k. Insurance Expense (SE) Prepaid Insurance (A) l. Depreciation Expense (SE) Accumulated Depreciation (CA)

Increase/Decrease Increase Increase* Increase Decrease Increase Increase Increase Decrease Increase Decrease Increase** Increase Increase Increase* Increase** Decrease Decrease Decrease Decrease Decrease Increase Decrease Increase** Decrease Increase** Increase***

* Increase in Shareholders’ Equity ** Decrease in Shareholders’ Equity *** Decrease in Assets LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-5B Assets Date Sept 1 4 7 9 15 19 20 21

Cash 20,000 10,000 (4,500)

A/R

Delivery Van

2,500

4,000 2,100 (15,000)

4,000

(1,800)

(700)

(400)

(150)

2,100 (2,700)

(2,700) 15,000 (1,800) (700)

400 (150) 2,200

R/E/DD

4,500

29 30 30

Equip.

2,500

28 28

Inv.

Liabilities S/H Equity Bank Loan Common A/P Payable Shares R/E 20,000 10,000

(2,200)

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-6B Assets Date Jan 1 1 2 8 12 16:1 16:2 19 25 31:1 31:2

Cash 150,000 100,000 (8,000)

A/R

Inv.

Prepaid Rent

A/P

Liabilities Deferred Revenue

Loan Payable

R/E/ DD

100,000 5,000 26,200

6,500 9,100

(3,000)

18,200 (9,200)

R E

(750)

26,200 6,500

9,100 (9,200)

(7,000) 7,100 (5,000) (750)*

S/H Equity Common Shares R/E 150,000

(7,000) (7,100)

*$100,000 x 9% x 1/12 = $750 LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

(5,000)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-7B Transaction a. b. c. d. e.

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

Effect on Net Earnings (i) No effect No effect No effect Decrease of $1,200 (Advertising expense) Net increase of $26,300 (Sales of $38,200 less Cost of goods sold of $11,900) No effect Decrease of $5,000 (Wages expense) No effect No effect Decrease of $900 (Interest expense) Decrease of $2,000 (Depreciation expense) Decrease of $300 (Interest expense)

Effect on cash flows (ii) Increase of $125,000 Decrease of $40,000 No effect Decrease of $1,200 No effect (sold on account, inventory already owned Decrease of $20,000 Decrease of $5,000 Increase of $26,400 Decrease of $2,000 Decrease of $2,900 No effect No effect

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-8B

Assets

Date/Ref. a b c d e:1 e:2 f g h i j

Cash 250,000 100,000 (178,000) (50,000) 46,000

A/R

Inv.

Liabilities

Equip.

A/P

Dividends Payable

S/H Equity Loan Payable

Common Shares 250,000

R/E

Rev/Exp/ DD

92,000 (49,000)

Rev Exp

(3,700) (1,200) (22,600) (8,000)

Exp Exp Exp DD

100,000 178,000 75,000

25,000

46,000 (49,000)

(20,000) (3,700) (5,200)

(20,000) (4,000) (22,600) 8,000

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-9B

Assets Date /Ref a b c d e f g h i j k l *

Cash (10,000)

A/R

Inv.

Prepaid Insurance

Equip. 10,000

42,000 24,000 34,000 (36,000) (900)

Liabilities Dividends A/P Payable

S/H Equity Common Shares R/E

Rev/Exp/ DD

42,000

36,000 (34,000)

60,000

Rev

(39,000) (7,000) (675) (3,600) (1,600)

Exp Exp Exp Exp DD

(36,000) 900 (39,000)

(7,000) (675)* (3,600) (1,200)

$900/12 = $75 per month; $75 x 9 months (i.e. Apr.-Dec.) = $675

LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

1,600 (1,200)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-10B A Revenue – Net Earnings = Expenses $123,000 – $45,000 = $78,000 B Dividends declared = Retained earnings, beginning of the year + Net Earnings – Retained Earnings, end of year = $278,000 + $45,000 - $311,000 = $12,000 C Total assets, end of the year = Total Liabilities, end of the year + Total Common Shares, end of the year + Total Retained Earnings, end of the year = $408,000 + $150,000 + $311,000 = $869,000 D Proceeds from common shares issued during the year = Common shares, end of the year – Common shares, beginning of the year = $150,000 $100,000 = $50,000 E Revenues = Net earnings + Expenses = $77,000 + $158,000 = $235,000 F Retained earnings, end of year = Retained earnings, beginning of the year + Net earnings – Dividends declared = $321,000 + $77,000 – $20,000 = $378,000 G Common shares, end of year = Assets, end of year – Liabilities, end of year – Retained earnings, end of year (solved in F) = $726,000 - $273,000 $378,000 = $75,000 H Proceeds from common shares issued during the year = Common shares, end of the year (solved in G) – Common shares, beginning of the year = $75,000 - $50,000 = $25,000 LO 6 BT: AP Difficulty: C Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-11B a. Total revenues: $510,000 + $1,800 + $2,600 = $514,400 b. Total expenses: $364,000 + $43,700 + $38,000 + $200 + $22,700 = $468,600 c. Net earnings:

$514,400 - $468,600 = $45,800

d. Dividends declared: $145,000 + $45,800 - $185,500 = $5,300

Alternate: Beg. R/E + net income – dividends declared = End R/E $145,000 + $45,800 - ? (div. decl.) = $185,500 $190,800 - ? (div. decl.) = $185,500 ? (div. decl.) = $190,800 - $185,500 Therefore, dividends declared = $5,300 LO 6 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-12B a. i.

Sales revenue = $9,000 (#5)

ii. Cost of goods sold = $6,000 (#4) iii. Total expenses other than cost of good sold = $100 (#6) + $200 (#7) + $1,900 (#8) = $2,200 iv. Net earnings = $9,000 - $6,000 - $2,200 = $800 b. i.

Cash on hand: $15,000 (#1) - $4,000 (#2) - $500 (#3) - $3,000 (#4) + $4,500 (#5) - $1,900 (#8) - $300 (#9) = $9,800

ii.

Total assets other than cash: $12,000 (#1) + $4,000 (#2) + $500 (#3) + $6,000 (#4) - $6,000 (#5) + 4,500 (#5) - $100 (#6) - $200 (#7) = $20,700 Alternate: Equipment = $12,000 + $4,000 - $200 = $15,800 Supplies = $500 - $100 (#6) = $400 Inventory = $6,000 - $6,000 = 0 Accounts receivable = $4,500 (#2) Total assets other than cash = $15,800 + $300 + $4,500 = $20,700 iii. Total liabilities: $6,000 - $3,000 = $3,000

iv. Share capital: $15,000 + $12,000 = $27,000 v. Retained earnings: $0 + $800 - $300 = $500

LO 6 BT: AP Difficulty: C Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-13B a. Insomniacs Coffee Ltd. Statement of Income For the year ended December 31, 2024 Sales revenue Less expenses: Cost of goods sold Wages expense Rent expense Advertising expense Depreciation expense Interest expense Total expenses

$2,910,000

$1,650,000 510,000 180,000 78,000 82,000 42,000 2,542,000

Net Income

$ 368,000

Retained Earnings at January 1, 2024 Plus: Net Income Less: dividends declared

$410,000 368,000 180,000

Retained earnings at December 31, 2024

$598,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-13B (Continued) c. Insomniacs Coffee Ltd. Statement of Financial Position As at December 31, 2024 ASSETS Current assets Cash Accounts receivable Inventory Prepaid Insurance

$ 120,000 185,000 305,000 23,000 633,000

Non-current assets Equipment

1,240,000

Total Assets

$1,873,000

LIABILITIES & SHAREHOLDERS’ EQUITY Current liabilities Accounts payable $340,000 Wages payable 45,000 385,000 Non current liabilities Loan Payable 790,000 Total liabilities Shareholders’ equity

1,175,000

Common shares Retained earnings Total Shareholders’ Equity

$ 100,000 598,000 698,000

Total Liabilities and Shareholders’ Equity

$1,873,000

LO 6 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14B a. Assets Date/ Ref.

Cash

Jan. 1

700,000

Jan. 1

250,000

Jan. 3

(700,000)

(90,000)

155,000

A/R

Inv.

Liabilities

Buildings

Land

A/P

Wages Payable

Dividend Payable

S/H Equity Loan Payable

Common Shares

(95,000)

(91,800)

(15,000)*

300,000

Total

237,700

Exp

(96,000)

Exp

(15,000)

Exp

(35,000)

Exp

(15,000)

100,000

155,000 (132,000) (95,000) 4,200 (35,000)**

(7,500)

(128,000)

400,000

190,000

11 12

Rev

250,000

(128,000) 132,000

310,000

700,000

6 7

R/E

Rev/ Exp/ DD

7,500 23,000

62,000

265,000

*$250,000 x 6% = $15,000 ** ($300,000 - $ 20,000) ÷ 8 = $35,000

400,000

5,000

4,200

7,500

250,000

700,000

21,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14B (Continued)

a. Moksh Ltd. Statement of Income For the Year Ending December 31, 2024 Revenues Sales revenue Expenses Cost of goods sold Wages expense Interest expense Depreciation expense Net income

$310,000

$128,000 96,000 15,000 35,000

274,000 $ 36,000

Moksh Ltd. Statement of Changes in Equity For the year ended December 31, 2024 Number Share of Capital Retained Common Common Earnings Shares Shares Balance, Beginning of Year $0 Net Income 36,000 Declaration of Dividends (15,000) Issuance of Common Shares 10,000 $700,000 Balance, End of Year 10,000 $700,000 $21,000

Total $0 36,000 (15,000) 700,000 $721,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14B (Continued) Moksh Ltd. Statement of Financial Position As at December 31, 2024 ASSETS Cash Accounts Receivable Inventory Land Building TOTAL ASSETS LIABILITIES Accounts Payable Wages Payable Dividends Payable Bank Loan Payable TOTAL LIABILITIES

$237,700 23,000 62,000 400,000 265,000 $987,700

5,000 4,200 7,500 250,000 266,700

SHAREHOLDERS’ EQUITY Common Shares Retained Earnings TOTAL SHAREHOLDERS’ EQUITY

$721,000

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$987,700

700,000 21,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-14B (Continued) Moksh Ltd Statement of Cash Flows For the Year Ending December 31, 2024 Cash Flow from Operating Activities: Cash collections from customers Cash payments to suppliers Cash payments for wages Cash payments for interest Cash flows from operating activities

$287,000 (185,000) (91,800) (15,000) (4,800)

Cash Flow from Investing Activities: Purchase of land and building Cash used in investing activities

(700,000) (700,000)

Cash Flow from Financing Activities: Cash proceeds from issuance of shares Cash proceeds from bank loan Cash paid for dividends Cash from financing activities

700,000 250,000 (7,500) 942,500

Increase in cash Cash, beginning of year Cash, end of year

237,700 0 $237,700

LO 5,6 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-15B a. Assets Date/ Ref.

Cash

Jan.11

300,000

Jan.12

(80,000)

Item 3 3

30,000

July 1

(60,000)

A/R

Land

Building

57,500

Deferred Revenue

(205,000)

Item 9

200,000

Item 10

Notes Payable

Common Shares

(50,000)

R/E/DD

22,500

300,000

(190,000)

(50,000)

(7,125)

(5,750)

(20,000)

(3,000)

60,000 250,000

250,000

(205,000) (200,000)

(7,125)

Item 125

(5,750) (15,000)

5,000

Item 146

3,000 170,000

R/E

150,000

120,000

Item 114

Dividends Payable

(190,000)

Item 8

Totals

Interest Payable

172,500

250,000 50,000

A/P

7,500

Item 7

Item 13

Equipment

S/H Equity

300,000

Item 5 Item 6

Inventory

Liabilities

50,000

60,000

57,500

165,375

114,250

45,000

7,500

3,000

5,000

60,000

450,000

46,625

2 (12,000 x $25) = $300,000 (6,000 x $25) = $150,000 + $80,000 = $230,000 x ¼ for land = $57,500 3 4 (4 X $7,500) = $30,000 ($172,500 – $30,000) ÷ 20 = $7,125 5 ($120,000 – $5,000) ÷ 10 x 6/12 = $5,750 6 $60,000 x 10% x 6/12 = $3,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-15B (Continued) b. A.J. Smith Company Statement of Income For the year ended December 31, 2024 Sales revenue Rent revenue Total revenues Expenses Cost of goods sold Depreciation expense Interest expense Operating expenses Net income

$300,000 22,500 $322,500 $190,000 12,875 3,000 50,000

255,875 $ 66,625

A. J. Smith Company Statement of Changes in Equity For the year ended December 31, 2024 Number of Share Capital Common - Common Retained Shares Shares Earnings Total Balance, Beginning of Year $0 $0 Net Income 66,625 66,625 Declaration of Dividends (20,000) (20,000) Issuance of Common Shares 12,000 $300,000 300,000 Issuance of Common Shares 6,000 150,000 150,000 Balance, End of Year 18,000 $450,000 $46,625 $496,625

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-15B (Continued)

A.J. Smith Company Statement of Financial Position As at December 31, 2024 Assets Cash Accounts receivable Inventory Land Buildings Equipment Total assets

$170,000 50,000 60,000 57,500 165,375 114,250 $617,125

Liabilities Accounts payable Notes payable Interest payable Deferred revenue Dividends payable Total liabilities

$ 45,000 60,000 3,000 7,500 5,000 120,500

Shareholders’ Equity Common shares Retained earnings Total retained earnings Total liabilities and shareholders’ equity

$450,000 46,625 496,625 $617,125

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP2-15B (Continued) A.J. Smith Company Statement of Cash Flows For the year ended December 31, 2024 Cash flows from operating activities Cash receipts from customers Cash receipts from rent revenue Cash paid for inventory Cash paid for operating expenses Cash from operating activities

$250,000 30,000 (205,000) (50,000) $25,000

Cash flows from investing activities Purchase of property, plant & equipment

(140,000)

Cash flows from financing activities Issuance of common shares Payment of dividends Cash from financing activities Increase in cash Beginning cash balance Ending cash balance

300,000 (15,000) 285,000 $170,000 0 $170,000

c. Students should utilize the three performance measures introduced in the chapter: Profit margin ratio (using total revenues): $66,625/$322,500 = 20.7% Return on Assets: $66,625/$617,125 = 10.8% Return on Equity: $66,625/$496,625 = 13.4% Ideally, they should consider these numbers with respect to industry averages; however, these are not provided. Students should also identify from the cash flow statement that positive cash flows were generated from operating activities, which is a good sign – especially in the company’s first year of operations. LO 5,6,7 BT: AP Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP 2-1 Most public companies operate internationally and a significant number of them are also cross-listed, meaning that they are listed on stock exchanges both inside and outside of Canada. IFRS, a common set of financial reporting standards, was developed to minimize the differences in financial reporting across countries and to reduce the need for companies to generate different sets of financial information in each country in which they operate or raise funds. ASPE, on the other hand, represents a set of simplified standards that Canadian standards setters have established to reduce the financial reporting burden for private companies. The objective of both IFRS and ASPE is to produce financial reporting that is useful to the financial statement users. Both IFRS and ASPE focus on the needs of shareholders (current and potential) and creditors in determining the financial information that would be useful. Specifically, the standards’ aim is to provide financial information that assists these two user groups in making decisions about providing resources to the reporting company, such as whether they should buy or sell the reporting company’s shares, and whether they should extend credit to the reporting company. The needs of these two user groups often correspond with the needs of other users, such as employees, unions, and governments, but they may not completely overlap. LO1 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP2-2

Companies who are dual-listed on the TSX and NYSE have a choice to use IFRS or U.S. GAAP. It is likely that the company using IFRS is a Canadian-based company which is filing on both exchanges and doesn’t want to prepare two different sets of financial statements. They may want to be able to compare their results with other companies using IFRS to prepare their financial statements. Conversely, it is likely that the company using U.S. GAAP is a company dealing mainly in Canada and in the U.S. with predominantly U.S. competitors against which it wants to benchmark against. LO1 BT: C Difficulty: C Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP2-3

Following are some suitable answers. There may be other valid responses. I would like to know how the additional funds will be used by the borrower. If the business demonstrates that it will be able to increase profitability and cash flows from operations from the use of the additional funds, the request will be viewed in a positive light. I would want to know how much profit the company has made to date. I would look at retained earnings for this information. I would want to know if past sales levels and profits are sustainable in the future. I would also look at the company’s current and non-current liabilities to find out what other obligations the company currently has that require repayment. I would want to know whether the company was paying its current loan payments on schedule. I would look at the mix between liabilities and equity to determine how the company has funded its operations so far. I would want to know how much was funded through debt and how much was funded through investments from shareholders. I would want to know what capital assets the company owns, and the age and condition of those assets to determine whether they will need replacing in the near future. If they do, that could possibly compromise the company’s ability to use them to generate revenue. I could determine the age of the assets by looking at their original cost vs. the amount of cost that has been depreciated to date. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP2-4 a. From the perspective of a shareholder of the company, treating the cost of a piece of equipment as an expense at the date of purchase will misstate net income in the current period as well as in future periods. The current period’s income would be understated because the full cost of the equipment would be deducted in the current period rather than being depreciated and allocated to each of the future periods in which it is expected to help generate revenue (i.e. the estimated useful life of the asset). Future periods’ income will be overstated since there will be revenue shown in those periods, but no expense related to the cost of the equipment being used to generate the revenue. In addition, there would be no equipment on the statement of financial position. b. From the perspective of a buyer, the concern would be the equipment would not be listed on the statement of financial position of the company (since it would already have been expensed). In attempting to value the assets of the company, the buyer would have to recognize that there are some assets that do not appear on the statement of financial position, but should be considered in valuing the company. In addition, the balance of retained earnings would be lower because the full cost of the equipment had been charged to an expense at its purchase. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP2-5

When the cash is received in August, the university would record a liability, deferred revenue. As each month passes, a portion of the deferred revenue would be recognized as revenue, thus decreasing the liability and increasing retained earnings. The university would recognize the revenue evenly over the months of September through December, as the tuition would cover the December exam period. LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP2-6

The statement of income and the statement of financial position are both prepared using accrual accounting. These financial statements may show strong earnings, yet the company may have problems making loan payments if most of its sales were on credit, and if it then has problems collecting from its customers. By comparing the current and previous statement of financial position, a user can see the change in cash from the beginning of the year to the end of the year. There may be a very small change; however there may be thousands of cash transactions during the year. The statement of cash flows categorizes all cash transactions into operating, investing, and financing activities. This allows the user to determine where cash is coming from and where it is going. It is particularly important to know whether the company can pay for its current obligations to vendors and employees through cash generated from operations. If the company has to sell its property, plant and equipment in order to pay for its operating expenses, then the company may be in serious jeopardy of not being able to continue. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: : Communication CPA: cpa-t001 CM: Reporting

UP2-7

Many businesses are required to sell on account, in order to remain competitive. If revenue were calculated from the cash flow inflows from sales revenue, a great deal of revenue still receivable would not be included, understating net income. Similarly, businesses deal with suppliers on account. If expenses were calculated based on the cash outflows related to expenses, several expenses would be omitted as they were incurred on account or require payment later than the date they are incurred. This would cause net income to be overstated. Overall, the cash basis is not a true reflection of the activities of the business for a given period of time. The best way to calculate net income is to use the accrual basis of accounting. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP2-8

I would tell my friend NOT to invest in this company because it is not generating enough cash from operations (i.e. it has negative cash flows from operating activities) to cover its operating expenses. It appears that the company is selling its property, plant and equipment (i.e. it has positive cash flows from investing activities). The normal balance for investing should be negative, indicating that the company is using cash to acquire property, plant and equipment to grow its business and increase its operating profits. A company that sells its property, plant and equipment may soon have to go out of business as it has no means to generate income. Similarly, an increase in cash from financing activities indicates that the company is borrowing money or is obtaining financing from shareholders through the issuance of shares to generate enough cash to continue operations. LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP2-9

This company is not generating enough cash from operations (i.e. it has negative cash flows from operating activities) to cover its operating expenses. It appears that the company is purchasing property, plant and equipment (i.e. it has negative cash flow from investing activities) which is a good thing as it indicates that the company is using cash to acquire property, plant and equipment to grow its business and increase its operating profits in the future. The purchases of this property required financing, which is confirmed by the increase in cash from financing activities. It appears that the company is either a new company in a growth phase and able to attract capital (in which case it may be a good time to accept the job), or it is an older company with declining operations that is still able to secure new financing (in which case you may want to consider the company’s ability to turn its operations around and its ability to continue to secure additional financing before deciding whether to accept the job). LO 6 BT: C Difficulty: C Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Work in Progress WIP2-1

“If the company followed the cash basis of accounting, it would recognize $500 after the initial meeting as the company has received the cash. The remaining $700 would be recognized when the cash is received from the client.” “If the company followed the accrual basis of accounting, it would recognize $1,200 as revenue when the client is billed. At this point, the revenue has been earned.” The deposit of $500 would be recorded as deferred revenue until the will is satisfactory for the client.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP2-2

Shareholders’ equity is the residual amount that remains when total liabilities are subtracted from total assets. It represents a company’s net assets. It is the shareholder’s claim on the company. Shareholders’ equity is not money since money (cash) as it includes all of the various assets of a company (cash, accounts receivable, inventory, equipment etc.) If a company’s assets are liquidated, the cash received would likely be different than the amount that the assets are carried at on the statement of financial position.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP2-3

The statement: “Companies that have a large amount of retained earnings have been profitable” is correct. The statement “They should distribute the retained earnings as dividends, or pay off any debt, or invest the amount to generate some extra income for the company” is incorrect. Retained earnings are not cash so it can’t be used to pay off debt and dividends can only be declared and paid if there is cash available. Retained earnings are earnings that have been retained in the company so they do represent a reinvestment of earnings into the company but again they do not represent cash, which is an asset.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP2-4

Companies can generate cash to pay for purchases of land, building, equipment and inventory in two ways: borrow money or issue shares. So if the company has a low debt balance, it likely has issued shares for cash to finance its significant purchases or it used cash earnings from prior periods to fund the purchase.

LO 7 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI2-1: Nutrien Ltd. All dollar amounts are expressed in millions of US dollars. a.

Growth from fiscal year 2019 to 2020.

Sales

+4.1%

($20,908 – $20,084) / $20,084

Cost of goods +7.2% sold Net earnings -53.7%

($14,814 – $13,814) / $13,814

iii.

($459 – $992) / $992

iv. Total assets

+0.8%

($47,192 – $46,799) / $46,799

-2.2%

($22,365 – $22,869) / $22,869

Total shareholders’ equity

We would not generally expect all of these accounts to grow at the same rate for a variety of reasons. For example: • Sales can increase from an aggressive pricing policy or as a result of increased spending on marketing and advertising, which would normally each lead to a higher profit as a percentage of sales. • Cost of goods sold increased at a higher rate than sales, indicating that some cost savings or efficiencies were not achieved. Overall net earnings decreased by 53.7% because of increased cost of goods sold and expenses from operations. • The increase in sales outpaced the increase in total assets. • Equity balances are affected by the issuance or repurchase of shares, by the rate of profitability, and by the dividend policy, among other things. Nutrien bought back shares in 2020, decreasing the company’s share capital by US$98 million ($15,771 – $15,673). Dividends declared were greater in amount than net earnings resulting in a decrease in retained earnings by US$495 million ($7,101 - $6,606), a 7.5% decrease.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-1(Continued) Nutrien is in a phase of modest growth. Additional information, especially in the Management Discussion and Analysis section of the annual report, should help to clarify the meaning of these changes and the prospects for further growth. b.

Total liabilities Total shareholders’ equity Total Assets

2020 $24,827 22,365 $47,192

52.6% 47.4% 100%

2019 $23,930 51.1% 22,869 48.9% $46,799 100%

The equity investors financed less of the company in 2020 than they did in 2019. In 2019, equity investors had financed 48.9% of the company’s assets. In 2020, this ratio decreased to 47.4%. c. (Note: ratios are computed using ending equity and assets, and interest expense is not added back to income for the ROA calculation, as that concept has not been introduced in the text). 2020 Profit margin $459/$20,908 = 2.2% ROA $459/$47,192 = 1.0% ROE $459/$22,365 = 2.1%

2019 $992/$20,084 = 4.9% $992/$46,799 = 2.1% $992/$22,869 = 4.3%

These ratios each indicate a negative change in performance, with all ratios deteriorating significantly. The issue revolves around a substantial increase in cost of goods sold (7.2%) compared to a modest increase in sales (4.1%). Comments could include: • Pricing pressures could have been the cause of the decline in gross profit. • Beyond the decline in gross profit there were substantial increases in operating expenses from 2019 to 2020.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-1(Continued) • Return on assets and return on equity align with the previous two indicators, reducing more than half from 2019 to 2020. • The results from part (a) do help interpret the ratios in part (c) because where we see a decline in net earnings year over year we would expect to see a corresponding decreased ROA and ROE. LO 7 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting and Finance

RI2-2: High Liner Foods All dollar amounts are expressed in thousands of US dollars. a. The $112,739 in common shares represent the net proceeds received from shareholders at the time the shares were issued. b. The $183,649 in retained earnings represents the cumulative lifetime income that the company has earned, less all dividends paid out during that period. In other words, it represents the company’s cumulative earnings that have been retained and reinvested in the company, rather than being distributed to shareholders as dividends. c. 2020: $485,556 / $776,558 = 62.5% 2019: $552,324 / $820,494 = 67.3% There is a decrease in the percentage of High Liner’s assets that were financed by creditors. d. Total assets decreased slightly $776,558 in 2020 from $820,494 in 2019. This decrease of $43,936 (5.4%) comes largely from inventory and accounts receivable. e. If High Liner were to pay the income taxes payable, both assets and liabilities would decrease by the same amount and shareholders’ equity would not change. The expense related to these income taxes has already been recognized (i.e. it was recorded at the same time as the payable). The basic accounting equation would remain in balance.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-2 (Continued) f. Gross Profit Percent 2020 2019

$177,924 / $827,453 = 21.5% $185,860 / $942,224 = 19.7%

High Liner’s gross profit was higher in 2020 relative to 2019. Sales have decreased, however, cost of sales has decreased by a greater percentage. The company is making slightly more gross profit on each dollar of sales revenue. g. Geographic information for sales:

Location Outside of Canada Canada Total

Sales 2020 $626.2 201.3 $827.5

Sales As a 2019 Decrease % $712.4 $ 86.2 12.1% 229.8 28.5 12.4% $942.2 $114.7 12.2%

As a percentage, High Liner’s outside of Canada operations suffered a slightly reduced decline in sales compared to the operations in Canada. In dollars, the outside of Canada segment is more than three times the size of the Canadian segment. LO 4,7 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-3: Maple Leaf Foods Inc. All dollars amounts are expressed in thousands of Canadian dollars. a. At December 31, 2020, Maple Leaf Foods Inc. had $100,828 cash and cash equivalents available to use. b. 2020: 2019:

$1,932,466 / $3,860,205 = 50.1% $1,949,870 / $3,514,035 = 55.5%

The percentage of Maple Leaf Food’s assets financed by shareholders decreased by 5.4% in 2020. This trend means that the company’s creditors financed a greater proportion of the company’s assets than in the previous year. c. Accounts receivable increased by ($159,750 - $154,969) $4,781 (3.1%). Sales increased by ($4,303,722 - $3,941,545) $362,177 or (9.2%). This may mean that credit sales have increased slower than sales, that customers are taking less time to pay, or that credit terms have changed. d. Gross profit: 2020: $703,053 / $4,303,722 = 16.3% 2019: $590,979 / $3,941,545 = 15.0% The gross profit has improved substantially in 2020. Increases in gross profit can be generated through increases is sales prices or through efficiency in the production of the meat products sold.

e. The financing section of the statement of cash flows shows $78,932 of dividends paid in 2020.

f. The company acquired $432,540 of long-term assets. The proceeds from the sale of long-term assets were in the amount of $37,373. The proceeds represent 8.6% of the amount of the purchases.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-3 (Continued) g. i. Profit margin: 2020 $113,277 / $4,303,722 = 2.6% 2019 $74,628 / $3,941,545 = 1.9% ii. ROA

2020 $113,277 / $3,860,205 = 2.9% 2019 $74,628 / $3,514,035 = 2.1%

iii. ROE

2020 $113,277 / $1,932,464 = 5.9% 2019 $74,628 / $1,949,870 = 3.8%

h. These ratios indicate major increases in the margins and returns realized, which is consistent with the increase in sales of 9.2% ($4,303,722 – $3,941,545) / $3,941,545 and the increase in gross profit discussed in d. above. LO 7 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-4: Sleep Country Canada Holdings Inc. All dollars amounts are express in thousands of Canadian dollars). a. The amount of dividends declared during fiscal 2020, as shown in the statement of changes in shareholders’ equity, was $13,627. b. The declaration of dividends affects the accounting equation by reducing shareholders equity and increasing liabilities (i.e. dividends payable) by the amount of the dividends declared. c. The amount of dividends actually paid during fiscal 2020 was $13,627, as shown on the statement of cash flows. d. The payment of dividends affects the accounting equation by reducing cash by the amount paid and reducing the dividends payable liability by the same amount. e. Gross profit margin on sales:

Revenues Cost of Sales Gross Profit

2020 $757,699 513,203 $244,496 32.3%

2019 $712,372 489,082 $223,290 31.3%

The gross profit margin increased by 1.0%, meaning that the company’s gross margin on sales improved from 2019 to 2020. Based on these calculations, we see that the company’s product costs represented about $0.68 for every $1 sales. f. Sleep Country’s cash flow pattern in 2020 was +/-/-, which fits the “normal” pattern discussed in the chapter for a company that pays dividends and is investing in property, plant and equipment. LO 4,7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI2-5 Answers to this question will depend on the company selected. LO 7 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C2-1a. Cash 1 2 3 4 5 6 7 8 9 Total

A/R

Car

1,800 3,000 (3,000) (623)

Interest Payable

A/P

Loan Parents

Loan - Car

Common Shares 1,800

3,000 8,000

5,000 (500) 60

(6,000) (9,600) 19,200 4,777

R/E

100 300 300

(2,000) 6,000

100

60 11,077

3,000

Depreciation calculation: ($8,000 - $6,000) Interest expense on loan from parents: $3,000 x 6% x 4 / 12 = $60

4,500

1,800

(123) E - Int (60) E - Int (6,000) E - Wages (9,700) E - Op 19,500 R (2,000) E - Dep 1,617 11,077

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-1 (Continued) Wroad Wrunner Ltd. Statement of Income For the four months ending August 31, 2XXX Revenue Expenses: Interest expense – Loan from parents Interest expense – Car loan Wages expense Operating expenses Depreciation expense

$ 19,500 $

60 123 6,000 9,700 2,000 17,883 $ 1,617

Net income

Wroad Wrunner Ltd. Statement of Financial Position As at August 31, 2XXX Assets: Cash Accounts Receivable Car Total Assets

$ 4,777 300 6,000 $11,077

Liabilities: Accounts Payable Interest Payable Notes Payable Loan Payable – Car Total Liabilities Shareholder's Equity: Common Shares Retained Earnings Total Shareholder’s Equity Total Liabilities and Shareholder’s Equity

100 60 3,000 4,500 $ 7,660

1,800 1,617 3,417 $11,077

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-1 (Continued) b. Profit Margin = Net earnings / Total revenues Profit margin = $1,617 / $19,500 = 8.3% Wroad Wrunner Ltd. made $1,617 before income taxes in the first four months of operation, which is quite impressive – especially in light of the small amount she invested in the business. This profit is after Nola paying $6,000 in wages to herself. c. Nola presently owes $7,660 as of August 31. If she sells the car for $6,000, collects the outstanding receivables and uses the existing cash of $4,777, Nola would have more than enough money to pay off all her liabilities. In fact, she would have $1,617 (the shareholder’s equity) left over. LO5,6,7 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-2

Daisy-Fresh Dry Cleaning 1. The payment of the insurance policy should have been recorded as a prepaid expense when it was purchased. A prepaid expense is a current asset because there is a future benefit associated with the policy. As the year progresses, the benefits of the policy are used up because the company has been provided with insurance coverage for that time period. As the benefits of the policy expire, the related costs should be expensed. At the end of the first year, one-third of the three-year policy would have expired; therefore, one-third of the policy costs should be expensed. The remaining two-thirds should remain as a prepaid expense on the asset side of the statement of financial position. 2. The full amount of the cost of the new dry-cleaning machine ($10,000) should have been recorded as an asset when it was purchased. As time passes and the machine is used, it should be depreciated as an expense on the statement of income which would reduce the carrying value of the machine on the statement of financial position. The machine's depreciation expense should be reported in the same period in which it is used to help generate revenue. Using straight-line depreciation would result in an expense of $800 for the current year ([$10,000 - $2,000] / 5 * 6/12 = $800) 3. The company should report all future claims on its assets even when those claims don’t become due for four years. The loan should be recorded as a long-term liability until the end of the third year, at which point it becomes a current liability, payable within the normal operating year of the company. Recording the loan on the books now provides a complete listing of total liabilities owed by the organization. 4. The interest on the loan to the bank should be recorded in the period in which it is incurred. Even though the owner did not yet pay any of the interest, there is an obligation to pay the interest in the near future, thus there is a claim on the assets of the company that should be recorded in the financial statements. The company should report an interest expense on the statement of income and an interest payable on the statement of financial position, as a current liability.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-2 (Continued) 5. Dividends represent a distribution of profits to the shareholders. Dividends are not recorded as an expense but rather directly reduce the retained earnings of the business. Because dividends are a distribution of profit and not an expense, their payment should not be reported on the statement of income. The payment of dividends appears on the statement of retained earnings (ASPE) or the statement of changes in equity (IFRS), and as a financing activity on the statement of cash flows. LO 5,6 BT: C Difficulty: M Time: 25 min. AACSB: : Communication CPA: cpa-t001 CM: Reporting

C2-3 Mega Manufacturing Mega Manufacturing appears to be improving its financial position to be more In line with the performance of other companies in the same industry. Profit margin has decreased in the past year, which indicates that the level of profit generated by each dollar of sales revenue declined. The company remains well above the industry average. Currently the company is able to generate a return of 10% on its assets. This means that for every $100 invested in assets the company is able to generate profits of $10. The company appears to be performing slightly below the average for companies in the industry, but has improved these results in the last year. Finally, the return on equity ratio compares the profits earned in the business to the amount invested by shareholders. Shareholders will use this ratio to evaluate the ability of the business to provide them with an acceptable return on their investment. Investors will often compare the return on equity for businesses of similar risk to make decisions about buying new shares or selling their existing shares. With a return on shareholders’ equity of 12%, Mega Manufacturing is providing investors with a return that is below the industry average. The 2% increase over the past year should make this company an attractive investment, especially if it continues to increase and it becomes closer to the industry average. LO7 BT: AN Difficulty: C Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-4 Canadian Cookies and Cakes Ltd. Assets

Liabilities

Date/

S/H Equity

Interest

Ref.

Cash

1:1

30,000

1:2

(10,000)

1:3

30,000

Supplies

42,000

2:2

(33,600) (37,000)

3:1

(12,000)

3:2

(46,000)

(27,000)

A/P

Payable

Bank Loan

Common Shares

98,000

Totals

12,500

(33,600)

(12,000)

(30,000)

(1,600)

(15,000)

98,000

(37,000) 46,000 3,000 1,600

(13,500)

R/E/DD

42,000

5 6

R/E

30,000

2:1 2:3

Equipment

1,500 8,400

46,000 66,900

9,500

1,600

20,000

30,000

5,800 66,900

___________________________________________________________________________________________________ Solutions Manual 2-77 Chapter 2 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-4 (Continued) a. Calculation of cash on hand at end of year: See template, or… Cash received: Bank loan $ 30,000 Shareholders’ investment 30,000 Sale of products 98,000 Cash paid out: Purchase of baking supplies ($42,000 – $5,000) $ 37,000 Rent payments on ovens 12,000 Payment on bank loan 10,000 Payment of wages ($30,000 – $3,000) 27,000 Payment of other expenses 13,500 Purchase of ovens 46,000

$158,000

(145,500) $ 12,500

Calculation of net income for the year: See template, or… Sales revenue Cost of goods sold ($42,000 x 80%) Wages expense Rent expense Interest expense Other expenses Net income

$98,000 $33,600 30,000 12,000 1,600 15,000

(92,200) $ 5,800

________________________________________________________________________________________________ Solutions Manual 2-78 Chapter 2 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C2-4 (Continued) b. See template for calculations

Canadian Cookie and Cakes Ltd. Statement of Financial Position December 31, 20xx Cash $12,500 Baking supplies 8,400 Baking ovens 46,000

Total assets

$66,900

Accounts payable Interest payable Bank loan payable Total liabilities Common shares Retained earnings Shareholders’ equity Total liabilities and shareholders’ equity

$ 9,500 1,600 20,000 $31,100 $30,000 5,800 35,800 $66,900

c. The shareholder’s proportionate claim on the reported net assets (assets less liabilities) is $11,933 ($35,800 x 33.33%). In light of the profitable operations during the first year of operations, the company should be worth more than its book value and the shareholder should be able to sell her shares for more than this. On the other hand, if she is desperate to sell she may be willing to take less than the book value of her share of the company and accept something less than $11,933. It is worth noting that the income tax expense was not taken into consideration in the calculation of the results and revisions would be required once the calculation of amounts owing are made. LO 5,6 BT: C Difficulty: M Time: 45 min. AACSB: : None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 2-79 Chapter 2 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice

________________________________________________________________________________________________ Solutions Manual 2-80 Chapter 2 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 3 Double-Entry Accounting and the Accounting Cycle Learning Objectives 1. Explain how the double-entry accounting system works, including how it overcomes the limitations of the template approach. 2. Explain the normal balance concept and how it is used within the doubleentry accounting system. 3. Identify and explain the steps in the accounting cycle. 4. Explain the significance of a company’s decisions regarding its chart of accounts and the implications of subsequent changes. 5. Explain the difference between permanent and temporary accounts. 6. Identify and record transactions in the general journal and general ledger. 7. Explain why adjusting entries are necessary and prepare them. 8. Explain why closing entries are necessary and prepare them.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4.

2 2 2 2

1. 2. 3. 4.

2 2 2 6

1. 2.

4 2

1. 1,2 2. 5 1. 7,8 2. 7 1. 6,7

Item LO

Discussion Questions C 5. 2 C 9. 7 C 13. 7 C 17. C C 6. 3 C 10. 8 C 14. 7 18. C K 7. 3 C 11. 7 C 15. 7 19. C K 8. 3 C 12. 7 C 16. 7 20. Application Problems K 5. 6 AP 9. 7 AP 13. 6,7,8 AP 17. K 6. 6,7 AP 10. 8 AP 14. 6,7,8 AP K 7. 6 11. 6,7,8 AP 15. 6,7 AP AP C 8. 6,7 AP 12. 6,8 AP 16. 7 AP User Perspective Problems C 3. 2 C 5. 3 C 7. 7 C 3. C 4. 3 C 6. 4 C 8. 3 C Work in Process C 3. 8 C 5. 8 C C 4. 8 C 6. 8 C Reading and Interpreting Published Financial Statements C 3. 7 AN 4. 7 C 5. 8 AN 6. C Cases AN 2. 6,7 AN 3. 6,7 AN 4. 6,7 AN 5.

8 8 8 7,8

C C C C

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file.

LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ3-1

The role of the Statement of Income (Income Statement) is to show the net income (profit or loss) for the fiscal year of an organization as a measure of the entity’s financial performance. It summarizes all the revenues and expenses of a business over a specified time period and the net income represents the return earned on the shareholders’ investment and on the assets invested by the company. All accounts on the statement of income are temporary accounts, so they are reset to $0 at the end of each fiscal period. The Statement of Financial Position (Balance Sheet) summarizes all the assets, liabilities and shareholders’ equity accounts of the business at a point in time. It is a measure of the entity’s financial position at a specific date. All accounts on the statement of financial position are permanent or continuing accounts.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-2 a. F b. F c. F d. T e. T f. F g. T h. F LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-3 a. Revenue, CR b. Expense, DR c. Asset, DR d. Liability, CR e. Shareholder’s equity, CR f. Asset, DR g. Liability, CR h. Shareholder’s equity, CR i. Dividends declared, DR j. Liability, CR k. Expense, DR LO 2 BT: K Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-4 a. Asset, DR b. Expense, DR c. Asset, DR d. Expense, DR e. Liability, CR f. Revenue, CR g. Asset, DR h. Contra-asset, CR i. Liability, CR j. Shareholders’ equity, CR k. Asset, DR LO 2 BT: K Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-5

Expense accounts have debit balances, and debit entries increase these accounts. Shareholders’ equity accounts and revenues normally have credit balances, and debit entries reduce these accounts. These statements are consistent because revenues increase net income and expenses reduce net income, and therefore the shareholders’ equity account of retained earnings.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-6

Chart of accounts Opening balances

Closing entries Financial statements prepared

Transaction analysis

Adjusted trial balance prepared

Journal entries

Adjusting entries

Journal entries posted to General Ledger Trial Balance Prepared

Transactions are analyzed to determine whether they require recording in the accounts. If so, the journal entries are prepared (in the general journal) and these are subsequently posted (instantly, daily, weekly, etc.) to the general ledger. A trial balance is then prepared to ensure that total debits equal total credits across all accounts. At the end of each month, the accounts are reviewed to determine where there are balances that need to be updated or corrected. If so, then adjusting entries are prepared and posted to the general ledger. An adjusted trial balance is then prepared to ensure total account debits still equal total account credits. At this point, the financial statements can be prepared based on the balances in the adjusted trial balance.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-6 (Continued) Once the financial statements have been prepared, closing entries are prepared to close all temporary accounts. The closing entries are posted to the general ledger and a post-closing trial balance is prepared to ensure that debits still equal credits. At this point, the company is ready to start its next accounting cycle. LO 3 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-7

The general ledger contains the details of all transactions for each account. It also has totals for each account in the ledger. The general ledger allows us to know the balance of each account at any given time. At period end, the balances are used to prepare the financial statements. It allows for a quick summary reference to the account information rather than having to sort through the detailed transactions in the general journal.

LO 3 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-8

If a company has a credit balance at the beginning of the year, we know that it is not a new company. We also know that the company has had a history of cumulative profits over the life of the company’s operations. Any losses experienced would have been less than the profits to date. In addition, the net profits exceed any dividends declared to date.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-9

Deferred revenue occurs when cash has been received in the accounting period before the revenue is earned. It is a liability because the goods or services are still owed to the customer. Accrued revenue occurs when the revenue has been earned and is recognized before the cash is received. Accrued revenue, when recorded, generates an asset (accounts receivable) for the amount of cash that will be received in the future. For example, deferred revenue would be recorded if a conference center received a cash deposit before the customer uses the centre’s facilities. The centre would not be able to record the deposit as revenue until the facilities have been used by the customer. Accrued revenue would be recorded if a bank had an outstanding loan with one of its customers and the interest on the loan isn’t due to be paid until the end of the year. The bank in entitled to the interest revenue as it is earned. Any earned but uncollected interest would be accrued at the end of each accounting period by the bank.

LO 7 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-10 In an adjusted trial balance, retained earnings has its beginning of period balance whereas the rest of the permanent accounts have their proper end of period balance. This is because no entries are made directly to retained earnings during the accounting period. Separate temporary accounts of revenue, expenses, and dividends declared are used instead to keep track of the transactions that affect retained earnings through the fiscal period. Closing entries transfer the net results of the revenues and expenses (net income) to retained earnings and also close out (bring to zero) any dividends declared accounts and recognize these dividends as a reduction of retained earnings. After this, the retained earnings account equals its end of period balance. LO 8 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-11 A prepaid expense is an asset that arises when a company pays for services or goods in advance of the services or goods being used. A common example is insurance coverage that is paid for in advance of the coverage period. At the time of payment, an asset (prepaid expenses or prepaid insurance) is created. Then, as the coverage is used up, the prepaid asset is reduced and insurance expense is recorded. Another very common prepaid expense is prepaid rent. Most landlords require that rent be paid in advance. This is recorded as a prepaid expense at the time of payment. It is then expensed (as rent expense) as the rental period passes. Office supplies are considered a type of prepaid asset until they are used in the course of doing business, at which time they become an expense. LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-12 An accrued expense is an expense that has been incurred but not yet paid for. The expense is recognized on the statement of income and the associated accrued liability is recognized on the statement of financial position. For example, the interest cost for the month is an expense incurred in the current month but may not be paid until a loan or note payable matures, say in six months’ time. Therefore, the accrued interest payable is recognized at the same time, as a current liability. LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-13 A prepaid expense is an asset as it has been paid for prior to the expense being incurred. In other words, it is something that the company has paid for, but the expense itself will be incurred at a later date (i.e. cash paid first, then expense recorded later). Insurance and rent are common prepaid expenses as both must generally be paid for in advance of the service (i.e. insurance or rent expense) being received and the related expense incurred. An accrued expense is one that the company has incurred, but not yet paid. In other words, the company has made use of some service or received some goods for which they still owe payment (i.e. expense incurred, but cash is paid later). With accrued expenses, an expense is recorded as well as a liability for the future payment.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-13 (Continued) A common example of an accrued expense is wages as employees normally work (and the wage expense incurred) before being paid. LO 7 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-14 The effect of not recording an accrued expense is that the expenses will be understated and the net income for the current period will be overstated. Liabilities will also be understated. If not corrected, the expense will be recognized in the next period when it is paid for, thus leading to an overstatement of expenses and an understatement of net income in the next period. LO 7 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-15 Depreciation expense is the allocation of part of the cost of long lived items such as equipment to each accounting period as the asset is used and its economic benefits consumed. Each year’s allocation is recognized as depreciation expense on the Statement of Income. Accumulated depreciation is a contra account to the non-current asset and appears on the Statement of Financial Position. It represents the total of all the depreciation expense that has been recognized for the specific asset up to the reporting date. LO 7 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-16 Adjusting entries are needed when a company needs to recognize a revenue or an expense before the receipt or payment of cash. They are also required when a company needs to recognize a revenue or expense in an accounting period after the cash has been received or paid. The two key things to remember about adjusting entries: • They never involve cash • They are made at the end of each accounting period (such as each month, quarter or year-end) LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ3-17 Closing entries transfer the net result of all temporary account balances to retained earnings and bring the temporary account balances to $0. They are made so that (1) retained earnings is brought up to the reporting date correct balance for the statement of financial position (2) the temporary accounts can begin the next accounting fiscal year with zero balances. LO 8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-18 The Income Summary account is a temporary account used only on the last day of a company’s fiscal year. Revenue and expense accounts are closed to the Income Summary account, following which its balance will correspond to the company’s net income (or loss) appearing on the statement of income. That balance is then closed to retained earnings. It minimizes the number of transactions flowing through retained earnings. LO 8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-19 Revenues, expenses and dividends declared are considered temporary accounts as the balance of each of these accounts is transferred to the retained earnings account at the end of each year. Temporary accounts start the new year with a zero balance. LO 8 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ3-20 A company might prepare adjusting journal entries and financial statements monthly while another might report on a quarterly basis, at the end of each three months. Some companies require more up-to-date information because this information is relied upon for internal (management) and external (investor and creditor) decision-making. The closing of the temporary accounts only occurs once, at the end of the fiscal year. LO 7,8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP3-1A 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

L, CR R, CR L, CR A, DR E, DR A, DR L, CR A, DR R, CR L, CR

LO 2 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-2A 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

SE, CR DD, DR E, DR SE, CR CA, CR E, DR L, CR A, DR A, DR L, CR

LO 2 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-3A 1. CA, Permanent 2. L, Permanent 3. SE, Permanent 4. L, Permanent 5. E, Temporary 6. R, Temporary 7. DD, Temporary 8. R, Temporary 9. A, Permanent 10. E, Temporary LO 5 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-4A a. Assets (materials inventory) increase, liabilities (accounts payable) increase b. Assets decrease (cash), liabilities decrease (accounts payable) c. Assets decrease (cash), shareholders’ equity decreases (wages expense increases) d. Assets increase (art inventory) and assets decrease (cash) e. Assets increase (cash increase > art inventory decrease), shareholders’ equity increases (sales revenue increase > cost of goods sold increase) f. Assets increase (cash), assets decrease (accounts receivable) g. Assets decrease (cash), liabilities decrease (bank loan payable) and shareholders’ equity decreases (interest expense increases) h. Assets decrease (accumulated depreciation, a contra asset increases), shareholders’ equity decreases (depreciation expense increases) LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-5A a. Inventory Accounts Payable

3,100

b. Accounts Payable Cash

3,000

c. Accounts Receivable Sales Revenue Cost of Goods Sold Inventory

2,700

d. Cash Accounts Receivable

2,000

e. Supplies Accounts Payable

1,400

f. Supplies Expense Supplies

3,100

3,000

2,700 1,800 1,800

2,000

1,400 500 500

g. Equipment Cash

7,500

h. Cash Bank Loan Payable

12,000

i. Cash Common Shares

20,000

j. Wages Expense Cash

6,300

k. Interest Expense Bank Loan Payable Cash

150 1,850

7,500

12,000

20,000

6,300

2,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-5A (Continued) l. Rent Expense Cash

2,500

m. Land Cash Mortgage Payable

23,000

2,500

3,000 20,000

LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-6A 1. Equipment Cash Notes Payable

200,000

2. Inventory Accounts Payable

160,000

3. Prepaid Insurance Cash

2,700

4. Cash Accounts Receivable Sales Revenue

65,000 220,000

5. Accounts Payable Cash

80,000

6. Cash Accounts Receivable

180,000

7. Cash Deferred Revenue

15,000

8. Wages Expense Cash

60,000

50,000 150,000

160,000

2,700

285,000

80,000

180,000

15,000

60,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-6A (Continued) 9. Dividends Declared Dividends Payable

10,000

10. Cost of Goods Sold Inventory $160,000 - $40,000

120,000

10,000

120,000

11. Deferred Revenue Sales Revenue1 1 $15,000 X 30%

4,500

12. Insurance Expense1 Prepaid Insurance 1 $2,700 x 9/12 = $2,025

2,025

4,500

2,025

13. Depreciation Expense1 6,875 Accumulated Depreciation, Equipment 1 (($200,000 – $50,000)/20) x 11/12 = $6,875 14. Interest Expense1 5,500 Interest Payable 1 $150,000 x 4% x 11/12 = $5,500 15. Wages Expense Wages Payable

6,875

5,500

6,000 6,000

LO 6,7 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7A a.

1. Cash Common Shares

200,000

2. Inventory Accounts Payable

475,000

3. Accounts Receivable Sales Revenue Cost of Goods Sold Inventory

640,000

4. Cash Accounts Receivable

580,000

5. Accounts Payable Cash

430,000

6. Vehicles Cash

36,000

7. Rent Expense Prepaid Rent Cash

24,000 2,000

8. Operating Expenses Cash Accounts Payable

20,000

200,000

475,000

640,000 380,000 380,000

580,000

430,000

36,000

26,000

18,000 2,000

9. Depreciation Expense 2,000 Accumulated Depreciation, Vehicles

2,000

10. Dividends Declared Cash

6,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7A (Continued) b. Sweet Dreams Chocolatiers Ltd.: T-Accounts Cash Bal. 0 (1) 200,000 430,000 (5) (4) 580,000 36,000 (6) 26,000 (7) 18,000 (8) 6,000 (10)

Accounts Receivable Bal. 0 (3) 640,000 580,000 (4) Bal. 60,000

Bal. 264,000

Bal. (7)

Prepaid Rent 0 2,000

Bal.

2,000

Inventory Bal. 0 (2) 475,000 380,000

(3)

Bal. 95,000

Vehicles Bal. 0 (6) 36,000 Bal. 36,000

Accumulated Depreciation, Vehicles Bal. 0 2,000 (9) Bal.

2,000

Accounts Payable 0 Bal. (5) 430,000 475,000 (2) 2,000 (8) 47,000 Bal.

Common Shares 0 200,000

Bal. (1)

200,000

Bal.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7A (Continued) Retained Earnings 0 Bal.

Dividends Declared Bal. 0 (10) 6,000 Bal. 6,000

Sales Revenue 0 Bal. 640,000 (3) 640,000 Bal.

Cost of Goods Sold Bal. 0 (3) 380,000 Bal.380,000

Rent Expense Bal. 0 (7) 24,000

Operating Expenses Bal. 0 (8) 20,000

Bal. 24,000

Bal. 20,000

Depreciation Expense Bal. 0 (9) 2,000 Bal.

2,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7A (Continued)

c. Sweet Dreams Chocolatiers Ltd. Trial Balance December 31, 2024

Cash Accounts receivable Prepaid rent Inventory Vehicles Accumulated depreciation, vehicles Accounts payable Common shares Retained earnings Dividends declared Sales revenue Cost of goods sold Rent expense Operating expenses Depreciation expense

Debit $264,000 60,000 2,000 95,000 36,000

Credit

$2,000 47,000 200,000 -06,000 640,000 380,000 24,000 20,000 2,000 $889,000

$889,000

LO 6 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-8A Aug.1

Vehicles Cash Notes Payable

90,000

Prepaid Insurance Cash

5,100

Cash Accounts Receivable Sales Revenue

18,000 18,000

Cost of Goods Sold Inventory

12,500

Inventory Accounts Payable

16,000

Cash Deferred Revenue

10,000

Dividends Payable Cash

25,000

50,000 40,000

5,100

36,000

12,500

16,000

10,000

25,000

Adjusting entries: 31

Insurance Expense1 Prepaid Insurance 1 $5,100 X 1/17

300 300

Depreciation Expense1 1,000 Accumulated Depreciation, Vehicles 1 ($90,000 - $18,000) / 6 X 1/12 = $1,000 Interest Expense1 Interest Payable 1 $40,000 X 2% X 1/12 = $67

1,000

67 67

LO 6,7 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-9A Adjusting entries 1. Deferred Revenue 9,300 Sales Revenue ($12,400 x 3/4)

9,300

2. Wages Expense Wages Payable

2,000 2,000

3. Rent Expense Prepaid Rent

42,000 42,000

Correct balance of prepaid rent at Dec. 31, 2024 = December 31’s prepayment of $4,000 for January, 2025. Therefore, the balance of Prepaid Rent account must be brought to $4,000. ($46,000 - $4,000 = $42,000). Alternatively, rent expense for year = ($3,000 x 6) + ($4,000 x 6) = $42,000. 4. Supplies Expense1 4,500 Supplies 4,500 1 ($5,000 - $500) This brings the Supplies account to its correct balance of $500. 5. Depreciation Expense1 6,500 Accumulated Depreciation, Building 1 ($150,000 – $20,000) ÷ 20 = $6,500 6. Interest Expense1 Interest Payable 1 ($40,000 x 9% x 9/12 = $2,700)

6,500

2,700 2,700

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-9A (Continued) Calculation of income before income tax: Sales revenue ($840,000 + $9,300) Cost of goods sold Wages expense ($95,000 + $2,000) Miscellaneous expense Rent expense Supplies expense Interest expense Depreciation expense Income before income tax

$849,300 (482,000) (97,000) (14,000) (42,000) (4,500) (2,700) (6,500) $ 200,600

*($200,600 x 30% = $60,180) 7. Income Tax Expense* Income Tax Payable

60,180 60,180

LO 7 BT: AP Difficulty: H Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-10A Closing entries, September 30: Sales Revenue Interest Revenue Income Summary

488,000 2,000

Income Summary Cost of Goods Sold Wages Expense Rent Expense Depreciation Expense

455,000

Income Summary1 Retained Earnings 1 ($490,000 - $455,000)

35,000

Retained Earnings Dividends Declared

18,000

490,000

316,000 70,000 26,000 43,000

35,000

18,000

a. Closing balance of Retained Earnings, September 30: Retained earnings, opening balance Add: net income Less: dividends declared Retained earnings, closing balance

$70,000 35,000 ( 18,000) $87,000

LO 8 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11A a. Singh Company: Transactions and adjusting entries 1. Cash Common Shares

250,000

2. Cash Bank Loan Payable

50,000

3. Land Buildings Cash

60,000 140,000

4. Inventory Accounts Payable

130,000

5. Cash Accounts Receivable Sales Revenue

30,000 175,000

6. Cost of Goods Sold Inventory

120,000

7. Accounts Payable Cash

115,000

8. Cash Accounts Receivable

155,000

9. Wages Expense Cash Wages Payable

57,000

250,000

50,000

200,000 130,000

205,000 120,000

115,000

155,000

55,000 2,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11A (Continued) 10. Interest Expense1 Cash 1 $50,000 x 6% = $3,000

3,000 3,000

11. Depreciation Expense1 4,000 Accumulated Depreciation, Building 1 ($140,000 - $20,000) / 30 years = $4,000 12. Dividends Declared Dividends Payable

4,000

7,000 7,000

b. Singh Company: T-Accounts

(1) (2) (5) (8)

Cash 0 250,000 200,000 (3) 50,000 115,000 (7) 30,000 55,000 (9) 155,000 3,000 (10)

Accounts Receivable 0 (5) 175,000 155,000 (8) 20,000

112,000

Inventory 0 (4) 130,000 120,000

(6)

10,000

(3)

Land 0 60,000

Buildings 0 (3) 140,000

60,000

140,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11A (Continued) Accumulated Depreciation, Bldgs. 0 4,000 (11) 4,000 Accounts Payable 0 (7) 115,000 130,000

(4)

Bank Loan Payable 0 50,000 (2) 50,000

Interest Payable 0

Dividends Payable 0 7,000 (12)

7,000

(1)

250,000

Dividends Declared 0 (12) 7,000 7,000 (CE) 0

(9)

2,000

15,000

Common Shares 0 250,000

Wages Payable 0 2,000

Retained Earnings 0 (CE) 7,000 21,000 (CE) 14,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11A (Continued) Sales Revenue 0 0 (CE) 205,000 205,000 (5) 0

Cost of Goods Sold (6) 120,000 120,000

(CE)

Interest Expense 0 (10) 3,000 3,000 (CE)

Depreciation Expense 0 (11) 4,000 4,000 (CE)

0 Income Summary

0 Wages Expense 0 (9) 57,000 57,000 (CE)

(CE) (CE)

184,000 21,000

0 205,000 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11A (Continued) c. Singh Company Adjusted Trial Balance December 31, 2024

Cash Accounts receivable Inventory Land Building Accumulated depreciation, building Accounts payable Bank loan payable Dividends payable Wages payable Common shares Retained earnings Dividends declared Sales revenue Cost of goods sold Wages expense Interest expense Depreciation expense

Debit $ 112,000 20,000 10,000 60,000 140,000

Credit

$ 4,000 15,000 50,000 7,000 2,000 250,000 0 7,000 205,000 120,000 57,000 3,000 4,000 $533,000

$533,000

d. Closing Entries (CE) Sales Revenue Income Summary

205,000

Income Summary Cost of Goods Sold Wages Expense Interest Expense Depreciation Expense

184,000

205,000

120,000 57,000 3,000 4,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11A (Continued) Income Summary1 Retained Earnings 1 ($205,000 - $184,000)

21,000

Retained Earnings Dividends Declared

7,000

21,000

7,000

LO 6,7,8 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-12A a. Hughes Tools Company: Journal Entries 1. Cash Common Shares

175,000

2. Cash Notes Payable

225,000

3. Rent Expense Prepaid Rent Cash

60,000 15,000

4. Equipment Cash

220,000

5. Inventory Cash

90,000

6. Inventory Accounts Payable

570,000

7. Cash Accounts Receivable Sales Revenue

80,000 720,000

8. Cash Accounts Receivable

650,000

175,000

225,000

75,000

220,000

90,000

570,000

800,000

650,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12A (Continued) 9. Accounts Payable Cash

510,000

10. Cost of Goods Sold Inventory

560,000

11. Selling and Administrative Expenses Cash Accounts Payable

510,000

560,000

86,500 82,500 4,000

12. Interest Expense1 22,500 Notes Payable 25,000 Cash 1 ($225,000 X 10% = $22,500)

47,500

13. Depreciation Expense1 20,000 Accumulated Depreciation, Equipment 20,000 1 [($220,000 – $20,000) ÷ 10 years = $20,000] 14. Dividends Declared Cash

7,000 7,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12A (Continued) b. Hughes Tools Company: T-Accounts

(1) (2) (7) (8)

Cash 0 175,000 75,000 (3) 225,000 220,000 (4) 80,000 90,000 (5) 650,000 510,000 (9) 82,500 (11) 47,500 (12) 7,000 (14)

Accounts Receivable 0 (7) 720,000 650,000 (8) 70,000

98,000

(5) (6)

Inventory 0 90,000 570,000 560,000 (10)

(3)

Prepaid Rent 0 15,000 15,000

100,000

(4)

Equipment 0 220,000 220,000

Accounts Payable (9)

0 510,000 570,000(6) 4,000 (11) 64,000

Accumulated Depreciation, Equip. 0 20,000 (13) 20,000

Income Summary 800,000 (CE) (CE) 749,000 (CE) 51,000 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12A (Continued)

Notes Payable 0 (12) 25,000 225,000

(2)

200,000 Common Shares 0 175,000

(1)

Retained Earnings 0 (CE) 7,000 51,000 (CE)

175,000 Dividends Declared 0 (14) 7,000 7,000(CE)

44,000 Sales Revenue 0 800,000

(CE) 800,000

0 Cost of Goods Sold 0 (10) 560,000 560,000 (CE)

(7)

0 Rent Expense 0 (3) 60,000 60,000 (CE)

Depreciation Expense 0 (13) 20,000 20,000 (CE)

Interest Expense 0 (12) 22,500 22,500 (CE)

Selling & Administrative Expenses 0 (11) 86,500 86,500 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12A (Continued) c. Hughes Tools Company Adjusted Trial Balance September 30, 2024 Debit Cash $ 98,000 Accounts receivable 70,000 Inventory 100,000 Prepaid rent 15,000 Equipment 220,000 Accumulated depreciation, equipment Accounts payable Notes payable Common shares Retained earnings Dividends declared 7,000 Sales revenue Cost of goods sold 560,000 Rent expense 60,000 Depreciation expense 20,000 Interest expense 22,500 Selling & administrative expenses 86,500 $1,259,000

Credit

$ 20,000 64,000 200,000 175,000 -0800,000

$1,259,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12A (Continued)

d. Closing Entries (CE) Sales Revenue Income Summary

800,000 800,000

Income Summary 749,000 Cost of Goods Sold Rent Expense Depreciation Expense Interest Expense Selling and Administrative Expenses Income Summary Retained Earnings 1 ($800,000 - $749,000)

51,0001

Retained Earnings Dividends Declared

7,000

560,000 60,000 20,000 22,500 86,500

51,000

7,000

LO 6,8 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A a. Clean and White Linen Supplies Ltd. – Journal Entries 1. Prepaid Insurance Cash

3,900 3,900

2. Inventory Accounts Payable

120,000

3. Accounts Receivable Sales Revenue

180,000

Cost of Goods Sold Inventory

100,000

4. Cash1 Accounts Receivable Service Revenue 1 ($520,000 x 1/4)

130,000 390,000

5. Accounts Payable Cash

130,000

6. Cash

246,000

120,000

180,000

100,000

520,000

130,000

Accounts Receivable

246,000

7. Advertising Expense Cash

12,000

8. Interest Expense1 Bank Loan Payable Cash 1 $150,000 x 7% = $10,500

10,500 30,000

9. Cash

3,000

12,000

40,500

Dividend Revenue 10. Utilities Expense Cash

3,000 15,000 15,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) 11. Dividends Declared Cash

12,000

12. a. Wages Payable Wages Expense Cash

8,000 94,000

12,000

102,000

b. Wages Expense Wages Payable

2,000 2,000

13. Depreciation Expense1 30,000 Accumulated Depreciation, Equipment 1 ($330,000–$30,000] ÷ 10 years 14. Insurance Expense1 Prepaid Insurance 1 ($3,900 x 1/3)

30,000

1,300 1,300

b. Clean and White Linen Supplies Ltd.: T-Accounts

Cash Bal. 90,000 (4) 130,000 3,900 (1) (6) 246,000 130,000 (5) (9) 3,000 12,000 (7) 40,500 (8) 15,000 (10) 12,000 (11) 102,000 (12a)

Accounts Receivable Bal. 96,000 (3) 180,000 246,000 (6) (4) 390,000 420,000

Supplies 153,600

Bal.

2,000 2,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) Inventory Bal. 60,000 (2) 120,000 100,000

(3)

Prepaid Insurance Bal. 0 (1) 3,900 1,300 (14)

80,000

2,600

Long-term Investments Bal.

Bank Loan Payable

80,000

150,000 Bal. (8)

30,000

80,000 120,000

Equipment Bal. 330,000

Accumulated Depreciation, Equipment 90,000 Bal. 30,000 (13)

330,000 120,000

Accounts Payable 60,000 Bal. (5) 130,000 120,000 (2)

Wages Payable 8,000 Bal. (12) 8,000 2,000 (12b)

50,000 2,000

Common shares 250,000 Bal.

Retained earnings 100,000 Bal.

250,000 (CE)12,000 438,200 (CE) 526,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) Dividends Declared Bal. 0 (11) 12,000 12,000 (CE) 0 Service Revenue 0 Bal. 520,000 (4) (CE) 520,000 0 Sales Revenue 0 Bal. 180,000 (3) (CE) 180,000

Dividend Revenue 0 Bal. 3,000 (9) (CE) 3,000

Cost of Goods Sold Bal. 0 (3) 100,000 100,000 (CE) 0

Advertising Expense Bal. 0 (7) 12,000 12,000 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) Utilities Expense Bal. 0 (10) 15,000 15,000 (CE)

Wages Expense Bal. 0 (12a) 94,000 (12b) 2,000

96,000 96,000 (CE) 0

Insurance Expense Bal. 0 (14) 1,300 1,300 (CE) 0

Interest Expense Bal. 0 (8) 10,500 10,500 (CE) 0 Income Summary Bal. 0 703,000 (CE) (CE) 264,800 438,200 (CE) 438,200 0

Depreciation Expense Bal. 0 (13) 30,000 30,000 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) c. Clean and White Linen Supplies Ltd. Adjusted Trial Balance December 31, 2024 Debit Cash $153,600 Accounts receivable 420,000 Inventory 80,000 Supplies 2,000 Prepaid insurance 2,600 Long-term investments 80,000 Equipment 330,000 Accumulated depreciation, equipment Accounts payable Wages payable Bank loan payable Common shares Retained earnings Dividends declared 12,000 Service revenue Sales revenue Dividend revenue Cost of goods sold 100,000 Advertising expense 12,000 Utilities expense 15,000 Wages expense 96,000 Insurance expense 1,300 Interest expense 10,500 Depreciation expense 30,000 $1,345,000

Credit

120,000 50,000 2,000 120,000 250,000 100,000 520,000 180,000 3,000

$1,345,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) d. Clean and White Linen Supplies Ltd. Statement of Income For the year ended December 31, 2024 Revenues Service revenue Sales revenue Dividend revenue Total revenues Expenses Cost of goods sold Advertising expense Utilities expense Wages expense Insurance expense Interest expense Depreciation expense Total expenses Net income

$520,000 180,000 3,000 703,000 $100,000 12,000 15,000 96,000 1,300 10,500 30,000 264,800 $438,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) e.

Closing entries (CE) i. Service Revenue Sales Revenue Dividend Revenue Income Summary

520,000 180,000 3,000 703,000

Income Summary Cost of Goods Sold Advertising Expense Utilities Expense Wages Expense Insurance Expense Interest Expense Depreciation Expense

264,800

Income Summary1 Retained Earnings 1 ($703,000 - $264,800)

438,200

ii. Retained Earnings Dividends Declared

12,000

100,000 12,000 15,000 96,000 1,300 10,500 30,000

438,200

12,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13A (Continued) f. Clean and White Linen Supplies Ltd. Statement of Financial Position As at December 31, 2024 ASSETS Current assets Cash Accounts receivable Inventory Supplies Prepaid insurance Total current assets Long-term investments Equipment Less accumulated depreciation

$153,600 420,000 80,000 2,000 2,600 658,200 $80,000 330,000 (120,000)

210,000 290,000

TOTAL ASSETS

$948,200

LIABILITIES Current Liabilities Accounts payable Wages payable Total current liabilities

$50,000 2,000 $52,000

Non-current: Bank loan payable Total liabilities

120,000 $172,000

SHAREHOLDERS’ EQUITY Common shares Retained earnings* Total shareholders’ equity

$250,000 526,200

TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY *$100,000 + $438,200 – $12,000 = $526,200

776,200

$948,200

LO 6,7,8 BT: AP Difficulty: M Time: 90 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A a. Direnzo Panini – Journal Entries 1. Cash Accounts Receivable Sales Revenue

650,000 60,000

2. Inventory Accounts Payable

175,000

3. Cash

18,000

710,000

175,000

Accounts Receivable

18,000

4. Utilities Expense Cash

45,000

5. Cost of Goods Sold Inventory

200,000

6. Accounts Payable Cash

220,000

7. Wages Payable Wages Expense Cash

6,000 89,000

8. Dividends Declared Cash

35,000

45,000

200,000

220,000

95,000

35,000

Adjusting entries 9. Supplies Expense Supplies ($50,000 – $1,200)

48,800

10. Wages Expense Wages Payable

3,500

AP3-14A (Continued)

48,800

3,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

11. Insurance Expense1 Prepaid Insurance 1 ($3,000 - $1,500)

1,500

12. Depreciation Expense1 Accumulated Depreciation, Equipment 1 ($75,000–$3,000] ÷ 8 years

9,000

1,500

9,000

c. Direnzo Panini: T-Accounts

Cash Bal. 24,000 (1) 650,000 45,000 (3) 18,000 220,000 95,000 35,000

(4) (6) (7) (8)

Accounts Receivable Bal. 25,000 (1) 60,000 18,000 (3)

67,000 Supplies

297,000

Bal.

50,000 1,200

48,800 (9)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) Inventory Bal. 46,500 (2) 175,000 200,000

(5)

21,500

Bal.

Prepaid Insurance Bal. 3,000 1,500 (11) 1,500

Equipment 75,000

Accumulated Depreciation, Equipment 25,000 Bal. 9,000 (12)

75,000 34,000

Accounts Payable 50,000 Bal. (6) 220,000 175,000 (2)

Wages Payable 6,000 Bal. (7) 6,000 3,500 (10)

5,000 3,500

Common shares 75,000 Bal.

Retained earnings 67,500 Bal.

75,000 (CE)35,000 313,200 (CE) 345,700

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) Dividends Declared Bal. 0 (8) 35,000 35,000 (CE) 0 Sales Revenue 0 Bal. 710,000 (1) (CE) 710,000 0

Cost of Goods Sold Bal. 0 (5) 200,000 200,000 (CE) 0

Supplies Expense Bal. 0 (9) 48,800 48,800 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) Utilities Expense Bal. 0 (4) 45,000 45,000 (CE)

Wages Expense Bal. 0 (7) 89,000 (10) 3,500

92,500 92,500 (CE) 0

Insurance Expense Bal. 0 (11) 1,500 1,500 (CE)

Depreciation Expense Bal. 0 (12) 9,000 9,000 (CE)

Income Summary Bal. 0 710,000 (CE) (CE) 396,800 313,200 (CE) 313,700 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) d. Direnzo Panini Adjusted Trial Balance December 31, 2024 Debit Cash $297,000 Accounts receivable 67,000 Inventory 21,500 Supplies 1,200 Prepaid insurance 1,500 Equipment 75,000 Accumulated depreciation, equipment Accounts payable Wages payable Common shares Retained earnings Dividends declared 35,000 Sales revenue Cost of goods sold 200,000 Supplies expense 48,800 Utilities expense 45,000 Wages expense 92,500 Insurance expense 1,500 Depreciation expense 9,000 $895,000

Credit

34,000 5,000 3,500 75,000 67,500 710,000

$895,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) e. Direnzo Panini Statement of Income For the year ended December 31, 2024 Revenues Sales revenue Expenses Cost of goods sold Supplies expense Utilities expense Wages expense Insurance expense Depreciation expense Total expenses Net income

710,000

$200,000 48,800 45,000 92,500 1,500 9,000 396,800 $313,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) f.

Closing entries (CE) ii. Sales Revenue Income Summary

710,000 710,000

Income Summary Cost of Goods Sold Supplies Expense Utilities Expense Wages Expense Insurance Expense Depreciation Expense

396,800

Income Summary1 Retained Earnings 1 ($710,000 - $396,800)

313,200

ii. Retained Earnings Dividends Declared

35,000

200,000 48,800 45,000 92,500 1,500 9,000

313,200

35,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14A (Continued) g. Direnzo Panini Statement of Financial Position As at December 31, 2024 ASSETS Current assets Cash Accounts receivable Inventory Supplies Prepaid insurance Total current assets Equipment Less accumulated depreciation

$297,000 67,000 21,500 1,200 1,500 388,200 $75,000 (34,000)

41,000

TOTAL ASSETS

$429,200

LIABILITIES Current Liabilities Accounts payable Wages payable Total current liabilities

$5,000 3,500 $8,500

SHAREHOLDERS’ EQUITY Common shares Retained earnings* Total shareholders’ equity

$75,000 345,700

TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY *$67,500 + $313,200 – $35,000 = $345,700

420,700

$429,200

LO 6,7,8 BT: AP Difficulty: M Time: 90 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15A a. Arcadia Inc. Adjusting Journal Entries 1. Supplies Expense Supplies1 1 ($3,200 - $1,200)

2,000

2. Deferred Revenue1 Rent Revenue 1 (4 x $3,000)

12,000

3. Wages Expense Wages Payable

5,000

4. Depreciation Expense Accumulated Depreciation, Buildings

12,000

4. Depreciation Expense Accumulated Depreciation, Equipment

25,000

5. Dividends Declared Dividends Payable

10,000

6. Interest Receivable1 Interest Revenue 1 ($60,000 x 5% x 3/12) = $750 7. Prepaid Insurance Insurance Expense

2,000

12,000

5,000

12,000

25,000

10,000 750 750

1,500 1,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15A (Continued) b.

Arcadia Inc. Adjusted Trial Balance December 31, 2024 Debits $ 15,000 175,000 60,000 1,500 750 1,200 190,000 220,000

Credits

Cash Accounts Receivable Notes Receivable Prepaid Insurance ($0 + $1,500) Interest Receivable ($0 + $750) Supplies ($3,200 – $2,000) Inventory Equipment Accumulated Depreciation, Equipment ($15,000 + $25,000) $ 40,000 Buildings 290,000 Accumulated Depreciation, Buildings ($25,000 + $12,000) 37,000 Land 200,000 Accounts Payable 45,600 Notes Payable 45,000 Wages Payable ($0 + $5,000) 5,000 Dividends Payable ($0 + $10,000) 10,000 Deferred Revenue ($18,000 – $12,000) 6,000 Common Shares 526,000 Retained Earnings 269,100 Dividends Declared ($15,000 + $10,000) 25,000 Sales Revenue 954,000 Interest Revenue ($0 + $750) 750 Rent Revenue ($0 + $12,000) 12,000 Cost of Goods Sold 525,000 Utilities Expense 4,000 Wages Expense ($118,000 + $5,000) 123,000 Other Expense 8,000 Insurance Expense ($6,000 – $1,500) 4,500 Advertising Expense 66,000 Interest Expense 2,500 Supplies Expense ($0 + $2,000) 2,000 Depreciation Expense ($0 + $12,000 + $25,000) 37,000 ________ $1,950,450 $1,950,450

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15A (Continued) c. Arcadia Inc. Statement of Income For the year ended December 31, 2024 Revenues Sales revenue Rent revenue Interest revenue Total revenues Expenses: Cost of goods sold Utilities expense Wages expense Other expense Insurance expense Advertising expense Supplies expense Interest expense Depreciation expense Total expenses

$ 954,000 12,000 750 966,750

525,000 4,000 123,000 8,000 4,500 66,000 2,000 2,500 37,000 772,000

Net income

$194,750

Beginning retained earnings, Jan. 1, 2024 Net income Dividends declared Ending retained earnings, Dec. 31, 2024

$269,100 194,750 ( 25,000) $438,850

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15A (Continued) e. Arcadia Inc. Statement of Financial Position As at December 31, 2024 Current assets: Cash Accounts receivable Notes receivable Prepaid insurance Interest receivable Supplies Inventory Total current assets Non-current assets: Equipment Less: Accumulated depreciation Building Less: Accumulated depreciation Land Net non-current assets

$ 15,000 175,000 60,000 1,500 750 1,200 190,000 $443,450 220,000 (40,000) 290,000 (37,000) 200,000 633,000

Total assets

$1,076,450 Liabilities

Current liabilities: Accounts payable Notes payable Wages payable Dividends payable Deferred revenue Total liabilities

$ 45,600 45,000 5,000 10,000 6,000

Shareholders’ Equity Common shares $526,000 Retained earnings 438,850 Total shareholders’ equity Total liabilities and shareholders’ equity

$111,600

964,850 $1,076,450

LO 6,7 BT: AP Difficulty: H Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-16A a. 1. Sales $ 8,500 2. The cost of parts and oil used during the month is not provided. This is what would affect the statement of income 0 3. COGS (2,600) 4. Rent expense (750) nd The 2 $750 increases prepaid rent (an asset). This will become an expense of the following month when the rent is “used”. 5. Advertising expense (230) Last month’s advertising bill of $250 is an expense of the preceding month. 6. Wages expense (800) The cost of the assets given up ($500 cash and $300 tires).* 7. Operating expenses (875) The $125 paid for the previous month is part of the expenses of last month’s operations. 8. The $600 of parts are still in Jake’s inventory (an asset). They cannot be expensed until work has been performed on the vehicle and revenue is recognized from that work. 0 b. Net income for the current month

$3,245

* Even if the wages expense was measured at the retail value of the new set of tires, the net effect on the statement of income in the month would be the same: $500 cash payment + $400 fair value of the tires = $900. From this, a $100 profit on the disposal/sale of the tires would also be reported, leaving a net effect of $800 to be recognized in net income. LO 7 BT: AP Difficulty: H Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17A a.

Calculation of net income (or loss) Sales revenue Expenses: Cost of goods sold Telephone expense Wages expense Repair and maintenance expenses Rent expense Advertising expense Supplies expense Depreciation expense Utilities expense Interest expense Net loss

$66,450 32,000 200 25,000 400 4,800 750 4,200 500 600 300

68,750 $(2,300)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17A (Continued) b.

Closing entries (CE) i. Sales Revenue Income Summary

66,450 66,450

Income Summary 68,750 Cost of goods sold Telephone expense Wages expense Repair and maintenance expenses Rent expense Advertising expense Supplies expense Depreciation expense Utilities expense Interest expense

Retained Earnings Income Summary1 1 ($66,450 - $68,750)

2,300

ii. Retained Earnings Dividends Declared

1,200

Beginning retained earnings Net income (loss) Dividends declared Ending retained earnings

32,000 200 25,000 400 4,800 750 4,200 500 600 300

2,300

1,200 $17,600 (2,300) (1,200) $14,100

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17A (Continued) d. Little Lads and Ladies Ltd Statement of Financial Position As at December 31, 2024 Assets Current assets: Cash Accounts Receivable Prepaid Rent Supplies Inventory Total current assets Non-current assets: Equipment Less: Accumulated Depreciation

$ 3,000 10,000 400 800 8,000 $22,200 23,000 (1,500) 21,500

Total assets

$43,700 Liabilities

Current Liabilities: Accounts Payable Wages Payable Interest Payable Total current liabilities

$ 5,000 500 300 $5,800

Long Term Liabilities: Bank Loan Payable

3,800

Total liabilities

$9,600

Shareholders’ Equity Common Shares $20,000 Retained Earnings 14,100 Total shareholders’ equity Total liabilities and shareholders’ equity

34,100 $43,700

LO 8 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-1B 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

A, DR SE, CR E, DR DD, DR E, DR R, CR A, DR E, DR CA, CR A, DR

LO 2 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-2B 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

E, DR SE, CR E, DR A, DR L, CR DD, DR E, DR E, DR A, DR A, DR

LO 2 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-3B 1. L, Permanent 2. E, Temporary 3. A, Permanent 4. E, Temporary 5. SE, Permanent 6. CA, Permanent 7. DD, Temporary 8. R, Temporary 9. L, Permanent 10. A, Permanent LO 5 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-4B a. Assets increase (equipment), liabilities increase (accounts payable) b. Assets decrease (cash), liabilities decrease (accounts payable) c. Assets increase (supplies), assets decrease (cash) d. Assets increase (prepaid expense), assets decrease (cash) e. Assets decrease (cash), shareholders’ equity decreases (wages expense increases) f. Assets increase (cash from customer plus accounts receivable from insurance company > supplies used to repair and paint car), shareholders’ equity increases (sales revenue increase > supplies expense increase) g. Assets increase (cash), assets decrease (accounts receivable) LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-5B a. Cash

150,000 Common shares

b. Cash

150,000 75,000

Bank Loan Payable

75,000

c. Inventory Accounts Payable

47,200

d. Deposits Cash

10,000

e. Advertising Expense Accounts Payable

3,700

f. Wages Expense Cash

16,800

g. Cash Accounts Receivable Sales Revenue

34,700 34,700

Cost of Goods Sold Inventory

38,500

h. Accounts Payable Cash

41,600

i. Cash

21,600

47,200

10,000

3,700

16,800

69,400

38,500

41,600

Accounts Receivable

21,600

j. Equipment Cash

120,000

k. Interest Expense Bank Loan Payable Cash

11,100 7,600

120,000

18,700

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-5B (Continued) l. Rent Expense Cash

8,900

m. Dividends Declared Cash

12,200

n. Accounts Payable Cash

3,700

8,900

12,200

3,700

LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-6B Aug. 1 Cash Equipment Common Shares

250,000 50,000

Aug. 1 Cash Bank Loan Payable

100,000

300,000

100,000

Aug. 3 Rent Expense Deposits Cash

3,000 3,000

Aug. 8 Inventory Accounts Payable

32,800

Aug.12 Advertising Expense Cash

6,800

Aug.14 Cash Accounts Receivable Sales Revenue

25,100 25,100

Cost of Goods Sold Inventory

17,100

6,000

32,800

6,800

50,200

17,100

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-6B (Continued) Aug.19 Accounts Payable Cash

25,000

Aug.25 Cash Accounts Receivable

22,600

Aug.26 Inventory Accounts Payable

23,000

Aug.29 Utilities Expense Accounts Payable

2,700

Aug.31 Cash Accounts Receivable Sales Revenue

40,800 20,000

Cost of Goods Sold Inventory

20,700

Wages Expense1 Cash 1 $3,900 X 6

23,400

Bank Loan Payable Interest Expense1 Cash 1 $100,000 X 6% X 1/12

2,500 500

Dividends Declared1 Dividends Payable 1 30,000 shares x $1

30,000

25,000

22,600

23,000

2,700

60,800

20,700

23,400

3,000

30,000

LO 6,7 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7B a.

1. Cash Common Shares

150,000

2. Equipment Cash

75,000

3. Supplies Accounts Payable

9,600

4. Supplies Expense Supplies

8,400

5. Cash Service Revenue

124,000

6. Cash Bank Loan Payable

15,000

7. Wages Expense Cash Wages Payable

50,000

150,000

75,000

9,600

8,400

124,000

15,000

49,000 1,000

8. Depreciation Expense 3,000 Accumulated Depreciation, Equipment

3,000

9. Utilities Expense Cash

22,000

10. Interest Expense1 Cash 1 $15,000 x 8% x 6/12 = $600

22,000

600 600

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7B (Continued) b. Sparkling Clean Dry Cleaners: T-Accounts Cash Bal. 0 (1) 150,000 75,000 (2) (5) 124,000 49,000 (7) (6) 15,000 22,000 (9) 600 (10)

Supplies Bal. 0 (3) 9,600 8,400

(4)

Bal. 1,200

Bal. 142,400

Equipment Bal. 0 (2) 75,000 Bal. 75,000

Accumulated Depreciation, Equip. 0 Bal. 3,000 (8) 3,000

Accounts Payable 0 Bal. 9,600 (3)

Bank Loan Payable 0 Bal. 15,000 (6)

9,600 Bal. Wages Payable 0 Bal. 1,000 (7) 1,000 Bal. Service Revenue 0 Bal. 124,000 (5) 124,000 Bal.

Bal.

15,000

Bal.

Common Shares 0 Bal. 150,000 (1) 150,000

Bal.

Depreciation Expense Bal. 0 (8) 3,000 Bal. 3,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7B (Continued) Interest Expense Bal. 0 (10) 600

Supplies Expense Bal. 0 (4) 8,400

Bal.

Bal. 8,400

600

Utilities Expense Bal. 0 (9) 22,000

Wages Expense Bal. 0 (7) 50,000

Bal. 22,000

Bal. 50,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-7B (Continued) c. Sparkling Clean Dry Cleaners Inc. Trial Balance December 31, 2024 Debit Cash $142,400 Supplies 1,200 Equipment 75,000 Accumulated depreciation, equipment Accounts payable Wages payable Bank loan payable Common shares Retained earnings Service revenue Supplies expense 8,400 Utilities expense 22,000 Wages expense 50,000 Interest expense 600 Depreciation expense 3,000 $302,600

Credit

$3,000 9,600 1,000 15,000 150,000 -0124,000

$302,600

LO 6 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-8B Jan.1

Equipment Cash

145,000

Prepaid Rent Cash

14,400

Cash Deferred Revenue

50,000

Wages Expense Cash

9,000

Dividends Declared Dividends Payable

20,000

Cash Accounts Receivable Sales Revenue

31,000 31,000

Cost of Goods Sold Inventory

36,000

145,000

14,400

50,000

9,000

20,000

62,000

36,000

Adjusting entries: 31

Wages Expense Wages Payable

9,000 9,000

Depreciation Expense1 2,250 Accumulated Depreciation, Equipment 2,250 1 ($145,000 - $10,000) / 5 X (1/12) = $2,250 Rent Expense1 Prepaid Rent 1 $14,400 X 1/6 = $2,400

2,400 2.400

LO 6,7 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-9B Snowcrest Ltd.: Adjusting entries 1. Wages Expense1 1,600 Advances to Employees 1,600 1 ($2,000 x 80%) To bring the Advances account to 20% of $2,000. 2. Supplies Expense1 2,400 Supplies 1 ($3,000 - $600) To bring the Supplies account to $600. 3. Depreciation Expense Accumulated Depreciation, Equipment

2,400

1,000 1,000

4. Deferred Revenue 4,000 1 Sales Revenue 4,000 1 ($6,000 x 2/3) To bring the Deferred Revenue account to 1/3 of $6,000. 5. Interest Expense1 Interest Payable 1 $20,000 x 9% x 3/12 = $450

450

6. Wages Expense Wages Payable

500

7. Prepaid Rent Rent Expense

600

450

500

600

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-9B (Continued) Calculation of income before income tax: Sales revenue ($230,000 + $4,000) Cost of goods sold Wages expense ($34,000 + $1,600 + $500) Repair and maintenance expense Miscellaneous expense Rent expense ($6,600 - $600) Supplies expense Interest expense Depreciation expense Income before income tax

$234,000 (130,000) (36,100) (25,000) (15,000) (6,000) (2,400) (450) (1,000) $18,050

Income tax expense = 25% X $18,050 = $4,513

8. Income Tax Expense Income Tax Payable

4,513 4,513

LO 7 BT: AP Difficulty: H Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-10B a. Closing entries, June 30: Sales Revenue Service Revenue Income Summary

708,000 7,000

Income Summary Cost of Goods Sold Wages Expense Advertising Expense Depreciation Expense

500,000

Income Summary1 Retained Earnings 1 ($715,000 - $500,000)

215,000

Retained Earnings Dividends Declared

55,000

715,000

365,000 80,000 33,000 22,000

215,000

55,000

b. Closing balance of Retained Earnings, June 30: Retained earnings, opening balance Add: net income Less: dividends declared Retained earnings, closing balance

$160,000 215,000 ( 55,000) $320,000

LO 8 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11B a. Sofia Wholesale Ltd.: Transactions and adjusting entries 1. Cash1 Common Shares 1 100,000 shares x $3

300,000

2. Equipment Cash Notes payable

120,000

3. Prepaid insurance Cash

4,800

4. Inventory Accounts Payable

185,000

5. Cash Accounts Receivable Sales Revenue

236,000 192,000

Cost of Goods Sold Inventory

153,000

6. Cash Accounts receivable

166,000

7. Accounts Payable Cash

78,000

8. Wages Expense Cash Wages Payable

119,000

9. Prepaid rent1 Rent expense Cash 1 $54,600 x1/13

4,200 50,400

300,000

50,000 70,000

4,800 185,000

428,000 153,000 166,000

78,000

97,000 22,000

54,600

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11B (Continued) 10. Insurance Expense1 Prepaid Insurance 1 $4,800/2 years = $2,400

2,400

11. Interest Expense1 Interest Payable 1 $70,000 x 6% = $4,200

4,200

2,400

4,200

12. Depreciation Expense1 21,600 Accumulated Depreciation, Equipment 1 ($120,000 - $12,000) / 5 years = $21,600 13. Dividends Declared Dividends Payable

21,600

15,200 15,200

b. Sophia Company: T-Accounts Cash 0 (1) 300,000 50,000 (5) 236,000 4,800 (6) 166,000 78,000 97,000 54,600

(2) (3) (7) (8) (9)

Accounts Receivable 0 (5) 192,000 166,000 (6) 26,000

417,600

Inventory 0 (4) 185,000 153,000 32,000

(5)

Prepaid Insurance 0 (3) 4,800 2,400 (10) 2,400

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11B (Continued)

(9)

Prepaid Rent 0 4,200

Equipment 0 (2) 120,000

4,200

120,000

Accumulated Depreciation, Equip. 0 21,600 (12)

Wages Payable 0 22,000

21,600

22,000

Accounts Payable 0 (7) 78,000 185,000

Notes Payable 0 70,000

(4)

107,000

4,200

Dividends Payable 0 15,200 (13) 15,200

(1)

300,000 Dividends Declared 0 (13) 15,200 15,200 (CE) 0

(2)

70,000

Interest Payable 0 4,200 (11)

Common Shares 0 300,000

(8)

Retained Earnings 0 77,400 (CE) (CE)15,200 62,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11B (Continued) Sales Revenue 0 (CE) 428,000 428,000

Cost of Goods Sold 0 (5)

0 Insurance Expense 0 (10) 2,400 2,400 (CE)

(5) 153,000 153,000

(CE)

0 Rent Expense 0 (9) 50,400 50,400

(CE)

Interest Expense Depreciation Expense 0 0 (11) 4,200 4,200(CE) (12) 21,600 21,600 (CE) 0 Income Summary (CE) (CE)

350,600 77,400

0 428,000 (CE) 0

0 Wages Expense 0 (8) 119,000 119,000 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11B (Continued) c. Sofia Wholesale Ltd. Adjusted Trial Balance December 31, 2024 Debit Cash $ 417,600 Accounts receivable 26,000 Inventory 32,000 Prepaid insurance 2,400 Prepaid rent 4,200 Equipment 120,000 Accumulated depreciation, equipment Accounts payable Notes payable Interest payable Dividends payable Wages payable Common shares Retained earnings Dividends declared 15,200 Sales revenue Cost of goods sold 153,000 Wages expense 119,000 Insurance expense 2,400 Rent expense 50,400 Interest expense 4,200 Depreciation expense 21,600 $968,000

Credit

$ 21,600 107,000 70,000 4,200 15,200 22,000 300,000 0 428,000

$968,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-11B (Continued) d. Closing Entries (CE) Sales Revenue Income Summary

428,000

Income Summary Cost of Goods Sold Wages Expense Insurance Expense Rent Expense Interest Expense Depreciation Expense

350,600

Income summary1 Retained Earnings 1 ($428,000 - $350,600)

77,400

Retained Earnings Dividends Declared

15,200

428,000

153,000 119,000 2,400 50,400 4,200 21,600

77,400

15,200

LO 6,7,8 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-12B a. A J. Smith Company: Journal Entries 1. Cash Common Shares ($25 X 12,000 shares)

300,000 300,000

2. Land 1 57,500 Buildings 172,500 Cash 80,000 Common shares 150,000 1 ($25 X 6,000 shares) + $80,000 = $230,000 $230,000 X ¼ = $57,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12B (Continued) 3. Cash 30,000 Rent Revenue ($7,500 X3) Deferred Revenue

22,500 7,500

4a. Transaction entry: Equipment Cash Notes Payable

60,000 60,000

120,000

4b. Adjusting entry: Interest Expense1 3,000 Interest Payable 1 ($60,000 x 10% x 6/12 = $3,000) 5. Inventory Accounts Payable

250,000

6. Cash Accounts Receivable Sales Revenue

50,000 250,000

7. Cost of Goods Sold Inventory

190,000

8. Accounts Payable Cash

205,000

200,000

Cash Accounts Receivable

10. Operating Expenses Cash

3,000

250,000

300,000

190,000

205,000

200,000 50,000

11. Depreciation Expense1 7,125 Accumulated Depreciation, Buildings 1 ($172,500 – $30,000) ÷ 20 years = $7,125

50,000

7,125

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12B (Continued) 12. Depreciation Expense1 5,750 Accumulated Depreciation, Equipment 5,750 1 ($120,000 – $5,000) ÷ 10 years x 6/12 = $5,750 13.

Dividends Declared Cash Dividends Payable

20,000 15,000 5,000

b. A.J. Smith Company: T-Accounts

(1) (3) (6) (9)

Cash 0 300,000 80,000 (2) 30,000 60,000 (4a) 50,000 205,000 (8) 200,000 50,000 (10) 15,000 (13)

Accounts Receivable 0 (6) 250,000 200,000 (9) 50,000

170,000

(5)

Inventory 0 250,000 190,000 60,000

(2)

Buildings 0 172,500 172,500

(7)

(2)

Land 0 57,500 57,500

Accumulated Depreciation, Buildings 0 7,125 (11) 7,125

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12B (Continued)

Equipment 0 (4a) 120,000

Accumulated Depreciation, Equipment 0 5,750 (12)

120,000

5,750

Accounts Payable 0 (8) 205,000 250,000

(5)

45,000

Notes Payable 0 60,000 (4a) 60,000

Interest Payable 0 3,000 (4b) 3,000

Deferred Revenue 0 7,500 (3) 7,500

Dividends Payable 0 5,000 (13)

Common Shares 0 300,000 150,000

5,000 450,000

(1) (2)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12B (Continued) Retained Earnings 0 (CE) 20,000 66,625 (CE) 46,625 Dividends Declared 0 (13) 20,000 20,000 (CE)

Income Summary 322,500 (CE) (CE)255,875 (CE) 66,625 0 Sales Revenue 0 300,000

(6)

(CE)300,000

Rent Revenue 0 22,500

(3)

(CE) 22,500 0 Interest Expense 0 (4b) 3,000 3,000 (CE) 0

Cost of Goods Sold 0 (7) 190,000 190,000 (CE) 0 Depreciation Expense 0 (11) 7,125 (12) 5,750 12,875 12,875 (CE) 0

Operating Expenses 0 (10) 50,000 50,000 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12B (Continued) c. A.J. Smith Company Adjusted Trial Balance December 31, 2024 Debit Cash $ 170,000 Accounts receivable 50,000 Inventory 60,000 Land 57,500 Buildings 172,500 Accumulated depreciation, buildings Equipment 120,000 Accumulated depreciation, equipment Accounts payable Notes payable Interest payable Deferred revenue Dividends payable Common shares Retained earnings Dividends declared 20,000 Sales revenue Rent revenue Cost of goods sold 190,000 Interest expense 3,000 Depreciation expense 12,875 Operating expenses 50,000 $905,875

Credit

$ 7,125 5,750 45,000 60,000 3,000 7,500 5,000 450,000 -0300,000 22,500

_______ $905,875

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-12B (Continued) d. Closing Entries (CE) i. Sales Revenue Rent Revenue Income Summary

300,000 22,500 322,500

Income Summary Cost of Goods Sold Depreciation Expense Interest Expense Operating Expenses

255,875

Income Summary1 Retained Earnings 1 ($322,500 - $255,875)

66,625

ii. Retained Earnings Dividends Declared

190,000 12,875 3,000 50,000

66,625

20,000 20,000

LO 6,8 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13B a. Evergreen Retail Company: Journal Entries 1. Cash Common Shares

65,000

2. Cash Bank Loan Payable

15,000

3. Equipment Cash

25,000

4. Inventory Accounts Payable

60,000

5. Accounts Receivable Cash Sales Revenue

28,000 64,000

Cost of Goods Sold Inventory

44,000

6. Supplies Cash

65,000

15,000

25,000

60,000

92,000

44,000 800 800

7. Cash Accounts Receivable

24,000

8. Accounts Payable Cash

25,000

9. Wages Expense Cash

36,200

10. Interest Expense1 Cash 1 ($15,000 x 8% = $1,200)

1,200

24,000

25,000

36,200

1,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13B (Continued) 11. Dividends Declared Dividends Payable

2,000 2,000

b. Adjusting entries 12. Depreciation Expense1 3,000 Accumulated Depreciation, Equipment 1 ($25,000 – $1,000) / 8 = $3,000 13. Supplies Expense1 Supplies 1 ($800 - $200)

600

14. Wages Expense Wages Payable

800

3,000

600

800

c. Evergreen Retail Company: T-Accounts

(1) (2) (5) (7)

Cash 65,000 15,000 25,000 (3) 64,000 800 (6) 24,000 25,000 (8) 36,200 (9) 1,200 (10)

Accounts Receivable (5) 28,000 24,000 (7) 4,000

79,800

(6)

Supplies 800

(4)

800

16,000 600 (13)

200

Inventory 60,000 44,000

(5)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13B (Continued) Equipment (3) 25,000

Accumulated Depreciation, Equipment 3,000 (12)

25,000

3,000

Accounts Payable (8) 25,000 60,000 35,000

(4)

Wages Payable 800 (14) 800

Dividends Payable 2,000 (11)

Bank Loan Payable 15,000 (2)

2,000

15,000

Common Shares 65,000

Retained Earnings 0

(1)

65,000

0 (CE) 2,000

6,200 4,200

Dividends Declared (11) 2,000 2,000 2,000 (CE) 0

(CE)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13B (Continued) Income Summary 92,000 (CE) (CE) 85,800 6,200 (CE) 6,200 0

Sales Revenue

Cost of Goods Sold

92,000

(5)

92,000

(5)

44,000 44,000

(CE) 92,000

44,000 (CE) 0

Wages Expense (9) 36,200 (14) 800

Depreciation Expense (12) 3,000 3,000

37,000

3,000 (CE) 37,000 (CE)

Interest Expense (10) 1,200

Supplies Expense (13) 600

1,200

600 1,200 (CE)

600 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13B (Continued) d. Evergreen Retail Company Adjusted Trial Balance December 31, 2024 Debit $79,800 4,000 200 16,000 25,000

Cash Accounts receivable Supplies Inventory Equipment Accumulated depreciation, equipment Accounts payable Wages payable Dividends payable Bank loan payable Common shares Dividends declared 2,000 Sales revenue Cost of goods sold 44,000 Wages expense 37,000 Depreciation expense 3,000 Supplies expense 600 Interest expense 1,200 $212,800

Credit

3,000 35,000 800 2,000 15,000 65,000 92,000

$212,800

f. Closing entries (CE) i. Sales Revenue Income Summary Income Summary Cost of Goods Sold Wages Expense Depreciation Expense Supplies expense Interest Expense

92,000 92,000 85,800 44,000 37,000 3,000 600 1,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-13B (Continued) Income Summary1 Retained Earnings 1 ($92,000 - $88,500)

6,200

ii. Retained Earnings Dividends Declared

2,000

6,200

2,000

LO 6,7,8 BT: AP Difficulty: M Time: 80 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP3-14B a. WRCL: Journal Entries Jan 1

Trucks Cash Notes Payable

310,000

Prepaid Insurance Cash

3,300

Inventory Accounts Payable

13,000

Cash Deferred Revenue

4,500

Cash Accounts Receivable1 Sales Revenue 1 ($75,500 x1/3)

50,333 25,167

Cost of Goods Sold Inventory

52,100

31 Wages Expense Cash Wages Payable

32,000

110,000 200,000

3,300

13,000

4,500

75,500

52,100

26,000 6,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) Jan 31 Dividends Payable Cash 31

Rent Expense Cash

9,000 9,000 3,000 3,000

Adjusting entries

Jan 31 Supplies Expense1 Supplies 1 ($13,000 – $2,300)

10,700

31 Insurance Expense1 Prepaid Insurance 1 ($3,300/12 months)

275

10,700

275

31 Depreciation Expense 1 4,000 Accumulated Depreciation, Trucks 4,000 1 ($310,000 - $70,000) / 5 / 12 months = $4,000) 31Depreciation Expense Accumulated Depreciation, Equipment

60,000

31 Interest Expense1 Interest Payable 1 $200,000 x 9% x 1/12 = $450

1,500

31 Deferred Revenue Sales Revenue

60,000

1,500

12,800 12,800

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) c. WRCL: T-Accounts

Cash Accounts Receivable Bal. 268,000 Bal. 103,000 Jan 12 4,500 Jan 18 25,167 Jan 18 50,333 110,000 Jan 1 3,300 Jan 1 128,167 26,000 Jan 31 9,000 Jan 31 3,000 Jan 31 171,533 Inventory Bal. 136,000 Jan 5 13,000 52,100 Jan 18 96,900

Bal.

Prepaid Insurance Bal. 0 Jan 1 3,300 275 Jan 31 3,025

Supplies Trucks 13,000 Bal. 0 10,700 Jan 31Jan 1 310,000 2,300 310,000

Accumulated Depreciation, Trucks 0 Bal 4,000 Jan 31 4,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) Equipment Bal. 226,000

Accumulated Depreciation, Equipment 108,000 Bal. 60,000 Jan. 31

226,000 168,000

Wages Payable 0 Bal. 6,000 Jan 31 6,000

Interest Payable 0 Bal. 1,500 Jan 31 1,500 Accounts Payable 80,000 Bal. 13,000 Jan 5 93,000 Dividends Payable Bal. 9,000 Jan 31 9,000 0 Deferred Revenue 80,000 Bal. 4,500 Jan 12 Jan 31 12,800 71,700

Notes Payable 0 Bal 200,000 Jan 1

200,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) Common Shares 86,000 Bal. 86,000

Retained Earnings 133,000 Bal. (CE) 9,000

183,725 (CE) 352,225 Bal.

Dividends Declared Bal. 9,000 9,000 (CE) Bal. 0

Income Summary Bal. 0 1,069,300 (CE) (CE) 885,575 183,725 (CE) 183,725 Bal. 0

Sales Revenue Cost of Goods Sold 981,000 Bal. Bal. 528,000 75,500 Jan 18 Jan 18 52,100 12,800 Jan 31 1,069,300

580,100

(CE)1,069,300

580,100 (CE) 0

Wages Expense Bal. 132,000 Jan 31 32,000 164,000

0 Advertising Expense Bal. 29,000

29,000 164,000 (CE)

29,000 (CE) 0

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) Rent Expense Bal. 33,000 Jan 31 3,000

Depreciation Expense Bal. 0 Jan 31 4,000 Jan 31 60,000

36,000 36,000 (CE)

64,000 64,000 (CE)

0 0 Insurance Expense Bal. 0 Jan 31 275

Supplies Expense Bal. 0 Jan 31 10,700

275

10,700 275 (CE)

Interest Expense Bal. 0 . Jan. 31 1,500 1,500 (CE) _____________________ 0

10, 700 (CE)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) d. West Coast Recycling Ltd. Adjusted Trial Balance December 31, 2024 Debit Cash $ 171,533 Accounts receivable 128,167 Inventory 96,900 Prepaid insurance 3,025 Supplies 2,300 Equipment 226,000 Accumulated depreciation, equipment Trucks 310,000 Accumulated depreciation, trucks Accounts payable Wages payable Interest payable Deferred revenue Notes payable Common shares Retained earnings Dividends declared 9,000 Sales revenue Cost of goods sold 580,100 Wages expense 164,000 Advertising expense 29,000 Rent expense 36,000 Supplies expense 10,700 Insurance expense 275 Interest expense 1,500 Depreciation expense 64,000 $1,832,500

Credit

168,000 4,000 93,000 6,000 1,500 71,700 200,000 86,000 133,000 1,069,300

$1,832,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) e. West Coast Recycling Ltd. Statement of Income For the year ended December 31, 2024 Sales revenue Expenses Cost of goods sold Wages expense Advertising expense Rent expense Supplies expense Insurance expense Interest expense Depreciation expense Total expenses Net income

$1,069,300 $580,100 164,000 29,000 36,000 10,700 275 1,500 64,000 885,575 $183,725

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) f.

Closing entries (CE) i. Sales Revenue Income Summary

1,069,300 1,069,300

Income Summary Cost of Goods Sold Wages Expense Advertising Expense Rent Expense Supplies Expense Insurance expense Interest Expense Depreciation Expense

885,575

Income Summary1 Retained Earnings 1 ($1,069,300 - $885,575)

183,725

ii Retained Earnings Dividends Declared

$580,100 164,000 29,000 36,000 10,700 275 1,500 64,000

183,725

9,000 9,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-14B (Continued) g. West Coast Recycling Ltd. Statement of Financial Position As at December 31, 2024 Assets Current assets Cash Accounts receivable Inventory Supplies Prepaid rent Total current assets Non-current assets Equipment $226,000 Less accumulated depreciation (168,000) Trucks Less accumulated depreciation Total non-current assets

310,000 (4,000)

$ 171,533 128,167 96,900 2,300 3,025 401,925

58,000 306,000 364,000

Total assets

$765,925

Liabilities Current liabilities Accounts payable Deferred revenue Interest payable Wages payable Notes payable Total liabilities

$93,000 71,700 1,500 6,000 200,000 372,200

Shareholders’ equity Common shares Retained earnings1 Total shareholders’ equity

$86,000 307,725

Total liabilities & shareholders’ equity 1 $133,000 + $183,725 - $9,000 = $307,725

393,725 $765,925

LO 6,7,8 BT: AP Difficulty: H Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15B a.

Mahon Ltd. Adjusted Trial Balance December 31, 2024 Debits

Cash Accounts Receivable Supplies ($11,000 – $4,0004) Prepaid Insurance ($0 + $3,0005) Interest Receivable ($0 + $6,0001) Inventory Notes receivable Equipment Accumulated Depreciation, Equipment ($160,000 + $168,0006) Accounts Payable Interest Payable ($0 + $5,0003) Wages Payable ($0 + $80,0002) Dividends Payable ($0 + $250,0007) Deferred Revenue Notes Payable Common Shares Retained Earnings Dividends Declared ($180,000 + $250,0007) Sales Revenue Interest Revenue ($9,000 + $6,0001) Cost of Goods Sold Utilities Expense Interest Expense ($7,000 + $5,0003) Wages Expense ($360,000 + $80,0002) Rent Expense Insurance Expense ($16,000 – $3,0005) Miscellaneous Expense Advertising Expense Supplies Expense ($0 + $4,0004) Depreciation Expense ($0 +$168,0006)

Credits

$ 116,000 426,000 7,000 3,000 6,000 310,000 200,000 1,688,000 $ 328,000 217,000 5,000 80,000 250,000 29,000 250,000 348,000 1,142,000 430,000 3,410,000 15,000 2,046,000 86,000 12,000 440,000 33,000 13,000 32,000 54,000 4,000 168,000

________

6,074,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15B (Continued) b. Mahon Ltd. Statement of Income For the year ended December 31, 2024 Revenues Sales revenue Interest revenue Total revenues Expenses: Cost of goods sold Utilities expense Rent expense Wages expense Miscellaneous expense Insurance expense Advertising expense Supplies expense Interest expense Depreciation expense Total expenses

$ 3,410,000 15,000 3,425,000

$2,046,000 86,000 33,000 440,000 32,000 13,000 54,000 4,000 12,000 168,000

Net income

Beginning retained earnings, Jan. 1, 2024 Net income Dividends declared Ending retained earnings, Dec. 31, 2024

2,888,000 $537,000

$1,142,000 537,000 (430,000) $1,249,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-15B (Continued) d. Mahon Ltd. Statement of Financial Position As at December 31, 2024 Current assets: Cash Accounts receivable Notes receivable Prepaid insurance Interest receivable Supplies Inventory Total current assets Non-current assets: Equipment Less: Accumulated depreciation

$ 116,000 426,000 200,000 3,000 6,000 7,000 310,000 $1,068,000 1,688,000 (328,000) 1,360,000

Total assets

$2,428,000 Liabilities

Current liabilities: Accounts payable Notes payable Interest payable Wages payable Dividends payable Deferred revenue Total liabilities

$ 217,000 250,000 5,000 80,000 250,000 29,000 $831,000

Shareholders’ Equity Common shares 348,000 Retained earnings 1,249,000 Total shareholders’ equity 1,597,000 Total liabilities and shareholders’ equity

$2,428,000

LO 6,7 BT: AP Difficulty: H Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-16B a. and b. 1. Sales $30,000 2. COGS (17,400) 3. See below 0 4. See below 0 5. Utilities expense (430) 6. Other expenses (2,100) 7. Interest expense ($5,000 x 8% x 1/12) (33) 8. See below 0 Net Income $10,037

Does not affect June earnings. Does not affect June earnings.

Does not affect June earnings.

Items 3 & 4 - The purchase of merchandise on credit in 3 and the payment for the merchandise in 4 do not affect the statement of income. Merchandise purchased is an asset (inventory). It does not become an expense until the goods are sold, at which time the cost of the inventory becomes cost of goods sold expense and reported in the same period as the related sales revenue. The payment for the merchandise in 4 reduces cash and reduces accounts payable. Item 6 - The total expenses incurred affect the statement of income. Even though depreciation does not use cash, it is still an expense (it is a reduction in a PP&E asset) and it reduces current earnings. Item 7 - The $500 paid on loan principal in 7 reduces cash and loan payable liability. It does not affect the statement of income. Item 8 - Item 8 is not included because the revenue is not recognized until the work has been performed and the bike is delivered. Even if the customer had paid fully for the bike, the revenue has not been earned and therefore is not recognized on the statement of income. LO 7 BT: AP Difficulty: H Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17B a. Commerce Company Statement of Income For the Year Ended December 31, 2024 Revenues: Sales revenue Service revenue Total revenue Expenses: Cost of goods sold Utilities expense Wages expense Supplies expense Selling expenses Insurance expense Interest expense Miscellaneous expense Depreciation expense Total expenses Income before income taxes Income tax expense Net income

$179,800 93,100 $272,900 110,000 2,400 60,000 2,200 27,000 1,400 1,700 13,000 4,500

(A formal statement of income was not required.)

222,200 50,700 8,000 $ 42,700

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17B (Continued) b.

Closing entries (CE) i. Sales Revenue Service Revenue Income Summary

272,900

Income Summary Cost of Goods sold Utilities Expense Wages Expense Supplies Expense Selling Expenses Insurance Expense Interest Expense Miscellaneous Expense Depreciation Expense Income Tax Expense

230,200

Retained Earnings Income Summary1 1 ($272,900 - $230,200)

42,700

ii. Retained Earnings Dividends Declared c.

179,800 93,100

Beginning retained earnings Net income Dividends declared Ending retained earnings

110,000 2,400 60,000 2,200 27,000 1,400 1,700 13,000 4,500 8,000

42,700

12,400 12,400 $31,500 42,700 (12,400) $61,800

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17B (Continued) c. Commerce Company Statement of Financial Position As at December 31, 2024 Assets Current assets: Cash Accounts receivable Prepaid insurance Inventory Supplies Total current assets

$ 24,000 67,000 500 30,000 800

Non-current assets: Buildings Less: Accumulated depreciation Land Total non-current assets

72,000 (20,000) 82,000

$122,300

134,000

Total assets

$256,300 Liabilities

Current Liabilities: Accounts payable Wages payable Dividends payable Income tax payable Deferred revenue Notes payable Interest payable Total current liabilities

$ 36,000 3,000 4,000 2,000 1,200 15,000 300 $61,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP3-17B (Continued) Non-current liabilities: Loan payable

48,000

Total liabilities

$109,500 Shareholders’ Equity

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

$85,000 61,800 146,800 $256,300

LO 8 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS (UP) UP3-1 The Chart of Accounts and Managing Your Business What is a chart of accounts? • a key component of your information system • the list of all accounts needed to generate a full representation of the monetary amounts of the company’s individual assets, liabilities, owner equity, and revenues, expenses, gains, and losses. • the infrastructure on which your accounting system is built, structured (numbered) according to the types of accounting elements • Example: Assets (#1000 to 1999) Liabilities (#2000 to 2999) Equity (#3000 to 3500) Revenue and gains (#4000 to 4999) Expenses and losses (#5000 to 8999) • each company refines and changes the chart of accounts to meet its own unique needs, therefore there is not one common, generic chart of accounts that is used by all businesses. Why is a chart of accounts needed by a business? • To capture the financial information necessary to prepare financial statements for reporting externally • To capture the financial information necessary to manage your business appropriately internally How should you decide which accounts and how many accounts should be included in the chart of accounts? • Begin with identifying who uses your financial information (owners, the bank, other creditors, your unions, regulatory filings, Canada Revenue Agency, etc.) • For each, identify what information must be provided to meet that specific user’s requirements (e.g., financial accounting and reporting standards must be met if audited financial statements are required)

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-1 (Continued) • There will be considerable overlap, but the needs will differ in the amount of detail that is appropriate • For internal management purposes, identify how detailed the underlying data must be so that all levels in the company have the information necessary for decision-making Example of levels of detail: Asset (#1000 to 1999) - Inventory (#1100 to 1199) o Clothing (#1110 to 1120) ▪ Coats and jackets (#1111-100 to 1111-150) • Overcoats (#1111-101 to 1111-109) o Formal (#1111-102) ▪ Men’s (#1111-102-1) • Etc. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP3-2 In accounting, it is not good enough to have records and information only on the assets (economic resources) an entity has at a point in time. It is much more useful to also know to what extent the entity is required to distribute entity resources, its assets, to non-owners (liabilities) and what the owners’ equity interest is in such assets (owners’ or shareholders’ equity) at a point in time. When the entity engages in operations, its assets increase when it sells goods and services (as customers pay cash or give a promise to pay cash in the future) and its assets decrease when it incurs costs to run the business, such as when it pays its employees for work they’ve done. To properly manage a business, it is important to keep track of the amounts and what causes the increases in assets (revenues) and the amounts and what causes the assets to go down due to the cost of the effort of earning those revenues (expenses).

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-2 (Continued) To accumulate this information, assets are the focal point, and the accounting keeps track of the amounts and reasons for the changes in assets, as well as whether owners or non-owners are entitled to the assets at any point in time. Each transaction captured in the accounting system, therefore, does two things. One is to keep track of each asset and the other is to capture where the assets came from and for what purpose they were used. This is the basis of double-entry bookkeeping. Because of this two-fold requirement, assets are identified as being debits (having normal debit balances), and liabilities (obligations to distribute assets to non-owners) and the interest of owners in the assets are identified as being credits (having normal credit balances). If an entity lists all its assets and all its liabilities and owners’ equity in the assets at a point in time, the asset debits should equal the liability and equity credits. This is one proof of the accuracy of the recording of transactions in the accounts. As the entity sells goods and services and assets increase (consider new accounts receivable or cash that comes into the business), the assets are debited. They are increased. What is the source of the increase in assets from operations? It is called revenue. Therefore, increases in revenues are accounted for as credits, and again, the debits equal the credits. Revenues also increase the owners’ interest in the increased assets, so revenues and owners’ equity accounts both have “normal” credit balances. Alternatively, when the new accounts receivable and/or cash flowed into the business, another asset – the inventory – flowed out. Because this asset decreased, inventory is reduced by making a credit to the inventory asset account. Thus, its balance goes down. What caused the decrease in the asset? It was an expense of doing business, so the reason for the asset decrease (a credit) is the increase in an expense (a debit). The most important thing to remember is that assets have normal debit balances; therefore, increases in assets are debits and decreases in assets are the opposite – credits. Everything else flows from this.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-2 (Continued) What causes an entity’s assets to increase? Borrowings and other liabilities, owners’ contributions for their ownership interest and revenues. From all these sources, assets increase (debits) and liabilities, owner equity accounts or revenues also increase (credits). The accounts are balanced as the debit amounts are the same as the credit amounts. What causes an entity’s assets to decrease? Repayments of borrowings and other liabilities, distributions to owners, and incurring expenses from operating the business. From all of these, assets decrease (credits) and either liabilities or owner equity accounts decrease (debits) or expenses increase (debits). [Note that since new assets (debits) from revenues increase the owners’ equity in those assets (credits); the outflow of assets (credits) for expenses decrease the owners’ interest in the assets (debits).] So, assets and expenses have normal debit balances. They are increased with debits, decreased with credits. Liabilities, owners’ equity, and revenues have normal credit balances. They are increased with credits, decreased with debits. Debits and credits and normal balances are a means of helping to keep track of information needed to manage a business and to measure and report its financial position and the results of its operations. The only way to really appreciate normal balances and debits and credits is to practice the bookkeeping aspects and to follow the entries through to the end of the accounting cycle and preparation of financial statements. Then it will all fall into place. LO 2 BT: C Difficulty: M Time: 40 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-3 The debit and credit rule is based on the accounting equation. The equation is assets = liabilities + shareholders’ equity. Assets and liabilities are on opposite sides of the equation. The way they are increased and decreased are opposite to each other. If assets are decreased with credits then debits decrease liabilities. Perhaps the confusion comes from terminology used by banks. To a bank, your bank account is a liability. This is why, based on the bank’s perspective, an increase in their liability is a credit to your bank account. From your perspective, you view the bank account as an asset, and the bank’s terminology of increasing you account is called a credit. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP3-4 If your trial balance is in balance you may not conclude that your accounting is correct, you can conclude that your debit balances equal your credit balances. The purpose of a trial balance is to assist in detecting errors that may have been made in the recording process. Something is wrong if the ledger does not balance; that is, if the total of all the accounts with debit balances does not equal the total of all the accounts with credit balances. In such cases, there is no point in proceeding until the errors have been found and corrected. This makes the preparation of a trial balance a useful step in the accounting cycle. However, it is important to realize that the trial balance will not identify all types of errors. For example: ● The trial balance will still balance if the correct amount was debited or credited, but to the wrong account. An example is if a purchase of equipment was debited to the Inventory account, rather than to the Equipment account. ● The trial balance will still balance if an incorrect amount was recorded. An example is if a $450 transaction was recorded as a $540 transaction, for both the debit and credit portions of the entry. ● The trial balance will also not detect the complete omission or duplication of an entire journal entry. If neither the debit nor the credit portions of a journal entry were posted, the totals on the trial balance will still be equal. LO 3 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-5 A trial balance is prepared as a starting point to prepare financial statements. The accountant will be able to assess your company financial position at a high level. The trial balance will tell the accountant your revenues and expenses, including the type of each from this the accountant will know if the business is profitable or not. It will also tell your accountant what assets you have and the liabilities you owe. The accountant will be able to quickly determine how your business is financed, the extent of its liabilities and the nature of its assets. It will not, however, provide any information of cash flows or additional information that is typically included in the notes to the financial statements. LO 3 BT: C Difficulty: E Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP3-6 Although you are correct in your calculation of gross profit which is sales less cost of goods sold, we need to reflect the transaction in our journal entries into the proper accounts. The transaction represents a sale of an item which brings about revenue for the company and the usage of an asset, in this case inventory, which needs to be expensed. Users of the statements (including the company) need useful information which includes sales and cost of goods sold. If they only have the net (gross profit) they are not making their decisions based on the best information. Users want to know sales and cost of goods sold as well as gross profit. Comparisons of those accounts with their related accounts (example Inventory compared to Cost of Goods Sold) will help users determine if inventory is being managed efficiently. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-7 A deferral is when revenue recognition happens after the receipt of cash. The company receives the cash before the delivery of the goods or the performance of the service and so the company needs to defer (postpone) the recognition of revenue until it is earned. An accrual is when the company receives the cash after the delivery of the goods or after the service is performed and so the company needs to accrue the revenue when it is earned. LO 7 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP3-8 Memo To: Ms. Boss From: Commercial Lending Team While the numbers on an adjusted trial balance are the basis for the amounts that appear on the financial statements, additional information is provided on the financial statements. For example: • The statement of financial position is “classified” so that items with similar characteristics are grouped together. In addition, the hundreds (and maybe thousands) of accounts on the trial balance are summarized when the financial statements are prepared so that meaningful totals are provided of like items, making it much more readable than a trial balance. In effect, the preparation of financial statements converts raw data into useful information. • A statement of financial position sets out very clearly which assets and liabilities are current in nature, and which are non-current; what the amounts of total assets and total liabilities are, and what the equity of the shareholders is. This provides good information for our analysis of the company’s financial position such as its liquidity and solvency and risk. The adjusted trial balance classifies each account only as a debit or a credit.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-8 (Continued) • The statement of income also provides information in a way that makes it easier to analyse and assess performance, trends in profitability, and our ability to pinpoint areas of concern. It provides a “bottom line” that sums up well the results of operations over a period of time. It is not obvious, when dealing with the listing of all the revenue and expense accounts on a trial balance, what the results of recurring operations are and what the effect of non-operating and non-recurring items is. • The statement of cash flows, easily prepared from a statement of financial position and a statement of income (along with some supplementary information), is important to our clients and to our needs in assessing the company’s ability to repay loans, etc. A trial balance is not useful in evaluating the company’s cash flows. • Having appropriate sub-totals and totals on all the statements allows us to determine relationships between various items, such as return (net income) on assets invested or on shareholders’ investment (shareholders’ equity). I recommend that the bank’s policy should require the preparation and submission of financial statements, and indicate that an adjusted trial balance is not an acceptable alternative. In addition to the reasons indicated above, our clients also need this or similar information to enable them to better manage their businesses. LO 3 BT: C Difficulty: M Time: 25 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP3-9 I would recommend using the “closing entry” option of the accounting software at the company’s fiscal year end. You would select this option after all the journal entries and adjusting entries for the current fiscal period have been made and finalized, and before entries begin to be made for the new fiscal period. “Closing entries” serve two purposes: • To bring the temporary accounts for revenue and expenses for the period to zero (that is, to close them), transferring the profit or loss indicated by their net balances to Retained Earnings. Retained Earnings, a permanent account, is a statement of financial position account that continues on, year-after-year, accumulating the results of each year’s performance and its balance tells you the extent to which the net assets of the business were generated from undistributed past profits. • To bring the “dividends declared” account, that indicates the amount of assets generated from past profits distributed to shareholders during the year, to zero. Therefore, its balance is ‘closed out’ and transferred to Retained Earnings as well. The impact on your accounting records of closing the books is to bring all the revenue, expense, and dividends accounts back to zero so that they can begin again in the new fiscal year to accumulate the revenue, expense, and dividends amounts of the new fiscal period. With these accounts closed, the only accounts that have balances remaining in them are those representing statement of financial position accounts: assets, liabilities and owners’ equity accounts. Retained earnings is one of the owners’ equity accounts and it will now represent the amount of net assets generated from undistributed profits earned in previous periods, up to the reporting date. LO 8 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIP3-1 The double-entry debit and credit system works with the concept of left and right. Debit mean left (left hand side of the account) and Credit means right (right hand side of the account). The debit and credit system is that each transaction will have an equal debit side and a credit side, your debits must always equal your credits. This system is based on the accounting equation: Assets = Liabilities + Shareholder’s Equity. Since assets are found on the left or debit side of the equation, they normally have a debit balance, so to increase an asset you debit the account and to decrease an asset you would credit the account. For liabilities and shareholders’ equity, that are found on the right side of the equation or credit side, they normally have a credit balance, so to increase, you credit the account and to decrease you debit the account. For expenses and dividends declared, an increase would be a debit because they both decrease shareholder’s equity and a decrease would be a credit. LO 1,2 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP3-2 You classmate is correct that revenues and expense accounts are temporary accounts. At the end of each year, the net results of these two types of temporary accounts corresponds to the net income (or loss) appearing on the Statement of Income. Once the fiscal year ends, these accounts need to reset so that the business can start again in the next year after the completion of the closing process. Temporary accounts are closed to retained earnings and the temporary accounts are set to zero. Retained earnings reports the cumulative income of the organization since inception less any dividends declared. The balance sheet accounts, with the exception of Dividends Declared which is a temporary account, are permanent accounts as they do not get closed, their balances are continually updated. LO 5 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP3-3 Closing entries are made at the fiscal year to transfer balances appearing in the temporary accounts (revenue, expenses and dividends declared) to retained earnings. The closing entry process has achieved two key objectives: ● The balance in the Retained Earnings account has been brought up to date by adding the net income (or deducting the net loss) for the year and deducting the dividends declared during the year. ● The balances of all temporary accounts have been reset to zero, so that the accounts are ready to use at the start of the next year. LO 8 BT: C Difficulty: E Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP3-4 Closing entries are made at the fiscal year to transfer balances appearing in the temporary accounts (revenue, expenses and dividends declared) to retained earnings. The closing entry process has achieved two key objectives: ● The balance in the Retained Earnings account has been brought up to date by adding the net income (or deducting the net loss) for the year and deducting the dividends declared during the year. ● The balances of all temporary accounts have been reset to zero, so that the accounts are ready to use at the start of the next year. LO 8 BT: C Difficulty: E Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP3-5 The balance in retained earnings signals that the company has had net income in the past that has exceeded, in total, the net losses experienced to date. Retained earnings represents profits or earnings that have been retained and reinvested in the company rather than being distributed as dividends to shareholders. Retained earnings is equity and not an asset. It therefore does not represent cash set aside to finance the company in the future.

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP3-6 It is possible for a company to have declared dividends during the year and have no dividends payable balance on the company’s financial statements. If all dividends declared have been paid by the date of the financial statements, there would be no dividends payable balance to report. When dividends are declared, a dividends payable is created until the dividend is paid. Once the dividend is paid the liability no longer exists. LO 8 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS (RI)

RI3-1 Saputo Inc. a. (in $000s) Income Summary Retained Earnings Retained Earnings Dividends Declared

649,700 649,700 269,700 269,700

b. Saputo is likely to have prepaid insurance and prepaid property taxes. Because both insurance and property taxes are “used up” as a function of time, the prepaid accounts would be adjusted and insurance and property tax expenses recognized as each month passes. LO 7,8 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI3-2 High Liner Foods Incorporated a. $(000s) US Opening balance, retained earnings 162,773 Add net income 28,802 Less dividends declared (5,518) Retained earnings, December 31, 2020 $186,057 b.

Because the company has an opening balance in its Retained Earnings account, we know that: 1. This is not its first year of operations; 2. The company has been profitable; 3. The company’s profits have exceeded the dividends declared in past years; and. 4. The shareholders’ equity is larger than the capital originally contributed to the company for the shareholders’ ownership interests (common shares). The additional net assets (equity) were generated by inflows of net assets from revenues in excess of the outflow of net assets for expenses in operating the business.

c. (in US $000s) Depreciation Expense 10,635 Accumulated Depreciation, Production Equipment Accumulated Depreciation, Buildings Accumulated Depreciation, Computer Equipment

6,630 2,901 1,104

d. High Liner Foods would likely prepay its insurance costs on its property, plant and equipment and inventory, and its rent payments for non-owned space it uses. Because both insurance and rent relate to specific periods of time, these costs would be expensed as time passes and the services covered by the costs are used up. LO 7 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI3-3 The North West Company Inc.

a. Opening balance, retained earnings Add net income Less dividends declared

$(000s) 211,252 143,560 (67,276)

Retained earnings, January 31, 2021

$287,536

Two likely liabilities included in “accounts payable and accrued liabilities” on the company’s statement of financial position are a significant account payable to the wholesalers from whom the company purchases the foodstuffs and other merchandise that it sells, and employee wage costs that have accrued at January 31 but aren’t payable until the next payday after year end.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI3-3 (Continued) d. Type of asset Buildings Fixtures & equipment

Net book value/carrying amount $599,930 - $325,616 = $274,314 $348,173 - $253,800 = $ 94,373

These assets, on average, are more than half-way through their useful lives. For example, the buildings are $325,616/$599,930 = 54% depreciated, and perhaps even more, if the company assumes there will be a significant residual value at the end of its useful life. The fixtures and equipment are proportionately more used up than is the building, as the accumulated depreciation of $253,800 is 73% of the assets’ cost of $348,173. LO 7 BT: AN Difficulty: M Time: 25 min. AACSB: Analysis CPA: cpa-t001 CM: Reporting and Finance

RI3-4 Big Rock Brewery Inc. a. Opening balance, deficit Less net loss Less dividends declared Deficit, December 31, 2020 b.

$(000s) (79,761) (666) ( 0) $(80,427)

Because the company has a deficit opening balance in its Retained Earnings account, we know that: 1. This is not its first year of operations; 2. The company has generated a net loss (i.e. cumulative expenses and dividends declared have exceeded cumulative revenues) in in past years, and 3. The shareholders’ equity is smaller than the capital originally contributed to the company for the shareholders’ ownership interests (common shares). The reduction in net assets (equity) was generated by outflows of net assets for expenses in excess of the inflows of net assets from revenues in operating the business.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI3-4 (Continued) c.

The $387,000 of prepaid insurance premiums and property taxes is presented on the statement of financial position as “prepaid expenses” in the current asset section of the statement. The costs in the Prepaid Expenses account would be expensed as time passes (probably at each month end) as the insurance coverage and the prepayment of property taxes are used up. The cost of the insurance and the property taxes are based on a specific period of time. LO 7 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

RI3-5 Solution will vary with specific company that students choose. LO8 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI3-6 Solution will vary with specific company that students chose for RI3-5. LO10 BT: AN Difficulty: H Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASES SOLUTIONS (C) C3-1 Al’s Gourmet Fish a. Only $400,000 should be included as this period’s revenue (i.e. $520,000 cash received less $120,000 earned in prior periods). b. $276,000 of fish food expense should be reported this period (i.e. $460,000 less the 40%, which remains on hand at year-end). The remainder of the fish food purchased should be reported as inventory (an asset). c. Some portion of the cost of the fish tanks should be included in calculating current period earnings. Assuming straight-line depreciation and no residual value, $24,000 is the current period depreciation expense [i.e. ($80,000 + $40,000)/5]. d. It is appropriate for the company to pay Al wages to fairly compensate him for the actual amount of time worked (provided that the company is an incorporated business, and not a proprietorship or a partnership as these business forms have different mechanisms to distribute earnings to the owners). e. All the other expenses that were incurred during the year (as opposed to expenses that were paid) should be reported as expenses during the year. Therefore, assuming none of the $20,000 payments made in the current period were for the preceding period’s expenses, other operating expenses for the current period are $20,000 + $1,000 = $21,000. f. Assuming the selling price of the land was also $130,000, the gain on the sale of land is $40,000 (i.e. $130,000 less $90,000). g. Based on an accrual statement of income (see below), Al earned net income of $39,000. h. Whether it is sufficiently attractive for Al to remain in the fish business depends on many factors, such as the amount Al has invested in assets, the expansion opportunities, the general conditions in the fish industry, the willingness of the bank to provide financing, and the enjoyment Al derives from raising fish. Also, the reasonableness of the $60,000 salary Al earned needs to be factored into his decision.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-1 (Continued) Al’s Gourmet Fish Accrual-Basis Statement of Income For year ended 20xx Revenues and gains Sales revenue Gain on sale of land Total revenues and gains Expenses: Fish food expense $ 276,000 Depreciation expense 24,000 Other expenses 21,000 Wages expense 80,000 Total expenses Net income

$ 400,000 40,000 440,000

401,000 $ 39,000

LO6,7 BT: AN Difficulty: H Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-2 Sentry Security Services a. Sentry Security Services Statement of Income (accrual basis) December 31, 2024 Service revenue Expenses: Salaries expense Parts and supplies expense Vehicle expense Rent expense Insurance expense Depreciation expense, equipment Depreciation expense, vehicles Interest expense

$80,000 $37,250 13,750 4,000 6,000 1,350 3,600 5,000 1,500

Net Income

72,450 $ 7,550

Sentry Security Services Statement of Financial Position December 31, 2024 Current assets: Cash $ 5,000 Accounts Receivable 5,000 Prepaid Rent 500 Prepaid Insurance 650 Supplies 1,750 Total current assets Property and equipment: Equipment 18,000 Less: Accumulated Depreciation, Equipment (3,600) Vehicles 21,000 Less: Accumulated Depreciation, Vehicles (5,000) Net property and equipment Total assets

$12,900

30,400 $43,300

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-2 (Continued) Current liabilities: Accounts Payable Wages Payable

$ 500 250 $750

Non-current Liabilities: Notes Payable Total liabilities Shareholders’ equity: Common Shares Retained Earnings Total shareholders’ equity Total liabilities and shareholders’ equity

10,000 10,750 25,000 7,550 32,550 $43,300

b. Net income of $ 7,550 with a 9.4% net profit margin, particularly in its first year of operations, indicates that the business is healthy. The net income of $7,550 represents a 17.4% return on the assets invested which far exceeds what might be available from more passive investments. Also, total assets of $43,300 and only $10,750 of liabilities demonstrate the financial health of the business in that the shareholders have financed about 75% of the assets of the business. This indicates a relatively low risk factor. LO6,7 BT: AN Difficulty: H Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-3 Shirley’s Snack Shop a. Shirley's Snack Shop Inc. Statement of Income For the eight-months ended December 31, 2024 Sales revenue Expenses: Cost of goods sold Depreciation expense Interest expense Insurance expense Rent expense Wages expense Licence expense Miscellaneous expense* Net income

$ 42,800 $ 17,800 640 667 250 7,200 10,800 100 200

37,657 $ 5,143

Calculations: Sales revenue = $42,300 + $500 = $42,800 Cost of goods sold = ($22,500 – $4,500) – $200* = $17,800 Depreciation expense = ($9,600 – $0) / 10 x 8/12 = $640 Rent expense = $900 x 8 = $7,200 Wages expense = ($1,000 x 8) + ($350 x 8) = $10,800 Interest expense = $10,000 x 10% x 8/12 = $667 Licence expense = ($150 x 8/12) = $100 Miscellaneous expense = snacks used by owner = $200 * The cost of the snacks eaten by the owner should not be included in the cost of goods sold. It could be shown under a number of other expense categories, such as Meals and Entertainment Expense or Other Operating Expenses, rather than Miscellaneous Expense. Alternatively, if the $200 was a personal expense of the owner instead of a cost of doing business, it would be better treated as a dividend to the owner.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-3 (Continued) Shirley's Snack Shop Inc. Statement of Financial Position As at December 31, 2024 Assets Current Assets: Cash Accounts receivable Inventory Prepaid licence Prepaid insurance Prepaid rent Current assets Non-current assets Equipment (net)**

9,750 500 4,500 50 500 900 $ 16,200 8,960

Total assets Liabilities: Current liabilities: Accounts payable Wages payable Interest payable

$ 25,160

$ 4,000 350 667 $

Non-current liabilities: Bank loan payable Total liabilities Shareholder's Equity: Common shares Retained earnings Total shareholder’s equity Total liabilities and shareholder’s equity

5,017 10,000 15,017

$ 5,000 5,143 10,143 $ 25,160

** Equipment = $9,600 cost – $640 Accumulated depreciation = $8,960

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-3 (Continued) b. 1. Profit Margin = Net income / Total revenue 2024 profit margin = $5,143 / $42,800 = 12.0% 2. Return on assets = Net income / Average total assets 2024 ROA = $5,143 / $25,160 = 20.4% 3. Return on equity = Net income / Average shareholders’ equity 2024 ROE = $5,143 / $10,143 = 50.7% Note: ending balances for total assets and shareholders’ equity used rather than average because of first year of operations. Use of an average with $0 opening balance would increase the ROA and ROE significantly. Using these three performance measurements for analysis, Shirley’s Snack Shop is performing very well; particularly given it is its first period of operations. The company has earned respectable net income and has managed to generate these earnings without excessive use of assets or equity. The company’s financial standing at December 31, 2024 is also strong. Current assets are over 3 times the amount of current liabilities, indicating a strong working capital position and liquidity. While the assets are financed almost 60% by debt (liabilities) and therefore may be considered a little risky, Shirley’s use of borrowed capital from the bank has been beneficial. She is paying only 10% interest on the funds borrowed, but is earning twice that rate on the assets acquired with those funds. This indicates good use of leverage. LO6,7 BT: AN Difficulty: H Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-4 Mbeke’s Hardware Store a. Item 1: Because interest expense accrues with time and the loan was used to earn income in 2024, interest expense on the loan must be accrued at December 31, 2024. The company will have to record interest expense of $14,000 ($140,000 x 10% x 12/12) in 2024. This reduces net income by $14,000. Item 2: The wages were a cost of doing business in 2024, and therefore, will have to be accrued at December 31, 2024. An adjusting entry to do this will cause wages expense to increase by $10,000 and net income to decrease by $10,000. Item 3: The return of inventory recorded as a sale in 2024 did not occur until the new fiscal year, but the parties had agreed on the return on December 30th and accounts receivable at the balance sheet date must always be adjusted for expected returns and allowances. Therefore, sales revenue for 2024 must be reduced by $15,000 and cost of goods sold will also be reduced, but by $11,000. The net effect is a reduction in net income of $4,000. Item 4: The bill for utilities and other operating costs should have been recorded as an account payable at December 31, 2024 since it relates to services received during 2024. Even though the bill was not received until 2025, the benefits of the utilities were used to earn revenue in 2024. Such expenses have to be estimated and accrued if the invoices have not been received by the time the financial statements are completed. Accruing these bills causes 2024 net income to decrease by $2,000. b. 2023 net income

$60,000

2024 net income (as originally stated) #1 #2 #3 #4 2024 net income (restated) Net income for 2024 has increased by 0%.

$90,000 (14,000) (10,000) ( 4,000) ( 2,000) $60,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-4 (Continued) c. Given the fact that the financial statements are going to be used by the bank, Mark may be tempted not to make the above adjustments since they will decrease reported net income by $30,000. However, this would be, at best, unethical, and may even be considered fraudulent if the bank discovered later that required adjustments were known, but not made. Mark must ensure that the financial statements represent faithfully the results of the business for 2024. Mark should carefully review the 2023 financial statements to check whether any similar adjustments should have been made at the end of the preceding year, 2023. If so, this would have a positive effect on the 2024 net income actually earned. If no similar adjustments are required at the end of the 2023 fiscal year, Mark should prepare a detailed operating budget for 2025 (assuming the expansion goes ahead), indicating how he plans to increase the income generated by the business in the upcoming year and going forward. This should be supplemented with a 2025 cash budget, assuming the bank will advance him the funds for expansion. The bank will want to see how Mark expects to generate the cash flows to support the loan and interest costs associated with it. d. The bank can request that an independent auditor examine the financial statements. The auditor would then verify that the statements are presented fairly in accordance with generally accepted accounting principles and provide reasonable assurance that they are free from material misstatement. This third-party verification would provide the bank with the assurance that they could rely on the financial statements. Alternatively, as periodic audits are fairly expensive, the bank could only require Mark to have the auditor do a review engagement. This review has less assurance for the bank, but may cost Mark significantly less. LO6,7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-5 Downunder Company a. Downunder Company Statement of Income For the year ending December 31, 2024 Sales revenue Cost of goods sold Gross profit Expenses: Wages expense Depreciation expense Miscellaneous expense Interest expense Net income

$93,600 (41,000) 52,600 27,500 2,000 8,000 500

38,000 $14,600

Downunder Company Statement of Financial Position December 31, 2024 Assets

Cash Accounts receivable Inventory Equipment, net

Liabilities and Shareholders’ Equity $1,100 20,200 7,900 47,500

Accounts payable $13,000 Wages payable 1,200 Bank loan payable 15,000 Total liabilities 29,200 Shareholders’ equity Common shares $20,000 Retained earnings 27,500 Shareholders’ equity 47,500 Total Liabilities and Shareholders’ Equity

Total Assets

$76,700

Burnley, Understanding Financial Accounting, Third Canadian Edition

C3-5 (Continued) b. The main piece of information missing for the Statement of Financial Position is the opening Retained Earnings balance. For the above statement, Retained Earnings was “plugged” (a useful accounting term to indicate that the number is the one required to make something balance) in order to balance the statement based on the information that was available (Assets = Liabilities + Shareholders’ Equity). Additional information for the Statement of Financial Position would include: • Are there any receivables that should be accrued as revenue at December 31? • Is the inventory balance correct as of December 31, 2024? • Do any of the expenses represent amounts that should be reflected as a prepaid asset account instead of an expense? • Do any of the expenses include costs incurred for equipment that should be recognized on the statement of financial position instead of as an expense? • What is the estimated useful life and the residual value of the equipment? • What is the interest rate on the bank loan? • What portion of the year has the loan been outstanding? • To what date was the interest paid? Should there be any interest payable recognized at December 31? • Are there any income taxes payable? • Are there any outstanding accounts payable that haven’t yet been recognized in the balance provided? • Is the balance of wages payable correct? Are there any additional wages that should be accrued at the end of the 2024 year? • Is the bank loan a short-term or a non-current liability? What about the accounts receivable and accounts payable? Are they both all current items? Note that, except for the last bulleted item that deals with classification issues, the answers to the other questions would all equally affect the statement of income as well as the statement of financial position. LO 7 BT: C Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 4 Revenue Recognition and the Statement of Income

Learning Objectives 1. Explain the nature of revenue and why revenue is of significance to users. 2. Identify and explain the contract-based approach to revenue recognition. 3. Explain how revenue recognition is affected by the right of returns, warranties, consignment, and third-party sale arrangements. 4. Understand the difference between a single-step statement of income and a multi-step statement of income. 5. Understand the difference between comprehensive income and net income. 6. Understand the difference between presenting expenses by function or by nature of the item on the statement of income. 7. Calculate and interpret a company’s basic earnings per share.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4.

2 2 2 2

1. 2 2. 2,3 3. 2,3 1. 2.

1 2

1. 4,6 1.

BT Item LO

Item LO

Discussion Questions C 5. 2 C 9. 2 C 13. 4 C 17. C 6. 2 C 10. 3 C 14. 4 C 18. C 7. 2 C 11. 3 C 15. 4 C C 8. 2 C 12. 3 C 16. 5 C Application Problems AP 4. 2 AP 7. 2,4 AP 10. 4 AP AP 5. 2,3 AP 8. 4 AP 11. 4,6 AP AP 6. 2 AP 9. 4 AN 12. 4,7 AN User Perspective Problems C 3. 3 C 5. 2 C 7. 2 AP 9. C 4. 3 C 6. 2 C 8. 2 AP 10. Work in Process C 2. 2 C 3. 2 C 4. 3 C Reading and Interpreting Published Financial Statements AN 2. 4,6 AN 3. 6 AN 4. 4 AN Cases C 2. 3 C 3. 2 AP

6 7

C C

2 6

AP C

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Learning objective Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty E Easy M Medium H Hard Estimated time to complete in minutes Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflective Thinking Reflec. Thinking CPA Canada Competency Map Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ4-1

The contract-based approach, also known as the asset-liability approach, focuses on the contract the company has with their customers. This approach is used by companies following IFRS. The contract creates a right to receive consideration and performance obligations, and when there are changes in the net position of the contract, revenues can be recognized. This occurs when a company’s rights under the contract increase or when its performance obligation decrease. Under the earnings-based approach, revenue is recognized when it is considered earned, and can be used for companies following ASPE.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-2

Step 1: Identify the contract. A contract exists when all of the following criteria are met: • There is a legally enforceable agreement between two or more parties. • It has been approved and the parties are committed to their obligations. • Each party’s rights to receive goods or services or payments for those goods and services can be identified. • The contract has commercial substance, meaning that the risk, timing, or amount of the company’s future cash flows is expected to change as a result of the contract. • Collection is considered probable. Step 2: Identify the performance obligations. These are the goods and/or services to be delivered to the customer and are sometimes referred to as the contract deliverables.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-2 (Continued) Performance obligations relate to distinct goods or services. They are considered distinct if both of the following criteria are met: • The customer can benefit from the good or service (by using, consuming, or selling it) on its own or with other resources it possesses or can obtain from a third party. • The promise to transfer the goods or services is separate from other promised goods or services in the contract. That is, these goods or services are being purchased as separate items under the contract, rather than forming a larger good or service. Step 3: Determine the transaction price. The transaction price is the amount of consideration the company expects to receive in exchange for providing the goods or services. The amount of revenue the seller should recognize should reflect the consideration it expects to receive in exchange for providing the goods or services. If sales discounts are offered, the expected sales discount should reduce the transaction price. Step 4: Allocate obligations.

the

transaction

price

performance

If, in Step 2, only a single performance obligation was identified, then this step is not required. However, if multiple performance obligations were identified, then a portion of the transaction price determined in Step 3 must be allocated to each of them. The transaction price is allocated on the basis of the stand-alone selling price of each performance obligation.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-2 (Continued) Step 5: Recognize the revenue when each performance obligation is satisfied. As each performance obligation is satisfied, the company recognizes revenue equal to the portion of the transaction price that has been allocated in Step 4. Performance obligations are satisfied when control of the goods or services have been transferred to the customer. Indicators that control has been transferred include the customer having: • Physical possession • Legal title • The risks and rewards of ownership • Accepted the goods or received the services • An obligation to pay LO 2 BT: C Difficulty: H Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-3

When a company’s net contract position has increased it means that the company’s rights under the contract have increased or the company’s performance obligations have decreased. When the net contract position increases, the company can recognize revenue, if it has not, no revenue can be recognized.

LO 2 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-4

Performance obligation is the requirement to provide goods or services to customers. Once a company has satisfied its performance obligations, it can recognize revenue.

LO 2 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-5

The most common point at which revenue is recognized for the sale of goods is at the point of sale. When the customer takes possession of the goods sold, revenue is recognized for most sales at retail stores. Recognition at the point of sale (time of sale) at a retail store or when the shipment is received by the customer in case of on-line sales meets all of the five steps of contract-based revenue recognition. Step 1: Is there a contract? – Yes, both parties have agreed to the quantity, price, and payment terms and each party’s rights under the contract are clear. Step 2: What performance obligations are included in the contract: the quantity of item the customer is purchasing. Step 3: What is the transaction price? – The price of the items being purchased less any discounts. Any sales returns or warranties can be estimated based on previous history. Step 4: How should the transaction price be allocated to the performance obligations? – This is a single performance obligation so no need to allocate performance obligations. Step 5: Has the performance obligation been satisfied? – Yes, the customer now has physical possession of the goods and that includes the risks and rewards of ownership, the customer has accepted the goods and now has an obligation to pay for them, using cash, debit card, credit card, or accounts receivable.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-6

Revenue from the provision of services should be recognized when the performance obligation has been met. Once the services have been provided, the performance obligation has been met and revenue can be recognized. In the case of a yearly service contract, at the end of each month the portion of the performance obligation that has been completed can be recognized.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-7

Step 1: Is there a contract? – Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. Step 2: What performance obligations are included in the contract: the requirement to provide the customer with whatever type/quantity of product they are purchasing. Step 3: What is the transaction price? – The price of the items being purchased less any discounts. Any sales returns or warranties can be estimated based on previous history. Step 4: How should the transaction price be allocated to the performance obligations? – This is a single performance obligation so no need to allocate performance obligations. Step 5: Has the performance obligation been satisfied? – No, the company has not provided the promised goods. It would not recognize the revenue until the goods were delivered. Upon delivery, the customer has control of the goods, which is indicated by physical possession and the fact that it has the risks and rewards of ownership, it has accepted the goods, and it has an obligation to pay for them. The deposit would be recorded as: DR Cash CR Deferred Revenue until the goods were delivered and the customer has taken possession.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-8

The stand-alone price is the normal selling price for a specific good or service, sold on its own. If a contract has multiple performance obligations, the total contract amount or sales price would include all performance obligations. To calculate and record the revenue related to the performance of each performance obligation, the combined selling price is allocated to each performance obligation on the basis of the ratio of the stand-alone price for each performance obligation to the combined stand-alone price for all performance obligations under the contract.

LO 2 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-9

Sales discounts are reductions to the purchase price for goods or services if the buyer, who has purchased the goods on account, pays for their invoice within the discount period. Sales discounts are used to speed up cash collections. A typical sales discount is ‘2/10, net 30’. This means that the buyer is eligible for a 2% discount if payment is made within ten days. Otherwise, the full amount is due in 30 days from the date of the invoice. Sales discounts reduce the transaction price by the amount management estimates the sales discount to be taken by customers will be. This is because the price reduction is considered to be a form of variable consideration.

LO 2 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-10

If a company makes sales with a right of return, management must estimate the dollar amount of the expected returns because this amount affects the transaction price (Step 3 of the contract-based approach of revenue recognition). The amount of expected return is a form of variable consideration. A refund liability is established for the amount of expected returns because the consideration received from the customer will be reimbursed in the event of a return subsequent to the sale. The revenue recognized would be reduced by the amount of estimated refund liability.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-11

An assurance-type warranty provides warranty coverage included in the price of the product and is not considered to be a separate performance obligation, so there is no portion of the transaction price allocated to warranty revenue. A service-type warranty exists when a customer is given the option to purchase a separate warranty coverage; it is considered to be a separate performance obligation and a portion of the transaction price will be allocated to warranty revenue. Service warranties typically provide a longer warranty period.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ-4-12

The consignor is the owner of the goods which are to be sold and the consignee is tasked with selling the goods for a commission. The consignor does not recognize any revenue when they transfer the goods to the consignee because the consignor retains ownership of the goods. At the time of the sale, both the consignor and the consignee would recognize the revenue. The consignor’s transaction price (Step 3 of the contract-based approach of revenue recognition) would be the net amount (the selling price less consignee’s commission), while the consignee’s transaction price (Step 3) would be the amount of the commission earned.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-13

A single-step statement of income presents all revenues and expenses in a way that requires users to complete their own analysis to determine important measures such as gross profit margin or income from operating activities. Revenues and expenses are the only two groupings found on a single-step income statement. All sources of revenue are grouped together in one total, and all expenses are grouped together in one total. A multi-step statement of income is more useful because it allows users to easily identify gross profit and profits earned from operating activities separately from other revenues and expenses related to non-operating activities. Performance comparisons with prior years can more easily be made.

LO 4 BT: C Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-14

The major sections of the multi-step statement of income are: • Sales revenue or revenue: including sales of goods and services that are from regular operations; • Gross profit or gross margin: which is the difference between sales revenue and the cost of goods sold; • Profit from operations or operating income: arises after deducting operating expenses from gross profit; • Income before income tax expense: arises from deducting from profit from operations revenues and expenses from nonoperating sources. These non-operating sources would include interest revenue and interest expense and gain or loss on disposals of capital assets, for example. These incidental items are excluded from sales revenue and revenue and operating expenses to allow users to get a clearer picture of operating performance. • Net Income: this is the final result of the income statement, having deducted income tax expense from the sub-total, income before income tax. This result is often referred to as “the bottom line”.

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-15

The single-step method of presenting the statement of income contains the same data as the multi-step format – the differences relate to how the information is organized in the statement. Although there are many variations in practice, the general idea of the singlestep format is that all the revenues and gains are listed together. Then, all the expenses and losses are listed. As a result, there are fewer subsections and subtotals in a single-step statement, compared to the multi-step format. Although the data is organized differently in the single-step and multi-step statements of income, they both use the same data and thus both result in the same net income.

LO 4 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-16

Some typical items included in the statement of comprehensive income are net income and other items that cause changes in shareholders' equity, from non-owner sources, referred to as other comprehensive income. Other comprehensive income includes items such as gains or losses arising from the translation of foreign currencies, unrealized gains or losses arising from changes in the fair values of certain types of financial investments, and unrealized gains and losses from revaluations of long-term assets to fair value. Under IFRS, these may be included in other comprehensive income instead of net income. Comprehensive income is therefore broader than net income. It includes net income plus a few other specified items.

LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ4-17

Accounting standards offer companies the choice of presenting their expenses by function or by nature when preparing their statements of income. Function refers to what functional area of the business the expenses were related to. Examples of functional areas are cost of sales, administrative activities, and selling and distribution activities. The nature of the expense refers to what the expense actually was, rather than the purpose for which it was incurred. Statements of income presenting expenses by nature include expense items such as wage expense, depreciation expense, cost of goods sold, advertising expense and rent expense. Preparing statements of income by function requires management to exercise judgement in terms of which expenses are allocated to which function. No such judgement is required when the statement of income is prepared by the nature of the expenses.

LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ4-18

The basic earnings per share figure is a key ratio used to measure a company’s performance. It represents total earnings available to common shareholders for the period, on a per share basis. To determine income available to common shareholders, any required dividends to preferred shareholders must be deducted from net income prior to dividing by the weighted average number of common shares that are outstanding for the corresponding period.

LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP4-1A 1. a. b. c.

2. a. b. c.

3. a. b. c.

The performance obligation is one year of coverage under the insurance policy starting February 1, 2024. The transaction price is $1,800, the price of the policy. When the performance obligation(s) would be satisfied: The $1,800 collected on January 28 should be recorded initially as deferred revenue by the insurance company, and then, beginning in February, 1/12 of this amount will be recorded as a reduction of deferred revenue and an increase in revenue at the end of each month, as the performance obligation for the month has been satisfied.

The performance obligation is that Porter Airlines will provide you with a one-way flight home for Christmas. The transaction price is $398, the price of the ticket. When the performance obligation(s) would be satisfied: Porter Airlines should record the $398 as deferred revenue when they receive the cash in October. When the flight is provided by Porter at Christmas time, deferred revenue would be reduced and revenue increased by $398. Even though the ticket is non-refundable, Porter has not satisfied the performance obligation until they provide the flight.

The performance obligation is providing the dental checkup on April 5, 2024. The transaction price is $125, the cost of the dental checkup. When the performance obligation(s) would be satisfied: When the dental checkup is performed on April 5, 2024. The dentist should record $125 as revenue on April 5, 2024 and an account receivable for the payment that is due within 30 days.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-1A (Continued)

4. a. b. c.

The performance obligation is allowing the ticket holder to watch the 41 Winnipeg Jets games in their assigned seat. The transaction price is $6,087. When the performance obligation(s) would be satisfied: After each game is completed, the performance obligation for that game is satisfied. The Winnipeg Jets should recognize the collection of $6,087 as deferred revenue when they receive the cash in July, 2024. As each of the 41 games is played during the season, the Jets would recognize part of the revenue (i.e. 1/41) and so reduce deferred revenue and increase revenue. This is the case whether or not you attend all of the games. The onus is on the Jets to provide games, and their performance obligation is satisfied as each game is played.

LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-2A a. Question Step 1: Is there a contract?

Step 2: What performance obligations are included in the contract? Step 3: What is the transaction price? Step 4: How should the transaction price be allocated to the performance obligations? Step 5: Has a performance obligation been satisfied?

Analysis Yes, both parties have agreed to enter a contract. The goods and services to be provided, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility. The contract includes two performance obligations: the design of machines and the construction of the machines. The assurance warranty is not considered to be a separate performance obligation. The transaction price is $4.1 million.

Performance obligation Design of machines Construction of machines

% of Total SA Selling Price

Contract Price

Allocation of Contract Price

$510,000 11.31%

X $4.1 M

$463,710

$4,000,000 88.69% $4,510,000 100 %

X $4.1 M

$3,636,290 $4,100,000

Stand-Alone (SA) Selling Price

The first performance, the design of machines is satisfied on March 28, 2024 when the design is approved by Coastal. The revenue related to this performance obligation would be recognized at this point. The second performance obligation, the construction of the machines is satisfied on May 20, 2024, when the harvesters are delivered to Coastal. The revenue related to this performance obligation would be recognized at this point.

Revenue recognized for the year ended May 31, 2024 – the full contract of $4,100,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-2A (Continued)

TreeHold would record the following journal entries and adjusting journal entries in relation to these transactions: Feb 18

DR No entry 0 CR No entry 0 No entry because neither party has performed any obligations under the contract.

Feb 25

DR Cash CR Deferred Revenue

1,250,000 1,250,000

To record the receipt of the deposit, but as TreeHold has not satisfied any performance obligations, no revenue can be recorded. Mar 28

DR Deferred Revenue CR Service Revenue

463,710 463,710

To record the revenue related to the design of the machines, as the performance obligation for the machines has been satisfied May 18

DR No entry 0 CR No entry 0 No entry as the performance obligation has not been satisfied.

May 20

DR Accounts Receivable DR Deferred Revenue1 CR Sales Revenue 1 ($1,250,000 - $463,710)

2,850,000 786,290 3,636,290

To record the revenue related to the construction of the machines as the performance obligation for the machines has been satisfied less the estimated warranty liability. The related costs of construction would be recorded to Cost of Goods Sold.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-2A (Continued) May 20

June 2

DR Warranty Expense CR Warranty Liability To accrue warranty liability

230,000 230,000

DR Cash 2,850,000 CR Accounts Receivable 2,850,000 To record the collection on account from Coastal.

LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-3A a. Question Step 1: Is contract?

Analysis there a Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility as subscriptions are paid in advance and single Boxes are also sold in cash transactions. Step 2: What There is a single distinct good (a snack box) performance being provided under the contract: 10,000 obligations are included monthly subscriptions 10,000 x 12 months = in the contract? 120,000 boxes and 2,400 monthly boxes 2,400 x 12 = 28,800 boxes to specialty shops. Step 3: What is the The transaction prices are: transaction price? Good Box: $12.00 ($144/12 months) Oh So Good Box: $20.00 ($240/12 months) Specialty shop boxes: $8 each Step 4: How should the There is no need to allocate the transaction transaction price be price because there is a single performance allocated to the obligation. performance obligations? Step 5: Has a Revenue would be recognized once the performance obligation boxes are delivered to the subscription been satisfied? customers and the specialty shops, net of any refund liability. Revenue recognized in 2024 – October’s revenue

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-3A (Continued) b. Oct. 1

DR Cash CR Deferred Revenue

1,632,000 1,632,000

Good Box 10,000 x 80% x $144 = $1,152,000 Oh So Good Box 10,000 x 20% x $240 = 480,000 Total $1,632,000 Best Snacks has not satisfied any performance obligations. No revenue can be recognized. Oct. 31

DR Deferred Revenue CR Subscription Revenue

136,000 136,000

Good Box $1,152,000 / 12 = Oh So Good Box $480,000 / 12 = Total

$96,000 40,000 $136,000

To record the revenue for the monthly box as the performance obligation of Best Snacks for the delivery of the boxes for the month of October has been satisfied. DR Cost of Goods Sold CR Inventory Good Box (8,000 x $5) Oh So Good Box (2,000 x $9) Total

58,000 58,000 $40,000 18,000 $58,000

To record the cost of goods sold for the monthly boxes delivered for the month of October.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-3A (Continued) b. (Continued) Oct. 31

DR Accounts Receivable (2,400 x $8) 19,200 CR Refund Liability ($19,200 x 20%) 3,840 CR Sales Revenue 15,360 To record sales other than through subscriptions DR Cost of Goods Sold1 CR Inventory 1

Good Box (2,400 x $5)

12,000 12,000 $12,000

To record the cost of goods sold for the monthly boxes delivered to shops in the month of October. LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-4A a. Question Step 1: Is there a contract?

The transaction price is $4.2 million.

Performance obligation Hardware Support Services

% of Total SA Selling Price

Contract Price

Allocation of Contract Price

$3,200,000 71.11%

X $4.2 M

$2,986,620

$1,300,000 28.89% $4,500,000 100 %

X $4.2 M

$1,213,380 $4,200,000

Stand-Alone (SA) Selling Price

The first performance, the hardware is satisfied on June 30, 2024 when hardware is delivered to Western. The revenue related to this performance obligation would be recognized at this point. The second performance obligation, the support services is recognized in phases. Half of the support services will be recognized on July 31, 2024 and the remainder will be allocated monthly for the 35 remaining months until June 30, 2027

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-4A (Continued) b. 2024 June 14 DR No entry 0 CR No entry 0 No entry because neither party has performed any obligations under the contract. June 30 DR Accounts Receivable CR Sales Revenue DR Cost of Goods Sold CR Inventory

2,986,620 2,986,620 2,600,000 2,600,000

To record the revenue related to the hardware as the performance obligation for the hardware has been satisfied July 13 DR Cash

1,200,000

CR Accounts Receivable 1,200,000 Collection of first instalment under the contract July 31 DR Accounts receivable CR Service Revenue

606,690 606,690

To record the revenue related to half the support services provided during installation ($1,213,380 / 2 = $606,690)

monthly DR Accounts receivable CR Service Revenue

17,334 17,334

To record the revenue related to services provided to satisfy the performance obligation. ($606,690/35 = $17,334) for 5 months August to December 2024

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-4A (Continued) 2025 Jan. 1 DR Cash 1,000,000 CR Accounts Receivable 1,000,000 Collection of second instalment under the contract

monthly DR Accounts Receivable 17,334 CR Service Revenue 17,334 To record the revenue related to services provided to satisfy the performance obligation. ($606,690/35 = $17,334) for 12 months 2026 Jan. 1 DR Cash 1,000,000 CR Accounts Receivable 1,000,000 Collection of third instalment under the contract

monthly DR Accounts Receivable CR Service Revenue

17,334 17,334

To record the revenue related services provided to satisfy the performance obligation. ($606,690/35 = $17,334) for 12 months 2027 Jan. 1 DR Cash 1,000,000 CR Accounts Receivable 895,996 CR Deferred Revenue 104,004 Collection of fourth and final instalment under the contract

monthly DR Deferred Revenue CR Service Revenue

17,334 17,334

To record the revenue related to services provided to satisfy the performance obligation. ($606,690/35 = $17,334) for 6 months until June 30, 2027.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-4A (Continued)

June 30 July 31 Aug.- Dec. Dec. 31, 2024 Jan. - Dec. Dec. 31, 2025 Jan. - Dec. Dec. 31, 2026 Dec. 31, 2027

Accounts Receivable 2,986,620 1,200,000 606,690 86,670 2,479,980 1,000,000 208,008 1,687,988 1,000,000 208,008 895,996 895,996 -

July 13

Jan. 1

LO 2 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-5A a. Question Analysis Step 1: Is there a contract? Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility from the government agency. Step 2: What performance There is a single distinct good being obligations are included in provided under contract: 100 systems. the contract? Step 3: What is the The transaction price is $5,000,000 (100 x transaction price? $50,000) Step 4: How should the There is no need to allocate the transaction transaction price be price because there is a single performance allocated to the obligation. performance obligations? Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? systems are delivered to the customer. b. The following are the journal entries related to the DC Systems contract: 2024 DR Accounts Receivable CR Sales Revenue1 1 (80 x $50,000) DR Cost of Goods Sold CR Inventory2 2 (80 x $28,500)

4,000,000 4,000,000

2,280,000 2,280,000

To record the sale of systems delivered in 2024 DR Cash

3,200,000 CR Accounts Receivable 3,200,000 Collections on account

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-5A (Continued) 2025 DR Accounts Receivable CR Sales Revenue1 1 (20 x $50,000)

1,000,000 1,000,000

DR Cost of Goods Sold 570,000 2 CR Inventory 570,000 2 (20 x $28,500) To record the sale of systems delivered in 2025 DR Cash

1,500,000 CR Accounts Receivable 1,500,000 Collections on account c.

If refunds for the return of defective systems were 1%, sales would be decreased by 1% and a returns liability would be set up for 1% of the selling price. The following are the revised entries. 2024 DR Accounts Receivable 4,000,000 1 CR Refund Liability 40,000 CR Sales Revenue 3,960,000 1 ($4,000,000 x 1% = $40,000) DR Cost of Goods Sold CR Inventory

2,280,000

DR Cash 3,200,000 CR Accounts Receivable

2,280,000

3,200,000

2025 CR Accounts Receivable 1,000,000 1 CR Refund Liability CR Sales Revenue 1 ($1,000,000 x 1% = $10,000) DR Cost of Goods Sold 570,000 CR Inventory

570,000

DR Cash 1,500,000 CR Accounts Receivable

1,500,000

10,000 990,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

P4-5A (Continued) Later on, as defective units were returned, entries to reduce the Refund Liability, Accounts Receivable or Cash would be recorded. LO 2,3 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP4-6A Question Step 1: Is there a contract?

Analysis Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility as bookings are paid in advance. Step 2: What performance There is a single distinct service being obligations are included in provided under contract: booking the contract? beachfront properties Step 3: What is the The transaction price for the fee is transaction price? $7,800,000 x 12% = $936,000 for 2024, net of any cancellations. Step 4: How should the There is no need to allocate the transaction price be allocated transaction price because there is a single to the performance performance obligation. obligations? Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? reservation has been completed. Beach Life does not earn rental revenue, but rather earns fees for services performed. The service revenue that Beach Life would be able to recognize for the year ended December 31, 2024 is 90% of the 2024 fees $936,000 x 90% = $842,400. Of the remaining 10% of the fees, half or $46,800 ($936,000 x 10% x 1/2) can be recognized as revenue as the cancellations are 50% refundable. The remaining 50% will only be earned after the cancellation period has ended. LO 2 BT: AP Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-7A a. Kabili Bites Ltd. Statement of Income For the year ended December 31, 2024 Sales revenue Cost of goods sold Gross profit Operating expenses: Wages expense Income from operations

$6,915,000 3,298,000 3,617,000 1,310,000* $2,307,000

* $1,248,000 + $62,000 = $1,310,000

Cash collected Less catering deposit Add contract amount ($121,000 / .40%) Total

Transaction Price

2024 Revenue

$7,036,000 (121,000) 6,915,000

6,915,000

2025 Revenue

302,500 $302,500 $7,217,500 $6,915,000 $302,500

b. Question Step 1: Is there a contract?

Step 2: What performance obligations are included in the contract?

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-7A (Continued) Step 3: What is the transaction price? Step 4: How should the transaction price be allocated to the performance obligations? Step 5: Has a performance obligation been satisfied?

The transaction price is $7,217,500 There is no need to allocate the transaction price because there is a single performance obligation. Revenue would be recognized once the food services have been completed. The catering contract revenue of $302,500, which includes the deposit of $121,000 received in 2024, should not be recognized because the performance obligation has not yet been satisfied.

Yes the cost of goods sold is the cost of the food being provided to the customers.

Utilities, rent, insurance, depreciation, income tax expense, etc, answers will vary.

LO 2,4 BT: AP Difficulty: E Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-8A

2024 Sales Revenue = Gross margin $687 + COGS $949 = $1,636 Store expenses = Gross margin $687 – Operating income $283 – Administrative expenses $131 – Depreciation expense $110 = $163 Income tax expense = Income before income taxes $269 – Net income $215 = $54 2023 Gross margin = Operating income $270 + Store expenses $136 + Administrative expenses $109 + Depreciation expense $98 = $613 Cost of Goods Sold = Sales revenue $1,364 – Gross margin $613 = $751 Income before income taxes = Net Income $208 + Income Tax Expense = $260 Investment income = Income before income taxes $260 + Financing Expenses $18 – Operating income $270 = $8 2022 Cost of Goods Sold = Sales Revenues $1,118 – Gross Margin $448 = $670 Depreciation expense = Gross margin $448 – Operating income $145 – Store expenses $112 – Administrative expenses $89 = $102 Financing expenses = Operating income $145 + Investment income $12 – Earnings before income tax $142 = $15 Net income = Income before income tax $142 – Income tax expense $28 = $114 LO 4 BT: AP Difficulty: H Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-9A a. Webber Ltd Statement of Income For years ended November 30, 2025

2024

$3,150,000 1,764,000 1,386,000

$2,800,000 1,456,000 1,344,000

Operating expenses Wages expense 504,000 Advertising expense 310,000 General and administrative expenses 112,000 Utilities expense 88,000 Rent expense 36,000 Total operating expenses 1,050,000 Profit from operations 336,000

492,000 320,000 105,000 76,000 27,000 1,020,000 324,000

Other revenues Interest revenue Income before income tax Income tax expense Net income

6,100 330,100 102,000 $228,100

Sales revenue Cost of goods sold Gross margin

5,200 341,200 82,000 $259,200

b. Gross profit percentage 2025 = $1,386,000/$3,150,000 = 44.0% Gross profit percentage 2024 = $1,344,000/$2,800,000 = 48.0% Webber had a much better gross margin percentage in 2024. c. No, 2024, the year with the higher gross margin percentage did not have the highest net income. This is due to the fact that operating expenses were higher (as a percentage of sales). While having a higher gross margin increases the likelihood of a higher net income, a company also needs to control its operating expenses to ensure it is the case. LO 4 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-10A a. Single-step Sherwood Ltd. Statement of Income For the Year Ended June 30, 2024 Revenues Sales revenue Interest revenue Total revenue

$1,250,000 44,000 1,294,000

Expenses Cost of goods sold Advertising expense General and administrative expenses Selling expenses Depreciation expense Utilities expense Wages expense Interest expense Income tax expense Total expenses Net income

596,000 125,000 40,000 75,000 70,000 106,000 165,000 37,000 10,700 1,224,700 $ 69,300

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-10A (Continued) b. Multi-step Sherwood Ltd. Statement of Income For the Year Ended June 30, 2024

Sales revenue Cost of goods sold Gross profit Operating expenses Advertising expense General and administrative expenses Selling expenses Depreciation expense Utilities expense Wages expense Total operating expenses Profit from operations Other revenue and expenses Interest revenue Interest expense Income before income tax Income tax expense Net income

$1,250,000 596,000 654,000 125,000 40,000 75,000 70,000 106,000 165,000 581,000 73,000 44,000 (37,000) 80,000 10,700 $ 69,300

c. The single-step is simple and easy to read, however it does not give as much useful information to users. It is harder for users to analyze important measures such as gross profit margin or profit from operations. A multi-step statement of income is more useful because it allows users to easily identify gross profit and profits earned from operations separately from other revenues and expenses related to nonoperating activities. LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-11A a. Multi-step by nature Navaria Inc. Statement of Income For the Year Ended June 30, 2024 (in thousands of dollars) Sales revenue Cost of goods sold Gross profit Operating expenses: Administrative expenses Wages expense1 Advertising expenses Deprecation expense2 Rent expense3 Other expenses Total operating expenses Income from operations Other revenue and expenses: Interest revenue Financing expenses Income before income taxes Income tax expense Net Income 1

$119,728 79,159 40,569 9,550 6,287 5,866 678 98 641 23,120 17,449 630 (825) 17,254 4,953 $12,301

Wages expense ($1,927 + $774 +$3,586) = $6,287 Depreciation expense ($524 + $128 + $26) = $678 3 Rent expense ($65 + $33) = $98 2

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-11A (Continued) b. Multi-step by function Navaria Inc. Statement of Income For the Year Ended June 30, 2024 (in thousands of dollars) Sales revenue Cost of goods sold Gross profit Operating expenses Sales and marketing 1 Engineering2 Research and development 3 Administration Other Total operating expenses Income from operations Other revenue and expenses: Interest revenue Financing expenses Income before income taxes Income tax expense Net Income

$119,728 79,159 40,569 9,478 2,516 935 9,550 641 23,120 17,449 630 (825) 17,254 4,953 $12,301

Sales and marketing ($3,586 + $5,866 + $26) = $9,478 Engineering ($1,927 + $65 + $524) = $2,516 3 Research and development ($774 + $33 + $128) = $935 2

LO 4,6 BT: AP Difficulty: H Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-12A a. Single-step Thor Ltd. Statement of Income For the Year Ended July 31, 2024 Revenues Sales revenue Investment revenue Total revenues Expenses Cost of goods sold Selling expenses Administration expense Depreciation expense Utilities expense Wages expense Financing expense Income tax expense Total expenses Net income

$1,205,700 1,900 1,207,600 543,000 250,000 85,000 75,000 60,700 25,000 18,500 75,000 1,132,200 $ 75,400

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-12A (Continued) b. Multi-step Thor Ltd. Statement of Income For the Year Ended July 31, 2024 Sales revenue Cost of goods sold Gross profit Operating expenses Selling expenses Administration expense Utilities expense Wages expense Depreciation expense Total operating expenses Profit from operations Other revenue and expenses Investment revenue Financing expense Income before income tax Income tax expense Net income

$1,205,700 543,000 662,700 250,000 85,000 60,700 25,000 75,000 495,700 167,000 1,900 (18,500) 150,400 75,000 $75,400

c. Basic earnings per share: $75,400 = $1.26 60,000 shares d. The gross profit margin is $662,700 / $1,205,700 = 55.0% LO 4,7 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-1B 1. a. The performance obligation is the delivery of the printer b. The transaction price is the price of the printer. c. Best Buy should record revenue for the printer when they have completed the performance obligation – which would be indicated by delivering the printer to you on June 18. This is the provision of goods. There is a distinct point in time when the risks and rewards of ownership transfer to the buyer. After this point, Best Buy has no further involvement with the printer. Since you paid with your credit card, Best Buy is assured of payment. Best Buy would have accurate records of their cost to purchase the printer from their supplier, and would have accurate information on shipping costs if they paid for them. Depending on Best Buy’s return policy, an allowance for returns may need to be estimated. 2. a. The performance obligation is providing you with the furniture. b. The transaction price is $1,100 c. Leon’s should recognize revenue when the furniture was picked up by you. Delayed payment terms do not impact the recognition of revenue unless eventual payment is at risk. The performance obligation is met on December 19, 2024 when the furniture is sold to you. This is the provision of goods. The risks and rewards of ownership transfer to the buyer when the furniture is delivered. After this point, Leon’s has no further involvement with the furniture. Since the first payment is not due until January 2, 2026, there may be some risk that you will not pay. Leon’s would estimate the risk of non-payment based on their historical experience. Depending on Leon’s return policy, an allowance for returns may also have to be recorded.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-1B (Continued)

3. a. The performance obligation is providing access to the VIA rail service for April, May and June 2024. b. The transaction price is $500 c. The performance obligation would be satisfied when each month is completed and access to the VIA rail service is provided. 1/3 of the transaction price can be recognized at the end of each month. 4. a.

The performance obligations include providing you with an iPhone and the data plan for 2 years. This is a multiple performance obligation transaction, including both goods and services. The phone (goods) is provided at the beginning of the contract. However, the service is provided evenly over the contract period. The transaction price is $50 x 24 months = $1,200. Rogers would need to determine the normal selling price of the phone and of the service separately. The total revenue of $50 per month should be prorated between the phone (delivered) and the service (to be delivered). The phone revenue would be recognized when delivered as the performance obligation is satisfied. The data plan would be recognized at the end of each month as the service has been provided, which satisfies the service performance obligation.

LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-2B a. Question Step 1: Is there a contract?

Step 2: What performance obligations are included in the contract? Step 3: What is the The transaction price is $11 million. transaction price? Stand-Alone % of Total Step 4: How should Performance (SA) Selling SA Selling Contract the transaction obligation Price Price Price Design of the price be allocated $2,000,000 16.67% X $11 M to the performance trains Manufacturing obligations? $10,000,000 83.33% X $11 M of the trains $12,000,000

Step 5: Has a performance obligation been satisfied?

100 %

Allocation of Contract Price

$1,833,700 $9,166,300 $11,000,000

The first performance, the design of the trains is satisfied on May 9, 2024 when the design is approved by OM. The revenue related to this performance obligation would be recognized at this point. The second performance obligation, the manufacturing and delivery of the trains is satisfied on September 1, 2024, when the trains are delivered to OM. The revenue related to this performance obligation would be recognized at this point. As a result, all of the $11 million contract price would be recognized in the year ended October 31, 2024.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-2B (Continued) b.

Derby would record the following journal entries in relation to these transactions:

March 15 DR No entry 0 CR No entry 0 No entry because neither party has performed any obligations under the contract. March 29 DR Cash CR Deferred Revenue

5,100,000 5,100,000

To record the receipt of the deposit but, as Derby has not satisfied any performance obligations, no revenue can be recorded. May 9

DR Deferred Revenue CR Service Revenue

1,833,700 1,833,700

To record the revenue related to the design of the trains, as the performance obligation for the trains has been satisfied August 1 DR No entry 0 CR No entry 0 No entry as the performance obligation has not been satisfied. Sept. 1

DR Accounts Receivable DR Deferred Revenue1 CR Sales Revenue 1 (5,100,000 - $1,833,700)

5,900,000 3,266,300 9,166,300

To record the revenue related to the manufacturing of the trains, less the estimated warranty liability, as the performance obligation for the trains has been satisfied. The related costs of construction would be recorded to Cost of Goods Sold. Sept. 1

DR Warranty Expense CR Warranty Liability To accrue warranty liability

500,000 500,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-2B (Continued)

Sept. 30 DR No entry 0 CR No entry 0 No transaction as Derby has already recognized the revenue. Nov. 15

DR Cash 5,900,000 CR Accounts Receivable 5,900,000 To record the receipt of cash from OM.

LO 2,3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-3B a. Question Step 1: Is there a contract?

Revenue would be recognized once the meal kits are delivered to the grocery stores, net of any refund liability. For kits delivered to subscribers, an adjusting entry would be made at the end of each month.

Revenue from December meal kit sales at grocery stores: (4,500 x $15 x 90%) = $60,750 Revenue from December subscription sales: (800 x $900 X 1/3 months = $240,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-3B (Continued) b.

Gourmand Dinner Box would record the following journal entries:

Dec 1

DR Cash 720,000 1 CR Deferred Revenue 720,000 1 (800 subscriptions x $900) Gourmand has not satisfied any performance obligation; no revenue can be recorded. At the end of each month Gourmand would record the following adjusting journal entry:

Dec. 31

DR Deferred Revenue 240,000 CR Sales Revenue 240,000 ($720,000 / 3 months = $240,000) To record the revenue for the sale of kits by subscription, as the performance obligation to deliver kits has been satisfied

Summary entry for deliveries to grocery stores: DR Accounts Receivable CR Refund Liability CR Sales Revenue

67,500 6,750 60,750

(4,500 x $15 = $67,500, returnable are 10% x $67,500 = $6,750) To record the revenue for the meal kits sold to grocery stores, as the performance obligation has been satisfied. LO 2,3 BT: AP Difficulty: H Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-4B a. Question Step 1: Is there a contract?

Step 2: What performance obligations are included in the contract? Step 3: What is the The transaction price is $100 million. transaction price? % of Step 4: How Stand-Alone Total SA should the Performance (SA) Selling Selling Contract obligation Price Price Price transaction price X be allocated to the $95,000,000 86.36% $100M Satellites performance X Support obligations? Services $15,000,000 13.64% $100M $110,000,000

Step 5: Has a performance obligation been satisfied?

100 %

Allocation of Contract Price

$86,360,000 $13,640,000 $100,000,000

The first performance, the satellites is satisfied on Oct 1, 2025, when satellites are delivered to orbit. The revenue related to this performance obligation would be recognized at this point. The second performance obligation, the support services is recognized evenly over the 10 years after delivery. ($13,640,000 / 10 years = $1,364,000 per year, or $1,364,000 / 12 = $113,667 per month)

2024 – no revenue can be recognized as no performance obligations have been met 2025 – Sales revenue $86,360,000 and Service revenue $341,000 ($13,640,000/ 10 years X 3/12 = $1,364,000 X 3/12 = $341,000) 2026 –Service revenue $1,364,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-4B (Continued) b. 2024 Oct. 1

DR No entry 0 CR No entry 0 No entry, contract entered but no performance obligations have been performed.

Oct. 31

DR Cash 15,000,000 CR Deferred Revenue 15,000,000 To record the deposit received from First Web Ltd.

Dec. 31

DR No entry 0 CR No entry 0 No entry as, no performance obligations have been performed.

2025 Oct. 1

Dec 31

2026 Oct. 1

DR Cash 35,000,000 DR Deferred Revenue 15,000,000 DR Accounts Receivable 36,360,000 CR Sales Revenue 86,360,000 To recognize the revenue from the delivery of the satellite DR Accounts Receivable 341,000 CR Service Revenue 341,000 To recognize 3 months of support service ($13,640,000/ 10 years x 3/12 = $1,364,000 per year x 3/12 = $341,000

DR Cash 5,000,000 CR Accounts Receivable 5,000,000 To record the payment from First Web ($100 M – $50 M paid = $50 M owing; $50 M / 10 years = $5 million a year)

Dec. 31

DR Accounts Receivable 1,364,000 CR Service Revenue To record providing 1 year of service

1,364,000

LO 2 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-5B a. Question Analysis Step 1: Is there a contract? Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility. Step 2: What performance There is a single distinct good being obligations are included in provided under contract: 40,000 the contract? mattresses Step 3: What is the The transaction price is $4,000,000 (40,000 transaction price? x $100) Step 4: How should the There is no need to allocate the transaction transaction price be price because there is a single performance allocated to the obligation. performance obligations? Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? mattresses are delivered to the retailer, Zzz Ltd. 2024 revenue 15,000 mattresses delivered 15,000 x $100 = $1,500,000 2025 revenue 25,000 mattresses delivered 25,000 x $100 = $2,500,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-5B (Continued) b. 2024 DR Accounts Receivable CR Sales Revenue

1,500,000 1,500,000

DR Cost of Goods Sold (15,000 x $25) 375,000 CR Inventory 375,000 To record the sale of mattresses delivered in 2024 DR Cash

1,400,000

CR Accounts Receivable To record collections in 2024 2025 DR Accounts Receivable CR Sales Revenue

1,400,000

2,500,000 2,500,000

DR Cost of Goods Sold (25,000 x $25) 625,000 CR Inventory To record the sale of mattresses delivered in 2025 DR Cash

2,450,000

CR Accounts Receivable To record collections in 2025 c.

625,000

2,450,000

If returns for the return of mattresses were 1%, sales would be decreased by 1% and a returns liability would be set up for 1% of the selling price. The following are the revised entries. 2024 DR Accounts Receivable 1,500,000 1 CR Refund Liability CR Sales Revenue 1 ($1,500,000 x 1% = 15,000) DR Cost of Goods Sold CR Inventory

15,000 1,485,000

375,000 375,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-5B (Continued) DR Cash CR Accounts Receivable To record collections in 2024

1,400,000 1,400,000

2025 DR Accounts Receivable 2,500,000 2 CR Refund Liability CR Sales Revenue 2 ($2,500,000 x 1% = 25,000) DR Cost of Goods Sold CR Inventory

625,000

DR Cash CR Accounts Receivable To record collections in 2025

2,450,000

25,000 2,475,000

625,000

2,450,000

Later on, as mattresses are returned, entries to reduce the Refund Liability and Cash would be recorded. LO 2,3 BT: AP Difficulty: M Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-6B Question Analysis Step 1: Is there a contract? Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility as bookings are paid for when they are made. Step 2: What performance There is a single distinct service being obligations are included in provided under contract: booking luxury car the contract? rentals. Step 3: What is the The transaction price is $8,400,000 x 10% transaction price? = $840,000 for 2024, net of any cancellations. Step 4: How should the There is no need to allocate the transaction transaction price be price because there is a single performance allocated to the obligation. performance obligations? Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? cancellation period ended (20 days before the reservation date). Millionaire Ride does not earn rental revenue, but rather earns fees for services performed. The service revenue that Millionaire Ride would be able to recognize for the year ended December 31, 2024 is 75% of the 2024 fees $840,000 x 75% = $630,000. LO 2 BT: AP Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-7B a. Kohlrabi Electronics Ltd. Statement of Income For the year ended August 31, 2024 Revenues Sales revenue Service revenue1 Total revenues Operating expenses: Cost of goods sold Wages expense2 Income from operations 1 2

$6,097,000 637,000 6,734,000 2,199,000 1,503,000 3,702,000 $3,032,000

$897,000 – $260,000 for services to be completed in 2025 = $637,000 $1,447,000 + $56,000 = $1,503,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-7B (Continued) b. Question Analysis Step 1: Is there a contract? Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility as goods are paid for at the time of ordering. Step 2: What performance There are two obligations under contract: obligations are included in hardware and software, and consulting the contract? services. Step 3: What is the The transaction price is $6,097,000 for the transaction price? goods. Service revenues are earned separately from the sale of gods and are not provided as part of a bundled sale. Step 4: How should the The services are not bundled so the revenue transaction price be does not have to be allocated between allocated to the hardware and software sales and consulting performance obligations? services. Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? hardware and software has been delivered. For the consulting services, they would be recognized when completed, therefore the $260,000 of revenue that has been received but not completed, would not be recognized, as the performance obligation has not yet been satisfied. c.

Yes, the cost of goods sold is the cost of the hardware and software being provided to the customers.

Utilities, rent, insurance, depreciation, income tax expense, etc, answers will vary.

LO 2,4 BT: AP Difficulty: E Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-8B 2024 Gross Margin = Sales Revenue $2,000 - COGS $1,200 = $800 Travel Expenses = Gross margin $800 – Operating income $506 – Insurance expense $100 – Utility expenses $45 - Depreciation expense $50 = $99 Interest expense = Operating Income $506 + Rent Income $350 - Income before income taxes $811 = $45 Net income = Income before income taxes $811 – Income tax expense $20 = $791 2023 Gross margin = Operating income $426 + Insurance expense $57 + Utility expenses $35 + Travel expenses $100 + Depreciation expense $50 = $668 Cost of Goods Sold = Sales revenue $1,654 – Gross margin $668 = $986 Rental Income = Income before Income taxes $591 – Operating Income $426 + Interest expenses $60 = $225 Income tax expense = Income before income tax $591 - Net income $576 = $15

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-8B (Continued) 2022 Sales Revenue = Cost of Goods Sold $837 + Gross Margin $608 = $1,445 Operating Income = Gross margin $608 – Insurance expense $45 – Utility expense $15 – Travel expenses $105 – Depreciation expense $50 = $393 Income before income tax = Operating income $393 + Rental income $200 – Interest expense $65 = $528 Net income = Income before income tax $528 – Income tax expense $14 = $514 LO BT: AP Difficulty: H Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-9B a. Broiler Ltd Statement of Income For years ended September 30, 2025

2024

Sales revenue $3,750,400 Cost of goods sold 1,546,000 Gross profit 2,204,400 Operating expenses Wages expense 403,000 General and administrative expenses 222,000 Advertising expense 220,000 Utilities expense 90,000 Rent expense 15,000 Total operating expenses 950,000 Profit from operations 1,254,400 Other revenues Interest revenue 3,200 Income before income tax 1,257,600 Income tax expense 500,000 Net income $ 757,600

$2,450,000 1,366,000 1,084,000 376,000 155,000 300,000 66,000 12,000 909,000 175,000 4,000 179,000 75,000 $104,000

b. Gross profit percentage 2025 = $2,204,400/$3,750,400 = 58.8% Gross profit percentage 2024 = $1,084,000/$2,450,000 = 44.2% Broiler has a far better gross margin percentage in 2025. c. Yes, 2025, with the higher gross margin percentage, had a higher net income than in 2024. This may not always be the case as, even with a higher gross margin percentage, other expenses could be higher in a year to lower net income compared to another year. Also, a higher gross profit percentage of a small amount of revenue will likely result in a smaller amount of net income, when compared to a lower gross profit percentage of a large amount of revenue. LO 4,7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-10B a. Single-step Ballistik Ltd. Statement of Income For the Year Ended January 31, 2024 Revenues Sales revenue Interest revenue Total revenue Expenses Cost of goods sold Advertising expense Selling expenses General and administrative expenses Depreciation expense Interest expense Utilities expense Wages expense Income tax expense Total expenses Net income

$5,275,000 50,000 5,325,000 3,645,000 125,000 196,000 66,000 95,000 33,000 105,000 175,000 150,700 4,590,700 $ 734,300

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-10B (Continued) b. Multi-step Ballistik Ltd. Statement of Income For the Year Ended January 31, 2024 Sales revenue Cost of goods sold Gross profit Operating expenses Advertising expense Selling expenses General and administrative expenses Depreciation expense Utilities expense Wages expense Total operating expenses Income from operations Other revenues and expenses Interest revenue Interest expense Income before income tax Income tax expense Net income

$5,275,000 3,645,000 1,630,000 125,000 196,000 66,000 95,000 105,000 175,000 762,000 868,000 50,000 (33,000) 885,000 150,700 $ 734,300

c. The single-step is simple and easy to read. However, it does not give as much useful information to users. It is harder for users to analyze important measures such as gross profit margin or profit from operations. A multi-step statement of income is more useful because it allows users to easily identify gross profit and profits earned from operations separately from other revenues and expenses related to nonoperating activities. LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-11B a. Multi-step by nature Cartier Custom Homes Inc. Statement of Income For the Year Ended March 31, 2024 (in thousands of dollars) Sales revenue Cost of goods sold Gross profit Operating expenses: Advertising expense Administrative expenses Wages expense1 Deprecation expense2 Rent expense3 Other expenses Total operating expenses Income from operations Other revenue and expenses: Dividend revenue Financing expenses Income before income taxes Income tax expense Net Income 1

$2,671,928 1,650,159 1,021,769 3,678 10,645 115,360 8,870 8,065 1,761 148,379 873,390 2,730 (65,125) 810,995 167,753 $643,242

Wages expense ($107,000 + $5,764 +$2,596) = $115,360 Depreciation expense ($7,252 + $1,118 + $500) = $8,870 3 Rent expense ($1,765 + $6,300) = $8,065 2

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-11B (Continued) b. Multi-step by function Cartier Custom Homes Inc. Statement of Income For the Year Ended March 31, 2024 (in thousands of dollars) Sales revenue Cost of goods sold Gross profit Operating expenses Architectural activities1 Research and development2 Sales and marketing3 Administrative Other Total operating expenses Income from operations Other revenue and expenses: Dividend revenue Financing expenses Income before income taxes Income tax expense Net Income

$2,671,928 1,650,159 1,021,769 116,017 13,182 6,774 10,645 1,761 148,379 873,390 2,730 (65,125) 810,995 167,753 $643,242

Architectural ($107,000 + $1,765 + $7,252) = $116,017 Research and development ($5,764 + $6,300 + $1,118) = $13,182 3 Sales and marketing ($2,596 + $3,678 + $500) = $6,774 2

LO 4,6 BT: AP Difficulty: H Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-12B a. Single-step Egeland Ltd. Statement of Income For the Year Ended July 31, 2024 Revenues Sales revenue Interest revenue Total revenues Expenses Cost of goods sold Advertising expense Depreciation expense Distribution expenses Administration expenses Utilities Expense Interest expense Income tax expense Total expenses Net income

$2,788,800 19,200 2,808,000 1,556,000 64,000 216,000 414,000 279,000 16,000 44,000 77,000 2,666,000 $ 142,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP4-12B (Continued) b. Multi-step Egeland Ltd. Statement of Income For the Year Ended July 31, 2024 Sales Cost of goods sold Gross profit Operating expenses Advertising expense Depreciation expense Distribution expenses Administration expenses Utilities Expense Total operating expenses Profit from operations Other revenue and expenses Interest revenue Interest expense Income before income tax Income tax expense Net income

$2,788,800 1,556,000 1,232,800 64,000 216,000 414,000 279,000 16,000 989,000 243,800 19,200 (44,000) 219,000 77,000 $142,000

c. The gross profit margin is $1,232,800 / $2,788,800 = 44.2% d. Basic earnings per share: $142,000 – $15,000 = $1.59 80,000 shares LO 4,7 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP4-1

The “quality” of earnings refers to how certain an analyst is that the earnings reported in a company’s statement of income will result in actual cash flows. In examining the quality of earnings, you should look to the financial statements to examine the company’s revenues and expenses and their sources and uses of cash. The higher the proportion of earnings that are generated from the company’s core business, the higher their earnings quality. If earnings include significant amounts from peripheral activities (i.e. interest income, gains from the disposal of equipment, etc.), the earnings would be considered to be of lower quality as these items do not result from the company’s core operations. You should also review the revenue recognition policies of the company, which are described in the accounting policy note to the financial statements. One way to measure the quality of earnings is to compare the cash flow from operations (statement of cash flows) with the net earnings. If these two amounts are moving together (both up or both down) and if the cash flow is greater than the net earnings, we consider the earnings to be of high quality. If the two amounts do not move together and if the cash flow is less than the net earnings, we consider the earnings to be of low quality. LO 1 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP4-2 We would use the five step contract-based approach. Question Analysis Step 1: Is there a contract? Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility as credit checks are performed at the time of the sale. Step 2: What performance There is a single distinct good (appliances) obligations are included in being provided under the contract. the contract? Step 3: What is the The transaction price would be the price of transaction price? the appliances. Step 4: How should the There is no need to allocate the transaction transaction price be price because there is a single performance allocated to the obligation. performance obligations? Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? appliances are delivered to the customer and a receivable set up for the outstanding payments. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP4-3

Under the contract-based approach, the revenue would be recognized by Chargeit Inc. when the performance obligation is met, which is when the chargers and backup stations are sold to customers. On a practical level, revenue would be recorded at the end of the month (likely also the end of a reporting period), when the information used for reporting and remitting 80% of the proceeds from the sales is generated by the gas stations and retailers. Any items stolen would be identified by the re-stockers and the revenue for those would be recorded when identified, as it meets the condition that the gas station or retailer is responsible for stolen goods. The gas stations and retailers are acting as the consignees in this scenario and would therefore recognize revenue at the same time as Chargeit, when the items are sold.

LO 3 BT: C Difficulty: H Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP4-4

Under the contract-based approach, Kidlet Toys would recognize the revenue when the toys are delivered to the retailers, as the performance obligations have been met. Kidlet would have to estimate the amount of returns based on historical information and reduce the revenue recognized by that amount and record a corresponding refund liability.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP4-5

The recognition of the sale towards the bonus plan should be tied to the recognition of the sales revenue. The risks to the company for the recognition and ultimate collection of the sale should be taken into account when recognizing revenue and the related expenses, including the bonus expense for sales employees. I would not count revenue toward the bonus plan when the salesperson generates a purchase order. Although it can be argued that this is closer to the time when the salesperson has expended the effort to “sell” the customer and thus provides a more timely measure of sales people’s performance, the performance obligation has not been satisfied. Until the goods are shipped, the company has not fully earned the revenue by fulfilling their responsibility to the customer. I would not wait until the company receives payment unless I had reason to suspect that sales were being made to marginal customers with a high risk of non-payment. This could be a danger if a sales people are so motivated by the incentive plan that they are foregoing the company’s usual customer credit investigation policies. I would recommend that the company count a sale toward the bonus plan when it ships the goods, if a reasonable estimate can be made of the possibility of non-payment by the customer. Such an estimate is not likely to be a problem for a large company due to the past experience with customer collections.

LO 2 BT: C Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP4-6 Question Step 1: Is there a contract?

LO 2 BT: C Difficulty: E Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP4-7

Since the sports channel has not performed its part of the bargain, i.e. they have not aired the advertisements, no revenues should be recognized until the commercials are aired. The $2,000,000 in down payments should be treated as a liability for customer deposits (or deferred revenues) in the financial statements on December 31.

LO 2 BT: AP Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP4-8

Although the cash has been received and economic benefits have been received by the retailer, the performance obligation has not been met; they need to provide the goods to the customer before the revenue can be recognized. The amount of revenue will only be measurable at the time the gift cards are redeemed as the customer may purchase products that sell for less than, the same amount or more than the value of the gift card. The retailer also has no idea of what its product costs will be at the time the gift cards are sold. No revenue can be recognized until the retailer fulfills its obligation to holders of the gift cards by providing them with goods when the cards are redeemed. Thus, the gift cards should be recognized in the financial statements as a liability (i.e. deferred revenue). When the gift cards are redeemed at point of sale, the payment or a portion of the payment is made using the gift card. The sale will be completed through the delivery of merchandise and consequently the performance obligation will be met and the revenue recorded. The sale will be recorded with a reduction in deferred revenue for the appropriate portion using gift cards.

LO 2 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP4-9

At the end of the fiscal year, September 30, the $1,000,000 ($100,000 x 10 software units) of software sold in August still needs considerable customization. Given the need for extensive customization before the software is usable, the software and customization services are a single performance obligation. As such, Solution Software has not yet completed its performance obligations. The revenue would be recorded when the customization process has been completed.

LO 2 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP4-10 a. Preparing statements of income by function requires management to exercise judgement in terms of which expenses are allocated to each function. For example, wages must be allocated to the various functions. The students may be concerned about the reliability of the allocations of expenses between functions. The university would likely want to maximize the amounts allocated to instruction/student support and minimize the allocations to ancillary items. Students may also be concerned that the specific functions chosen by the university are too broad (i.e. there are only two) and may not provide useful information for comparing expenses from period by period for specific areas of the university or to other universities. For example, combining instruction with student support services does not enable users to see how much each of those different areas has changed from one period to the next. The university also has no category for administration, so it is unclear where the costs of the university’s executives would be allocated. It should be noted that if the university decides to prepare their statement of income by function, they will still need to present information on the nature of expenses in the notes to the financial statements. While this helps, it does not allow users to understand where these expenses have been allocated. The students’ union might want to recommend that the university adopt a few more functions. They may suggest splitting instruction and student support into two functions. They may also want to see the library, cafeteria, residence or the bookstore as separate functions. Normally, administration costs (i.e. the university’s executive and governance costs) are also of interest to students, so they could suggest that these be a separate function. The students’ union would also want to look at the categories used by other universities to ensure that the ones being proposed at their institution are comparable. This would allow the students’ union to compare changes from one period to the next and to the changes occurring at other universities. LO 6 BT: C Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK IN PROGRESS PROBLEM WIP4-1

The statement: “Under the contract-approach, companies recognize revenue whenever their net position in the contract improves” is correct. In this situation, the net position can only improve if the company’s rights under the contract have increased or if the performance obligation decreases. However, when a customer places an order and makes a deposit the net position in the contract has not changed. Both the rights under the contract and the performance obligation have increased by the same amount, corresponding to the amount of the deposit paid. No revenue should be recognized. The cash deposit is deferred revenue as the supplier still owes the customer the goods or services, so the performance obligations have not been met.

LO 2 BT: C Difficulty: H Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP4-2

Companies offer sales discounts to entice customers to pay more quickly so the company will receive the cash sooner to use in its operations. Offering a sales discount does not change the timing of the recording of sales revenue. A sales discount of 1/10; n/45 means if the customer pays within 10 days they can take a 1% discount off the invoice price and if they do not pay within 10 days the full amount of the invoice is due within 45 days of the invoice date.

LO 2 BT: C Difficulty: E Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP4-3

Companies offer sales discounts to speed up the collection of cash from customers but it also reduces the net revenue from the transaction if the customer pays within the ten days. If you offered a sales discount of 1/10; n/45 on a $2,000 purchase, it means the customer will pay $1,980 if they pay within 10 days (a 1% discount) or else pay the full $2,000 within 45 days from the date of the invoice.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP4-4

Consignees, not consignors, receive a commission when consigned goods are sold. Similarly, agents in a third-party sales arrangement receive a commission, which is a fraction of the sales price of the goods or services sold. Where consignees and third-party sales agents differ is with respect to the physical possession of the goods. The ownership of goods always rests with the consignor, but the possession of the goods is with the consignee until the goods are sold or returned to the owner, the consignor. In a third-party sale, the third-party agent does not have physical possession of the goods.

LO 3 BT: C Difficulty: H Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI4-1 a.

2020 Gross Profit Margin: $727.9 / $1,570.6 = 46.3% 2019 Gross Profit Margin: $785.0 / $1,581.6 = 49.6% Spin Master’s gross margin has decreased by 3.3% from 2019 to 2020. It means that the company has been unable to increase its selling prices or reduce its product costs (or both) so the company would have more of each dollar of sales to cover its non-product costs.

Spin Master uses a multi-step approach in the preparation of its consolidated statements of earnings and comprehensive income.

Spin Master presents its expenses by function. This approach requires a higher level of professional judgment than presenting by nature as all operating expenses must be allocated among the various functions of the company.

LO 4,6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI4-2 a. Gildan reduces its gross sales to net sales by deducting customer price discounts, sales discounts for prompt payments, volume rebates, estimated sales returns sales allowances for damaged goods. These types of reductions from sales are also tracked separately in the accounts for management decision making purposes. b. 2020 Gross Profit Margin: $249,059 / $1,981,276 = 12.6% 2019 Gross Profit Margin: $704,461 / $2,823,901 = 24.9% Gildan’s gross profit margin dramatically deteriorated 12.3% in 2020. This change is likely due to Covid 19. It means that the company has been unable to increase its selling prices or reduce its product costs, or both so the company would have more of each dollar of sales to cover its non-product costs. c. 2021 Gross Profit Margin: $1,765,011 / $4,026,259 = 43.8% 2020 Gross Profit Margin: $1,652,358 / $3,787,291 = 43.6% Dollarama’s gross profit margin increased slightly from the 2020 to the 2021 fiscal year. Its gross profit margin exceeds that of Gildan. d. Gildan uses a multi-step approach in preparing its consolidated statements of earnings and comprehensive income. e. Gildan presents its expenses by function, which takes more professional judgment that presenting by nature. With functional presentation, all operating expenses must be allocated by some fair estimates, among the various functions of the company. LO 4,6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI4-3 a.

Sales increased by 9.2% ($4,303,722 - $3,941,545) ÷ $3,941,545 Cost of goods sold increased by 7.5% ($3,600,669 - $3,350,566) ÷ $3,350,566. The increase in sales outpaced the increase in cost of goods sold resulting in an expected improvement in the gross profit percentage for 2020.

2020 Gross Profit Margin: $703,053 / $4,303,722 = 16.3% 2019 Gross Profit Margin: $590,979 / $3,941,545 = 15.0% Maple Leaf’s gross profit margin improved by 1.3% in 2020.

Maple Leaf presents its operating expenses by function, showing costs of selling, general, and administration. This requires professional judgement. However, by combining virtually all operating expenses into one function, less judgment is required than if the functions were separated. Because Maple Leaf only has one grouping (or function), there is little distinction in the information that would have been presented had the statement of income been prepared by nature.

LO 6 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI4-4 a. High Liner used a multi-step format, as indicated by a separate calculation of gross profit, results from operating activities, income before income taxes, and net income. b. 2020 Gross Profit Margin: $177,924 / $827,453 = 21.5% 2019 Gross Profit Margin: $185,860 / $942,224 = 19.7% High Liner’s gross profit margin percentage increased 1.8% from 2019 to 2020. The product cost for each $1 of sales were $0.785 in 2020 and $0.803 in 2019. c. 2020 Net Profit Rate (Margin): $28,802 / $827,453 = 3.5% 2019 Net Profit Rate (Margin): $10,289 / $942,224 = 1.1% High Liner’s net profit as a percentage of revenue increased in 2020. LO 4 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C4-1

Revenue recognition guidelines generally require that a sale be recognized when control of the item is transferred to the buyer. Under the current arrangements, control is transferred when the goods are picked up by the buyer’s truck from the factory. If the company changes its sales terms so that it is responsible for shipping, control will not pass until the goods are received by the buyer, from the trucking companies. The result of changing its sales terms and becoming responsible for product delivery will be that QSC will appear to have a drop in sales. This is because revenue recognition will be delayed by the extra shipping time. It should be noted that this apparent drop will occur only in the year of the change. However, it should also be noted that the company estimates that it will be able to increase it selling prices if this change is made, so the drop in sales revenue to reflect the five days will be offset by higher revenues from the increased selling prices. In addition, expenses previously incurred in settling the disputes concerning product spoilage will be eliminated. LO 1 BT: C Difficulty: H Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

C4-2

The extended warranties is considered a service warranty and should be considered a separate performance obligation from the sale of the appliances. It should be initially classified as deferred revenue as no revenue will be recognized until these warranties come into effect. At the start of the warranty period, which would be after the manufactures warranty period has expired, the company can start to recognize revenue over the life of the extended warranty as the performance obligation is fulfilled. If the costs can be reasonably estimated and are expected to be incurred evenly over the threeyear warranty period, then the revenue recognition could be on a straight-line basis over the length of the extended warranty. If the costs are expected to be incurred unevenly (i.e. no predictable pattern), then the revenue should be recognized by dividing the costs incurred by the total estimated costs, and then multiplying that percentage by the total amount of extended warranty sales. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C4-3 Question Analysis Step 1: Is there a contract? Yes, both parties have agreed to enter into a contract. The quantity, price, and payment terms have been agreed to and each party’s rights under the contract are clear. The contract is consistent with both parties’ lines of business, meaning it has commercial substance. There are no indications of any concerns regarding collectibility. Step 2: What performance There is a single distinct good: custom obligations are included in furniture the contract? Step 3: What is the The transaction price is $9,000. ($3,000 transaction price? deposit, $3,000 on delivery and $3,000 30 days after delivery) Step 4: How should the There is no need to allocate the transaction transaction price be price because there is a single performance allocated to the obligation. performance obligations? Step 5: Has a performance Revenue would be recognized once the obligation been satisfied? furniture is delivered to the customer. Based on the above, the full $9,000 should be recognized as revenue at the time of delivery of the furniture. If revenue is recognized at the time of delivery, the cash down payment should be recorded as deferred revenue. The required journal entries would be as follows: 2024 Feb 1

DR Cash ............................................ 3,000 CR Deferred Revenue ............... To record the cash collected in advance

3,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

C4-3 (Continued) June 15 DR Cash ........................................... DR Deferred Revenue ....................... DR Accounts Receivable ................... CR Sales Revenue .................... To record the sale of furniture

3,000 3,000 3,000 9,000

June 15 DR Cost of Goods Sold………………6,300 CR Inventory…………………… . 6,300 To record the costs related to the design and manufacturing of the custom furniture. July 14 DR Cash ............................................ CR Accounts receivable............. To record the collection on account

3,000 3,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley: Understanding Financial Accounting, Third Canadian Edition

CHAPTER 5 THE STATEMENT OF CASH FLOWS

Learning Objectives 1. Understand and explain why the statement of cash flows is of significance to users. 2. Explain how the statement of cash flows and the statement of income differ. 3. Identify the three major types of activities that are presented in a statement of cash flows and describe some of the typical transactions included in each category of activity. 4. Prepare a statement of cash flows using the indirect method for operating activities. 5. Prepare a statement of cash flows using the direct method for operating activities. 6. Interpret a statement of cash flows and develop potential solutions to any cash flow challenges identified. 7. Calculate and interpret a company’s operating cash flows ratio and determine the amount of net free cash flow being generated.

Burnley: Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5 6. 7.

1 2 3 3 3 3 3

1. 2. 3. 4.

3 3 3 3

1. 2. 3.

1 2 2

1. 2.

3 3

6,7

Item

BT Item

Item

Discussion Questions C 8. 3 C 15. 4,5 C 22. 6 C 29. C 9. 6 C 16. 3 C 23. 6 C 30. C 10. 2 C 17. 3 C 24. 6 C 31. C 11. 4 C 18. 4 C 25. 3 C 32. C 12. 4,5 C 19. 3 C 26. 3 C 33. C 13. 4,5 C 20. 3 C 27. 6 C 34. C 14. 4,5 C 21. 6 C 28. 6 C 35. Application Problems K 5. 4 AP 9. 4,5 AP 13. 5 AP K 6. 4,5 AP 10. 4,5 AP 14. 6 AN AP 7. 4,5 AP 11. 4,5 AP 15. 6 AP K 8. 4,5 AP 12. 4,5,6 AP 16. 6 AP User Perspective Problems C 4. 3 C 7. 6 AN 10. 7 AN C 5. 2 C 8. 6 AN 11. 7 AN C 6. 2 C 9. 6 AN Work in Process C 3. 6 AN 5. 2 C 7. 2 C C 4. 2 C 6. 4 C Reading and Interpreting Published Financial Statements AN 2. 6,7 AN 3. 6,7 AN 4. 6,7 AN 5. Cases AN 2. 6 AN 3. 1,6 AN 4. 1 C 5.

6 6 6 6 7 6 6

C C C C AN C C

1,6

Burnley: Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file.

LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley: Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ5-1

Because income recognition is done on an accrual basis, the recognition of revenues and expenses may not correspond with cash inflows and outflows. Therefore, the statement of income is not as useful in determining the how much cash the company has received, paid and has available for use. Since cash is such an important commodity, and the company cannot operate without an adequate supply of it, the statement of cash flows provides useful information to the user. The statement of cash flows also identifies whether cash was received or spent on operations, investing, or financing. This helps users know where the company is generating cash and where it is using cash, providing valuable insights to the company’s overall economic health.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-2

Cash flows from operating activities include all the cash inflows and outflows related to the sale of goods and services – the activities that the company provides in its normal operations whereas net income includes accruals like accounts receivable and accounts payable, it provides the company’s profitability which is different from its cash flow.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-3

A company that experiences a net loss of $5 million for the year will not necessarily have a decrease in cash of the same amount. Some of the expenses deducted from net income do not represent cash outflows. Examples include depreciation and amortization expense. In addition, cash may have been obtained by borrowing money or selling shares to keep the operations going. Finally, some additional cash outflows from the repayment of debt or the payment of dividends will cause a difference between any change in the cash balance compared to the net loss of $5 million.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-4

The three major categories of cash flows are: Operating Activities – These cash flows are associated with the daily operations of the company in selling goods and services to customers. A company’s revenues, expenses and changes in most current asset and liability accounts used for operations are reflected here. Investing Activities – These cash flows are associated with the long-term investment of cash. The major categories of items that fit in this section are the investment in property, plant, and equipment, intangibles, the investment in other companies through acquisitions, and the proceeds from selling any of these assets. Financing Activities – These cash flows are associated with raising funds (cash) from two major sources: creditors (loan proceeds) and shareholders (proceeds from issuing shares). They also include the repayment of loan principal, the repurchase of shares and the payment of dividends.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-5

If the operating section of the statement of cash flows is prepared under the direct method, it reports the actual gross cash collections from customers, cash payments to suppliers, cash payments to employees, etc. It adjusts most of the individual items on the statement of income from the accrual basis to the cash basis. The indirect method arrives at the same total cash flow from operations but starts with the net income for the period and adjusts it for all non-cash items such as depreciation or amortization and changes in the related current asset and current liability accounts.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-6

The indirect method uses accrual based net income as a starting point. A reconciliation is required to adjust the operating income to a cash basis. This reconciliation is a strength of the indirect method, as it very clearly shows the linkage between net income and cash flows from operating activities and may highlight some areas or trends of concerns.

LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-7

Cash flows generated from financing and investing activities are limited. A company cannot generate cash from financing activities indefinitely since too much debt will render a company too risky for investors and no creditor will be willing to lend more money. Similarly, there is a limit to the amount of cash that can be generated through equity investors. In order for investors to be willing to purchase shares in a company, they must be convinced that a reasonable rate of return will be achieved from the company’s operations. Cash generated from investing activities is generally from the sale of long-term investments or long-term assets, both of which are finite. If we want to assess a company’s financial health with respect to the future, we must look for cash generated by normal ongoing operating activities. The operations section includes the cash flows that result directly from the sale of goods and services to customers. This is the company’s core reason for being in business. This cash flow is useful in predicting future cash flow as the company’s core business is likely to continue from one year to the next. Cash flows from financing and investing, however, are not likely to reoccur at similar levels each year, so these cash flows are not as useful in predicting future cash flows.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-8

While an increase in cash and cash equivalent is viewed as a good result, it depends on how that increase was achieved. A company would be viewed as being successful if the majority of the increase came from an increase in cash generated from operations. On the other hand, if the increase in cash came from borrowing money or selling shares, this would not be viewed as a positive trend.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-9

It is not unusual for a recently established company to experience negative cash flows from operations. The primary reason is that a start-up would normally experience a net loss in the first year of operations. In addition, some of the sales on account would be tied up in accounts receivable. Cash may also be tied up in inventory. This is normal and would not be viewed with concern by financial statement users. On the other hand, when a company is no longer a start-up, the expectation is that the majority of cash inflows will come from operations. A negative cash from operations would be viewed with concern by financial statement users.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-10

A company that has net income for the year could have negative cash flows from operating activities. Large increases in accounts receivable and inventory, possibly caused by growth in sales, cause cash to be tied up and not available for operations. Deceases in accounts payable would be another source of reduction in cash from operations.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-11

Depreciation is added back to net income under the indirect method because we are trying to determine net income on a cash basis rather than on an accrual basis. Since depreciation expense is a non-cash item and it reduced net income (as all expenses do), it must be added back, thereby removing it from the calculation income on a cash basis. While this may make it appear that it is a source of cash, it is not.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-12

An increase in depreciation will lower net income, which is the starting point in the indirect method. Lower net income, with higher depreciation added back, will have the same net cash flow effect as not changing depreciation at all. Since depreciation is left out of the calculation of cash from operating activities prepared using the direct method, any increase in the amount of depreciation will have no effect.

LO 4,5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-13

An increase in accounts payable is a normal trend when the business is experiencing growth. Hand in hand with the growth would come an increase in accounts receivable and inventory. An increase in accounts payable has a positive effect on cash from operations, while increases in accounts receivable and inventory have the opposite effect. They cause cash to be tied up and have a negative effect on cash from operations. In this case, the increase in accounts payable was only partially offset by increases in accounts receivable and inventory, so the net effect would be an increase in cash from operating activities.

LO 4,5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-14

A decrease in profitability brought on by a decrease in sales brings with it a decrease in accounts receivable and inventory. Decreases in accounts receivable and inventory have a positive effect on cash flow from operations.

LO 4,5 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-15

To speed up the collection of accounts receivable, the company’s management could change the terms of payment with customers to a shorter period. This would decrease the balance of accounts receivable and increase cash flows from operating activities. This decision could have a detrimental effect on the company in the long-term as customers may go to the competition for better terms of payment thereby reducing sales. Another step that could be taken to increase cash from operations is to reduce inventory. Management could take concrete steps to order less inventory and hold a minimum amount of inventory on hand. This too could have detrimental effects on the company as this action could lead to stock outs and the company cannot fulfill sales orders. Frustrated customers could then go to the competition for a more reliable supplier of goods. This too could reduce sales and have adverse consequences to net income.

LO 4,5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-16

The net cash flows from investing activities is usually negative as companies must purchase new PP&E (a negative cash flow) to grow operations or even to just replace those assets which have reached the end of their useful life. The cash outflow indicates the company is acquiring new capital assets (land, plant, equipment, intangibles, long-term investments, etc.). These cash outflows can continue as long as a company has cash or can arrange new financing. A positive cash flow from investing, however, would indicate a company is selling property, plant, and equipment. Such assets can only be sold once, so there is a limit to the amount of cash inflow that can be produced.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-17

Net cash flow from financing activities could be negative when a company is repaying debt principal or paying dividends in excess of the cash received from new borrowings or share issuances.

LO 3 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-18

A gain on the sale of equipment is a non-cash item that increases net income prepared on an accrual basis. When preparing the statement of cash flows using the indirect method, such gains must be deducted from net income. Those gains are non-cash and are related to investing activities (i.e. selling PP&E) rather than operating activities.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-19

If net cash flows from investing are positive, then the company has received more cash proceeds from the sale of investments in the shares of other companies than they spent to purchase new investments during the period. This could also happen if the company’s proceeds from the sale of property, plant, and equipment exceeded amounts spent to purchase new PP&E. This is often considered an indication that the company may be at financial risk if they are liquidating assets to pay their operating expenses in the period. On the other hand, if the proceeds come from the proceeds of selling shares of other companies, this would not be perceived as a troublesome trend.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-20

Cash flows from financing may be positive if the company has issued new shares or taken out new loans, or has increased its bank indebtedness. If cash inflows from these items are greater than cash used to pay dividends or to repay debt, then the net balance will be positive. It is worthwhile to see where extra cash is being used; perhaps for expansion, and investing in new PPE, or may be to cover daily operating expenses.

LO 3 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-21

The longer the cash-to-cash cycle, the greater the company’s cash requirements. It is a problem during periods of high sales growth, since products must be purchased or produced before they can be sold. More cash is tied up in inventory. Start-up companies face challenges because suppliers require them to pay for goods and raw materials up front, but it may take weeks or months before the company is able to sell the product and collect from customers. Most companies cannot sustain these high growth rates for long unless they can secure more long-term types of financing through equity or debt.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-22

Large increases in accounts receivable and inventory caused by growth in sales, cause cash to be tied up and not available for operations. This in turn leads to lower cash flows from operations. In order to fulfill sales orders, inventory must be on hand and reasonable terms of payment must be granted to customers. There is therefore a significant time lag between when suppliers must be paid on purchases of inventory and when the ultimate collection for a credit sale takes place.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-23

The acquisition of property, plant, and equipment requires a cash outflow from investing at the time of purchase. This cash may come from cash inflows from operating (if the cash is from current or past profits), financing (if the cash is borrowed or results from the issuance of shares), or investing (if one asset is sold to purchase another). If the cash comes from debt financing, it will require cash repayment over a number of future years. As the asset is used, the cost is depreciated. This is a non-cash transaction. Depreciation expense is ignored under the direct method as it is a non-cash item. There may also be cash outflows for repairs and maintenance. These would reduce cash flows from operating activities. When the asset is sold, any cash received is recorded as a cash inflow from investing activities. Under the indirect method, any gains or losses on the disposal must be removed from operating income in the statement of cash flows. Under the direct method, these non-cash gains or losses are ignored.

LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-24

Cash flows from operating are typically positive, as companies sell goods and services at a higher price than their cost to produce or provide the goods and services. Cash flows from investing are typically negative as companies spend more cash purchasing property, plant, and equipment than they receive from selling these items.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-25

Management of a company using IFRS might choose to classify payments of interest as a financing activity because they believe it is a financing cost to pay interest on borrowed funds. It can be argued that since borrowing money is a financing activity, the related interest payments should be included in the same section. This would also result in interest payments and dividends payments being included in the same cash flow category. As both are returns to the provider of a company’s financing, it can be argued that they should be presented in the same cash flow category.

LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-26

Management of a company using IFRS might choose to classify payment of dividends as an operating activity so users can more easily assess the company’s ability to generate sufficient operating cash flows to fund dividend payments or the extent of operating cash flows available after the payment of dividends, for reinvestment in the company. This would also result in interest payments and dividends payments being included in the same cash flow category. As both are returns to the provider of a company’s financing, it can be argued that they should be presented in the same cash flow category.

LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-27

The cash-to-cash cycle is the time between when a company pays out cash to purchase goods or raw materials for manufacturing until those goods are ultimately paid for by the customer. The purchase of equipment does not affect this cycle as equipment is not a good or raw material so it will not lengthen or impact the cash-to-cash cycle.

LO 6 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-28

Knowledge of the timing of the collection of receivables and of payments to suppliers, as well as the level of inventories, can help users of the financial statements understand the relationship between the recognition of revenue from sales and the related cash flows. For instance, the more time the company gives its customers to pay (accounts receivable policy), the greater the lag will be between the recognition of the sale for income purposes and the recognition of the cash inflow. The higher the level of inventories required at the end of each period, the bigger the gap will be between the outflow of cash to pay for inventory and the recognition of those costs as expenses for the cost of goods sold at the time of sale. The accounts payable policy also introduces a lag between the recognition of costs and the cash outflow.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-29

The cash-to-cash cycle is the time between when a company makes cash payments for goods or raw materials for manufacturing products until those goods are ultimately paid for by the customer and the company receives cash. The longer the cash-to-cash cycle, the more cash the company will need to maintain for its ongoing operations.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-30

Three potential reasons that may cause a company to experience problems with its cash-to-cash cycle include: 1. Slow cash collection from customers: Cash flow problems related to collections from customers may be alleviated by increasing the amount of cash sales, accepting credit cards, or reducing the credit period for customers who buy on account. Companies have to carefully consider the sales terms they provide their customers. Customers may not be happy with having to pay cash or with reduced credit periods and may be able to get better terms from competitors. While accepting credit cards would enable the company to collect its receivables more quickly, credit card companies charge fees and these additional costs will affect overall profitability. Receivables may also be collected more quickly by offering cash discounts for early payment.

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-30 (Continued) 2. Lack of credit from suppliers: Negotiating with suppliers to be able to purchase on credit or for delayed payments would also help shorten the cash-to-cash cycle, however this generally requires the company to have established its creditworthiness to suppliers. It takes time to do this, and suppliers may be hesitant to extend credit to newly formed companies, which have greater cash-to-cash cycle problems. 3. Too much cash tied up in inventory: Cash flow problems related to having significant cash resources tied up in inventory may be alleviated by reducing inventory levels. This needs to be monitored to ensure that sales are not lost or delayed due to lack of inventory. This will require the company to implement procedures to monitor inventory and may include purchasing in smaller quantities. LO 6 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-31

The cash flow pattern expected for a new company in its first year would be -/-/+. It would be expected that new companies have negative operating cash flows in the first few years as they are growing and building inventory. The investing would be negative as they would be purchasing equipment and other property, plant and equipment in their first year. There would likely be a positive cash inflow from financing activities as the company would have borrowed money or issued shares to finance the start-up.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ5-32

The cash flow pattern expected from a successful company that generates sufficient cash flows from its operations to fund expansion and debt repayment would be +/-/-. Successful companies have positive cash flows from operating activities, they would have growth in property, plant and equipment to expand, which would create negative cash flows from investing activities. Successful companies would have negative cash flows from financing activities as they repay debt and pay dividends.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

DQ5-33

Net free cash flow is considered to be the cash flow generated from a company’s operating activities that would be available to the common shareholders. The formula is cash flows from operating activities minus net capital expenditures minus dividends on preferred shares.

LO 7 BT: AN Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

DQ5-34

Analyzing prior years’ statements of cash flows allows the user to identify trends and in particular, assess the stability of the organization’s ability to generate cash from operations. Additionally, it allows the user to review the history of investing and financing activities. For example, are large investments in equipment required every year, every three years or every five years? Prior statements will provide the user with the company’s large investment requirements and will, therefore, assist in the prediction of needed cash flows for equipment replacement and upgrades in the future. As well, large amounts borrowed in prior statements give rise to expected repayments in the upcoming years.

LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ-35

A company’s board of directors may want to determine the CEO’s bonus based on cash flows from operating activities rather than based on net income to encourage good cash management. Companies can survive net losses but they fail much more quickly when they have negative cash flows (it impacts their abilities to continue operations in the future). Also, net income involves accruals some of which are based on estimates and judgements which could be manipulated to improve net income, whereas they do not impact cash flows.

LO 6 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP5-1A

a. Investing b. Financing c. Operating (The Net Income would be the starting point in the Operating section if using the indirect method and left out if using the direct method.) d. Financing (The dividends paid to shareholders could also be classified as an operating activity under IFRS.) e. Investing f. Operating g. Financing h. Financing i. Operating (The gain or loss would be an adjustment in the Operating section if using the indirect method and left out if using the direct method. There would also be an entry for the cash proceeds, if any, in the Investing section.) j. Investing

LO 3 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP5-2A a. b. c. d. e. f. g.

no effect decreases cash no effect decreases cash (by amount of down payment) no effect decreases cash increases cash (unless issuing shares in exchange for another asset, such as land or equipment, or from a stock dividend) h. decreases cash i. decreases cash j. increases cash LO 3 BT: K Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-3A a. b. c. 1.

Interest Expense Cash

30,000

Decreases cash by $30,000 30,000 [$500,000 x 6%]. Reported in cash flows from operating activities.

Trucks Cash

50,000

Decreases cash by $50,000. 50,000 Reported in cash flows from investing activities.

Depreciation Expense Accumulated Depreciation, Trucks

No effect on cash. 10,000 If using the indirect method, add back to net income when 10,000 determining cash flows from operating activities.

Cash Accumulated Depr. Equipment Gain on Disposal

40,000 125,000 160,000 5,000

Equipment Cash Notes Payable

200,000

Increases cash by $40,000. The proceeds of $40,000 would be treated as a cash inflow from investing activities. If using the indirect method, the gain would be deducted from net income when determining cash flows from operating activities.

Decreases cash by $50,000. 50,000 Reported in cash flows from 150,000 investing activities. The non-cash part of the transaction would be disclosed in the notes.

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-3A (Continued)

Cash Deferred Revenue

2,000

Increases cash by $2,000. Reported in cash flows from 2,000 operating activities because deferred revenue increased from the prior year (add the $2,000 difference).

Income Tax Expense 85,000 Decreases cash by $70,000. Cash 70,000 Reported in cash flows from Income Tax operating. Because taxes payable Payable 15,000 increased from the prior year, (add the $15,000 difference).

LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP5-4A

Transaction 1. Purchased inventory on account. 2. Sold at a gain equipment that the company was finished using. 3. Repayment of loan principal. 4. Declaration of dividends. 5. Accrued interest owing on loan. 6. Made sales on account. 7. Collection of account receivable from customer. 8. Cash purchase of equipment.

Effect on Effect on Cash Flow Net Income No effect Increase

No effect Increase

Decrease No effect No effect No effect Increase

No effect No effect Decrease Increase No effect

Decrease

No effect

LO 3 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-5A Cash Flow from Operations

Net Income Add: Depreciation expense Decrease in inventories Decrease in accounts receivable Increase in accounts payable Increase in interest payable Increase in income tax payable Less: Increase in inventories Increase in accounts receivable Decrease in accounts payable Decrease in interest payable Decrease in income tax payable Cash Flow from Operations

Joulie Ltd. $92,400

Mansour Inc. $115,200

Warren Ltd. $163,200

8,400

21,600 9,600

33,600

3,000 4,200

10,200 5,040 1,400

3,000

7,800

4,800

16,800 6,000 7,800

1,800

600 1,800

$104,400

$132,200

LO 4 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

$202,440

Burnley: Understanding Financial Accounting, Third Canadian Edition

P5-6A a.

Nomad Adventures Ltd. Statement of Cash Flows, Indirect Method For the Year Ended March 31, 2024

Cash Flows from Operating Activities Net Income Add: Depreciation Expense Add: Loss on Sale of Equipment Less: Increase in Accounts Receivable Less: Increase in Inventory Add: Increase in Accounts Payable Net cash provided by operating activities Cash Flows from Investing Activities Less: Purchase Equipment Add: Proceeds from the sale of Equipment Net cash used for investing activities Cash Flows from Financing Activities Less: Dividends Paid Add: New Bank Loan Less: Repayment of Bank Loan Net cash used for financing activities

$ 398,900 113,000 17,100 (43,000) (110,000) 145,000 $521,000 (415,000) 9,900 (405,100) (54,900) 23,100 (18,100) (49,900)

Net change in Cash

$ 66,000

Ending Cash Opening Cash Net change in Cash

$ 120,000 54,000 $ 66,000

Non-cash investing and financing activities: During the year, land with a value of $225,000 was acquired by issuing common shares of the same value.

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-6A (Continued) Beginning balance

Equipment 810,000 225,000

Balance after sale of equipment Cost of equipment purchased Ending balance

585,000 415,000

Cost of equipment sold (given) This is the missing amount, which will produce the ending balance

1,000,000

Retained Earnings 102,000 398,900 500,900

Dividends declared during year

75,900 425,000

Beginning balance Net income for 2024 Balance after income added This is the missing amount, which will produce the ending balance Ending balance

Dividends Payable 54,000 75,900 129,900

Dividends paid during year

Principal repayments made during the year

75,000

Beginning balance Dividends declared Balance This is the missing amount, which will produce the ending balance Ending balance

Bank Loan Payable 180,000 23,100

Beginning balance New borrowings

203,100

Balance after new borrowings

54,900

18,100

This is the amount that will produce

185,000

the ending balance Ending balance

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-6A (Continued) b. Direct Method: Nomad Adventures Ltd. Statement of Cash Flows, Direct Method For the Year Ended March 31, 2024 Cash Flows from Operating Activities Cash receipts from customers $1,777,000 Cash paid to suppliers (1,004,000) Cash paid to employees (252,000) Net cash provided by operating activities

Category

Starting Point (from Statement of Income)

$ 414,400 (109,500) (135,000) (5,400) $164,500

Adjustments (from Statement of Financial Position)

Total =A+B

Receipts from customers

Sales Revenue

450,000

Change in Accounts Receivable

(35,600)

Payments to suppliers

Vehicle operating expenses

(102,400)

Change in Prepaid Insurance

(10,000)

Change in Accounts Payable

2,900

(109,500)

Payments to employees

Wages Expense

(134,000)

Change in Wages Payable

(1,000)

(135,000)

Payment of interest

Interest Expense

(5,400)

Change in Interest Payable

N/A

(5,400)

Cash Flows from Operating Activities

LO 4,5 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

414,400

164,500

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-8B a.

Canbuild Materials Ltd. Statement of Cash Flows, Indirect Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Net Income $168,000 Add: Depreciation Expense 98,000 Less: Increase in Accounts Receivable (69,000) Add: Decrease in Inventory 20,000 Add: Increase in Accounts Payable 2,000 Net cash provided by operating activities

$219,000

Cash Flows from Investing Activities Less: Purchase of Equipment Add: Proceeds from the Sale of Equipment Net cash used for investing activities

(138,000) 25,000 (113,000)

Cash Flows from Financing Activities Less: Dividends Paid Net cash used for financing activities

(136,000) (136,000)

Net change in Cash

($30,000)

Ending Cash Opening Cash Net change in Cash

$ 20,000 50,000 ($30,000)

Supplemental Cash Flow information: Cash paid for interest

$12,000

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-8B (Continued) Beginning balance

Equipment 195,000

Balance after sale of equipment Cost of equipment purchased

42,000 138,000

Ending balance

180,000

153,000

Cost of equipment sold This is the missing amount, which will produce the ending balance

Retained Earnings 73,000 168,000 241,000 Dividends declared during year

141,000 100,000

Beginning balance Net income for 2024 Balance after income added This is the missing amount, which will produce the ending balance Ending balance

Dividends Payable 24,000 141,000 165,000 Dividends paid during year

136,000 29,000

Beginning balance Dividends declared Balance This is the missing amount, which will produce the ending balance Ending balance

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-8B (Continued) b. If Direct Method is used: Canbuild Materials Ltd. Statement of Cash Flows, Direct Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Cash receipts from customers Cash paid to suppliers Cash paid to employees Cash paid for interest

$ 1,176,000 (724,000) (221,000) (12,000)

Net cash provided by operating activities Category Receipts from Customers Payments to Suppliers

Payment to Employees Payment for Interest

Starting Point (from Statement of Income) Sales Revenue Cost of Goods Sold Administrative Expenses Advertising Expense Wages Expense Interest Expense

A 1,245,000 (655,000) (46,000) (45,000) (221,000) (12,000)

Adjustments (from Statement of Financial Position) Change in Accounts Receivable Change in Inventory Change in Accounts Payable

Cash Flows from Operating Activities

LO 4,5 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

$219,000 B (69,000) 20,000 2,000

Total =A+B 1,176,000

(724,000) (221,000) (12,000) 219,000

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-9B a.

Marchant Ltd. Statement of Cash Flows, Indirect Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Net Income Add: Depreciation Expense Add: Decrease in Accounts Receivable Less: Increase in Inventory Less: Decease in Wages Payable Less: Decrease in Accounts Payable Net cash provided by operating activities Cash Flows from Investing Activities Less: Purchase of Property, Plant & Equipment Net cash used for investing activities Cash Flows from Financing Activities Less: Dividends Paid Add: Issuance of Common Shares Less: Repayment of Loan Payable Net cash used for financing activities

$ 44,000 30,000 20,000 (40,000) (2,000) (3,000) $49,000 (50,000) (50,000) (9,000) 50,000 (50,000) (9,000)

Net change in Cash

($10,000)

Ending Cash Opening Cash Net change in Cash

$ 60,000 70,000 ($10,000)

Supplemental Cash Flow information: Cash paid for interest

$ 24,000

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-9B (Continued)

Balance after sale of equipment Cost of equipment purchased

Equipment 650,000 0 650,000 50,000

Ending balance

700,000

Dividends declared during year

Retained Earnings 265,000 44,000 309,000 9,000

Beginning balance

Cost of equipment sold This is the missing amount, which will produce the ending balance

300,000

Beginning balance Net income for 2024 Balance after income added This is the missing amount, which will produce the ending balance Ending balance

Dividends Payable 0 9,000 9,000 Dividends paid during year

Principal repayments made during the year

Beginning balance Dividends declared Balance This is the missing amount, which will produce the ending balance Ending balance

Loan Payable 400,000 0 400,000

Beginning balance New borrowings Balance after new borrowings

9,000

50,000 350,000

This is the amount that will produce the ending balance Ending balance

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-9B (Continued) b. If Direct Method is used: Marchant Ltd. Statement of Cash Flows, Direct Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Cash receipts from customers Cash paid to suppliers Cash paid to employees Cash paid for Interest Net cash provided by operating activities Category Receipts from Customers Payments to Suppliers

Payment to Employees Payment of Interest Payment of Income Tax

Starting Point (from Statement of Income) Sales Revenue Other Income Cost of Goods Sold Supplies Expense Other Operating Expenses Wage Expense Interest Expense Income Tax Expense

A 450,000 8,000 (240,000) (15,000) (5,000) (100,000) (24,000) N/A

$ 478,000 (303,000) (102,000) (24,000)

Adjustments (from Statement of Financial Position) Change in Accounts Receivable Change to Other Income Change in Inventory Change in Accounts Payable

$49,000 B 20,000 N/A (40,000) (3,000)

Change in Wages Payable (2,000) Change in Interest Payable N/A Change in Income Tax Payable N/A Cash Flows from Operating Activities

Total = A+B 478,000

(303,000) (102,000) (24,000) 49,000

c. Net income of $44,000 is lower than the cash generated from operations of $49,000. These amounts should not be the same as the calculation of net income may include non-cash items and differences arising from using the accrual basis of accounting versus the cash basis of accounting. d. The working capital did not change by the same amount as cash generated by operations. Working capital increased $15,000 ($410,000 in 2024 – $395,000 in 2023). More than just operating activities affect working capital—financing and investing activities also affect it. For example, the $50,000 of cash from the issuance of shares increased the company’s cash balance, thus increasing working capital at Dec. 31, 2024, but did not increase the cash generated by operations on the 2024 statement of cash flows. LO 4,5 BT: AP Difficulty: H Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-10B a.

Standard Card Company Statement of Cash Flows, Indirect Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Net Income Add: Depreciation Expense Add: Loss on Sale of Equipment Less: Increase in Accounts Receivable Less: Increase in Inventories Add: Decrease in Prepaid Insurance Add: Increase in Accounts Payable Less: Decrease in Interest Payable Less: Decrease in Deferred Revenue Net cash used for operating activities

$ 44,000 12,000 13,000 (5,000) (90,000) 10,000 5,000 (1,000) (5,000) $(17,000)

Cash Flows from Investing Activities Less: Purchase of Equipment Add: Proceeds from the Sale of Equipment1 Net cash provided by investing activities

(55,000) 67,000

Cash Flows from Financing Activities Add: Issuance of Common Shares Less: Repayment of Long-term Debt Less: Dividends Paid Net cash provided by financing activities

85,000 (50,000) (7,000)

12,000

28,000

Net change in Cash

$23,000

Ending Cash Opening Cash Net change in Cash

$134,000 111,000 $ 23,000

Supplemental Cash Flow information: Cash paid for interest (see T-Account) Cash paid for income tax

$ 9,000 $ 24,000 $23,000

Proceeds on sale of equipment = Carrying amount – loss on sale of equipment [($100,000 - $20,000) – $13,000 = $67,000] 1

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-10B (Continued) Equipment Beginning balance

350,000

Balance after sale of equipment Cost of equipment purchased

250,000 55,000

Ending balance

305,000

100,000

Dividends declared during year

This is the missing amount, which will produce the ending balance

Retained Earnings 224,000 44,000 268,000 7,000 261,000

Dividends paid during year

Dividends Payable 0 7,000 7,000 7,000 0

Long Term Debt payments made

Long Term Debt 150,000 0 150,000 50,000 100,000

Interest paid during year

Cost of equipment sold

Interest Payable 4,000 8,000 12,000 9,000 3,000

Beginning balance Net income for 2024 Balance after income added This is the missing amount, which will produce the ending balance Ending balance

Beginning balance Dividends declared Balance This is the missing amount, which will produce the ending balance Ending balance

Beginning balance New borrowings Balance after new borrowings This is the amount that will produce the ending balance Ending balance

Beginning balance Interest Expense Balance This is the missing amount, which will produce the ending balance Ending balance

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-10B (Continued) b. If Direct Method is used: Standard Card Company Statement of Cash Flows, Direct Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Cash receipts from customers Cash paid to suppliers Cash paid for Interest Cash paid for Income Tax Net cash provided by operating activities

$ 197,000 (182,000) (9,000) (23,000) ($17,000)

LO 4,5 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-11B Medicinal Plant Ltd. Statement of Cash Flows, Indirect Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Net Income Add: Depreciation Expense Less: Gain on Sale of Equipment Less: Increase in Accounts Receivable Less: Increase in Inventories Less: Decrease in Accounts Payable Less: Decrease in Wages Payable Net cash provided by operating activities

$9,550,000 1,500,000 (300,000) (2,400,000) (3,000,000) (250,000) (200,000)

Cash Flows from Investing Activities Less: Purchase of Equipment Add: Proceeds from the sale of Equipment Net cash used for investing activities

(7,200,000) 2,500,000

Cash Flows from Financing Activities Less: Dividends Paid Net cash used for financing activities

(1,000,000)

$4,900,000

(4,700,000)

(1,000,000)

Net change in Cash

$(800,000)

Ending Cash Opening Cash Net change in Cash

$ 5,600,000 6,400,000 $ (800,000)

Supplemental Cash Flow information: Cash paid for interest Cash paid for income tax

$1,350,000 $1,600,000

Non-cash investing and financing activities: During the year, the company’s board of directors approved the retirement of bonds with a carrying amount of $4,000,000 through the issuance of common shares.

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-11B (Continued)

Balance after sale of equipment Cost of equipment purchased

Equipment 42,000,000 4,200,000 37,800,000 7,200,000

Ending balance

45,000,000

Dividends declared during year

Retained Earnings 23,750,000 9,550,000 33,300,000 1,000,000

Beginning balance

32,300,000

Cost of equipment sold This is the missing amount, which will produce the ending balance

Beginning balance Net income for 2024 Balance after income added This is the missing amount, which will produce the ending balance Ending balance

Dividends Payable 0 1,000,000 1,000,000 Dividends paid during year

1,000,000 0

Bonds Payable 28,000,000 0 28,000,000 Bond repayments made during the year*

4,000,000 24,000,000

* Non-cash as repaid through the issuance of common shares

Beginning balance Dividends declared Balance This is the missing amount, which will produce the ending balance Ending balance

Beginning balance New borrowings Balance after new borrowings This is the amount that will produce the ending balance Ending balance

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-11B (Continued) If Direct Method is used: Medicinal Plant Ltd. Statement of Cash Flows, Direct Method For the Year Ended December 31, 2024 Cash Flows from Operating Activities Cash receipts from customers Cash paid to suppliers Cash paid for employees Cash paid for interest Cash paid for income tax Net cash provided by operating activities Category

Receipts from Customers Payments to Suppliers

Starting Point (from Statement of Income) Sales Revenue Cost of Goods Sold

Payment to Employees Payment for Interest Payment for Income Taxes

Wages Expense Interest Expense Income Tax Expense

(1,800,000) (1,350,000) (1,600,000)

45,000,000 (29,500,000)

$ 42,600,000 (32,750,000) (2,000,000) (1,350,000) (1,600,000)

Adjustments (from Statement of Financial Position) Change in Accounts Receivable Change in Inventory Change in Accounts Payable Change in Wages Payable

Cash Flows from Operating Activities

LO 4,5 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

$4,900,000 B (2,400,000) (3,000,000) (250,000) (200,000)

Total =A+B 42,600,000 32,750,000 (2.000,000) (1,350,000) (1,600,000) 4,900,000

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-12B a.

Autonomous Control Ltd. Statement of Cash Flows, Indirect Method For the Year Ended September 30, 2024

Cash Flows from Operating Activities Net Income Add: Depreciation Expense Less: Gain on Sale of Equipment Add: Decrease in Accounts Receivable Less: Increase in Inventory Less: Decrease in Accounts Payable Net cash provided by operating activities

$ 9,000 170,000 (35,000) 50,000 (92,000) (70,000)

Cash Flows from Investing Activities Add: Proceeds from the sale of Equipment1 Net cash used for investing activities

97,000

Cash Flows from Financing Activities Less: Dividends Paid2 Less: Repayment of Bank Loan Net cash used for financing activities

(84,000) (75,000)

$32,000

97,000

(159,000)

Net change in Cash

$(30,000)

Opening Cash

$20,000

Ending Cash (Bank indebtedness)

(10,000)

Net change in Cash

$(30,000)

Carrying amount of equipment sold + gain on sale ($62,000 + $35,000) = $97,000 2 Decrease in Retained earnings + Net income (($300,000 - $225,000) + $9,000 = $84,000

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-12B (Continued) If Direct Method is used: Autonomous Control LTD. Statement of Cash Flows, Direct Method For the Year Ended September 30, 2024 Cash Flows from Operating Activities Cash receipts from customers Cash paid to suppliers Cash paid to employees Cash paid for interest Cash paid for income tax Net cash provided by operating activities Category Receipts from Customers Payments to Suppliers

Payment to Employees Payment for Interest Payment for Income Taxes

Starting Point (from Statement of Income) Sales Revenue Cost of Goods Sold Utilities Expense Rent Expense Wages Expense Interest Expense Income Tax Expense

A 8,350,000 (7,450,000) (276,000) (200,000) (245,000) (30,000) (5,000)

$ 8,400,000 (8,088,000) (245,000) (30,000) (5,000)

Adjustments (from Statement of Financial Position) Change in Accounts Receivable Change in Inventory Change in Accounts Payable

Cash Flows from Operating Activities

$32,000 B 50,000 (92,000) (70,000)

Total =A+B 8,400,000

(8,088,000) (245,000) (30,000) (5,000) 32,000

Autonomous is in a challenging position. Although sales have declined by 15%, accounts receivable have decreased by only 10%, indicating that there is likely a problem collecting from customers who have already purchased. The company should check to see whether any of its customers have become bankrupt, and if any receivables need to be written off. If that were the case, the small net income of $9,000 would likely become a net loss, possibly a significant loss. This would not look attractive to investors.

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-12B (Continued) Meanwhile, the company’s inventory has increased by 15% [($692,000 – $600,000) / $600,000]. This is inconsistent to the slowing of sales, and may also indicate that the company has manufactured more inventory than it should have. Another indication that the inventory might need to be written down due to its age is that the extra purchases of inventory must have been made long before year end, as there is a very small increase in the balance of accounts payable. Autonomous has a very small amount of cash generated from operations. This result would have been a negative cash flow if it not were for the gain on the sale of the equipment. This is not a good sign. Nothing in the case indicates that the company needs to change its equipment, or that its equipment had become obsolete. The fact that they were able to sell the equipment at a gain of $35,000 indicates that their depreciation rate may have been too high, and indicates that there was a market for it, so it was not likely obsolete. Instead, it appears that it was sold to generate cash in order to cover operating costs. The gain on the sale of equipment led to net income of $9,000. Without this gain, there was an operating loss of $21,000. This gain is a one-time event, and is not sustainable income. *Other valid comments could also be made. LO 4,5,6 BT: AP Difficulty: H Time: 70 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-13B a. Accounts receivable, end of last year + Sales – Cash collected from customers = Accounts receivable, end of this year

$ 30,000 315,000 A ???? $ 34,000

A = $311,000 b. Inventory, end of last year + Purchases – Cost of goods sold = Inventory, end of this year

$ 49,000 B ???? (246,000) $ 43,000

B = $240,000 Accounts payable, end of last year + Purchases – Cash paid to suppliers = Accounts payable, end of this year

$ 33,000 240,000 C ???? $ 37,000

C = $236,000 LO 5 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP5-14B a.

IFLG spent $14,582 over the last three years on the acquisition of property, plant and equipment and computer software. Meanwhile, cash from operations is negative $7,753 over the last three years. From 2022 to 2024, cash from operations was not sufficient to meet these needs and so these non-continuing uses of cash were financed with cash on hand in 2022 and 2023 and with bank indebtedness in 2024.

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-14B (Continued)

There were also cash outflows in 2022 and 2023 for the repurchase of common shares, although this has stopped in 2024, likely because of the lack of available cash due to the massive net loss in 2024. In terms of the future, the cash from operations is not keeping pace with the needs of the company and something will have to be done to solve this problem. The company cannot hope to rely on increased debt financing indefinitely. b. Accounts receivable has increased by $119 in 2024. This might be due to an increase in sales revenue but does not appear likely, as the net loss has increased in 2024. If accounts receivable is increasing without a corresponding increase in sales revenue, it may indicate a cash collection problem. The company should review its credit policies and may consider tightening credit terms if bad debts are increasing, or offering customers incentives for early payment by giving sales discounts. Increases in accounts payable should be compared to increases in inventory. In times of growth, both should increase at the same pace. Payments of accounts payable are steadily increasing while inventory is levels are shrinking. This trend is a strong indication that the suppliers are reacting to IFLG’s worsening profitability and may be tightening their terms of payment. For example, they may be resorting to COD (cash on delivery) terms. Inventory levels have been decreasing steadily over the three-year period. This decline may be due to store closings due to losses c.

IFLG has financed its repayment of debt and acquisition of property, plant and equipment and computer software by increasing its bank indebtedness.

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-14B (Continued) d.

Change in long-term debt: Net borrowings 2022: 0 – 0 = 0 2023: 0 – 0 = 0 2024: $5,284 – $2,900 = 2,384 2,384 Change in shareholders’ equity: + Net income (Loss)

2022: 2023: 2024:

1,400 (9,389) (19,869) (27,342)

+ Common share issued

2022: 2023: 2024:

183 227 0 410

- Common shares repurchased

2022: 2023: 2024:

(11,400) (275) 0 (11,675)

Net change in shareholders’ equity

$(38,607)

It is much more heavily dependent upon debt financing in 2024. Debt financing has increased by $2,384, but equity has decreased by ($38,607). This is a much riskier capital structure, as interest must be paid on debt financing and the principal must ultimately be repaid. LO 6 BT: AN Difficulty: H Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

AP5-15B

The cash flow pattern would be - / - / +. Cash from operating activities is likely to be negative as the company is new and has to build up its inventory. It has to pay its paper and other suppliers quickly, however its customers have a lengthy period for payment of their invoices. As a new company, Crafty would have purchased binding machines for its books which would have resulted in negative cash flows from investing activities. To offset all of these cash outflows, Crafty would have had to borrow money through bank loans or issue shares. This would create a positive cash inflow from financing. LO 6 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP5-16B The cash flow pattern would be - / - / +. Cash from operating activities is likely to be negative since the company is not yet profitable and it has to grant long credit periods for its customers while its suppliers do not grant credit, which can lead to cash flow difficulties. GHF would have negative cash from investing activities as it just finished construction on a manufacturing facility. As GHF has received money from a group of banks, their cash from financing activities would be positive. LO 6 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP5-1

The operations section includes the cash flows that result directly from the sale of goods and services to customers. This is the company’s core reason for being in business. This cash flow is useful in predicting future cash flows as the company’s core business is likely to continue from one year to the next. Cash flows from financing and investing, however, may not appear at similar levels each year, so these cash flows are not as useful in predicting future cash flows. Also, because the cash inflows from investing and financing are dependent upon the willingness of lenders and investors to participate in the financing of the company, these users look for positive cash flow from operations to ensure that it is sufficient over the long term to pay interest, repay principal, pay dividends and fund future growth. The cash flow from operations section starts with the net income figure and, by comparing net income to cash flow from operations, the user can determine the significance of the timing of the company’s cash inflows and outflows. Except for the adjustment for the add back of depreciation expense and amortization expense, large differences between net income and cash flow from operations signal the importance to the company in monitoring credit relationships with customers and suppliers and monitoring the company’s ability to sell inventory quickly. The analysis of changes in non-cash working capital accounts can indicate specific problems with accounts receivable, accounts payable, or inventory policies. For example, a cash outflow from an increase in accounts receivable may signal a problem with collectability from customers. This may require the company to review credit-granting policies or to offer incentives to customers for early payment using cash discounts. LO 1 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-2

Management compensation plans are typically used to motivate managers to consider the long-term health of the company. Therefore, the statement of income would likely be a better performance measure to use than the cash flow from operations since it focuses on the longer run net effect on the wealth of the shareholder rather than the immediate cash picture. On the other hand, if cash flow management were a particular problem for your company, you might be tempted to put in measures of both net income and cash flow to focus managers on both the long-term picture as well as the shorter run cash flow issue. Care should be taken to look at any possible manipulation of results using either measure of performance. Manipulation may occur from entering into transactions near the end of fiscal year which may not be in the best interest of shareholders on the long run. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP5-3

In general, lenders should be quite satisfied with the classification of cash flows into the three categories of operating, investing, and financing activities. These activities represent the sources (financing) and uses (investing) of cash, in addition to the cash generated as a result of business activities (operating). However, the classification of interest as an operating activity is inappropriate in the sense that interest represents a return paid to lenders, and is thus related to financing rather than to the revenuegenerating activities of the business. When using the indirect method, the amount of interest paid is included in the net income and is not highlighted in the statement of cash flows. (Note: IFRS allows companies to report interest and dividend payments as either operating activities or financing activities.) LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-4

The bank loan officer is very interested in determining the ability of the company to pay back its loan. If the loan is short-term, then the bank must look for repayment of the loan from operating cash flows and secondarily from other sources of cash that the company might have. The statement of cash flows best provides this information. The information on the statement of income represents the company’s best estimate of the net cash proceeds that will ultimately result from the sale of goods and services during the current accounting period. However, there are many timing differences in these numbers that prevent net income from being a shortrun predictor of cash. If the banker is evaluating a long-term loan, then the statement of income becomes much more important since the repayment of the loan will take place over a much longer period of time. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP5-5 a. Capitalizing the costs of capital assets and depreciating them in future periods, as is done when long-term equipment is purchased, results in these assets being expensed over their useful life, in the periods in which these expenditures result in revenue generation. This approach allocates a portion of the asset’s cost to each period in which it helps to generate revenue. From a cash perspective, however, the cash outflow occurs in the period in which the acquisition occurs, rather than the periods in which the asset is depreciated. In order to track the cash situation of a company, the statement of cash flows must be used. Because of deferring expenses, companies can be profitable and yet not have sufficient cash on hand to meet their obligations. b. A wave of bankruptcies could signal a problem with the information being received and used by investors and lenders. As mentioned in (a), companies could be reporting positive net income while struggling to meet their financial obligations. For a lender using only a statement of income, lending to a profitable company would seem a minimal risk. If the company is experiencing severe cash flow problems however, this could lead to it being unable to meet its financial obligations, which could result in bankruptcy. Use of the statement of cash flows would assist financial statement users in assessing the organization’s future solvency. LO 2 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-6

The stock analyst attempts to assess and value the productive capabilities of a company. Those productive capabilities are carried out over long periods of time and hence the statement of income is likely to be a better source of information in trying to predict future results. The analyst cannot, however, ignore the statement of cash flows as it provides useful information about the ability of the company to meet is cash flow and liquidity needs. If the company is unsuccessful in managing its cash position in the short run, it may not survive long enough to capture the value that is represented in its forecasted earnings. Yet, if you had to decide which statement would likely be more useful, you would conclude that the statement of income is more useful to the analyst. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP5-7 a. Yes, this is a risky investment. There is no guarantee that the new drug will be successful (i.e. be effective and receive approval from Health Canada). There is a danger that the company could spend all remaining cash in the development process and be left with nothing of value to sell. If so, investors will lose their investment. b. Accumulating large amounts of cash or short-term investments is not necessarily a sign of good management. Cash in particular, usually earns no return or a very low return. While holding sufficient cash to meet the company’s cash flow needs is necessary, having larger balances is not a good utilization of the company’s resources. Since the company has no revenues, the cash on the balance sheet was recently raised from this year’s issuance of 1,000,000 shares. The company has not yet spent this cash on research and development of the new drug, but this cash may be used up to fund next year’s development costs. Thus, accumulation of cash is the result of a financing activity rather than operating, and has nothing to do with whether management is doing a good job in developing the drug.

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-7 (Continued) c. It would be very useful to have information on the company’s cash flow from operating activities. This amount, which will be negative given the company’s lack of revenues except for modest returns on its invested cash, could be divided into the sum of the company’s cash and short-term investment balance to give an indication of how many years or portions of a year that these resources would be able to fund. This is sometimes referred to as the burn rate. In the absence of this information, Jacques could look at the expenses over the last few years to get an indication of the average annual cash outflow. As the company has no owned capital assets, it is likely that the expenses on the statement of income will closely mirror cash outflows. He can then evaluate how much longer the company could continue at current spending levels, without new cash inflows. For example, if cash and short-term investments currently total $1.5 million, and average expenses over the last few years are about $1.0 million annually, the company could continue its operations for about the next 18 months without further cash inflows. Of course, this assumes cash expenditures will continue at levels similar to prior years. This may not be accurate because, if the new drug is close to a breakthrough, spending patterns may change, or there may be revenues earned shortly. d. Advantages in buying shares in Health Life right now: • New drug sounds promising; with this intellectual property, the company has a valuable asset • Could buy shares before the share price increases, which will occur once the new drug’s success has been proven • Company appears to have sufficient liquidity to complete testing of new drug • Company has been successful in attracting financing through the issuance of shares, thus the marketplace judges the company to have high potential value

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-7 (Continued) Disadvantages in buying shares in Health Life right now: • If drug is not successful, company is unlikely to have any assets to return investment to shareholders. Investors could lose everything. There is no mention as to whether other drugs are being tested. • No guarantee that drug will be successful or that its use will be approved by government regulators or that a competitor will not succeed earlier than that company • Cash on hand may not be sufficient to complete development and testing • If cash is not sufficient to complete development and testing, company may have difficulties raising more financing or if they succeed in issuing more shares, any future earnings will be diluted • If news has already leaked of drug’s likely future success, an efficient market may have already increased the company’s share price LO 6 BT: AN Difficulty: H Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

UP5-8 a. One of the reconciling items between net earnings and cash provided by operations is a deduction of $120,000 for the change in current assets other than cash. Because the amount is deducted, it means that current assets increased. An increase in current assets would be consistent with an increase in sales. As sales increase, so would accounts receivable (if sales are made on credit) and inventory levels. Also, as inventory increases, accounts payable are also likely to increase. b. Green Company appears to have reduced its financial risk during 2024. $1,300,000 of bonds were retired and $1,000,000 of additional shares were issued. Retained earnings also increased during the year, because the net earnings were $644,000 while the dividends were only $250,000. The company therefore significantly decreased its long-term debt (by $1,300,000) and significantly increased its shareholders’ equity (by $1,394,000), which reduced its level of financial risk. The decrease in debt reduces its requirements to repay interest and principal, which gives Green Company more flexibility in times of tight cash flow.

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-8 (Continued) c. The company appears to be growing as new property, plant and equipment costing $1,200,000 was purchased and property, plant and equipment that the company had finished using, with a carrying value of $386,000 ($400,000 proceeds - $14,000 gain) was sold, resulting in a net investment of $814,000. This net investment is substantially more than the $230,000 of depreciation expense in 2024. Since the net value of the company’s property, plant and equipment increased (by $584,000), it seems that the company is expanding. By examining the company’s total investment in property, plant, and equipment and accumulated depreciation, a clearer picture of the rate of expansion that occurred in 2024 could be obtained. Comparative figures for the cash flow statement for 2023 would also be useful in assessing trends. d. Green Company generated $820,000 from operations, which exceeded the $800,000 it required to fund its net increase in property, plant and equipment. As such, it appears that the company could maintain its productive capacity without additional financing. However, the company would have to curtail its dividend payments unless additional financing was obtained. LO 6 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

UP5-9 a. Accounts receivable have increased by $80,000 this year. The statement of cash flows shows that the change in accounts receivable had a negative effect on cash, which means that accounts receivable must have increased. b. Inventory has decreased $20,000 during 2024. The statement of cash flows shows that the effect of the change in inventory increased operating cash flows by $20,000. This means that $20,000 of the cost of goods sold was from inventory purchased in previous years, rather than in current year.

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-9 (Continued) c. In adjusting the net income to a cash basis, $45,000 was deducted for prepaid expenses. This indicates that the company has increased the level of its prepaid expenses. This hurt the company’s cash position as it reduced when prepayments were made. d. Accounts payable increased by $75,000. Indicates that the amount of the company’s accounts payable increased. Given this, it appears that the company placed greater reliance on trade credit as form of financing during 2024. e. Johann Manufacturing had an $80,000 increase in accounts receivable during the year. A creditor would want to know if the increase in receivables was due to an increase in sales. If not, it may indicate that the company is having problems collecting their accounts receivable. In addition, the company’s accounts payable increased (by $75,000) at the same time it had a decrease in its inventory (of $20,000). At the same time, the company began the year with a large cash balance and increased it by a very significant amount (from $566,000 to $1,314,000). A creditor would want to be assured that the company was not deliberately holding back on its payments to suppliers. f. The cash balance at December 31, 2024 is $1,314,000. Thus, the company will have a shortfall of at least $686,000 if it retired the bonds in January 2025. It is unlikely that all of this cash could be used for the repayment of bonds as the company has other current liabilities to pay. Thus, Johann Manufacturing will require significant long-term financing in order to fund the $2,000,000 in bonds maturing. These funds could be borrowed or raised through the issuance of additional shares. LO 6 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

UP5-10

Net free cash flow is the cash flow generated from a company’s operating activities that would be available to the company’s common shareholders. These cash flows would also be available to service debt (i.e. pay interest and repay loan principal). As a lender, I would want to know that the company has sufficient cash to pay interest and repay loan principal before lending funds. If not, then I would not want to lend money to the company.

LO 7 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

UP5-11

As a shareholder or potential investor, I would be interested in knowing how much cash the company has available to distribute to common shareholders through dividends. This is what net free cash represents. While demonstrating a positive net free cash flow is considered to be a good thing, it is also important to consider why a company may have a negative free cash flow amount. It may be due to the company having made significant capital expenditures, such as buying property, plant, and equipment during the period. If this is the situation, it is also positive, because these assets will be available to generate revenues for the company in future periods. While cash flows from operating activities is also an important piece of information for shareholders/potential investors, it does not reflect cash required for capital purchases. As such, net free cash flow may be more relevant to a potential investor.

LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley: Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIP5-1

The indirect method of preparing the statement of cash flows starts with net income and then adjusts it for any non-cash items on the statement of income and the changes in all non-cash working capital accounts. The gain from the sale of equipment is a non-cash item; it represents the difference between the cash received from the sale and the carrying amount of the equipment on the books of the company. In order to remove a gain from net income it needs to be subtracted as gains increase net income. The proceeds from the sale of the equipment appear as an inflow under the investing section. When dividends are declared, they are not necessarily paid, so the dividends could still be outstanding at the end of the year which would mean that they dividends would not be included on the statement of cash flow as they have not yet been paid. Any outstanding unpaid dividends would be reported as dividends payable on the statement of financial position. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP5-2

Payments of interest are most commonly classified as operating activities as interest is an expense and flows through net income. The repayment of loan principal is classified as a financing activity. However, when following IRFS, interest payments can be classified as financing activities on the statement of cash flows. You are correct that dividend payments are normally classified as financing activities. When following IRFS, payments of dividends can also be classified as an operating activity. You are correct that the declaration of dividends reduces retained earnings, but it does not affect the statement of cash flows until the dividends are actually paid, which is typically at a later date than the declaration date. LO 3 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

WIP5-3 • Expenses exceeded revenues for the period – it would actually be all expenses and losses exceeded all revenue and gains as all are included on the statement of income. • Retained earnings will be reduced by the amount of the loss – correct • Cash flows from operating activities will be negative – not necessarily, as the net loss could have occurred from a significant non-cash item such as depreciation expense or a loss on the sale of a capital asset. • Cash flows from financing activities will have to be positive or else the company would have had to cease operations – financing activities could be negative if the company repaid any debt during the year or they repurchased shares during the year (it is less likely they would pay dividends during the year of a net loss). There could be significant amounts of cash that remain available to continue operations into the future. It is also possible that the company has cash reserves generated in prior period that it was able to use to fund the loss of the current year. LO 6 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

WIP5-4 If a company is profitable, this does not guarantee that it will have positive cash flows. While it is correct to state that making profit is making money, profit does not necessarily mean cash inflows. Increases in net income will not necessarily lead to increase in cash by the same amount. The company likely made sales on account and the cash from the sales is tied up in accounts receivable, representing one of the reasons why an increase in net income will not necessarily mean an increase in cash. In addition, the company has likely made some cash outflows for the purchase of property, plant, and equipment or the payment of dividends which will make the increase in income not equal the increase in cash. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

WIP5-5 Cash flows from operating activities represents the cash generated from a company’s core operations. This cash is unlikely to be sitting in the company’s bank account as it may have been used to repay debt, purchase new equipment, etc. It is important to note that dividends are distributions of profits, not cash flows from operating activities. As a result, while the generation of cash flows from operating activities may lead to dividends, the company must have the cash and a balance in retained earnings before any dividends can be declared. LO 2 BT: C Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP5-6 An increase is inventory has a negative effect on cash flow from operations. On the other hand, the payment of dividends, although it has a negative effect on cash flow, is not part of operations. The payment of dividends is a financing activity. An increase in accounts receivable means that more cash is tied up and not yet collected from customers following a sale on account. This has a negative effect on cash flow from operations. On the other hand, it is true that an increase in wages payable has a positive effect on cash flows from operations. LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP5-7

The proposal could improve profitability if the customers are buying more equipment and the company is receiving interest from the receivable as well. However, the company needs to have the cash to purchase of the equipment to sell to the customer. These equipment sales will actually decrease cash flows from operating activities as collection for the sales will be delayed for several years while payments to suppliers for the equipment will have to be made in the near term, which will require additional financing. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI5-1 Aritzia Inc. Note: figures used are in thousands of Canadian dollars. a. In 2020, Aritzia had a net cash and cash equivalents increase of $16,853. In 2019, the company had a net cash and cash equivalents decrease of $11,578. b. In 2020 Aritzia had net income of $90,594. For the same period cash flows generated from operating activities was in the amount of $222,076. The difference between these two was primarily due to depreciation and amortization expense of $93,502 and a non-cash finance expense of $28,319. c. Accounts payable and accrued liabilities decreased by $1,444 in 2020. This decrease in payables causes cash flows from operating activities to be lower. The decrease means that more money was paid to creditors and the amounts owing to them have reduced from the level of the previous year. d. Inventory decreased by $18,462 in 2020. This decrease in inventory causes cash flow from operating activities to be higher. This decrease means that less money was paid out for the purchase of inventory during 2020. e. The cash outflow for the purchase of property, plant and equipment was $45,591. There were no proceeds from the sale of property, plant and equipment.

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-1 (Continued) f. Net free cash flow: 2020: Cash generated from operating activities Net capital expenditures

$222,076 (47,790) $174,286

2019: Cash generated from operating activities Net capital expenditures

$ 96,175 (62,010) $34,165

There was an overall positive trend in net free cash flow, because the net free cash flow has increased significantly from 2019 to 2020. g. Operating cash flow ratio: 2020: $222,076 / $153,843 = 1.44 2019: $96,175 / $90,611 = 1.06 This ratio has improved from 2019, as there is a higher proportion of cash flows generated from operating activities compared to total current liabilities. h. The company’s cash flow pattern is + / - / - (operating /investing /financing). This pattern indicates that the company is generating positive cash flows from operating activities, while spending cash for capital investments and has negative cash flows from financing from paying off debt and repurchasing shares. This is a good sign to a banker or investor as the risk of non payment is low and the company is growing its operations and generating a higher net income and cash from operating activities. LO 6,7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-2: Dollarama Inc. Note: figures used are in thousands of Canadian dollars. a. In 2021, Dollarama had a net income of $564,348 and net cash flows from operating activities of $889,082. As with most companies, the largest difference between these two amounts was depreciation and amortization, which are non-cash expenses. b. The amount of inventory increased by $7,164 from 2020 to 2021, as shown by the decreased cash inflow of $7,164 for merchandise inventory. This is consistent with the increased purchases of property and equipment, and intangible assets, shown in the investing section of the statement of cash flows and is consistent with the company continuing to open and stock new stores. c. Accounts payable and accrued liabilities increased by $33,727 in 2021 compared to 2020. This increase in payables causes cash flows from operating activities to be higher. The increase means that more money is due to creditors at the end of 2021 than at the end of 2020. This increase is consistent with the increase in inventories, although at a lower amount. It might also be an indication of better negotiation of terms with suppliers. d. Depreciation and amortization expense is added back to net income under the indirect method because we are trying to determine net income on a cash basis rather than on an accrual basis. Since depreciation expense is a non-cash item and it reduced net income (as all expenses do), it must be added back, thereby removing it from the calculation income on a cash basis. e. In 2021, Dollarama issued $300,000 of new long-term debt. This was a refinancing of floating rate notes that were paid off for the same amount. There was a significant increase in lease liabilities (i.e. cash outflows of $163,804). A modest amount of cash was generated by the issuance of common shares. The proceeds were used to help dividends, and repurchase a significant number of the company’s own shares (i.e. cash outflows of $87,042). Compared to 2021, 2020 had a much higher amount of cash used in financing activities. The company has been changing its capital structure from equity to debt over the two years reported.

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-2 (Continued) f. Dollarama paid dividends of $54,770 in 2021. This is modest in comparison to the amount of cash used to repurchase the company’s own shares in the amount of $87,042. LO 6,7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-3: CANADA GOOSE HOLDINGS INC. Note: figures used are in millions of Canadian dollars. a. In 2020, Canada Goose’s cash decreased by $56.9. By contrast, in 2019, the company’s only decreased by $6.7 and in 2018 cash increased by $85.6. b. In 2020, Canada Goose had a net income of $151.7. For the same period cash flows from operating activities was a positive amount of $62.5. The largest difference between these two was $63.1 of depreciation and amortization. This addition to net income is offset by a substantial increase in inventory of $141.8 and an increase in income taxes paid of $52.1. This explains why cash flow from operating activities was lower than net income for the same period. c. Trade receivables increased by $10.6 in 2020. This increase caused cash flows from operating activities to be lower. The increase also means the customers owe Canada Goose more at the end of 2020 than at the previous year end. d. The balance in inventory increased by $141.8 during 2020. This is a much larger increase than in 2019 ($87.3) or 2018 ($39.5). Accounts payable and accrued liabilities decrease $1.3 during 2020. This trend is not consistent and means that Canada Goose is not getting financing from their suppliers for the increased amount of inventory.

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-3 (Continued) e. Net free cash flow 2020: Cash from operating activities Net capital expenditures

$62.5 (62.3) $ 0.2

2019: Cash from operating activities Net capital expenditures1

$73.4 (49.3) $24.1

2018: Cash from operating activities Net capital expenditures2

$126.2 (33.8) $92.4

1 2

($30.3 + $19.0) ($26.1 + $7.7)

Cash from operating activities keeps declining while net capital expenditures keeps increasing over the three year period. Overall, net free cash flow decreased by $92.2 or 99.8% from 2018 to 2020 which is a negative trend. f. If the net free cash flow of 2021 is essentially nil as it was in 2020, Canada Goose will not be able to continue to repurchase shares at the level done in 2020 ($38.7) as it will run out of cash. g. Operating Cash flows ratio: 2020: $62.5 / $201.3 = 31.0% 2019: $73.4 / $136.6 = 53.7% There has been a substantial deterioration in the operating cash flow ratio in 2020. Cash flow from operating activities decreased 14.9% while current liabilities increased 47.4%. LO 6,7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-4: CARGOJET INC. Note: figures used are in millions of Canadian dollars. a. In 2020, Cargojet’s cash increased by $2.1. In 2019, the company’s cash increased by $2.5. b. In 2020, Cargojet had a net loss of $87.8. For the same period, cash flows from operating activities were a positive amount of $292.6. As with most companies, one of the largest differences between these two was $109.1 of depreciation and amortization. Another addition to net loss was the fair value adjustment on stock warrants of $177.9. c. The balance in trade and other receivables decreased by $10.0, resulting in an inflow of cash. This may indicate that better terms were negotiated with customers. d. Trade and other payables increased by $21.9 in 2020, resulting in an inflow of cash. This may indicate that better terms were negotiated with suppliers. e. Net free cash flow 2020: Cash from operating activities Net capital expenditures1

$292.6 (142.2) $150.4

2019: Cash from operating activities Net capital expenditures

$144.9 (216.8) $( 71.9)

1 2

(-$146.6 + $0.8 + $3.6) (-$218.1 + $1.3)

The trend from 2019 to 2020 is strongly positive, with Cargojet generating positive net free cash flow in 2020.

Burnley: Understanding Financial Accounting, Third Canadian Edition

RI5-4 (Continued) f. Operating Cash flow ratio: 2020: $292.6 / $180.6 = 162.0% 2019: $144.9 / $114.5 = 126.6% There has been a substantial improvement in the operating cash flow ratio in 2020. Cash flow from operating activities increased 101.9% while current liabilities increased 57.7%. g. Cargojet’s cash flow pattern is + / - / - in 2020 (operating/ investing/financing) and + / - / + in 2019. The company made a smaller investment in property, plant, and equipment in 2020 less than it made in 2019. It appears that cash from operations and new long-term debt was used to finance the investment in 2019. Cash from operating activities were used to invest in property, plant, and equipment in 2020. These are indicators that the company is growing and may be an excellent investment. A comparison of actual sales from 2020 to 2019 is useful in making any lending or investment decision. LO 6,7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI5-5: Answers will vary with the company chosen. LO 6 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C5-1

Atlantic Service Company a. Although Atlantic’s net income increased from 2023 to 2024, it is in a very poor cash position with a bank overdraft of $54,000, larger than the $25,000 from the previous year. Further, its accounts receivable, inventory and accounts payable have all increased. The company has managed to generate solid cash flows from its operations (i.e. $210,000 in 2024 and $201,000 in 2023). This is a positive sign. Its cash flow problem appears to result from purchases of equipment for which no long-term financing was obtained. b. To overcome its cash flow challenges, Atlantic could attempt to collect the accounts receivable sooner and reduce the level of its inventories. It might also consider discontinuing dividend payments (although the amounts are quite small) and reassessing the need for such large investments in equipment. However, it is likely that Atlantic should increase its long-term financing by issuing more shares or by arranging for a long-term loan, perhaps secured by a mortgage on its equipment. Future purchases of equipment should be suspended until the cash situation improves likely from the securing of long-term debt. LO 6 BT: AN Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

C5-2 a. Robertson Furniture Ltd. Just because a company has a large cash balance does not indicate that it is a sound investment. It is important to carefully review how the cash is being generated. Based on an analysis of Robertson’s statement of cash flows there are several areas of concern: i. Robertson Furniture has earned very little income on the accrual basis over the past two years; in fact, in 2024, the company experienced a loss of $4,000. ii. Accounts receivable have been increasing dramatically over the past two years, which may indicate that the company is having trouble with collections. iii. Inventory has increased over the past two years, which may indicate that the company is having trouble selling inventory. iv. The company’s accounts payable balance has increased which means it owes more to its suppliers. Some of the increase in cash has resulted from not paying these liabilities, which will ultimately have to be paid. v. The company raised a significant amount of cash in 2023 and 2024 through the issuance of bonds and common shares, not through operating activities. This is an activity that cannot be sustained on a long-term basis. Further, the additional $100,000 in bonds will have to be repaid at the end of their term. vi. Finally, the company also generated large amounts of cash over the past two years by selling assets (i.e. property, plant and equipment, and investments). Again, this activity does not provide a stable source of cash to continue operations into the future. Further, the company appears to be selling its property, plant and equipment but not replacing the assets sold. This is also not a good sign as seems that the business is contracting rather than growing. In order for a company to remain solid in the future, they must be able to generate cash from operations, not just by issuing debt or selling assets.

Burnley: Understanding Financial Accounting, Third Canadian Edition

C5-2 (Continued) b. Some questions that might be raised include: i. What steps are being taken to improve collection efforts from customers (i.e. prompting, better credit screening, incentives for early payment)? ii. What is the company’s inventory turnover rate and how does this compare to industry standards? Is this inventory subject to obsolescence or deterioration? iii. What is the state of the company’s long-term assets? Given the recent disposals, will new acquisitions be required? iv. What steps are being taken to move the company into a profitable position and, specifically, to begin generating sufficient cash from operations to sustain the company? v. When are the bonds payable due (i.e. what is their term?)? What investments, if any are left to be sold and are these investments necessary for the company to continue its operations? LO 6 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

C5-3

Ridlow Shipping Ltd. Owen is not correct in his statement that the preparation of a statement of cash flows represents an unnecessary expense. While Owen is correct in realizing the importance of knowing the business’s cash balance, he has failed to fully understand the purpose of the statement of cash flows. Beyond showing the balance of cash, the statement of cash flows provides the users with a summary of the entity’s sources and uses of cash during the period (i.e. it explains why the company’s cash balance decreased by $37,000 in 2024). In addition, the statement of cash flows groups these sources and uses of cash into operating, investing, and financing activities. This allows users to see exactly where cash generated and how it was spent. By reviewing Ridlow’s cash flow statement we can see that the company generated a significant amount of cash from operations. Over the long-term, a company must be able to generate cash from operations in order to remain in business. The operating section shows the cash generated by operating activities, which can be compared to the net income generated under the accrual basis. The operating section also shows that

Burnley: Understanding Financial Accounting, Third Canadian Edition

C5-3 (Continued) accounts receivable increased during the year. This may indicate that the company is having some difficulty collecting its accounts receivable balances. We can also see that accounts payable increased during the year. Owen may want to look into this, given that inventory levels appeared to stay relatively constant. This is type of analysis statement of cash flows facilitates. The financing section of the statement of cash flows presents the inflows and outflows of cash related to obtaining cash from shareholders and lenders. Users of the statement of cash flows can easily see details such as how much debt was repaid during the period or the cash obtained by issuing shares. For example, Ridlow repaid $100,000 in bonds during 2024 and issued $50,000 in common shares. This may indicate that the company is revising its capital structure. The financing section will also detail the amount of dividends paid during the year. Ridlow has paid dividends of $75,000 in each of the past two years. The investing section of the statement of cash flows provides information about the purchase and sale of assets during the year. The statement shows the proceeds received from the sale of capital assets, and investments and any cash spent to purchase new assets or investments. By reviewing the statement of cash flows for Ridlow Shipping, users can quickly see that during 2024, the company purchased some property, plant, and equipment for $215,000 and also sold some investments for $50,000. In summary, the statement of cash flows contains very important information for managing a company. It is critical that management understands where the company’s cash came from (i.e. is it from operations, the sale of assets, etc.) and how it was used. LO 1,6 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

C5-4

Jones Printing Memorandum To: Ben Jones Re: Statement of Cash Flows Ben, I have reviewed the financial statements you sent me and we will now need to prepare a statement of cash flows before your loan application can be processed. The statement of cash flows will allow the loan committee to see the sources and uses of cash in your printing business, and therefore, be better able to evaluate your loan request. The statement of cash flows outlines how the cash was generated and spent during the year by operating, financing, and investing activities. Operating activities include the cash inflows that result from the revenue you generate in the business. This section also provides details as to major cash outflow for operations, such as payments to suppliers. The financing section of the statement of cash flows shows how the cash was obtained and spent. For example, the users of the statement of cash flows can easily see details such as how much debt was repaid during the period, how much was paid out in dividends or the amount of cash obtained by issuing shares. The investing section of the statement of cash flows provides information about the purchase and sale of long lived assets during the year. The statement shows the proceeds received from the sale of property, plant, and equipment, intangibles and investments, and any cash spent to purchase new long lived assets or investments. The final section of the statement of cash flows reconciles the net cash inflows and outflows during the year to the change in the cash balances reported on the statement of financial position.

Burnley: Understanding Financial Accounting, Third Canadian Edition

C5-4 (Continued) In order to prepare a statement of cash flows for Jones Printing we will need, in addition to the statement of financial position and statement of income, details concerning the following: i. The proceeds received from the sale of any property, plant, and equipment, intangibles or investments. ii. The cost of any property, plant, and equipment or investments purchased during the year. iii. The proceeds of any long-term loans obtained during the year and the amount of any principal payments made on the long-term debt. iv. The amount of any dividends paid during the fiscal year. Once you have obtained all this information, I will be pleased to assist you in the preparation of the statement of cash flows. Please feel free to call me if you have any additional questions. LO 1 BT: C Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

C5-5 Kralovec Company a. In terms of understandability, the direct method is likely better. Most users will be able to understand the cash flows resulting from collections from customers, payments to suppliers, etc. When reviewing a statement of cash flows prepared under the indirect method, users may be uncertain why an increase in accounts receivable reduces cash flows from operating activities, etc. As the cash flows from operating activities section is the only area of difference between the two methods, no further analysis will be required in terms of this question. Overall, most readers would likely prefer the direct method. b. Direct method: Cash inflows from operations were greater than cash outflows by $1,170,000 for 2024, which is positive. The company paid income taxes, so it must have been profitable.

Burnley: Understanding Financial Accounting, Third Canadian Edition

C5-5 (Continued) Indirect method: • Net income of $705,000 – so we know that the business was profitable (i.e. it does not have to be inferred). • Decrease in inventory by $35,000 – this may indicate better inventory management (which is positive) or reduced sales requiring less inventory (which is negative). • Loss on sale of machinery of $34,000 – this indicates that the company received less on the sale of the machinery than its carrying amount and indicates that the company may need to revise its depreciation estimates. • Increase in accounts receivable by $100,000 – this may indicate increased sales (which is positive) or problems collecting accounts from customers (which is negative). • Increase in accounts payable by $21,000 – this may indicate increased purchases from suppliers who granted credit (which is positive) or difficulties paying suppliers (which is negative). c. The indirect method is more useful with accounts receivable, inventory and accounts payable requiring further investigation. LO 1,6 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley: Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 6 Cash and Accounts Receivable Learning Objectives 1. Explain why cash and accounts receivable are of significance to users. 2. Describe the valuation methods for cash. 3. Explain the main principles of internal control and their limitations. 4. Explain the purpose of bank reconciliations, including their preparation and the treatment of related adjustments. 5. Explain why companies sell on account and identify the additional costs that result from this decision. 6. Explain how the carrying amount of accounts receivable is determined. 7. Explain the allowance method of accounting for expected credit losses. 8. Identify the various risk characteristics that could be used to group receivables, determine the expected rates of credit losses for the groupings, and quantify the total expected losses. 9. Explain the direct writeoff method of accounting for credit losses and when it is acceptable to use it. 10. Explain alternative ways in which companies shorten their cash-to-cash cycle. 11. Explain the concept of liquidity. Calculate the current ratio, quick ratio, accounts receivable turnover ratio, and average collection period ratio and assess the results.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

Item LO

Item

BT Item LO

Discussion Questions 1.

11.

16.

21.

12.

17.

22.

13.

18.

23.

14.

19.

7,9

24.

10.

15.

20.

25.

Application Problems 1.

10.

6,10

13.

11.

7,8, AP 9

14.

12.

15.

User Perspective Problems 1.

3,4

10.

Work in Process 1.

Reading and Interpreting Published Financial Statements 1.

10,11 AN

5,7

Cases 1.

3,4

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file.

LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ6-1 Management is responsible for safeguarding the assets of a company. It establishes policies and procedures to help protect and manage assets like cash, inventory, supplies, buildings, and equipment. These policies and procedures form part of a company’s internal control system. Internal controls are particularly important for cash, to ensure that cash is not lost or stolen, and to ensure cash balances are properly managed. If stolen, cash cannot usually be traced back to the specific company from which it was taken. If a company has too little cash, this can lead to operational difficulties, or at worst, bankruptcy. Having too much cash is also not a good management practice since cash is an asset that usually earns little return (bank deposit interest rate). An effective control system should include the following measures: 1. Physical controls to guard against theft. For cash, these may include locks, safes, and frequent deposits. 2. Specific individuals should be assigned certain responsibilities over the handling and recording of cash. 3. Separation of duties so that one person is not responsible for too many tasks. If an employee’s responsibilities are too broad, they may be able to commit a theft and cover up its occurrence. With respect to cash, separation of duties would have one employee receiving cash, another authorized to sign cheques, and a third responsible for recording transactions in the accounting records. In addition, cheques may require more than one signature. 4. The adherence to company policies should be scrutinized and monitored. When assigning tasks, the work performed by some employees may serve as verification of work or tasks performed earlier by another employee. The verification may also be performed by someone outside of the organization. 5. Effective use of documentation ensures that all transactions are recorded on a timely basis, only authorized transactions are recorded, and employees are properly trained to reduce errors in cash management. LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-2 The tone established at the top tends to permeate the organization. If the board places a strong emphasis on internal controls, then senior management will too. If senior management places a strong emphasis on internal controls, then other employees in the organization will as well. LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-3 An internal control system includes (1) physical controls (locks, alarms, cash registers); (2) assignment of responsibilities (making one person responsible for each task); (3) separation of duties (separation of transaction authorization, recording, and asset custody); (4) independent verification (either internal or external); and (5) documentation (receipts, invoices, and so on). Students may pick any three of these. In the case of a coffee shop, regular bank deposits should be made and any cash on hand should be securely stored in cash registers and safes. Each cashier should be responsible for their own cash drawer. At the end of their shift, they must ensure that the cash in the register is equal to the sales rung up on the cash register. This makes it easy to determine who is responsible should any cash shortages occur. The store manager may double check the cash counts made by the store cashiers to ensure that they are accurate and complete. For a coffee shop, one person should make cash sales and another person should reconcile them to the totals provided by the cash register. Yet a third person should make the bank deposit, and finally a fourth person should be responsible for bank reconciliations. The cash register tape would provide documentation for the amount of sales recorded and cash received. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-4 An internal control system includes (1) physical controls (locks, alarms, cash registers); (2) assignment of responsibilities (making one person responsible for each task); (3) separation of duties (separation of transaction authorization, recording, and asset custody); (4) independent verification (either internal or external); and (5) documentation (receipts, invoices, and so on). Students may pick any three of these. In the case of a grocery store, managers should be responsible for issuing refunds or credits. The cashiers should need management authorization to approve any refunds or price overrides to ensure they are legitimate and not the cashier pocketing the cash received from the customer and then recording a return on the sale or price change. Cashiers should be responsible for their own cash drawer. At the end of their shift, they must ensure that the cash, debit, and credit sales in the register are equal to the total sales rung up on the cash register. The manager then double checks the cash counts and reconciliation prepared by the cashiers to ensure accuracy and completeness. The cash register tape or total reading would provide documentation for the amount of revenue earned and cash received. When receiving merchandise for resale, one person should count and verify what items have been received on pre-numbered receiving slips. Another person should compare what was received to what was ordered to ensure everything ordered was received. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-5 An internal control system includes (1) physical controls (locks, alarms, cash registers); (2) assignment of responsibilities (making one person responsible for each task); (3) separation of duties (separation of transaction authorization, recording, and asset custody); (4) independent verification (either internal or external); and (5) documentation (receipts, invoices, and so on). Students may pick any three of these.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-5 (Continued) In the case of a campus bookstore, books are carefully placed on labelled shelves and perpetual inventory control software is used to record all purchases, returns and sales. Through this software, up-to-date records are maintained. Turnstiles may be used at the entrance and exit to the bookstore to count the number of persons entering, and to keep track of the people who are leaving. At busy times (i.e. the beginning of the semester, Christmas, etc.), security guards may be posted at the entrance and exit of the bookstore to ensure that all purchases are recorded. The guards will also ensure that the bookstore’s policy of not allowing back packs in the store is followed. At the campus bookstore, one person is authorized to order the books from publishers, another employee receives and counts them when they are delivered, while another employee records the purchase in the perpetual inventory system. In the case of a campus bookstore, each cashier is responsible for their own cash drawer or uses pass codes when a till is shared with another cashier. At the end of their shift, they must ensure that the cash in the register is equal to the sales rung up on the cash register, under their code. This makes it easy to determine who is responsible should any cash shortages occur. Collections of sales are recorded through cash registers as they occur. The register tape is used to reconcile sales rung up with cash, debit, and credit card slips. LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-6 Documentation – use of pre-numbered cheques/stamping “paid” on invoices / recording the cheque number and initials of which clerk processed the invoice. Independent verification – having the accounts payable manager prepare a summary of cheques and following up on any missing cheques. LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-7 Documentation – receiving documents are signed by technician who received the computer(s) and sent to the accounts payable department. The accounts payable clerk matches the receiving report to the invoice before preparing the cheque. Separation of duties – IT department orders the computers and the accounts payable department pays for them. Custody of assets always needs to be separate from access to the accounting records. LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001, cpa-t004 CM: Reporting and Audit

DQ6-8 Cost/benefit – management will only establish controls when the benefits that result from implementing the control exceed the cost of having the control in place. Human error – an error in the design of internal controls may impact their effectiveness. Many controls rely on human judgement, so poor training or carelessness can impact their effectiveness. Collusion – if two or more employees work together they can circumvent existing controls related to separation of duties. Management override – if management can override controls, they may be circumvented even if working effectively. Changing circumstances – internal controls that are well-designed for a certain point in time may become ineffective in the future due to changing circumstances. Students may pick any three of these. LO 3 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-9 Separation of duties, as small organizations have a limited number of staff. As a result, it may be necessary to have duties which would ideally be carried out by different employees carried out by one employee. This means that review and reconciliation by the business owner takes on added significance. LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-10 The purpose of a bank reconciliation is to ensure that any differences between the accounting records for cash and the bank records are identified and explained and any necessary adjustments are recorded to update the cash account in the accounting records. It is related to the independent verification principle for internal control. Ensuring the accuracy of the cash account minimizes the risk of fraudulent cash transactions being reflected in a company’s accounts. The procedure may also detect unauthorized disbursements of cash. LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-11

Differences between the cash balance per a company’s general ledger and the closing balance on its monthly bank statement arise because of timing differences between when the business and the bank record transactions or errors. Examples include: • Cheques written by the company that have not yet cleared the bank • Deposits made by the company that have not yet been recorded by the bank • Transactions conducted by the bank that have not yet been recorded by the company such as bank service charges • Recording errors made by either the company or the bank

LO 4 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-12

The internal control principle that the recommendation relates to is the independent verification. A senior staff member with sufficient accounting knowledge can detect any unusual items that appear on the bank reconciliation and can follow up with the bookkeeper to ensure that the reconciling items are valid and that the amounts reported as the balance per the general ledger and the balance per the bank statement are also valid and accurate.

LO 3 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-13

When companies make sales on account, they may incur additional costs such as: • Staff costs related to credit-granting. This includes assessing the credit history of customers seeking credit. • Staff costs related to follow-up and account collection. This includes the cost of sending statements to customers and following up with customers who do not pay by the due dates. • Credit losses related to accounts that become uncollectible.

LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-14 Normal terms with credit sales allow customers at least 30 days to pay their account. With credit card sales, cash is typically collected within one to two days, depending on the bank or credit card company. The credit card company becomes responsible for collecting the accounts and for any credit losses that may arise. Credit card companies charge a service fee that is normally 1 to 5% of sales. If this is lower than a company’s normal credit losses, and it allows the company to receive cash quicker, then this is money well spent. Credit card companies also assume the responsibility for authorizing or granting credit to card holders. This alleviates the companies who accept payment with these cards from having to undertake these activities, reducing their administrative expenses. From a marketing standpoint, allowing credit card sales will lead to increases in sales. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-15 Credit sales grant customers delayed payment terms. The customer receives the goods or services, and agrees to pay at a later date. Some customers may eventually default, and their account become uncollectible. If the company waits until they discover this default and the direct writeoff method is used, the writeoff occurs in a subsequent accounting period so the cost of this credit loss would not be recorded in the same accounting period as that of the sale. Sales revenue would be recorded in one period, and the expense of the credit losses would be recorded in another period. The allowance for expected credit losses enables a company to record the potential cost of credit losses in the same period as sales, even though the company does not know which customers will default in subsequent accounting periods. This allows better matching of expenses with the related revenues. LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-16 Allowance for Expected Credit Losses is a contra account to Accounts Receivable. It reduces the aggregate amount of the accounts receivable by the anticipated effects of uncollectible accounts. The allowance for expected credit losses has a normal credit balance because its purpose is to show that the debit balance amount in the accounts receivable will not be fully collected. The net amount of these two accounts is reported on the statement of financial position and corresponds to the carrying amount of the accounts receivable. Periodically, a company will estimate its potential credit losses based either on the amount of its credit sales or its accounts receivable balance. At that time, the credit losses account is debited and the allowance for expected credit losses is credited for the estimated amount. Subsequently, when a specific account becomes uncollectible, accounts receivable is credited and the allowance for expected credit losses accounts is debited. LO 6 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-17 The two methods of estimating uncollectible accounts are: Percentage of sales method: The credit losses for the period are estimated by multiplying the credit sales for the period by an appropriate percentage. The percentage is usually determined based on the company’s collection history and current economic conditions. Aging of accounts receivable method: Management estimates a percentage relationship between the amount of receivables and the expected writeoff of uncollectible accounts. The estimated percentage is based on historical experience, economic conditions or industry averages. The amount of credit losses is quantified as the difference between the amount expected to be uncollectable, which is the required ending balance, and the existing unadjusted balance in the allowance for expected credit losses account. LO 8 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-18 The direct writeoff method recognizes credit losses in the period in which the receivable is determined to be unrecoverable and removed from the accounts receivable records, not necessarily in the period in which the original credit sale was made. The allowance method estimates and records the estimated credit losses in the accounting reporting period of the original sale. LO 9 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-19 The allowance method means that the estimated amount of credit losses is recorded in the period in which the related credit sale was recorded. This is consistent with the requirements of accrual accounting. The direct writeoff method can be used if the results of applying it are not materially different from the results of applying the allowance method. This may be the case if credit sales and credit losses are very small and infrequent. LO 7,9 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-20 The allowance for expected credit losses normally has a credit balance, which represents the expected future credit losses. This balance is based on estimates. When an actual account is written off, the allowance account is debited. If more accounts are written off during a period than had been expected, the allowance will end with a temporary debit balance. A debit balance would mean that the estimate made for credit losses of the prior period was understated. LO 7 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ6-21 Company may shorten their cash-to-cash cycle by accepting credit cards rather than offering credit directly to customers, by offering sales discounts to encourage early payment, and by selling (factoring) their accounts receivable to a financial institution. Student may pick any two of these methods. LO 10 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ6-22 Two ratios that measure liquidity are the current ratio and the quick ratio. Both compare current assets to current liabilities, with the current ratio comparing total current assets and the quick ratio comparing total current assets less inventories and prepaid expenses. Both provide information on the ability of the company to pay its current liabilities, with the quick ratio providing more conservative information. The quick ratio will be lower than the current ratio because the quick ratio does not include inventory or prepaid accounts. LO 11 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

DQ6-23 A company with a high current ratio may not be as liquid as the ratio seems to indicate depending on the mix of its current assets. If the company has very low cash and accounts receivable it may have a liquidity issue if their current asset is mainly inventory that is not fast moving (i.e. takes up to a year to sell). LO 11 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

DQ6-24 The accounts receivable turnover ratio measures the “turnover” of the accounts receivable in a year. This measures the average number of times the total accounts receivable has been collected in full during the year. This ratio provides a measure of the efficiency of the collection of the accounts receivable. The average collection period ratio converts the accounts receivable turnover ratio into the average number of days that it takes a company to collect its receivables from its customers. LO 11 BT: AN Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

DQ6-25 Generally, high accounts receivable turnover ratios are better than low ratios because they indicate that accounts are being collected faster, and that the cash-to-cash cycle is shorter. LO 11 BT: AN Difficulty: E Time: 5 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP 6-1A

a. JB Games Ltd. Bank Reconciliation As of May 31

Balance per bank statement

$12,200 Balance per accounting records

$ 8,600

Add: outstanding deposits

1,650 Add: EFT receipts Correction of cheque # 791

2,100 90

Less: outstanding cheques

(4,235) Less: Bank service charges NSF cheque

(55) (1,120)

Reconciled balance

$ 9,615 Reconciled balance

$ 9,615

b. The reconciled balance of $9,615 will be the cash balance reported on the statement of financial position. c. Journal entries: Cash

2,100 Accounts Receivable

2,100

Cash Advertising Expense

Bank Charges Expense Cash

Accounts Receivable Cash

1,120

LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP 6-2A

Infinity Emporium Company Bank Reconciliation As of August 31

Balance per bank statement

$ 66,744 Balance per accounting records

Add: Outstanding deposit

12,240 Add: EFT receipt

Less: Outstanding cheques

(4,560) Less: Service charges NSF cheque Bank loan interest Bank loan payment ($900 -$130)

Reconciled balance

$ 74,424 Reconciled balance

$ 71,952 3,600 24 204 130 770 (1,128) $ 74,424

At August 31, the company has cash available of $74,424, although the actual cash in the bank account is $66,744.

Because the outstanding deposit had not been recorded by the bank, and exceeded the amount of outstanding cheques, the balance reported on the bank statement was lower than the adjusted balance. Similarly, because the collection of the account receivable by the bank had not been recorded by the company, the balance reported in the accounting records was too low and the adjusted balance was higher.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP 6-2A (Continued) d.

Bank Charges Expense Cash

Cash Accounts Receivable

3,600

Accounts Receivable Cash

204

Bank Loan Payable Interest Expense Cash

770 130

204

900

LO 4 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-3A Parcher Supplies Ltd. Bank Reconciliation As of October 31, 2024 Balance per bank statement

$ 8,859 Balance per accounting records

Add: outstanding deposits

2,820 Less: NSF cheque Insurance EFT

Less: outstanding cheques

(4,115)

Reconciled balance

$ 7,564 Reconciled balance

Correction of cheque #2116 Bank service charges

$ 9,671 (1,620) (275) (180) (32) $ 7,564

b. The reconciled balance of $7,564 will be the cash balance reported on the statement of financial position.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP 6-3A (Continued) c. Journal entries: Insurance Expense Cash

275

Advertising Expense ($975 - $795) Cash

180

Bank Charges Expense Cash

Accounts Receivable Cash

1,620

275

180

1,620

LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-4A a. Not included in the bank reconciliation because both the company and the bank have recorded the cheques b. Added to cash account (G/L) balance c. Not included in the bank reconciliation because both the company and the bank have recorded the deposit d. Deducted from cash account (G/L) balance e. Deducted from cash account (G/L) balance f. Deducted from cash account (G/L) balance g. Deducted from bank balance h. Added to bank balance i. Deducted from cash account (G/L) balance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP 6-4A (Continued) j. Deducted from bank balance k. Not included in the bank reconciliation because the error involved debiting the incorrect expense account. A correcting entry will be needed to debit Utilities Expense and credit Wages Expense, but the credit to Cash was correct. LO 4 BT: AP Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-5A a. 2024 Cash Accounts Receivable Sales

210,000 730,000

Cash

652,000

940,000

Accounts Receivable

652,000

Allowance for Expected Credit Losses Accounts Receivable

12,800

Accounts Receivable Allowance for Expected Credit Losses

5,100

Cash

5,100

12,800 5,100

Accounts Receivable Credit Losses 1 Allowance for Expected Credit Losses 1 ($23,600 - $9,400 + $12,800 - $5,100)

5,100 21,900 21,900

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP 6-5A (Continued) b.

Mills Manufacturing Ltd. Statements of Financial Position (Partial) As at December 31, 2024

Accounts Receivable* Less: Allowance for Expected Credit Losses** Net receivables

$255,200 (23,600) $231,600

*Accounts receivable = $190,000 + $730,000 – $652,000 – $12,800 + $5,100 – $5,100 = $255,200 **AFECL = $9,400 – $12,800 + $5,100 + $21,900 = $23,600 Accounts Receivable 190,000 730,000

652,000 12,800

5,100 5,100 255,200

Allowance for Expected Credit Losses 9,400 12,800 5,100 21,900 23,600

Credit losses = $21,900

LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-6A

a. Journal Entries

2023 Accounts Receivable 200,000 Sales Revenue (credit sales for year: $50,000 ÷ 0.25 = $200,000) Cash ($200,000 x .75) Accounts Receivable

200,000

150,000 150,000

Credit Losses 3,000 Allowance for Expected Credit Losses 2024 Accounts Receivable Sales Revenue (credit sales for year)

250,000

Cash*

247,500

3,000

250,000

Accounts Receivable 247,500 *($250,000 x 80%) + ($50,000 x 95%) = $247,500 Allowance for Expected Credit Losses Accounts Receivable (write off accounts judged uncollectible)

3,800 3,800

Accounts Receivable 1,500 Allowance for Expected Credit Losses Cash

1,500

1,500 Accounts Receivable (Record subsequent collection of accounts that were previously written off)

Credit Losses1 2,500 Allowance for Expected Credit Losses 1 ($3,200 - $3,000 + $3,800 - $1,500)

1,500

2,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-6A (Continued)

b. Accounts receivable, December 31, 2024 Less: Allowance for expected credit losses Accounts receivable, net Accounts Receivable 50,000 3,800 250,000 247,500 1,500 1,500

$ 48,700 (3,200) $ 45,500

Allowance for Expected Credit Losses 3,000 3,800

1,500 2,500

48,700

3,200 45,500

LO 6 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-7A a. Credit losses ($34,840 – $9,000) 25,840 Allowance for Expected Credit Losses

25,840

Allowance for ECL 9,000 25,840 34,840 b.

2024 Mar. 1

Allowance for Expected Credit Losses

800

Accounts Receivable Sept. 1

Accounts Receivable

800 800

Allowance for Expected Credit Losses Cash

800 800

Accounts Receivable

800

c. Dec. 31

Credit Losses ($33,500 + $1,000) Allowance for Expected Credit Losses

34,500

Allowance for ECL 1,000 34,500 33,500 LO 6 BT: AN Difficulty: M Time:25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

34,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-8A a. 1) Accounts Receivable Cash Sales Revenue

8,448,000 2,112,000

2) Cash

7,284,000

10,560,000

Accounts Receivable

7,284,000

3) Allowance for Expected Credit Losses Accounts Receivable

78,000 78,000

4) Accounts Receivable 8,100 Allowance for Expected Credit Losses Cash

8,100

8,100 Accounts Receivable

b. Accounts Receivable 1,193,400 7,284,000 8,448,000 78,000 8,100 8,100 2,279,400

8,100

Allowance for Expected Credit Losses 78,000 81,648 8,100 11,748

c. Credit Losses ($93,000 – $11,748) 81,252 Allowance for Expected Credit Losses

81,252

Allowance for ECL 11,748 81,252 93,000

d. Accounts Receivable Less: Allowance for Expected Credit Losses

$2,279,400 93,000

$2,186,400

LO 6 BT: AP Difficulty: M Time:35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-9A

a. and b. Accounts Receivable 900,000 4,900,000 5,800,000 70,000 6,000 6,000 1,730,000

Allowance for Expected Credit Losses 70,000 55,000 6,000 9,000

The ending balance in accounts receivable as at December 31, 2024 was $1,730,000. The allowance for expected credit losses unadjusted balance as at December 31, 2024 was a debit of $9,000. c. Credit Losses $80,000 + $9,000 = $89,000 Allowance for Expected Credit Losses 9,000 89,000 80,000 LO 6 BT: AP Difficulty: M Time:20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-10A a. Aged days: <31 days Aged days: 31-45 days Aged days: 46-90 days Aged days: >90 days

$150,000 x 4% = $ 6,000 $ 50,000 x 7% = $ 3,500 $ 75,000 x 10% = $ 7,500 $100,000 x 25% = $25,000 $42,000 Allowance for Expected Credit Losses 19,000 23,000 42,000

Credit Losses ($42,000 – $19,000) 23,000 Allowance for Expected Credit Losses 23,000 b.

I would reject this recommendation as it would further delay the receipt of cash for the company, and it is unlikely that their suppliers will all agree to extend the company's credit by another 30 days. In addition, it appears that there is a significant spike in the amount of uncollectible receivables as they get past 90 days old, which will be only 30 days past their proposed due date, thus likely increasing the amount of uncollectible accounts. The expected increased sales may be counteracted by an increased amount of uncollectible accounts, thus perhaps reducing the company's net income, rather than increasing it. Another consideration that should be looked at before making the decision is investigating the credit terms granted by the companies’ competitors.

The company should consider attempting to collect their receivables more aggressively between 31-90 days, since it appears that the receivables that are not yet collected after 90 days show a significant increase in the proportion that is uncollectible. Another possible solution to speed up the collection of the accounts receivable is to offer sales discounts to some of its customers for early payment.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-10A (Continued) c. (Continued) The company could also look at other steps, such as reducing credit sales by requiring customers seeking credit to pay with credit cards. The company could also look at factoring its older receivables. While there will be a significant discount, it may be less than the 25% loss the company is currently expecting to experience as credit losses. LO 6,10 BT: E Difficulty: H Time:30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-11A a. i. $40,000 – $5,000 = $35,000 ii. $40,000 + $5,000 = $45,000 When using the aging of accounts receivable method to determine credit losses, an adjustment is made for any existing balance in the allowance for expected credit losses. b. $60,000 This is the value of the accounts that were written off during the year. c. Accrual accounting requires companies to recognize expenses in the period in which they are incurred. Credit losses are a function of selling on account and is incurred in the period in which the credit sales take place. The allowance method does this by recognizing the credit losses in the period in which the sale occurs and providing an allowance for future writeoffs. Thus, it provides a better measure of periodic income than the direct writeoff method. Also, under the allowance method, the accounts receivable are presented on the statement of financial position at a realistic amount (their net carrying amount), representing the amount that is actually expected to be collectible. By contrast, the direct writeoff method simply reports the receivables at their gross amount, and therefore overstates their value. LO 7,8,9 BT: AP Difficulty: H Time:30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-12A 1. Statement of Income Statement of Financial Position Statement of Cash Flows 2. Statement of Income Statement of Financial Position

Statement of Cash Flows 3. Statement of Income Statement of Financial Position Statement of Cash Flows

AP6-13A Net Loss Less : Credit losses Adjusted Net Loss

No effect No effect No effect No effect Increase in cash $16,000 Increase in allowance for expected credit losses $16,000 Net effect to statement is zero Increase in cash $16,000 Decrease in Income before taxes of $43,000 Decrease in Assets $43,000 No effect

$(89,200) (48,300) $(137,500)

Note : The writeoff of the accounts receivable of $36,100 and recovery of accounts receivable of $8,900 have no impact on net income (loss). LO 6 BT: AP Difficulty: M Time:10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-14A a. Current ratio =

Quick ratio

Current Assets Current Liabilities

$40,000 + $130,000 + $18,000 + $390,000 + $35,000 $85,000 + $37,000 + $45,000 + $10,000 + $90,000

$613,000 $267,000

2.3

Current Assets – Inventory – Prepaid Expenses Current Liabilities

$613,000 – $390,000 – $35,000 $267,000

0.7

b. The company has exceeded its target of 2.2 for the current ratio, but did not meet its target of 0.9 for the quick ratio. In fact, the quick ratio is worse this year than last, having dropped from 0.8 last year to 0.7 for the current year. c. The company could improve its current position by reducing its substantial investment in inventory (i.e. reducing inventory levels, carrying a smaller range of products, etc.). Reducing the inventory level would free up some cash and thus enable the company to reduce its short-term liabilities, which would improve its current ratio somewhat and dramatically improve its quick ratio. The risk associated with reducing the amount of inventory that the company carries is that there may be a negative effect on sales due to stock outs. LO 11 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-15A a. 2024 Current ratio =

Current Assets Current Liabilities

Current assets = $50,000+ $170,000 + $480,000 + $11,000= $711,000 Current liabilities = $230,000 + $46,000 + $23,000 = $299,000 Current ratio =

$711,000 / $299,000 = 2.38

Quick ratio

Current Assets – Inventory – Prepaid Expenses Current Liabilities

Quick assets =

$711,000 – $480,000 – $11,000 = $220,000

Current liabilities = 230,000 + 46,000 + 23,000 = 299,000 Quick ratio

$220,000 / $299,000 = 0.74

2023 Current ratio =

Current Assets Current Liabilities

Current assets = $79,000 + $120,000 + $280,000 + $5,000 = $484,000 Current liabilities = $135,000 + $32,000 + $18,000 = $185,000 Current ratio =

$484,000 / $185,000 = 2.62

Quick ratio

Current Assets – Inventory – Prepaid Expenses Current Liabilities

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-15A (Continued) Quick assets =

$484,000 – $280,000 – $5,000 = $199,000

Current liabilities = $135,000 + $32,000 + $18,000 = $185,000 Quick ratio

$199,000 / $185,000 = 1.08

Both the current and quick ratios have worsened since 2023. Moksh’s current ratio only weakened slightly and remains healthy. The change in the company’s quick ratio is a concern as it has declined from 1.08 to 0.74, meaning that the company only has $0.74 in quick assets for every $1 in current liabilities. The main reason for the decline in this ratio is the significant increase in the company’s accounts payable, likely caused by the large increase in inventory. b. Moksh’s current ratio is fine, however its quick ratio is too low. In the short term, perhaps they could have a sale. This would convert inventory into quick assets, (cash or accounts receivable) and improve the quick ratio. Reducing its current liabilities would also improve the quick ratio. For example, the company could reduce its accounts payable by carrying less inventory (assuming most inventory is purchased on account), or it could refinance some of its current liabilities into long-term liabilities. c. 2024 A/R Turnover = $860,000 = 5.06 times $170,000 Average Collection = 365 = 72.1 days Period 5.06 2023 A/R Turnover = $740,000 = 6.17 times $120,000 Average Collection = 365 = 59.2 days Period 6.17

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-15A (Continued) The company’s A/R turnover ratio has worsened in 2024 as the company has one fewer turnovers of its inventory during the year. The average collection period increased by 12.9 days, moving from 59.2 days to 72.1 days. This is not a positive change. d. If Moksh’s normal credit terms are net 30 days, the company has been doing a poor job in relation to its collections. In both 2023 and 2024, the company’s average collection period was almost double the net 30 day term. LO 11 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

AP6-1B

a. Comet Company Bank Reconciliation As of April 30, 2024

Balance per bank statement

$ 7,582 Balance per general ledger

$ 4,643

Add: outstanding deposit

1,531 Add: Collection of accounts receivable

1,015

Less: outstanding cheques (*) bank deposit error

(3,120) Less: Service charges (360) (3,480)

(25)

Reconciled balance

$ 5,633 Reconciled balance

$ 5,633

* ($1,250 + $520 + $1,350) = $3,120 b. Comet Company should report $ 5,633 as the cash balance. c. Bank Charges Expense Cash Cash

25 25 1,015

Accounts Receivable

1,015

LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-2B a. Catalina Holdings Ltd. Bank Reconciliation As of October 31, 2024

Balance per bank statement

$ 26,936.89 Balance per cheque book

$ 21,260.16

12,314.10 Add: interest paid by bank Correction of cheque error EFT receipt

19.99 270.00 3,110.25

Less: outstanding cheques (*)

(15,808.17) Less: NSF cheque Bank services

(1,125.58) (92.00)

Reconciled balance

$ 23,442.82 Reconciled balance

$ 23,442.82

Add: outstanding deposit

* ($10,505.10 + $5,303.07 = $15,808.17) b. At October 31, CHL has $23,442.82 available. c.

Journal entries: Cash

19.99 Interest Revenue

19.99

Cash 270.00 Utilities Expense ($960 - $690) Cash

270.00

3,110.25 Accounts Receivable

3,110.25

Accounts Receivable Cash

1,125.58

Bank Charges Expense Cash

92.00

1,125.58

92.00

LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-3B Montgomery Manufacturing Ltd. Bank Reconciliation As of October 31, 2024 Balance per bank statement

$ 8,900 Balance per accounting records

Add: outstanding deposit Less: outstanding cheques

Reconciled balance

$ 9,485

750 (1,450) Less: Bank service charges NSF cheque EFT payment Error correction on cheque #1872 $ 8,200 Reconciled balance

(40) (820) (245) (180) $ 8,200

b. The cash reported on the Statement of Financial Position at October 31, should be $8,200. c. Journal entries: Bank Charges Expense Cash

Accounts Receivable Cash

820

Insurance Expense Cash

245

Utilities Expense ($755 - $575) Cash

180

820

245

180

LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-4B a. Deducted from the cash account (G/L) balance b. Not included in the bank reconciliation because both the company and the bank have recorded the transactions c. Deducted from the bank balance d. Added to the cash account (G/L) balance e. Not included in the bank reconciliation because both the company and the bank have recorded the transactions f. Added to the bank balance g. Deducted from the cash account (G/L) balance h. Deducted from the cash account (G/L) balance i.

Deducted from the cash account (G/L) balance

LO 4 BT: AP Difficulty: H Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-5B a. Accounts Receivable Sales Revenue

820,000 820,000

Cash

780,000 Accounts Receivable

780,000

Allowance for Expected Credit Losses Accounts Receivable

6,000 6,000

Accounts Receivable 850 Allowance for Expected Credit Losses Cash

850

850 Accounts Receivable

850

Credit Losses1 8,200 Allowance for Expected Credit Losses 8,200 1 ($7,250 - $4,200 + $6,000 - $850 b. Accounts receivable, December 31, 2024 $154,000 ($120,000+$820,000–$780,000–$6,000+$850–$850) Less: Allowance for expected credit losses ($4,200 – $6,000 + $850 + $8,200) (7,250) Accounts receivable, net $146,750 Accounts Receivable 120,000 820,000 780,000 6,000 850 850 154,000

Allowance for ECL 4,200 6,000 850 8,200

7,250 146,750

c.Credit losses for year appearing in the statement of income for the year ended Dec. 31, 2024: $8,200. LO 6 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-6B

a. Journal Entries

2023 Accounts Receivable 680,000 Sales Revenue (credit sales for year: $136,000 ÷ .20 = $680,000) Cash ($680,000 x 80%) Accounts Receivable

680,000

544,000 544,000

Credit losses ($680,000 x 2%) 13,600 Allowance for Expected Credit Losses

13,600

2024 Accounts Receivable Sales Revenue (credit sales for year)

952,000

Cash*

843,200

952,000

Accounts Receivable 843,200 *($952,000 x 75%) + ($136,000 x 95%) = $843,200

Allowance for Expected Credit Losses 19,800 Accounts Receivable (write off accounts judged uncollectible) Accounts Receivable 3,200 Allowance for Expected Credit Losses Cash

19,800

3,200

3,200 Accounts Receivable (Record subsequent collection of accounts that were previously written off)

3,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-6B (Continued) Credit Losses1 23,800 Allowance for Expected Credit Losses 1 ($20,800 – 13,600 + 19,800 – 3,200) b. Accounts receivable, December 31, 2024 Less: Allowance for expected credit losses Accounts receivable, net Accounts Receivable 680,000 544,000 952,000 843,200 19,800 3,200 3,200 225,000

23,800

$225,000 (20,800) $204,200

Allowance for ECL 13,600 19,800 3,200 23,800 20,800

204,200

LO 6 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-7B Allowance for Expected Credit Losses 6,230 17,760 23,990 a. 2023 Dec. 31 Credit Losses 17,760 Allowance for Expected Credit Losses b. 2024 Apr. 17

Allowance for Expected Credit Losses Accounts Receivable

17,760

1,450 1,450

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-7B (Continued) Sept. 1

Accounts Receivable 1,450 Allowance for Expected Credit Losses Cash

1,450

1,450 Accounts Receivable

1,450

c. Allowance for Expected Credit Losses 4,520 33,140 28,620

Dec. 31

Credit Losses 33,140 Allowance for Expected Credit Losses

33,140

LO 6 BT: AN Difficulty: M Time:25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-8B

1. 1) Accounts Receivable Cash Sales Revenue

21,086,000 5,272,000

2) Cash

19,923,000

26,358,000

Accounts Receivable 3) Allowance for Expected Credit Losses Accounts Receivable

19,923,000 102,200 102,200

4) Accounts Receivable 21,300 Allowance for Expected Credit Losses Cash Accounts Receivable

21,300

21,300 21,300

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-8B (Continued) 2. Accounts Receivable 2,978,500 19,923,000 21,086,000 102,200 21,300 21,300 4,039,300

Allowance for Expected Credit Losses 102,200 95,312 21,300 14,412

3. Credit Losses ($129,300 – $14,412) 114,888 Allowance for Expected Credit Losses 114,888 Allowance for ECL 14,412 114,888 129,300

4. Accounts Receivable Less: Allowance for Expected Credit Losses

$4,039,300 129,300

$3,910,000

LO 6 BT: AP Difficulty: M Time:35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-9B

a. and b.

Accounts Receivable 2,800,000 16,700,000 17,400,000 193,000 39,000 39,000 3,307,000

Allowance for Expected Credit Losses 193,000 102,000 39,000 52,000

The ending balance in accounts receivable as at December 31, 2024 was $3,307,000. The allowance for expected credit losses unadjusted balance as at December 31, 2024 was a debit of $52,000.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-9B a. and b (Continued) c. Credit Losses $52,000 + $210,000 = $262,000 Allowance for ECL 52,000 262,000 210,000 LO 6 BT: AP Difficulty: M Time:20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-10B a. Aged days: <45 days Aged days: 45-90 days Aged days: 90-120 days Aged days: >120 days

$724,000 x 2% = $ 14,480 $685,000 x 6% = $ 41,100 $197,000 x 15% = $ 29,550 $109,000 x 30% = $ 32,700 $117,830

Allowance for D/A 37,250 80,580 117,830 Credit Losses ($117,830 – $37,250) Allowance for Expected Credit Losses

80,580 80,580

b. Without recourse means that the finance company assumes the risk should the account receivable become uncollectible. If they are unable to collect any of the accounts receivable, they will not get the cash. If, on the other hand, you factored the accounts receivable with recourse the finance company would be able to transfer any uncollectible accounts back to you in exchange for cash, and since they had not assumed the risk, they will provide a higher purchase price. c. The company should consider attempting to collect their receivables more aggressively between 45-120 days, since it appears that the receivables that are not yet collected after 120 days show a significant increase in the proportion that is uncollectible.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-10B (Continued) Another possible solution to speed up the collection of the accounts receivable is to offer sales discounts to some of its customers that are currently slow in paying their account. The company could also look at other steps, such as reducing credit sales by requiring customers seeking credit to pay with credit cards. The company could ask the factor to accept receivables older than 120 days. While there will be a significant discount charged by the factor, it may be less than the 30% loss the company is currently expecting to experience as credit losses. LO 6,10 BT: E Difficulty: H Time:30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-11B a. i. $34,000 + $6,000 = $40,000 ii. $450,000 – $34,000 = $416,000 b. i. $34,000 – $6,000 = $28,000 ii. $450,000 – $34,000 = $416,000 c. $17,500 Credit losses is equal to the amount of accounts were written off during the year.

that

d. $450,000 (no allowance for expected credit losses) e. Accrual accounting requires companies to recognize expenses in the period in which they are incurred. Credit losses are a function of selling on account and is incurred in the period in which the credit sales take place. The allowance method does this, by recognizing bad debts expense in the period in which the sale occurs and providing an allowance for future writeoffs. This provides a better measure of periodic income than the alternative which is the direct writeoff method.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-11B (Continued) Also, under the allowance method the accounts receivable are presented on the statement of financial position at a realistic amount (their net carrying amount), representing the amount that is actually expected to be collectible. By contrast, the direct writeoff method simply reports the receivables at their gross amount, and therefore overstates their value. LO 7,8,9 BT: AP Difficulty: H Time:30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP6-12B 1. Statement of Income Statement of Financial Position

Statement of Cash Flows

No effect Increase in cash $27,400 Increase in allowance for expected credit losses $27,400 Net effect to statement is zero Increase in cash $27,400

2. Statement of Income Statement of Financial Position Statement of Cash Flows

No effect No effect No effect

3. Statement of Income

Decrease in Income before taxes of $52,900 Decrease in Assets $52,900 No effect

Statement of Financial Position Statement of Cash Flows

LO 7 BT: AP Difficulty: H Time:20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-13B Net Income Less : Credit losses Adjusted Net Income

$256,500 (61,700) $194,800

Note : The writeoff of the accounts receivable of $16,900 and the recovery of a accounts receivable of $12,200 have no impact to net income. LO 6 BT: AP Difficulty: M Time:10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-14B a. Current ratio =

Quick ratio

Current Assets Current Liabilities

$32,600 + $396,200 + $715,800 + $17,100 $602,300 + $32,800 + $62,300 + $96,600

$1,161,700 $ 794,000

1.46

Current Assets – Inventory – Prepaid Expenses Current Liabilities

$1,161,700 – $715,800 – $17,100 = $428,800 $794,000 $794,000

0.54

b. The company has met the minimum current ratio requirement under the bank loan covenant but has failed to reach the quick ratio covenant. If the company does not meet its covenants the bank could call the loan (demand the company repay the balance of the loan back right away). c. The quick ratio would be adjusted for as follows: $428,800 + $100,000 (loan added to cash) $794,000 = 0.67 A loan would increase the assets in the numerator of the quick ratio and allow the company to meet its target of 0.65. The bank would not be able to call the loan as the company would not be breaking the debt covenant.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-14B (Continued) d. Management could improve its current position by reducing its substantial investment in inventory (i.e. reducing inventory levels, carrying a smaller range of products, etc.). Reducing the inventory level would free up some cash and thus enable the company to reduce its short-term liabilities, which would improve its current ratio somewhat and dramatically improve its quick ratio. The risk associated with reducing the amount of inventory is that there may be a negative effect on sales due to stock outs. LO 11 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

AP6-15B a. 2024 Current ratio =

Current Assets Current Liabilities

Current assets = $32,800 + $274,200 + $628,900 + $18,200 = $954,100 Current liabilities= $439,400 + $29,700 + $22,500 + $67,200 = $558,800 Current ratio =

$954,100 / $558,800 = 1.71

Quick ratio

Current Assets – Inventory – Prepaid Expenses Current Liabilities

Quick assets =

$954,100 – $628,900 – $18,200 = $307,000

Current liabilities = $439,400+ $29,700 + $22,500 + $67,200 = $558,800 Quick ratio

$307,000 / $558,800 = 0.55

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-15B (Continued) 2023 Current ratio =

Current Assets Current Liabilities

Current assets = $99,500+$205,600 + $475,600 + $16,100 = $796,800 Current liabilities= $308,200 + $31,700 + $18,000 + $51,900 = $409,800 Current ratio =

$796,800 / $409,800 = 1.94

Quick ratio

Current Assets – Inventory – Prepaid Expenses Current Liabilities

Quick assets =

$796,800 – $475,600 – $16,100 = $305,100

Current liabilities = $308,200 + $31,700 + $18,000 + $51,900= $409,800 Quick ratio

$305,100/ $409,800 = 0.74

Both the current and quick ratios have worsened since 2023. b. The change in the company’s quick ratio is a concern as it has declined from 0.74 in 2023 to 0.55 in 2024, meaning that the company only has $0.55 in quick assets for every $1 in current liabilities. The main reason for the decline in this ratio is the significant increase in the company’s accounts payable, likely caused by the large increase in inventory even though sales are declining. Sindarius’s current ratio is fine, however it’s quick ratio is too low. In the short term, perhaps they could have a sale. This would convert inventory into quick assets, (cash or accounts receivable and improve the quick ratio. Reducing its current liabilities would also improve the quick ratio. For example, the company could reduce its accounts payable by carrying less inventory (assuming most inventory is purchased on account), or it could refinance some of its current liabilities into long-term liabilities.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP6-15B (Continued) c. 2024 A/R Turnover = $1,950,000 = 7.11 times $274,200 Average Collection = 365 = 51.3 days Period 7.11 2023 A/R Turnover = $1,990,000 = 9.68 times $205,600 Average Collection = 365 = 37.7 days Period 9.68 The company’s A/R turnover and corresponding average collection period ratios have worsened in 2024. The average collection period increased by 13.6 days, moving from 37.7 days to 51.3 days. This is not a positive change, particularly when combined with declining sales. d. If Sindarius’s normal credit terms are net 45 days, the company has been doing a poor job in relation to its collections for 2024 as it is taking more than 45 days to collect accounts receivable. In 2023, however, Sindarius’s collection period was less than 45 days meaning they were doing a good job in collecting receivables. LO 11 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t1005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP6-1a. The board could communicate with all the organization’s staff and volunteers the importance of internal controls. The board could also ask management to report to the board on the effectiveness of the internal control system to encourage management to make internal controls a focus. b. Donations could be recorded on duplicate pre-numbered donation slips to ensure all have been recorded. Assign a person to collect and another person to deposit all cash donations (these people should not have access to the accounting records). Have a policy that all donations must be issued a donation receipt. Someone could reconcile the total cash deposits with the total receipted donations to ensure that all donated cash is deposited in the organization’s bank account. LO 3 BT: E Difficulty: M Time:15 min. AACSB: Communication CPA: cpa-t001, cpa-t004 CM: Reporting and Audit

UP6-2 Your bank balance may not be complete. It will not include outstanding deposits or cheques that you have written that have not yet cleared the bank. The bank may have made errors that would not be corrected if you did not do a reconciliation and there may be bank charges or amounts collected that you may be unaware of. Basing your business decisions solely on the balance in the bank account could cause you to overdraw your account due to outstanding cheques or preauthorized payments, and puts you at risk of incurring additional bank fees and upsetting the suppliers you paid. LO 4 BT: C Difficulty: M Time:15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP6-3 Bank reconciliations are important for the management of cash because they keep the company up-to-date in terms of recording all transactions that affect its cash balance. In doing so, the company can assess its need for cash, or perhaps plan short-term investments to earn a return on excess cash. Bank reconciliations are also a good internal control over cash because their basic function is to reconcile independent records of the same bank account and possibly detect undeposited cash receipts or unauthorized payments. LO 3,4 BT: C Difficulty: M Time:15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP6-4 a. It is important to review the bank reconciliation each month because there is no segregation of duties for the billing, collecting, depositing, and reconciling of cash. Fraudulent or unauthorized transactions or errors could be recorded that you would not be aware of. b. When reviewing the bank reconciliation, you should be watching for any suspicious transactions, particularly withdrawals that you do not recognize or that you did not authorize. You should pay attention to any adjustments recorded on the bank reconciliation, and consider the validity of the adjustments. This could include looking at the bank statement, asking for deposit slips/receipts in support of outstanding deposits, reviewing the dates and payees for outstanding cheques, etc. LO 3,4 BT: C Difficulty: H Time:20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP6-5 If you are providing your customers with a 60-day term you are forgoing cash for the time it takes to collect the account. Theoretically, if the cash were collected sooner, it could be invested and interest income earned. However, cash is typically used to manage operations and not used to invest in interest-bearing instruments so it is not foregoing interest income. But, it could delay paying of liabilities or purchasing more inventory as the cash is unavailable until collected. LO 5 BT: C Difficulty: M Time:15 min. AACSB Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

UP6-6 You could require that outstanding accounts receivable balances from US customers be paid before new shipments are (i.e. do not extend further credit to US companies and change terms to COD – cash on delivery). You could also shorten the credit terms for US companies so they are required to pay sooner and follow-up with them promptly if they aren’t paying in time. Finally, offering cash discounts could speed up collections. LO 10 BT: AN Difficulty: H Time:15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP6-7 a. Additional credit risk factors besides the length of time a receivable is outstanding can be used in determining expected credit losses. These include geographic regions, type of customer, whether wholesale or retail. The size of the customer, the type of product the receivable is related to and whether the receivable is covered by trade credit insurance or not are additional credit risk factors. Expected future economic conditions (local, national or international) may also be factors that affect the collection of receivables. b. An example of groupings and subgroupings that could be used in assessing credit risk is a company could start by grouping receivables by geographic location (i.e. Eastern Canada, Central Canada and Western Canada) and then have subgroupings for customer type (i.e. wholesale and retail) within each region, if the credit risk of these groups/subgroups is different. LO 8 BT: E Difficulty: M Time:15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

UP6-8 A compensation plan that rewards managers for achieving a certain level of reported net income has the potential to influence management’s assessment of the collectability of its accounts receivable. For example, if management determines that the year-end balance of accounts receivable is collectible in full, then no credit losses would be recorded and the reported net income will be higher as a result. Managers who receive bonuses based on net income may be motivated to understate credit losses and overstate accounts receivable. LO 7 BT: E Difficulty: M Time:15 min. AACSB: Ethics and Analytic CPA: cpa-t001, cpa-t004 CM: Reporting and Audit

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP6-9 a.

Event #1 would have resulted in an increase in sales revenues on the statement of income and a corresponding increase in the balance of accounts receivable in statement of financial position. Accounts Receivable Sales Revenue

2,300,000 2,300,000

Event #2 would have resulted in offsetting effects on the statement of financial position, with a decrease in the balance of accounts receivable and an increase in the balance of cash. Cash Accounts Receivable

2,250,000 2,250,000

Event #3 would have had no net effect on the statement of financial position as accounts receivable and the allowance for expected credit losses, its contra account, would decrease by the same amount. There would be no impact on the statement of income. Allowance for Expected Credit Losses Accounts Receivable

38,000 38,000

Event #4 would have resulted in an increase in credit losses on the statement of income and a corresponding decrease in the balance of net accounts receivable in statement of financial position. Credit Losses1 46,000 Allowance for Expected Credit Losses 1 ($26,000 -$18,000 + $38,000)

46,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP6-9 (Continued) b.

Statement of Financial Position, December 31, 2024 Accounts receivable1 Allowance for expected credit losses2 Accounts receivable, net 1 2

$262,000 (26,000) $236,000

$250,000 + $2,300,000 – $2,250,000 – $38,000 = $262,000 $18,000 + $46,000 – $38,000 = $26,000

Accounts Receivable 250,000 2,300,000 2,250,000 38,000 262,000

Allowance for Expected Credit Losses 18,000 38,000 46,000 26,000

c. The only information available to evaluate the adequacy of Ontario’s allowance for expected credit losses at December 31, 2024 is the value of the receivables written off during 2024, the ending balance in receivables, and prior year-end information. In this case, credit losses of $46,000 was recorded and, as of December 31, 2024, $38,000 of accounts have been written off. It would be very useful to analyze the remaining balance in accounts receivable to arrive at an estimate of the additional amount that is uncollectible. An allowance of $26,000 remains at December 31, 2024, while $18,000 remained at December 31, 2023. Based on the accounts receivable balance at those related points in time, the allowance as a percentage of accounts receivable was 7.2% (2023) and 9.9% (2024), representing approximately a 2.7% increase in the allowance percentage. It appears that the amounts of credit losses and allowance for expected credit losses might be adequate based on the available information. Further analysis might reveal adjustment (additional charge) is appropriate. LO 7 BT: E Difficulty: H Time:40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP6-10 a. 2024

2023

2022

Allowance for expected credit losses

$128.9

$121.9

$118.0

Total accounts receivable (gross)

$1,598.7

$1,352.5

$1,162.8

% considered uncollectible

8.06%

9.01%

10.15%

Credit losses

$312.4

$271.5

$267.0

Sales revenue

$12,661.8

$11,367.8

$10,420.0

2.47%

2.39%

2.56%

Credit losses as a % of sales

c. From parts (a) and (b), we can see that the portion of Lowrate’s receivables that are considered uncollectible has declined and that credit losses as a percentage of sales also declined. If we quantify the receivable written off as a percentage of sales we see:

Accounts written off ÷ sales

2024

2023

2022

2.41%

2.35%

2.85%

These changes are positive, in spite of the modest increase in percentage in 2024. However, if we are trying to determine if the company’s collection of receivables has improved between 2022 and 2024, we can see that between 2022 and 2024, sales increased by 21.5% while accounts receivable have grown by 40.7%. This implies that the company’s collection of its accounts receivable has deteriorated during the period but that fewer of these receivables have ended up being written off (i.e. while they are slower to collect, they are ultimately collecting a greater percentage than in the past).

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP6-10 (Continued) d. 2024 A/R Turnover

= Credit Sales / average Accounts Receivable = $12,661.8 / [($1,469.8 + $1,230.6) / 2] = 9.4 times

Average collection period

2023 A/R Turnover

= A/R Turnover / 365 = 365 / 9.4 = 38.8 days

= Credit Sales / average Accounts Receivable = $11,367.8 / [($1,230.6 + $1,044.8) / 2] = 10.0 times

Average collection period

= A/R Turnover/365 = 365 / 10.0 = 36.5 days

The average collection period has lengthened by 2.3 days in 2024, which means that it has gotten worse in 2024. LO 11 BT: AN Difficulty: M Time:40 min. AACSB Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK IN PROGRESS PROBLEM WIP6-1 The accounts receivable control account just keeps track of the dollar amount of accounts receivable outstanding, the accounts receivable subledger is used to manage the details of each customer. The subledger will have the details of all the accounts receivable transactions for each individual customer. The total of all account balances in the subledger must agree to the balance in the Accounts Receivable control account. A regular (monthly) accounts receivable reconciliation should be done to ensure that the posting process is accurate. LO3 BT: C Difficulty: M Time:20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP6-2 1. Visa, Mastercard and other credit card companies are responsible for collecting the money and deciding to grant credit to the customer on behalf of the merchant. The credit card company will pay the merchant for the amount charged on their credit cards (less a percentage fee for the service). The credit card company will pay the company almost immediately which shortens the cash to cash cycle. 2. Accepting credit cards eliminates the need for the company to approve and monitor customer credit. If the credit card fees are less than the company’s credit approval and manufacturing costs, then the company will save money. 3. Accepting credit cards may increase overall sales as the credit card company may grant credit to customers that the company would not have. LO5 BT: C Difficulty: M Time:20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP6-3 The balance in the allowance for expected credit losses account does not represent the amount of credit losses that were recorded during the period as a reduction in net income. Rather, the balance in the allowance for expected credit losses account represents, at that point in time, the amount of receivables that management estimates will be uncollectible. Accounts receivable need to be reduced by this amount to arrive at the carrying amount of accounts receivable. The allowance for expected credit losses account is a contra account to accounts receivable. The allowance for expected credit losses account is arrived at by assessing the credit risk factors that affect the likelihood of the collection of accounts receivable. These credit risk factors include the length of time that the company’s receivables have been outstanding, but also includes other factors such as the geographic location, the type of customer (wholesale or retail), the size of the customer, the type of product the receivable is related to and whether the receivable is covered by trade credit insurance or not. LO7 BT: C Difficulty: M Time:15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP6-4 Accounts Receivable Turnover will vary from year to year, company to company and industry to industry so there needs to be more information provided to compare the turnover ratio to (a prior year or another company or an industry standard). The expected performance of the turnover ratio is determined by the terms of collection given to customers by the merchant. Sales discounts will also affect this ratio. With a 4.2 Accounts Receivable Turnover, the merchant is only collecting its Accounts Receivable approximately 4.2 times each year or it is taking, on average, 87 days (365/4.2) to collect accounts receivable. If the company has payment terms of less than 87 days, they are not doing a good job of collecting their Accounts Receivable. LO11 BT: AN Difficulty: H Time:20 min. AACSB: Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI6-1 To: Arthur Eshelman The fact that there is a high degree of concentration of accounts receivable in this situation would not increase the credit risk of this company, since almost all its receivables are attributed to provincial government liquor authorities. The remainder of deliveries are made to third party warehouses in British Columbia, Ontario, Manitoba and Saskatchewan. This means that the chance of collecting all its outstanding accounts receivable is excellent. Thus, the credit risk is very low for this company. LO11 BT: AN Difficulty: H Time:20 min. AACSB: Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI6-2 a. Not past due 30-60 days 60-90 days Over 90 days

2020 94.9% 3.1% 0.7% 1.4%

2019 96.1% 2.6% 0.2% 1.1%

The age mix of BRP deteriorated in 2020 from 2019. The portion of receivables that are not past due has decreased and the remaining categories have all increased meaning less accounts are being collected within the payment terms. b.

2020: $3.5/ $337 = 1.04% 2019: $3.7/$337.7 = 1.10% The total percentage of uncollectible accounts receivable has decreased from 2019 to 2020 which is favourable because less accounts are considered uncollectible and we expect to have less writeoffs.

Accounts receivable turnover rate: 2020 $6,052.7 / $335.5 = 18.15 times 2019 $5,243.8 / $334.0 = 15.70 times Accounts receivable turnover is favourable, BRP is turning over their accounts receivable faster in 2020 than 2019.

Average collection period: 2020 365/18.15 = 20.1 days 2019 365/15.70 = 23.3 days Both collection periods are under 30 days and the collection time has improved by 3.2 days in 2020. As they are lower than 30 days it would appear that BRP has more accounts receivable with less than 30-day terms.

LO11 BT: AN Difficulty: M Time:25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI6-3 a. Total accounts receivable has decreased by $168,000,000 (or 17.9%) and the allowance has increased by $3,000,000 (or 7.1%). As a percentage of accounts receivable in 2020, the allowance is 5.9% while in 2019 it was 4.5%. The collectability of accounts receivable has gotten worse. The amount being written off more than doubled in 2020 and increased by $7,000,000. b. Not past due Past due 1-30 days Past due 31-90 days Past due 91-120 days Past due greater than 120 days

2020 0.2% 0% 0% 6.3% 58.9%

2019 0% 0% 1.5% 10.5% 54.2%

There has not been a significant change in the allowance for accounts that are past due 31-90 days. There has been a significant decrease in the allowance for accounts past due 91-120 days, while there has been an increase related to accounts past due for more than 120 days. The allowance for accounts past due greater than 120 days represents 58.9% of the accounts in 2020 and was 54.2% in 2019. This show that Finning expects to collect only a fraction of these accounts. c.

The credit losses for 2020 was $16,000,000 as reported in the schedule of movement in the allowance for doubtful accounts schedule.

LO11 BT: AN Difficulty: M Time:30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI6-4 a. i. Current ratio: 2020: $351,719 / $152,562 = 2.31 2019: $391,198 / $209,631 = 1.87 ii. Quick ratio: 2020: ($351,719 - $250,861 - $4,176) / $152,562 = 0.63 2019: ($391,198 - $294,913 - $4,322) / $209,631 = 0.44 iii. Accounts receivable turnover rate: 2020 2019

$827,453 / $60,927 = 13.58 times $942,224 / $85,089 = 11.07 times

iv. Average collection period: 2020 2019

365/13.58 = 26.9 days 365/11.07 = 33.0 days

b. Both the current ratio and quick ratios are trending upward and have improved. Both ratios demonstrate strong liquidity. High Liner is collecting its accounts receivable in a more efficient manner in 2020 as compared to 2019. It took 33 days to collect in 2019 and only 27 days to collect in 2020. LO11 BT: AN Difficulty: M Time:25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI6-5 a. i. Current ratio 2020 : $4,069.0 / $2,493.5 = 1.63 2019 : $3,133.8 / $1,932.5 = 1.62 ii. Quick ratio 2020: ($4,069.0 - $106.6 - $2,220.9) / $2,493.5 = 0.70 2019: ($3,133.8 - $57.8 - $1,681.0) / $1,932.5 = 0.72 iii. A/R Turnover 2020: $14,943.5 / $1,371.8 = 10.89 times 2019: $13,501.9 / $1,248.2 = 10.82 times iv. Average Collection Period 2020: 365 /10.89 = 33.5 days 2019: 365 /10.82 = 33.7 days b. The current ratio increased slightly from 2019 to 2020. The quick ratio, decreased but remain strong. The main increase in the current ratio is due to no current portion of long-term debt being due in 2020 versus $323,400,000 due in 2019. The accounts receivable turnover and average collection period ratios have stayed almost the same with both years over 33 days to collect. The increase in the amount of accounts receivable of $123.6 million (9.9% from 2019) is in line with the increase in revenues of $1,441.6 million (10.7% from 2019). LO11 BT: AN Difficulty: M Time:25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI 6-6

Answers to this question will depend on the company selected.

LO11 BT: AN Difficulty: M Time:30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C6-1 Versa Tools Inc. Memorandum To: Arthur Eshelman Re: Internal controls and cash balances Arthur, Protection and control of cash is key to the success of any business. Because of its very nature, cash is particularly susceptible to theft and internal controls must therefore be established to protect and manage a company’s cash balances. After having reviewed the operations of Versa Tools Inc. I have identified several weaknesses in internal controls related to cash that should be corrected. i.

Currently, you employ only one person in the accounting department, which does not allow for a proper separation of duties. When one person is responsible for receiving cash, recording cash receipts and disbursements, and depositing cash in the bank, there is an increased possibility that fraud could occur. Where possible, you should try to separate these duties so that a different employee is responsible for receiving the cash, recording the accounting transactions, and depositing the cash in the bank. With different employees performing these duties, collusion (i.e. two or more employees working together to circumvent internal controls) would have to occur among employees for a theft to be perpetrated. I realize that due to the size of your business a proper segregation of duties may be impossible. As a compensating control, I recommend that management continue to review all cash transactions on a regular basis.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-1 (Continued) ii. Currently, cash is not being deposited on a regular basis and is easily accessible by anyone in the main office area. You should ensure that cash is physically protected. This would include depositing cash receipts on a daily basis and keeping any cash that is maintained on the premises in a locked till or safe. iii. All cash receipts should be documented (i.e. pre-numbered paper receipts issued), so that they can be tracked until recorded. iv. The current accountant has no formal training and is not entering transactions into the computer system on a regular basis. This increases the chance that mistakes and omissions will occur. In a strong system of internal control, management should establish an effective record keeping system that includes ensuring that all employees are properly trained and educated about the system. v. A bank reconciliation ensures that the company’s accounting records agree with the bank statement. Due to the lack of controls in other areas, the preparation of monthly bank reconciliations is essential for Versa Tools. The bank reconciliation should be performed by someone other than the person responsible for the record keeping function, and should be reviewed regularly by management. Arthur, you should review the bank reconciliation to ensure that the information reflected in it is accurate (i.e. that deposit slips/receipts are available for each deposit in transit, and that the general ledger cash balance agrees with the bank statement balance, etc.) and that all payments made from the bank account have been properly authorized and supported by verifiable business transactions. Implementing these controls will greatly improve the ability of Versa Tools to protect its cash balances. With proper controls in place, you should have more time to concentrate on expanding the business. LO3 BT: C Difficulty: H Time:40 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-2 a. Balance per bank statement Add: Outstanding deposit/ Undeposited receipts

$18,380.00 ?*

Less: Outstanding cheques $(241.75) (258.25) (190.71) (226.80) (165.28) (1,082.79) Unadjusted cash balance

$17,297.21

Balance per accounting records Add: Collection of note receivable Less: Bank service charges

$21,892.72 300.00 22,192.72 (50.00)

Corrected cash balance

$22,142.72

* The amount of the outstanding deposit or undeposited receipts required to make the bank reconciliation balance would be: = $22,142.72 - $17,297.21 = $4,845.51 If Rob deposited $3,845.51, then the amount of cash he stole would be: = $4,845.51 - $3,845.51 = $1,000 b.

Rob did not include two outstanding cheques, for $241.75 + $258.25, in the reconciliation. The combined effect of these two omissions was $500.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-2 (Continued) In addition, Rob treated the collection of the note receivable of $300 and the service charges of $50 as adjustments to the bank statement balance, when they should have been adjustments to the company’s cash balance. The net total for these items was $250. However, because they were included in the wrong portion of the reconciliation (i.e., as adjustments to the bank’s balance, rather than to the company’s balance) this resulted in an error of twice that amount, or $500. c. To prevent this type of occurrence, the company: • Should segregate the duties concerning the collection and disbursements of cash • Ensure that pre-numbered receipts are issued for all cash received by the company and that all receipts are matched to the journal entries recording the cash receipt • Have the bank reconciliation reviewed by the general manager, with the general manager verifying all outstanding deposits to deposit slips/receipts and tracing all outstanding cheques to see if they cleared the bank within the first 10 days of next month. Any cheques that did not clear should be followed up. LO3,4 BT: E Difficulty: H Time:50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-3 Sanjay Supplies Limited Calculations: 2024

2023

2022

Current Ratio

$3,880 / $980 = 3.96

$2,820 / $710 = 3.97

$2,370 / $690 = 3.43

Quick Ratio

($3,880 – $1,730) / $980 = 2.19

($2,820 – $1,250) / 710 = 2.21

($2,370 – $940) / 690 = 2.07

A/R Turnover

$17,100 / [($1,510 + $2,130) / 2] = 9.40

$16,300 / [($1,180 + $1,510) / 2] = 12.12

Average Collection Period

365 / 9.40 = 38.8 days

365 / 12.12 = 30.1 days

Sales Growth %:

4.9% from 2023 to 2024 28.3% from 2022 to 2023

Discussion: Sanjay’s sales have increased dramatically over the past two years (i.e. 28.3% from 2022 to 2023 and 4.9% from 2023 to 2024). The company’s current (4.0) and quick (2.2) ratios are also good and have remained constant from 2023 to 2024 and improved from 2022 to 2023. However, its cash and cash equivalents have steadily decreased, from $250 ($210 + $40) in 2022 to $20 in 2024. The main reasons for this are the large increases in accounts receivable and inventories, coupled with decreased accounts payable. The accounts receivable turnover has decreased, from 12.1 times in 2023 to 9.4 times in 2024. This might indicate that Sanjay is either increasing its sales by granting easier credit or is experiencing serious problems in collections. Accounts receivable increased by 80.5% during the threeyear period, while sales on credit increased by only 34.6%. Sanjay management should review this situation and take corrective action. The company’s average collection period also increased significantly between 2023 and 2024.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-3 (Continued) It takes Sanjay an average of an additional 8.7 days to collect from its customers, which lengthens the company’s cash-to-cash cycle and consequently necessitates the increase in short term bank loan. Management should also determine why inventories are increasing so rapidly. Inventories increased by more than 84.0% over a two-year period, while sales on credit increased by only 34.6%. By reducing inventory levels, Sanjay could reduce its storage and handling costs, and the financing costs of having cash tied up in inventory. However, the cost savings from reduced inventory levels must be weighed against the risk of lost sales if customer demand cannot be met, and potential lost savings if Sanjay does not take advantage of bulk purchase discounts, or does not purchase in advance of supplier price increases. It should also be noted that accounts payable decreased during the threeyear period. This is unusual, during a period when sales and inventories have increased, and should also be investigated. LO10,11 BT: AN Difficulty: M Time:45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-4 Heritage Mill Works a. During the current year, the company wrote off accounts representing 2.36% of credit sales (i.e. $73,400 / $3,105,000 = 2.36%). Taken as a percentage of the year end balance in accounts receivable, 22.2% ($73,400 / $330,000) of receivables were written off during the year. This amount is quite high. The receivable turnover is very strong at 9.4 times ($3,105,000 / $330,000) or 38.8 days (365 / 9.4 times). Since the industry is strong and houses are selling, it is reasonable to assume that the risk factors affecting the ability to collect accounts receivable will not change in the coming year. Depending on the unadjusted balance in the allowance for expected credit losses, I would recommend recording an amount of credit losses for the year that will result in the balance of the allowance for expected credit losses to be the sum of 4% of receivables less than 60 days and 30% of receivables outstanding 60 days or more. Note: students can use any number or strategy here, but they must adequately support their choice. b. If a company’s credit policy is too restrictive, it risks losing sales by not granting credit to good customers. Customers may purchase lumber from other suppliers who will grant them credit. However, if credit is granted too easily, the company risks incurring a high level of uncollectible accounts. It is this trade-off between losing sales and incurring large bad debts that must be considered in determining an appropriate credit policy. c. Utilizing notes receivable may be appropriate as they generate interest revenue. Also, a signed note is stronger evidence of the debt than is an accounts receivable. It is also advantageous for the contractors as they have more time to pay their bills. But, it would slow down the cash-to-cash cycle. d. Other steps Heritage Mill Works could consider taking to reduce the risk of non-collection could include: • Using less liberal credit terms Consider receiving a deposit prior to delivery of merchandise inventory, or make deliveries cash on delivery for customers deemed to be higher risk, or for which the business does not have considerable history.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-4 (Continued) • Undertake credit checks to ensure that the customers are capable of meeting their obligations • Consider using a collection agency. • Set up control procedures that customers that exceed their credit limit are not shipped any goods until their account is paid. LO5,7 BT: E Difficulty: H Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-5 a. Internal Control Considerations

Application to MegaMax Theatre

Assignment of responsibility

Only the cashiers are authorized to sell tickets. Only the manager and cashiers can handle cash. Only the manager has access to unlocked rolls of tickets.

Documentation

The tickets are pre-numbered. Cash count sheets are prepared and initialed. Deposit slips are prepared. Copies are used for verification and recording.

Separation of duties

The duties of receiving cash and admitting customers are separately assigned, to the cashier and the doorperson. The manager maintains custody of the cash, while the accountant records receipt of the cash.

Physical controls

A safe is used to hold cash during the day. Cash is deposited at the end of each day. Locked machines are used to hold and issue the tickets.

Independent verification.

Cash counts are made by the manager at the end of each shift. Daily comparisons of the number of tickets sold and the cash, debit and credit card receipts received are made by the controller.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C6-5 (Continued) b.Weaknesses in the internal control system that could enable a cashier and/or doorperson and cashier to misappropriate cash include: There is no mention of the torn ticket stubs (which are supposed to be dropped into a locked box) being checked. These should at the very least be subject to periodic spot-checks against the number of people in the theatre and the amount of cash collected. Discrepancies between the amount received by each cashier and the number of tickets issued are not discussed with the cashiers until their next shift. This may make it very difficult to determine the reasons behind the discrepancies and how they should be resolved. Possible abuses by cashiers and doorpersons include: i.

The cashier and doorperson could agree to let friends into the theatre without purchasing tickets, in exchange for "under the table" payments.

ii.

Instead of tearing the tickets in half, the doorperson could return the tickets to the cashier who could resell them, and the two could divide the extra cash.

iii.

The cashier could issue less expensive tickets than what the customers paid for, and arrange with the doorperson to admit the customers. The difference between the value of the tickets issued and the cash received could later be divided between the cashier and the doorperson.

LO5,7 BT: E Difficulty: H Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 7 INVENTORY Learning Objectives 1. Discuss the importance of inventory to a company’s overall success. 2. Distinguish between the different inventory classifications and determine which goods should be included in a company’s inventory. 3. Explain the differences between perpetual inventory systems and periodic inventory systems. 4. Explain why cost formulas are necessary and calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a perpetual inventory system. 5. Explain the value at which inventory is carried on the statement of financial position and determine the impact of inventory valuation errors. 6. Explain how a company’s gross margin is determined and why it is an important measure. 7. Describe management’s responsibility for internal control measures related to inventory. 8. Calculate the inventory turnover ratio and the days to sell inventory ratio and explain how they can be interpreted by users. 9. Calculate the cost of goods sold and ending inventory under the specific identification, weighted-average, and first-in, first-out cost formulas under a periodic inventory system.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

Item

1. 2. 3. 4. 5 6.

1 2 2 2 2 2

C K K K C AP

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

3 3 3 3 3 3

1. 2. 3. 4.

2 4,6 9 4,6

AP AP AP AP

5. 6. 7. 8.

9 4,6 9 4,6

1. 2. 3.

7 2 1

C C C

4. 5. 6.

4 6 6

1. 2.

2 3

C C

6,8

Item

Discussion Questions C 13. 4 K 19. 5 C 14. 4 K 20. 5 C 15. 4 C 21. 6 C 16. 4 C 22. 6 C 17. 5 C 23. 7 C 18. 5 C 24. 8 Application Problems AP 9. 9 AP 13. 8 AP 10. 5 AP 14. 8 AP 11. 5 AP 15. 6,8 AP 12. 5 AP 16. 6,8 User Perspective Problems C 7. 6 C 10. 6,8 C 8. 6 C 11. 8 C 9. 6,8 AN 12. 8 Work in Process C 4. 4 C 5. 4

Item

C C C K C AN

25. 26. 27.

8 8 8

AN C C

AN AN AN

13.

AP AP AN AN

Reading and Interpreting Published Financial Statements AN 2. 2,8 AN 3. 5,8 AN 4. 2,5,8 AN 5. 2,5,8 AN Cases C 2. 8 AN 3. 5 AP 4. 4 C 5. 3,4,5,7 C

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ7-1

Inventory is significant to financial statement users because it is often the single largest type of asset owned and managed by the company. As such, the inventory on hand affects the statement of financial position, and the inventory transferred to customers throughout each period affects the statement of income (as cost of goods sold) – both in material amounts. The profitability of an entity depends to a large extent on the decisions management makes about its inventory. Inventory management is a balancing act. Purchasing too much inventory means the entity incurs significant costs for storage, insurance and handling and increases the likelihood of incurring costs related to obsolescence, spoilage or other impairment in value of the goods. On the other hand, too little inventory on hand means lost sales due to carrying a limited variety of products or because of stock-outs.

LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-2

A retailer holds merchandise inventory – goods acquired that are already in a finished state for resale to customers.

LO 2 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-3

A manufacturer holds three classifications of inventory: raw materials, work-in-process, and finished goods. Raw materials are the items that are needed to manufacture or build the goods that are sold to customers. As the term suggests, work-in-process makes up all those goods that have been started into production but have not yet been completed.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-3 (Continued) The costs of work-in-process are made up of raw materials, labour costs and a variety of manufacturing overhead costs such as electricity to run the machinery and light the factory, and factory supervisory salaries. Finished goods are all those goods where the manufacturing process has been completed and the goods are awaiting sale. Like work-in-process, these also are made up of raw material, labour and manufacturing overhead costs. LO 2 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-4

FOB destination and FOB shipping point refer to when ownership of the goods is transferred from the seller (vendor) to the purchaser (customer or buyer). FOB means “free on board.” FOB destination means that the goods become the property of the purchaser when they are received by the purchaser. Under FOB destination, the seller incurs the cost for the transportation of the goods to the purchaser’s place of business. Alternatively, FOB shipping point means that legal title to the inventory items is transferred once the goods leave the premises of the seller or vendor and, under FOB shipping point, the purchaser is responsible for the cost of shipping. Therefore, the FOB terms indicate in whose inventory the goods belong at any point in time.

LO 2 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-5

If a company has goods “out on consignment,” it means that the goods are physically located in the premises of another company (the consignee), who will sell the inventory. The consignee is merely acting as an agent of the owner (the consignor) of the inventory, and the agent will receive a commission on any of the owner’s inventory it sells. Title to the inventory is never transferred to the agent. It remains the legal property and in the inventory of the consignor, the company whose goods are “out on consignment.”

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-6 (a) The goods in transit at year end costing $10,000 with terms FOB shipping point should be in the inventory of the buyer at year end. Title to the goods was transferred to the buyer at the point they were shipped by the seller or vendor. (b) Goods in transit at year end costing $12,000 with terms FOB destination should be in the inventory of the selling company at year end. Title to the goods is not transferred to the buyer until the goods arrive at their destination. LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-7

A perpetual inventory system is an accounting system that “perpetually” keeps track of the inventory a company has on hand. It does this by adjusting the accounting records when purchases of inventory are made by increasing the inventory on hand. When inventory is sold, the accounting records are adjusted by decreasing the inventory, transferring the cost of the inventory sold to the expense account -- cost of goods sold. In this way, the inventory in the accounting records is always (i.e., perpetually) at the amount of inventory that should be on hand at any time. A company that might use a perpetual system is a car dealership. In this business the costs associated with each specific inventory item are significant and traceable to the units on hand and those that are sold. There are also relatively few transactions so the costs of maintaining this more detailed system are reasonable compared to the information benefits derived from the system.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-8

A periodic inventory system is an accounting system that requires a physical inventory count “periodically,” such as at each month, quarter, or year end, to determine the cost of inventory on hand at that time. An inventory count is necessary to determine the amount and cost of inventory on hand because the purchases during the period are accumulated in an account called “Purchases” and no entry is made to transfer the cost of the inventory sold to the Cost of Goods Sold account until an inventory count is carried out. At that point, a calculation is made to determine the cost of goods available for sale (opening inventory + purchases). The ending inventory determined through the physical count is then deducted from the cost of goods available for sale to determine the cost of the goods sold during the period. An accounting adjusting entry is then made that brings the Inventory account to the correct balance per the inventory count, reduces the Purchases account to $0, and recognizes the remaining costs as Cost of Goods Sold. A company that might use a periodic inventory system is merchant who sells very few items of inventory. In this case, the owner-manager can tell from “walking around” which inventory needs replenishment. Another case would be where the type of inventory does not lend itself to tracking using a perpetual system. Inventory in liquid form fits this situation. An example would be fuel tanks for an oil and gas distributor.

LO 3 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-9

The basic differences between a periodic and a perpetual inventory system:

Periodic Perpetual Sophistication of accounting inventory system: Relatively straightforward and less More complex and more costly to set up and costly to set up and to maintain to maintain Degree of control over inventory quantities: Other controls must be put in place to A perpetual system maintains tighter ensure there is adequate protection controls over inventory as indicated by the because usually there are no accounting maxim – “what gets measured accounting numbers available to gets managed”. That is, it is more difficult to indicate the actual amount that hide theft or other inventory losses when should be on hand. explanations are required for differences from the accounting records. Automatic reordering is also facilitated by perpetual inventory systems. Need for inventory counts: Needed to determine how much Not needed to determine the amount of inventory is on hand and what the inventory on hand and the cost of goods sold cost of goods sold is, although but rather to determine that the perpetual estimates can be made for interim inventory system is operating as intended. financial statements. The accounting entries – when inventory is purchased: Purchases xx Inventory xx Cash/Accounts Payable xx Cash/Accounts Payable xx The accounting entries – when inventory is sold: Cash/Accounts Receivable xx Cash/Accounts Receivable xx Sales Revenue xx Sales Revenue xx Cost of Goods Sold xx Inventory xx Additional period end entry required: Inventory (ending) xx No additional entry unless the result of the Cost of Goods Sold xx physical count differs from the inventory Purchases xx amount in the accounting records. Inventory (opening) xx LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-10

The advantages and disadvantages of the perpetual inventory system relative to a periodic inventory system: Advantages of perpetual system Disadvantages of perpetual system Provides better internal control over More costly to develop, put in place inventory within the accounting system. and maintain. The cost of inventory on hand and the cost of the goods sold are known on a continuous basis. Detailed information about quantities is available for establishing automatic reorder points, thus reducing the chance of stock-outs. Fewer costly inventory counts are required. The amount of inventory lost to shrinkage (theft, spoilage, etc.) can be easily identified. Better information is available to enable responses to customers about the availability of goods. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-11

No matter what type of inventory system a company has in place, the total of the cost of the opening inventory + the cost of all the goods purchased in the period = the cost of goods available for sale. At the end of an accounting period, the cost of all the goods available for sale is in one of two places: an inventory count establishes how much is still on hand, and the remainder – the residual amount – is included in the cost of goods sold. This description is more accurate when describing a periodic system, because the only way to find out an accurate amount for the cost of goods sold is to deduct the cost of the ending inventory (taken by count) from the cost of goods available for sale (opening inventory + purchases). Under a perpetual system, every time a sale is made, inventory costs are transferred to the cost of goods sold, so there is no residual amount.

LO 3 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-12

The use of a perpetual inventory system does not eliminate the need to conduct inventory counts. At least annually, each type or category of inventory needs to be counted to determine whether the perpetual system is working as intended, and to ensure that the balances provided by the accounting system are an accurate representation of the cost of goods still on hand at period end. Only by physically counting the inventory can the company determine how much shrinkage there has been due to such events as breakage, theft, spoilage, etc. To the extent the cost of the inventory on hand according to the count is higher or lower than the cost remaining in inventory on the books, an adjustment is needed to correct the accounting records.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-13

When the purchase cost of the goods acquired in an accounting period are different from the cost of the goods in opening inventory and from other purchases in the year, cost formulas are necessary to determine which costs should be included in ending inventory and which costs should be included in the cost of goods sold.

LO 4 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-14

Specific identification cost formula: the costs assigned to the units in ending inventory are the specific costs incurred to acquire those actual units, and the costs assigned to the units that were sold are the actual costs of each specific unit sold. FIFO cost formula: costs are assigned to units under the assumption that the costs of the first units acquired are the first to flow out to cost of goods sold. This results in ending inventory being assigned the most recent costs and cost of goods sold being assigned the oldest costs.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-14 (Continued) Weighted-average cost formula: the assumption is that the costs of the opening inventory and the cost of all the units purchased during the period are co-mingled. Under a periodic system, the units available for sale are assigned a weighted-average cost based on the cost of all the goods available for sale. This weighted-average cost is used to determine the cost of the units in ending inventory and the cost of the units sold. Under a perpetual system, a new weighted-average cost is calculated every time a purchase is made. LO 4 BT: K Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-15

The accounting standards indicate that the specific identification method should be used wherever possible. This method requires each unit to be separately identifiable and the specific cost of each to be tracked in the accounting system. In this way, the specific cost of the units left on hand in ending inventory can be determined, as can the specific cost associated with the units sold. This cost formula is generally applied only when the inventory is made up of a small number of high-value, unique items. If the specific identification method is not practical to use, then cost formula to be used should mirror physical flow of goods to the extent possible. If a company has a policy, for example, that the older items of inventory must be used up before the newer inventory items are sold to customers, then the first-in, first-out method would be the obvious choice of cost formula. However, if the newer purchases are co-mingled with the older inventory on hand, the cost of the units sold cannot be differentiated from the cost of those still on hand. The weighted-average cost formula would better represent the physical flow. There is some flexibility in choosing between these two methods, but companies generally choose based on what is practical in the circumstances and which system provides better information for management.

LO 4 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-16

The specific identification cost formula is appropriate for companies to use when inventory is made up of small quantities of high-priced, unique products whose specific costs can be identified with specific units. In this situation, the cost of the additional bookkeeping required is justified based on the ease of identifying specific goods and the quality of the information that is provided for management purposes. Accounting standard setters may have taken this position to eliminate the possibility of financial engineering of the accounting results by management. For example, assume a company acquires two identical refrigerators for inventory at different times in the year. The first one cost the company $600 and the second one cost $750 due to increased manufacturing costs. At year end, assume one has been sold and one remains in inventory. If management were motivated to show improved profits, they could assign the $600 cost to the unit sold (cost of goods sold) and the $750 cost to the item left in ending inventory. Alternatively, if the motivation is to minimize income taxes (and therefore income before income taxes), management could choose to assign the $750 cost to cost of goods sold and the $600 to the ending inventory. The use of the specific identification cost formula prevents the possibility of manipulating profits by management.

LO 4 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-17

Assuming a trend of rising prices, FIFO will produce statement of financial position values of ending inventory that are slightly higher than those under the weighted-average cost formula. They are higher because ending inventory is assigned the most recent purchase cost which would be the highest for the year. The weighted-average approach, as its name implies, averages the rising costs with the lower first-of-year costs, so the ending inventory cost would be lower. The cost of goods sold under FIFO will generally be lower than the weighted-average in such a year. This is because cost of goods sold is assigned all the older and lower costs under FIFO, while under the weighted-average formula, it would be assigned an average cost amount that takes in the higher end-of-year costs.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-17 (Continued) If costs in the year were on a decreasing trend, the opposite effects would be seen with FIFO reporting a lower ending inventory on the statement of financial position and a higher cost of goods sold on the statement of income. LO 5 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-18 (a) Assuming costs are not constant, the choice of inventory cost formula has an impact on the statement of income because the cost formula directly impacts cost of goods sold which will impact gross margin and net income. (b) Assuming costs are not constant, the choice of inventory cost formula has an impact on the statement of financial position because the cost formula directly impacts the inventory value which will impact current and total assets. (c) The choice of inventory cost formula will not impact the statement of cash flow as the cash spent on inventory will be the same regardless of which cost formula a company selects. It will impact some values on the statement of cash flow as the cost of goods sold and inventory values will be different but the net impact to cash will be the same. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-19

The lower of cost and net realizable value valuation should be applied to individual items. If it is not practical to apply it to individual items, companies apply the lower of cost and net realizable valuation to groups of similar items. The cost of the inventory (determined using either specific identification, FIFO or weighted- average cost formula) is compared to the inventory’s net realizable value – its expected selling price less costs to complete and sell. As the valuation method indicates, the lower value is used. If the net realizable value is used because it is lower and the inventory is written down below its cost, then subsequent recoveries can be recognized at a later date, but the amount recovered is limited to the extent of the previous write-down. This is done to ensure that inventory is not carried on the statement of financial position at a value greater than the company expects to realize from the sale of those goods.

LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-20

Current ratio – If the inventory was overstated it would mean that current assets are overstated and that would mean the current ratio (current assets divided by current liabilities) would also be overstated. Gross margin – If the inventory was overstated, cost of goods sold would be understated as goods available for sale are allocated between inventory and cost of goods sold. If cost of goods sold is understated then gross margin [(sales – cost of goods sold)/sales] would be overstated.

LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-21

Gross margin, also known as gross profit, is the amount remaining after the cost of goods sold is deducted from sales revenue. It is often represented as a percentage and interpreted to mean the amount left from each sales dollar (after the cost of the goods sold is deducted) to cover other expenses and contribute to profit. Gross margin is a key performance measure as it indicates how well management has managed its purchases and pricing strategies. Performance in these areas will determine whether the company’s other costs can be met and whether their operations will ultimately be profitable.

LO 6 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-22

The gross margin ratio, also known as gross profit ratio, is (sales less cost of goods sold) divided by sales. A company can either increase its selling price or decrease its product costs to increase the gross margin ratio.

LO 6 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-23

By shrinking the package size, the amount of food that is sold is reduced. A smaller package will contain less product and correspondingly the cost of goods sold for the product will reduce. This way, in spite of pressures to reduce the selling price, the gross margins can be maintained.

LO 6 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-24

Internal controls are necessary for inventory in order to safeguard it from such risks as fire, theft and spoilage; to restrict its acquisition, receipt and issuance to authorized personnel; and to ensure it is accounted for and reported correctly and completely. The key internal controls expected for a system of internal control for inventory include: • Physical controls such as fencing, locked or limited access • Assignment of responsibilities to specific employees so each knows who is responsible for what activities and on what basis they will be held accountable • Separation of duties among those associated with the purchasing, the receipt and issuing of inventory and separate from those responsible for the accounting records and payment of purchase invoices • Independent verification of the existence and condition of inventory with the accounting records • Appropriate documentation supporting the purchasing, receiving, storage and shipping/distribution of inventory to customers.

LO 7 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ7-25

A high inventory turnover is normally considered to be positive as the more times a company sells its inventory in a year the better. If inventory is sitting in the store or warehouse it is not generating any sales. A higher ratio means that the company has sold through its inventory more times than a company with a lower turnover ratio. If the turnover is too high it is possible that the company may experience stock-outs – that is, it runs out of goods. This can result in lost sales.

LO 8 BT: AN Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

DQ7-26

The two key ratios used to analyze inventory are the inventory turnover ratio and the days to sell ratio. The inventory turnover ratio (cost of goods sold ÷ average inventory) tells you how many times a year the investment in inventory turns over. To “turn over” inventory means to sell it. A higher number is usually preferred to a lower number. A company whose inventory has a healthy turnover means it can have fewer dollars invested in this asset, and incur lower costs of storage, insurance and interest, and have fewer obsolescence issues. The days to sell ratio is closely related to the inventory turnover ratio. It probably makes sense that a company with an inventory turnover ratio of 12 for the year sells its investment in inventory in a month – or 30 to 31 days. This is its days to sell ratio – the number of days on average it takes to turn over and replace its inventory. It is calculated as 365 days ÷ the inventory turnover ratio. Here, a lower number is preferred as the cash-tocash cycle (time between when you acquire and pay for your inventory to the time you sell it and receive cash back again) is reduced.

LO 8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ-27

Three reasons why a company would want or need to estimate the cost of goods sold or the cost of its inventory are: 1) the inventory has been destroyed or stolen and it is impossible to count; 2) the company uses a periodic inventory system and wants to prepare monthly financial statements, but does not want to incur the cost of counting the inventory each month; and 3) the company wants to have an estimate of the inventory that should be on hand, before it begins the physical count, so that it can determine whether goods have been lost or stolen.

LO 8 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ7-28

The basic assumption inherent in the gross margin inventory estimation method is that the company’s gross margin percentage for the current period is the same as previous periods’ percentage or its “normal” gross margin percentage. This assumption might be a challenge to defend for companies that experience a changing mix of sales during the year and from year-to-year. That is, some goods are sold at with high mark-ups on cost, while others may have a low mark-up percentage. The actual gross margin rate for any year is the weighted-average of all the actual mark-ups on the goods sold. If such a company wants to use the gross margin estimation method, it could develop a revised estimate of the weighted-average gross margin for the current period by segmenting its sales according to the specific mark-ups used. In this way, it could use a more relevant ratio because it applies to the current year’s experience. It is not using last year’s or other rates that do not reflect current conditions.

LO 8 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP7-1A

Include all FOB shipping point orders as the inventory becomes the buyer’s responsibility when the item leaves the seller. Exclude all FOB destination orders as the inventory doesn’t become the buyer’s responsibility until it is received. December 1, 2024 December 10, 2024 December 19, 2024 Total inventory to include

$75,000 95,000 45,000 $215,000

LO 2 BT: AP Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP7-2A a.

i. FIFO Cost of goods sold = (3,000 x $30.50) + [(500 x $40) + (500 x $40] + (200 x $50) + (1200 x $50) = $201,500 Sales Revenue = $315,000 + $52,500 + $72,000 = $439,500 Gross margin = Sales Revenue - COGS Gross margin = $439,500 – $201,500 = $238,000

Ending Inventory = (100 units X $50) + (500 units X $30.04) =$20,020

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-2A (Continued) ii. Weighted-average

Mar 1 Mar 7 8 15 20 25 27

Beg. Inv. Purchase Purchase Sale Sale Purchase Sale

# Units

Costs

3,000 1,000 1,500 5,500 (3,500) 2,000 (700) 1,300 500 1,800 1,200 600

$91,500 40,000 75,000 206,500 (131,425) 75,075 (26,285) 48,790 15,020 63,810 42,540 $21,270

Cost per unit $30.50 $40.00 $50.00 $37.55

Sales

$315,000 $37.55 $52,500 $37.53 $35.45 $35.45

Weighted-average cost of goods sold: Mar 15 sale 3500 units X $37.55 = Mar 20 sale 700 units X $37.55 = Mar 27 sale 1,200 units X $35.45 =

$131,425 $ 26,285 $ 42,540

Total cost of goods sold =

$200,250

Gross margin = $439,500 – $200,250 =

$239,250

$72,000 $439,500

EI = $21,270 from the table or (600 units X $35.45/unit = $21,270) b.

Under FIFO, the gross margin is $238,000 Gross margin % = $238,000 / $439,500 = 54.15% Under weighted-average, the gross margin is $ $239,262 Gross margin % = $239,250 / $439,500 = 54.44% Weighted Average produced the higher gross margin.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-3A a. i.

FIFO

Mar 1 Mar 7 8 15 20 25 27 TOTALS

Beg. Inv. Purchase Purchase Sale Sale Purchase Sale

# Units

Purchases

3000 1000 1500 (3500) (700) 500 (1200) 600

$91,500 $40,000 $75,000

Cost per unit $30.50 $40.00 $50.00

Sales

$315,000 $52,500 $15,020 $221,520

$30.04 COGAS

$72,000 $439,500

Cost of goods available for sale = $221,520 Total units available = 3000+ 1000+ 1500 + 500 = 6000 Total units sold= 3500+ 700 + 1200 = 5400 Total units remaining = 6000 – 5400 = 600 Cost of goods sold: 3000 units x $30.50= $91,500 1000 units x $40.00 = $40,000 1400 units X $50.00 = $70,000 5400 units $201,500 Gross margin = Sales revenue - COGS Gross margin = $439,500 - $201,500 = $238,000 Ending Inventory = (500 X $30.04) + (100 X $50) = $20,020 or = COGAS – COGS = $221,520 – $201,500 = $ 20,020

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-3A (Continued)

ii. Weighted-average Cost of goods available for sale = $221,520 Total units available = 3000+ 1000+ 1500 + 500 = 6000 Total units sold= 3500+ 700 + 1200 = 5400 Total units remaining = 6000 – 5400 = 600 Weighted-average cost per unit = COGAS / Total units available = $221,520 / 6000 units available = $36.92 per unit Units sold = 3500+ 700 + 1200 = 5400 Cost of goods sold = 5400 x $36.92 = $199,368 Gross margin = $439,500 – $199,368 = $240,132 Gross Margin % = $240,132 / $439,500 = 54.64% Ending Inventory = 600 units X $36.92 = $22,152 or = COGAS – COGS = $221,520 – $199,368 = $22,152 b. Under FIFO: Gross margin = $238,000 Gross margin % = $238,000 / $439,500 = 54.15% Under Weighted-Average: Gross margin = $240,132 Gross margin % = $240,132 / $439,500 = 54.64% Weighted Average produced the higher gross margin ratio. LO 9 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-4A a.

Weighted-average COGS: # Units Mar. 1 Beg Inv 2 Sales 13 Purchase 20 Sales

7,500 (5,000) 2,500 5,000 7,500 (2,800)

Cost per unit $7.00 $7.00 $7.00 $8.00 $7.6667 $7.6667

Purchases $52,500

$40,000

$92,500 COGAS

TOTALS

4,700

$7.6667

Mar. 2 sale 5,000 units X $7.00/unit = Mar.20 sale ($52,500 – $35,000 + $40,000) ÷ 7,500 units = $7.6667 per unit 2,800 X $7.6667 =

$35,000

21,467 $56,467

b. FIFO COGS: Mar. 2 sale 5,000 units X $7.00/unit = $35,000 Mar.20 sale 2,500 units X $7.00/unit = $17,500 + 300 units X $8.00/unit = 2,400 19,900 $54,900 c. The FIFO cost formula results in a greater gross margin for March. This is because the total sales revenue is the same under either method, but the COGS is smaller under FIFO because the older, lower costs were assigned to cost of goods sold, resulting in a larger gross margin for the month.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-4A (Continued) d. Ending inventory, weighted-average cost: 4,700 units X $7.6667/unit = $36,033 or $92,500 – $56,467 = $36,033 Ending inventory, FIFO cost: 4,700 units X $8.00/unit $92,500 – $54,900

= $37,600 or = $37,600

Therefore, the FIFO cost formula results in a larger inventory balance at the end of March. e. Because the cost of goods available for sale ($92,500) is the same regardless of the cost formula used, the cost formula with the higher ending inventory should also result in the lower cost of goods sold amount, the larger gross margin and the larger net income. This is the case when the FIFO inventory cost formula is used above. Alternatively, the cost formula that allocates the lower cost to ending inventory will have the larger cost of goods sold amount on the statement of income. This, in turn, results in a smaller gross margin and smaller net income. This is the case when the weighted-average cost formula is used above. LO 4,6 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-5A a. Weighted-average COGS: # Units Mar. 1 Beg Inv 2 Sales 13 Purchase 20 Sales Totals

Cost per unit 7,500 $7.00 (5,000) 2,500 $7.00 5,000 $8.00 7,500 (2,800) 4,700

Purchases $52,500

$40,000

$92,500 COGAS

Weighted-average cost of goods available for sale/unit = $92,500 ÷ (7,500 units + 5,000 units) = $7.40 per unit Cost of goods sold = (5,000 units + 2,800 units) X $7.40/unit = $57,720 b. FIFO COGS: Mar. 2 sale 5,000 units X $7.00/unit = $35,000 Mar.20 sale 2,500 units X $7.00/unit = $17,500 + 300 units X $8.00/unit = 2,400 19,900 $54,900 c. The FIFO cost formula results in a higher gross margin for March. This is because the total sales revenue is the same under both methods, but the COGS is smaller under FIFO, resulting in a larger gross margin for the month. d. Ending inventory, weighted-average cost: 4,700 units X $7.40/unit = $34,780 or $92,500 – $57,720 = $34,780 Ending inventory, FIFO cost: 4,700 units X $8.00/unit $92,500 – $54,900

= $37,600 or = $37,600

Therefore, the FIFO cost formula results in a larger inventory balance at the end of March.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-5A (Continued) e. Because the cost of goods available for sale ($92,500) is the same regardless of the cost formula used, the cost formula with the higher ending inventory should also have the lower cost of goods sold, the larger gross margin and the larger net income. This is the case when the FIFO inventory cost formula is used above. Alternatively, the cost formula that allocates the lower cost to ending inventory will have the larger amount of cost of goods available for sale as cost of goods sold on the statement of income. This, in turn, provides a smaller gross margin and smaller net income. This is the case when the weighted-average cost formula is used above. LO 9 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP7-6A a. Perpetual i. FIFO # Units Aug. 1 6

Beg. Inv. Purchase

Sale

Purchase

Sale

Purchase

Sale

15 35 50 (5) 45 10 55 (40) 15 5 20

Cost per unit $1,000 $ 800

Costs $15,000 28,000 43,000

$1,100

$11,000

900

4,500

(10) 10

$58,500

 COGAS

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-6A (Continued) Cost of goods available for sale = $58,500 Total units available for sale = 65 units Total units sold = 55 units Total units remaining = 10 units FIFO cost of goods sold (55 units sold) = (15 x $1,000) + (35 x $800) + (5 x $1,100) = $48,500 or Sale (Aug 8) Sale (Aug 20)

5 x $1,000 10 x $1,000 30 x $800 = 40

= $5,000 A = $10,000 $24,000 $34,000 B

Sale (Aug 30)

5 x $800 5 x $1,100 10

= $4,000 = $5,500 $9,500 C

COGS

=A+B+C = $5,000 + $34,000 + $9,500 = $48,500

Ending Inventory = (5 units X $1,100) + (5 units X $900) = $10,000 or = COGAS – COGS = $58,500 – $48,500 = $10,000 Gross margin = Sales Revenue – Cost of Goods Sold = (55 x $2000) – $48,500 = $110,000 – $48,500 = $61,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-6A (Continued) ii. Weighted-average # Units Aug 1 6 8

Beg. Inv. Purchase Sale

Purchase

Sale

Purchase

Sale

15 35 50 (5) 45 10 55 (40) 15 5 20

Cost per unit $1,000.00 $800.00 $860.00

Costs $15,000 28,000 43,000

$860.00 1,100.00 $903.64

38,700 11,000 49,700

$903.64 $900.00 902.73

13,555 4,500 18,055

$902.73

$9,027.27

(10) 10

Weighted-average cost of goods sold: (there are discrepancies from rounding unit costs) Aug 8 sale 5 x $860 = $4,300 Aug 20 sale 40 x $903.64 = 36,145.45 Aug 30 sale 10 x $902.73 = 9,027.27 $49,472.73 Ending Inventory = 10 units x $902.73 = $9,027.30 or = COGAS – COGS = $58,500 - $49,472.73 = $9,027.27 Gross margin = Sales Revenue – Cost of Goods Sold = (55 x $2000) – $49,472.73 = $110,000 – $49,472.73 = $60,527.27

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-6A (Continued) b. The FIFO method results in the higher gross margin. This can be explained by the fact that the FIFO ending inventory costs deferred to the statement of financial position are higher than the costs deferred to the next period under the weighted-average method. The other result is that COGS is lower under the FIFO method, resulting in a higher gross margin amount and percentage. LO 4,6 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-7A a.

Periodic ii. FIFO # Units Aug. 1 6

Beg. Inv. Purchase

Sale

Purchase

Sale

Purchase

Sale

15 35 50 (5) 45 10 55 (40) 15 5 20

Cost per unit $1,000 $ 800

Costs $15,000 28,000 43,000

$1,100

$11,000

900

4,500

(10) 10

Cost of goods available for sale = $58,500 Total units available for sale = 65 units Total units sold = 55 units Total units remaining = 10 units

$58,500

 COGAS

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-7A (Continued) FIFO cost of goods sold (55 units sold) = (15 x $1,000) + (35 x $800) + (5 x $1,100) = $48,500 or Sale (Aug 8) Sale (Aug 20)

5 x $1,000 10 x $1,000 30 x $800 = 40

= $5,000 A = $10,000 $24,000 $34,000 B

Sale (Aug 30)

5 x $800 5 x $1,100 10

= $4,000 = $5,500 $9,500 C

COGS

=A+B+C = $5,000 + $34,000 + $9,500 = $48,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-7A (Continued) ii. Weighted-average: W/A cost per unit = COGAS / Total units available = $58,500 / 65 units = $900 W/A Cost of goods sold: 55 units x $900= $49,500 W/A Ending inventory: 10 units x $900 = $9,000 or = COGAS – COGS = $58,500 – $49,500 = $9,000 Gross margin = Sales Revenue – Cost of Goods Sold = (55 x $2000) – $49,500 = $110,000 – $49,500 = $60,500 b. FIFO produces the higher gross margin because the FIFO ending inventory is larger than the weighted-average amount for ending inventory, and because FIFO COGS is lower than the weightedaverage COGS. LO 9 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8A a. Perpetual i.

FIFO # Units

Feb 1 10

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

7,500 (6,500) 1,000 4,000 5,000 500 5,500 (4,000) 1,500 4,000 5,500 (2,900) 2,600

Cost per unit $25.00

$187,500

26.00

104,000

29.00

14,500

35.00

140,000

Cost of goods available for sale = $446,000 Total units available for sale = 16,000 units Total units sold = 13,400 units Total units remaining = 2,600 units

Costs

$446,000

 COGAS

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8A (Continued) FIFO cost of goods sold (13,400 units sold) = (7,500 x 25) + (4,000 x $26) + (500 x $29) + (1,400 x 35) = $355,000 or Sale (Feb 10)

6,500 x $25

= $162,500 A

Sale (Feb 25)

1,000 x $25 3,000 x $26 4,000

= $25,000 = $78,000 $103,000 B

Sale (Feb 28)

1,000 x $26 500 x $29 1,400 x $35 2,900

= $26,000 = $14,500 = $49,000 $89,500 C

COGS

=A+B+C = $162,500 + $103,000 + $89,500 = $355,000

Ending Inventory = (2,600 units X $35) = $91,000 or = COGAS – COGS = $446,000 – $355,000 = $91,000 Gross margin = Sales Revenue – Cost of Goods Sold = (13,400 x $85) – $355,000 = $1,139,000 – $355,000 = $784,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8A (Continued) ii. Weighted-average # Units Feb 1 10

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

Cost per unit $25.00

7,500 (6,500) 1,000 4,000 5,000 500 5,500 (4,000) 1,500 4,000 5,500 (2,900) 2,600

$25.00 26.00 $25.80 29.00 $26.09 $26.09 $35.00 $32.57 $32.57

Costs $187,500 (162,500) 25,000 104,000 129,000 14,500 143,500 (104,360) 39,140 140,000 179,140 (94,453) $84,687

Weighted-average cost of goods sold: Feb 10 sale Feb 25 sale Feb 28 sale

6,500 x $25 4,000 x $26.09 2,900 x $32.57

= = =

$162,500 104,360 94,453 $361,313

Ending Inventory = COGAS – COGS = $446,000 - $361,313 = $84,687 or 2,600 units x $32.57 = $84,682 (difference $5 due to rounding) Gross margin = Sales Revenue – Cost of Goods Sold = (13,400 x $85) – $361,313 = $1,139,000 – $361,313 = $777,687

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8A (Continued) c. The FIFO method results in the higher gross margin. This can be explained by the fact that inventory costs were increasing (from $25 to $35) and under FIFO, these higher costs are assigned to ending inventory rather than COGS. As a result, COGS is lower under FIFO and gross margin in higher. LO 4,6 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP7-9A b. Periodic i. FIFO # Units Feb 1 10

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

7,500 (6,500) 1,000 4,000 5,000 500 5,500 (4,000) 1,500 4,000 5,500 (2,900) 2,600

Cost per unit $25

Costs $187,000

104,000

14,500

140,000

$446,000

 COGAS

Cost of goods available for sale = $446,000 Total units available for sale = 16,000 units Total units sold = 13,400 units Total units remaining = 2,600 units FIFO cost of goods sold (13,400 units sold) = (7,500 x 25) + (4,000 x $26) + (500 x $29) + (1,400 x 35) = $355,000 or

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-9A (Continued) Sale (Feb 10)

6,500 x $25

= $162,500 A

Sale (Feb 25)

1,000 x $25 3,000 x $26 4,000

= $25,000 = $78,000 $103,000 B

Sale (Feb 28)

1,000 x $26 500 x $29 1,400 x $35 2,900

= $26,000 = $14,500 = $49,000 $89,500 C

COGS

=A+B+C = $162,500 + $103,000 + $89,500 = $355,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-9A (Continued) ii. Weighted-average: W/A cost per unit = COGAS / Total units available = $446,000 / 16,000 units = $27.88 W/A Cost of goods sold: 13,400 units x $27.88 = $373,592 W/A Ending inventory: = COGAS – COGS = $446,000 – $373,592 = $72,408 Gross margin = Sales Revenue – Cost of Goods Sold = (13,400 x $85) – $373,592 = $1,139,000 – $373,592 = $765,408 b. FIFO produces the higher gross margin because the FIFO ending inventory is larger than the weighted-average amount for ending inventory, and because FIFO COGS is lower than the weightedaverage COGS. LO 9 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-10A a. Item

(a)Unit Cost ($)

(b)Unit NRV ($)

Lower of (a)and(b) ($)

# of Units

Ending Inventory ($)

259 412

400 350

259 350

13 10

3,367 3,500

120 117

120 110

5 8

600 880 $8,347

Skates Bauer CCM Running shoes Adidas Nike Total

The lower of cost and net realizable value amount on an individual item basis to be reported on the statement of financial position is $8,347. b. Item Skates Bauer CCM Running shoes Adidas Nike

Unit Cost ($)

# of Units

Ending Inventory ($)

259 412

13 10

3,367 4,120

120 117

5 8

600 936 $9,023

The ending inventory balance for skates and running shoes using the historical unit costs provided is $9,023. c. Because current assets such as inventory should be reported on the statement of financial position at no more than the amount of cash expected to be generated from their use or sale, the lower of cost and net realizable value amount of $8,347 represents more faithfully, the inventory value for financial reporting purposes. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-11A a. The decline in net realizable value is relevant because when users see inventory listed on the statement of financial position they assume that it can be sold for at least as much as its carrying amount. This is not the case for CPC’s newsprint inventory, whose net realizable value is now less than its cost. Consequently, the inventory should be reported at its lower net realizable value, rather than its cost. b. Inventory must be reported at the lower of cost and net realizable value on the statement of financial position and the current NRV is $505 per tonne which is less than the average cost of $520 per tonne. As a result, the inventory should be valued at $631,250 ($505 x 1,250 tonnes). This assumes that the selling prices in the markets in which CPC sells its newsprint reflect the same prices as the international market. If CPC also has to incur additional selling costs associated with selling its newsprint, the unit net realizable value would have to be further reduced by the per tonne selling costs. c. CPC would also have to determine whether it has firm contracts with its customers that provide for a full recovery of CPC’s inventory and selling costs in which case no reduction in carrying amount would be required at the end of 2024. d. In deciding the dollar amount of inventory to report, several accounting concepts are important. The accounting principle of historic cost is key, which states that assets should normally be valued at their acquisition or production cost. However, the qualitative characteristic of relevance comes into play in this case where historic cost may not be the most relevant measure for the inventory. Net realizable value would be more useful for investor decision-making. The requirement for accounting measurements to represent faithfully what is being reported would also argue for NRV, which comes closer to the actual value of the inventory asset to the company. LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-12A

1 2 3 4

Cost of Sales Not affected Understated Understated Understated

Gross Margin Not affected Overstated Overstated Overstated

Inventory Understated Overstated Overstated Overstated

Retained Earnings Not affected Overstated Overstated Overstated

Current Ratio Overstated Overstated Overstated Overstated

Inventory Turnover Overstated Understated Understated Understated

LO 5 BT: AP Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP7-13A The first step is to estimate the cost-to-sales ratio from the prior year: $597,060 / $963,000 = 62%. We will assume that the mark-ups this year and the product mix sold are similar to the 2023 experience. Using this estimate, compute 2024 inventory balance at the date of the fire: Ending Inventory = Beginning inventory + purchases – cost of goods sold Estimate of Cost of Goods Sold = 62% of sales = $678,000 x 62% = $420,360 Therefore, the estimated amount of inventory on hand at the date of the fire = Ending Inventory = $88,000 + $486,000 – $420,360 = $153,640 LO 8 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-14A The estimated cost of the inventory lost in the flooded warehouse can be determined by subtracting the company’s actual inventory in all other warehouses after the flood on April 25 from an estimate of the company’s total inventory on hand just before the flood. Using the cost-to-sale ratio, the company’s estimated total ending inventory on April 25 was: Cost of Goods Sold

= 65% of sales = $1,028,000 x 65% = $668,200

Estimated ending Inventory = Beginning inventory + purchases – cost of goods sold Therefore: Estimated ending inventory

= $137,200 + $742,500 – $668,200 = $211,500 (for all locations)

The estimated cost of the inventory destroyed in the flash flood was: = Estimated inventory – Inventory at all other locations = $211,500 – $121,300 = $90,200 LO 8 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-15A

Clovis Inc. a. Average inventory: Inventory turnover ratio: COGS/average inventory

Days to sell inventory

b. Gross margin: Sales – COGS

Bantu Ltd.

($155,000 + $225,000)/2 ($675,000 + $420,000)/2 = $190,000 = $547,500 $1,375,000/$190,000 = 7.2 times

$1,945,000/$547,000 = 3.6 times

365 / 7.2 times = 50.7 days

365 / 3.6 times = 101.4 days

$1,875,000 - $1,375,000 $4,885,000 - $1,945,000 = $500,000 = $2,940,000

Gross margin ratio: $500,000/$1,875,000 Gross margin/Sales revenue = 26.7%

$2,940,000/$4,885,000 = 60.2%

c. and d. Clovis Inc. moves its inventory faster – 7.2 times in the year while Bantu sells through its inventory only 3.6 times in the year. This does not necessarily mean that Clovis manages its inventory better. Clovis has lower inventory levels to support a lower level of sales than Bantu. Because its sales are lower, Clovis might carry less variety within its product line, including items that have a lower mark-up. Bantu’s gross margin ratio at 60.2%, for example, is considerably higher than Clovis’ at only 26.7%. Two different strategies could be followed by the two companies. Because the gross margin earned is a function of the number of units sold and the gross margin earned on each unit sold, companies can follow a strategy of either increasing its turnover and sales, accepting a lower gross margin per unit; or a policy of earning a larger mark-up per unit but on fewer sales. In this case, Clovis is turning its inventory over faster, but it appears to be at the cost of reduced margin per unit. Since Clovis is a smaller operation than Bantu, it may be a newer entrant in the market.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-15A (Continued) Another issue that should be investigated is whether costs are increasing for the product lines sold and if Clovis is using a weighted-average cost formula while Bantu is using a FIFO formula. The effect of using a weighted-average approach when prices are rising is to have a lower cost of ending inventory and a resulting higher inventory turnover rate for no reason other than the choice of accounting policy. e. There is insufficient information to determine which company is actually better managed. While they are competitors, no information is provided about how they are attempting to compete, whether Clovis is a new market entrant, or what accounting policies they are following. On the surface, it appears that Bantu Ltd. is better because it has better results on basis of gross margin earned in total and per dollar of sales. f

If Clovis were to reduce its days to sell inventory ratio by 5 days (from 50.7 to 45.7 days) the following amount of capital would be freed up. The turnover of inventory ratio would be 7.99 times (365 days / 45.7). Dividing the company’s cost of goods sold by this proposed inventory turnover ratio gives us the proposed average inventory balance. In this case that would be $172,090 ($1,375,000 / 7.99), which is $52,910 less than inventory balance at the end of 2024. This indicates that the company would be able to free up just under $53 thousand in capital.

LO 6,8 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-16A a. Gross margin: Sales revenue - COGS

Gross margin ratio: Gross margin/Sales revenue Average inventory Inventory turnover ratio: COGS/Average inventory

i.Chicoutimi Ltée

ii. Jonquière Ltée

$6,150,000 - $2,460,000 = $3,690,000

$2,406,250 - $962,500 = $1,443,750

$3,690,000/$6,150,000 = 60%

$1,443,750/$2,406,250 = 60%

($395,000 + $425,000)/2 = $410,000

($150,000 + $200,000)/2 = $175,000

$2,460,000/$410,000 = 6 times

$962,500/$175,000 = 5.5 times

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-16A (Continued) b. i. Cost of Goods Sold Inventory

75,000 75,000

ii. Revised cost of goods sold: $2,460,000 + $75,000 = $2,535,000 Revised average inventory: ($395,000 + $425,000 - $75,000)/2 = $372,500 Gross margin: $6,150,000 - $2,535,000

= $3,615,000

Gross margin ratio: $3,615,000/$6,150,000

= 58.8%

Inventory turnover ratio: $2,535,000/$372,500

= 6.8 times

iii. When the correction is made to reduce the inventory valuation by $75,000, the costs associated with the decline in value become part of the cost of goods sold. With a higher cost of sales, the amount remaining to cover the other expenses and contribute to profit (the gross margin) goes down by the same amount. Therefore, the cost of goods sold percentage of sales increases and the gross margin ratio decreases. The inventory turnover ratio, on the other hand, appears to improve as it is now a larger number. This is deceptive and a result of merely increasing the numerator and decreasing the denominator as a result of recognizing the inventory shrinkage. c.

Without additional information and assuming Jonquière Ltée did not require a valuation adjustment this year, it appears from the ratios that the two companies are fairly evenly managed. Jonquière’s gross margin ratio is marginally higher than Chicoutimi’s and its inventory turnover ratio – based on “cost” numbers – is a little below that of Chicoutimi. However, the fact that Chicoutimi’s management was required to recognize a $75,000 impairment – or 17.6% of its ending inventory value, probably indicates that there was mismanagement on Chicoutimi’s part for that significant shrinkage factor. It appears that Jonquière Ltée is better at managing its inventory.

LO 6,8 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP7-1B

Burnley, Understanding Financial Accounting, Third Canadian Edition

LGC holds all their inventory on consignment which means they never actually take ownership of the clothing they are selling it on behalf of the individuals who provided them the clothes. The amount of inventory at December 31, 2024 is therefore zero.

The difference between the gross proceeds from sales to customers of $250,000 and the generated revenue of $100,000 is the amount due to the consignors. As LGC never owns the inventory they don’t have cost of goods sold related to the clothing. LGC is an agent that earns 40% of gross sales as revenue and pays the difference of $150,000 ($250,000 – $100,000) to the consignors.

LO 2 BT: AP Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP7-2B a. i. FIFO Cost of goods sold = (150 x $500) + (50 x $550) + (150 x $600) = $75,000 + $27,500 + $90,000 = $192,500 Gross margin = Sales Revenue - COGS Gross margin = $245,000 – $192,500 = $52,500 Ending Inventory = (50 units X $600) + (75 units X $660) = $79,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-2B (Continued) ii. Weighted-average

May 1 May 5

Beg. Inv. Sale

Purchase

Sale

Purchase

# Units

Costs

150 (100) 50 50 100 200 300 (200) 100 (50) 50 75 125

$75,000 (50,000) 25,000 27,500 52,500 120,000 172,500 (115,000) 57,500 (28,750) 28,750 49,500 $78,250

Cost per unit $500 $500 $500

Sales

$65,000

$525 $575 $575 $575 $575 $575 $626

Weighted-average cost of goods sold: May 5 sale 100 units X $500 = May 24 sale 200 units X $575 = May 27 sale 50 units X $575 =

$ 50,000 $115,000 $ 28,750

Total cost of goods sold =

$193,750

Gross margin = $245,000 – $193,750 =

$51,250

$140,000 $40,000 _______ $245,000

EI = $78,250 from the table or (125 units X $626/unit = $78,250) b.

Under FIFO, the gross margin is $52,500 Gross margin % = $52,500 / $245,000 = 21.43% Under weighted-average, the gross margin is $ $51,250 Gross margin % = $51,250 / $245,000 = 20.92% FIFO produced the higher gross margin.

LO 2,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-3B a. i.

May 1 Beg. Inv. May 5 Sale 9 Purchase 13 Purchase 24 Sale 27 Sale 30 Purchase TOTALS

# Units

Purchases

150 (100) 50 200 (200) (50) 75 125

$75,000

Cost per unit $500

Sales

$65,000 $27,500 120,000

$49,500 $272,000

550 600 $140,000 $40,000 660 _______ COGAS $245,000

Cost of goods available for sale = $272,000 Total units available = 150 + 50 + 200 + 75 = 475 Total units sold= 100 + 200 + 50 = 350 Total units remaining = 475 - 350 = 125 Cost of goods sold: 150 units x $500 = 50 units x $550 = 150 units x $600 = Total =

$75,000 $27,500 $90,000 192,500

Gross margin = Sales revenue - COGS Gross margin = $245,000 - $192,500 = $52,500 Ending Inventory = (50 X $600) + (75 X $660) = $79,500 or = COGAS – COGS = $272,000 – $192,500 = $79,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-3B (Continued) ii. Weighted-average Cost of goods available for sale = $272,000 Total units available = 150 + 50 + 200 + 75 = 475 Total units sold= 100 + 200 + 50 = 350 Total units remaining = 475 - 350 = 125 Weighted-average cost per unit = COGAS / Total units available = $272,000 / 475 units available = $572.63 per unit Total units sold= 100 + 200 + 50 = 350 Cost of goods sold = 350 x $572.63 = $200,420.50 Gross margin = $245,000 – $200,420.50 = $44,579.50 Ending Inventory = 125 units X $572.63 = $71,578.75 (rounding difference) or = COGAS – COGS = $272,000 – $200,420.50 = $71,579.50 b. Under FIFO: Gross margin = $52,500 Gross margin % = $52,500 / $245,000 = 21.43% Under Weighted-Average: Gross margin = $44,579.50 Gross margin % = $44,579.50 / $245,000 = 18.20% FIFO produced the higher gross margin ratio. LO 9 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-4B a.

Weighted-average COGS: # Units July 1 Beg Inv 2 Sales 5 Purchase 27 Sales TOTALS

9,500 (8,500) 1,000 7,500 8,500 (5,000)

Cost per unit $15.00 $15.00 $15.00 $18.00 $17.65 $17.65

Purchases $142,500 (127,500) 15,000 135,000 150,000 (88,250)

3,500

July 2 sale 8,500 units X $15.00/unit = July 27 sale ($142,500 – $127,500 + $135,000) ÷ 8,500 units = $17.65 per unit 5,000 X $17.65 =

61,750 $127,500

88,250 $215,750

b. FIFO COGS: July 2 sale 8,500 units X $15.00/unit = July 27 sale 1,000 units X $15.00/unit = $15,000 + 4,000 units X $18.00/unit = $72,000

$127,500 87,000 $214,500

c. The FIFO cost formula results in a greater gross margin for July. This is because the total sales revenue is the same under either method, but the COGS is smaller under FIFO because the older, lower costs were assigned to cost of goods sold, resulting in a larger gross margin for the month. d. Ending inventory, weighted-average cost: 3,500 units $277,500 – $215,750 = $61,750

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-4B (Continued)

Ending inventory, FIFO cost: 3,500 units X $18.00/unit $277,500 – $214,500

= $63,000 or = $63,000

Therefore, the FIFO cost formula results in a larger inventory balance at the end of July. e. Because the cost of goods available for sale ($277,500) is the same regardless of the cost formula used, the cost formula with the higher ending inventory should also result in the lower cost of goods sold amount, the larger gross margin and the larger net income. This is the case when the FIFO inventory cost formula is used above and costs are rising. Alternatively, the cost formula that allocates the lower cost to ending inventory will have the larger cost of goods sold amount on the statement of income. This, in turn, results in a smaller gross margin and smaller net income. This is the case when the weighted-average cost formula is used above. LO 2,4 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP7-5B a. Weighted-average COGS: # Units Jul. 1 Beg Inv 2 Sales 5 Purchase 27 Sales Totals

Cost per unit 9,500 $15.00 (8,500) 1,000 $15.00 7,500 $18.00 8,500 (5,000) 3,500

Purchases $142,500

$135,000

$277,500 COGAS

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-5B (Continued) Weighted-average cost of goods available for sale/unit = $277,500 ÷ (9,500 units + 7,500 units) = $16.32 per unit COGS = (8,500 units + 5,000 units) X $16.32/unit = $220,320 b. FIFO COGS: July 2 sale 8,500 units X $15.00/unit = July 27 sale 1,000 units X $15.00/unit = $15,000 + 4,000 units X $18.00/unit = $72,000

$127,500 87,000 $214,500

c. The FIFO cost formula results in a higher gross margin for March. This is because the total sales revenue is the same under both methods, but the COGS is smaller under FIFO, resulting in a larger gross margin for the month. d. Ending inventory, weighted-average cost: 3,500 units $277,500 – $220,320 = $57,180 Ending inventory, FIFO cost: 3,500 units X $18.00/unit $277,500 – $214,500

= $63,000 or = $63,000

Therefore, the FIFO cost formula results in a larger inventory balance at the end of July. e. Because the cost of goods available for sale ($277,500) is the same regardless of the cost formula used, the cost formula with the higher ending inventory should also result in the lower cost of goods sold amount, the larger gross margin and the larger net income. This is the case when the FIFO inventory cost formula is used above and costs are rising. Alternatively, the cost formula that allocates the lower cost to ending inventory will have the larger cost of goods sold amount on the statement of income. This, in turn, results in a smaller gross margin and smaller net income. This is the case when the weighted-average cost formula is used above. LO 9 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-6B a. Perpetual i.

FIFO # Units

Mar. 1 7

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

6,000 (4,000) 2,000 2,500 4,500 800 5,300 (2,500) 2,800 4,000 6,800 (3,500) 3,300

Cost per unit $18.00

Costs $108,000

$20.00

$50,000

$20.00

$16,000

$25.00

100,000

$274,000

 COGAS

Cost of goods available for sale = $274,000 Total units available for sale = 13,300 units Total units sold = 10,000 units Total units remaining = 3,300 units FIFO cost of goods sold (10,000 units sold) = (6,000 x $18) + (2,500 x $20) + (800 x $20) + (700 x $25) = $191,500 or Sale (March 7)

4,000 x $18

= $72,000 A

Sale (March 18) 2,000 x $18 500 x $20

= $36,000 = $10,000 $46,000 B

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-6B (Continued) Sale (March 29)

COGS

2,800 x $20 700 x $25 3,500

= $56,000 = $17,500 $73,500 C

=A+B+C = $72,000 + $46,000 + $73,500 = $191,500

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

6,000 (4,000) 2,000 2,500 4,500 800 5,300 (2,500) 2,800 4,000 6,800 (3,500) 3,300

Cost per unit $18.00 $18.00 $18.00 $20.00 $19.11 $20.00 $19.25 $19.25 $25.00 $22.63

Costs $108,000 (72,000) 36,000 50,000 86,000 16,000 102,000 (48,125) 53,875 100,000 153,875 (79,205) $74,670

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-6B (Continued) Weighted-average cost of goods sold: March 7 sale 4,000 x $18.00 = March 18 sale 2,500 x $19.25 = March 29 sale 3,500 x $22.63 =

$72,000 48,125 79,205 $199,330

Ending Inventory = 3,300 units = COGAS – COGS = $274,000 - $199,330 = $74,670 Gross margin = Sales Revenue – Cost of Goods Sold = (10,000 x $65) – $199,330 = $650,000 – $199,330 = $450,670 b. The FIFO method results in the higher gross margin. This can be explained by the fact that the FIFO ending inventory costs deferred to the statement of financial position are higher than the costs deferred to the next period under the weighted-average method. The other result is that COGS is lower under the FIFO method, resulting in a higher gross margin amount and percentage. LO 2,4 BT: AP Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-7B a. Periodic i. FIFO # Units Mar. 1 7

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

6,000 (4,000) 2,000 2,500 4,500 800 5,300 (2,500) 2,800 4,000 6,800 (3,500) 3,300

Cost per unit $18.00

Costs $108,000

$20.00

$50,000

$20.00

$16,000

$25.00

100,000

$274,000

 COGAS

4,000 x $18

= $72,000 A

Sale (March 18) 2,000 x $18 500 x $20

= $36,000 = $10,000 $46,000 B

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-7B (Continued) Sale (March 29)

COGS

2,800 x $20 700 x $25 3,500

= $56,000 = $17,500 $73,500 C

=A+B+C = $72,000 + $46,000 + $73,500 = $191,500

Ending Inventory = (3,300 units X $25) = $82,500 or = COGAS – COGS = $274,000 – $191,500 = $82,500 Gross margin = Sales Revenue – Cost of Goods Sold = (10,000 x $65) – $191,500 = $650,000 – $191,500 = $458,500 ii. Weighted-average W/A cost per unit = COGAS / Total units available = $274,000 / 13,300 units = $20.60 W/A Cost of goods sold: 10,000 units x $20.60 = $206,000 W/A Ending inventory: 3,300 units = COGAS – COGS = $274,000 – $206,000 = $68,000 Gross margin = Sales Revenue – Cost of Goods Sold = (10,000 x $65) – $206,000 = $650,000 – $206,000 = $444,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-7B (Continued) b. FIFO produces the higher gross margin because the FIFO ending inventory is larger than the weighted-average amount for ending inventory, and because FIFO COGS is lower than the weightedaverage COGS, because costs rose during the period. LO 9 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP7-8B a. Perpetual i. FIFO # Units Oct. 1 5

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

2,500 (350) 2,150 1,200 3,350 500 3,850 (1,500) 2,350 2,500 4,850 (3,500) 1,350

Cost per unit $13.50

Costs $33,750

14.00

16,800

13.50

6,750

12.00

30,000

$87,300

 COGAS

Cost of goods available for sale = $87,300 Total units available for sale = 6,700 units Total units sold = 5,350 units Total units remaining = 1,350 units FIFO cost of goods sold (5,350 units sold) = (2,500 x 13.50) + (1,200 x $14) + (500 x $13.50) + (1,150 x 12) = $71,100 Or

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8B (Continued) Sale (Oct 5)

350 x $13.50

= $4,725 A

Sale (Oct 15)

1,500 x $13.50

= $20,250 B

Sale (Oct 31)

650 x $13.50 1,200 x $14 500 x $13.50 1,150 x $12

= $8,775 =$16,800 = $6,750 =$13,800 $46,125 C

COGS

=A+B+C = $4,725 + $20,250 + $46,125 = $71,100

Ending Inventory = (1,350 units X $12) = $16,200 or = COGAS – COGS = $87,300 – $71,100 = $16,200 Gross margin = Sales Revenue – Cost of Goods Sold = [(350 x $25) + (5,000 x $35)] – $71,100 = $183,750 – $71,100 = $112,650

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8B (Continued) ii. Weighted-average # Units Oct 1 10

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

2,500 (350) 2,150 1,200 3,350 500 3,850 (1,500) 2,350 2,500 4,850 (3,500) 1,350

Cost per unit $13.50

14.00 13.68 13.50 13.66

12.00 12.80

Weighted-average cost of goods sold: Oct 10 sale Oct 15 sale Oct 31 sale

350 x $13.500 = 1,500 x $13.66 = 3,500 x $12.80 =

$4,725 20,490 44,800 $70,015

Ending Inventory = 1,350 units = COGAS – COGS = $87,300 - $70,015 = $17,285

Costs $33,750 (4,725) 29,025 16,800 45,825 6,750 52,575 (20,490) 32,085 30,000 62,085 (44,800) $17,285

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-8B (Continued) Gross margin = Sales Revenue – Cost of Goods Sold = [(350 x $25) + (5,000 x $35)] – $70,015 = $183,750 – $70,015= $113,735 The FIFO method results in the lower gross margin. This can be explained by the fact that costs are decreasing and the newest inventory is on the statement of financial position. The FIFO ending inventory costs deferred to the statement of financial position are lower than the costs deferred to the next period under the weighted-average method. The other result is that COGS is higher under the FIFO method, resulting in a lower gross margin amount and percentage. LO 2,4 BT: AP Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-9B a. Periodic i. FIFO # Units Oct. 1 5

Beg. Inv. Sale

Purchase

Sale

Purchase

Sale

2,500 (350) 2,150 1,200 3,350 500 3,850 (1,500) 2,300 2,500 4,850 (3,500) 1,350

Cost per unit $13.50

Costs $33,750

14.00

16,800

13.50

6,750

12.00

30,000

$87,300

 COGAS

350 x $13.50

= $4,725 A

Sale (Oct 15)

1,500 x $13.50

= $20,250 B

Sale (Oct 31)

650 x $13.50 1,200 x $14 500 x $13.50 1,150 x $12

= $8,775 =$16,800 = $6,750 =$13,800 $46,125 C

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-9B (Continued) COGS

=A+B+C = $4,725 + $20,250 + $46,125 = $71,100

ii. Weighted-average: W/A cost per unit = COGAS / Total units available = $87,300 / 6,700 units = $13.03 W/A Cost of goods sold: 5,350 units x $13.03 = $69,710.50 W/A Ending inventory: 1,350 units = COGAS – COGS = $87,300 – $69,710.50 = $17,589.50 ($1 rounding) Gross margin

= Sales Revenue – Cost of Goods Sold = [(350 x $25) + (5,000 x $35)] – $69,710.50 = $183,750 – $69,710.50 = $114,039.50

b. FIFO produces the lower gross margin when costs are decreasing because the FIFO ending inventory is less than the weighted-average amount for ending inventory, and because FIFO COGS is higher than the weightedaverage COGS. LO 9 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-10B a. Item

Skates: Bauer CCM Warrior Helmets: Adidas Nike Mission Total

(a)Unit Cost ($)

(b)Unit NRV ($)

Lower of (a)and(b) ($)

# of Units

Ending Inventory ($)

95 200 250

200 150 250

95 150 250

23 13 57

2,185 1,950 14,250

190 175 75

125 175 200

125 175 75

11 10 25

1,375 1,750 1,875 $23,385

The lower of cost and net realizable value amount on an individual item basis to be reported on the statement of financial position is $23,385. b. Item Skates Bauer CCM Warrior Helmets Adidas Nike Mission

Unit Cost ($)

# of Units

Ending Inventory ($)

95 200 250

23 13 57

2,185 2,600 14,250

190 175 75

11 10 25

2,090 1,750 1,875 $24,750

The ending inventory balance for skates and helmets using the historical unit costs provided is $24,750. c. Because current assets such as inventory should be reported on the statement of financial position at no more than the amount of cash expected to be generated from their use or sale, the lower of cost and net realizable value amount of $23,385 represents more faithfully, the inventory value for financial reporting purposes. LO 5 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-11B a. The decline in net realizable value is relevant because when users see inventory listed on the statement of financial position they assume that it can be sold for at least as much as its carrying amount. This is not the case for POC’s potash, whose net realizable value is now less than its cost. Consequently, the inventory should be reported at its lower net realizable value, rather than its cost. b. Inventory must be reported at the lower of cost and net realizable value on the statement of financial position and the current NRV is $235 per tonne which is less than the average cost of $250 per tonne. As a result, the inventory should be valued at $554,600 ($235 x 2,360 tonnes). This assumes that the selling prices in the markets in which POC sells its potash reflect the same prices as the international market. If POC also has to incur additional selling costs associated with selling its potash, the unit net realizable value would have to be further reduced by the per tonne selling costs. c. POC would also have to determine whether it has firm contracts with its customers that provide for a full recovery of POC’s inventory and selling costs, in which case no reduction in carrying amount would be necessary at the end of 2024. d. In deciding the dollar amount of inventory to report, several accounting concepts are important. The accounting principle of historic cost is key, which states that assets should normally be valued at their acquisition or production cost. However, the qualitative characteristic of relevance comes into play in this case where historic cost may not be the most relevant measure for the inventory. Net realizable value would be more useful for investor decision-making. The requirement for accounting measurements to represent faithfully what is being reported would also argue for NRV, which comes closer to the actual value of the inventory asset to the company. LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-12B

1 2 3 4

Cost of Sales Overstated Understated Understated Overstated

Gross Margin Understated Overstated Overstated Understated

Inventory

Retained Earnings Understated Understated Overstated Overstated Overstated Overstated Understated Understated

Current Ratio Understated Overstated Overstated Understated

Inventory Turnover Overstated Understated Understated Overstated

LO 5 BT: AP Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP7-13B The first step is to estimate the cost-to-sales ratio from the prior year: $(4,450,000 - $1,350,000) / $4,450,000 = 70%. We will assume that the mark-ups this year and the product mix sold are similar to the 2023 experience. Using this estimate, compute 2024 inventory balance at the date of the fire: Ending Inventory = Beginning inventory + purchases – cost of goods sold Estimate of Cost of Goods Sold = 70% of sales = $3,600,000 x 70% = $2,520,000 Therefore, the estimated amount of inventory on hand at the date of the fire = Ending Inventory = $5,600,000 + $1,358,000 – $2,520,000 = $4,438,000 LO 8 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-14B The estimated cost of the inventory lost in the destroyed warehouse can be determined by subtracting the company’s actual inventory in all other warehouses after the fire on October 13 from an estimate of the company’s total inventory on hand just before the fire. Using the cost-to-sale ratio, the company’s estimated total ending inventory on Oct 13 was: Cost of Goods Sold

= 35% of sales = $1,250,000 x 35% = $437,500 Estimated ending Inventory = Beginning inventory + purchases – cost of goods sold Therefore: Estimated ending inventory = $300,000 + $395,000 – $437,500 = $257,500 (for all locations) The estimated cost of the inventory destroyed in the fire was: = Estimated inventory – Inventory at all other locations = $257,500 – $95,000 = $162,500 LO 8 BT: AP Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-15B Mostly Inc. a. Average inventory: Inventory turnover ratio: COGS/average inventory

Days to sell inventory

b. Gross margin: Sales revenue – COGS

Hardly Ltd

($165,000 + $250,000)/2 ($565,000 + $590,000)/2 = $207,500 = $577,500 $900,000/$207,500 = 4.3 times

$1,750,000/$577,500 = 3.0 times

365 / 4.3 times = 84.9 days

365 / 3.0 times = 121.7 days

$1,310,000 - $900,000 = $410,000

$2,890,000 - $1,750,000 = $1,140,000

Gross margin ratio: $410,000/$1,310,000 $1,140,000/$2,890,000 Gross margin/Sales revenue = 31.3% = 39.4% c. and d. Mostly Inc. moves its inventory faster – 4.3 times in the year while Hardly sells through its inventory only 3.0 times in the year. This does not necessarily mean that Mostly manages its inventory better. Mostly has lower inventory levels to support a lower level of sales than Hardly. Because its sales are lower, Mostly might carry less variety within its product line, including items that have a lower mark-up. Hardly’s gross margin ratio at 39.4%, for example, is considerably higher than Mostly’s at only 31,3%. Two different strategies could be followed by the two companies. Because the gross margin earned is a function of the number of units sold and the gross margin earned on each unit sold, companies can follow a strategy of either increasing its turnover and sales, accepting a lower gross margin per unit; or a policy of earning a larger mark-up per unit but on fewer sales. In this case, Mostly is turning its inventory over faster, but it appears to be at the cost of reduced margin per unit. Since Mostly is a smaller operation than Hardly, it may be a newer entrant in the market.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-15B (Continued) Another issue that should be investigated is whether costs are increasing for the product lines sold and if Mostly is using a weighted-average cost formula while Hardly is using a FIFO formula. The effect of using a weighted-average approach when prices are rising is to have a lower cost of ending inventory and a resulting higher inventory turnover rate for no reason other than the choice of accounting policy. e. There is insufficient information to determine which company is actually better managed. While they are competitors, no information is provided about how they are attempting to compete, whether Mostly is a new market entrant, or what accounting policies they are following. On the surface, it appears that Hardly Ltd. is better because it has better results on basis of gross margin earned in total and per dollar of sales. f

If Mostly were to reduce its days to sell inventory ratio by 5 days (from 84.9 to 79.9 days) the following amount of capital would be freed up. The turnover of inventory ratio would be 4.57 times (365 days / 79.9). Dividing the company’s cost of goods sold by this proposed inventory turnover ratio gives us the proposed average inventory balance. In this case that would be $196,937 ($900,000 / 4.57), which is $53,063 less than inventory balance at the end of 2024. This indicates that the company would be able to free up just over $53 thousand in capital.

LO 6,8 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-16B a. Gross margin: Sales revenue - COGS

Gross margin ratio: Gross margin/Sales revenue Average inventory Inventory turnover ratio: COGS/Average inventory

i. Pembroke Ltd

ii. Deep River Ltd

$6,500,425 - $5,700,980 = $799,445

$7,256,700 - $4,500,000 = $2,756,700

$799,445/$6,500,425 = 12.3%

$2,756,700/$7,256,700 = 38.0%

($395,000 + $300,000)/2 = $347,500

($150,000 + $475,000)/2 = $312,500

$5,700,980/$347,500 = 16.4 times

$4,500,000/$312,500 = 14.4 times

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-16B (Continued) b. i.

Cost of Goods Sold Inventory

86,000 86,000

ii. Revised cost of goods sold: $4,500,000 + $86,000 = $4,586,000 Revised average inventory: ($150,000 + $475,000 - $86,000)/2 = $269,500

iii.

Gross margin: $7,256,700 - $4,586,000

= $2,670,700

Gross margin ratio: $2,670,700/$7,256,700

= 36.8%

Inventory turnover ratio: $4,586,000/$269,500

= 17.0 times

When the correction is made to reduce the inventory valuation by $86,000, the costs associated with the decline in value become part of the cost of goods sold. With a higher cost of sales, the amount remaining to cover the other expenses and contribute to profit (the gross margin) goes down by the same amount. Therefore, the cost of goods sold percentage of sales increases and the gross margin ratio decreases. The inventory turnover ratio on the other hand, appears to improve as it is now a larger number. This is deceptive and caused by increasing the numerator and decreasing the denominator as a result of recognizing the impairment in the inventory’s value.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP7-16B (Continued) c.

Without additional information and assuming Pembroke did not require a valuation adjustment this year, it appears Pembroke is slightly better at managing inventory in terms of gross margin. After the adjustment Deep River’s inventory turnover is 17.0 times compared to Pembroke’s inventory turnover of 16.4 times. Deep River’s gross margin ratio is significantly higher than Pembroke’s at 36.8% versus only 12.3% for Pembroke. However, the fact that Deep River’s management was required to recognize an $86,000 impairment – or 18.1% of its ending inventory value, probably indicates that there was mismanagement on Deep River’s part for that significant shrinkage factor. It appears that Pembroke is better at managing its inventory.

LO 6,8 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP7-1

Internal controls are all the policies and procedures a company puts in place to safeguard its assets, to ensure its economic resources are used efficiently and effectively and that the accounting records are complete and correct. The more significant specific assets are to an organization and the more marketable they are (i.e. cash or an inventory of high value electronics), the more important it is to implement strong internal controls for them. In most merchandising and manufacturing companies, inventories usually make up most of their current assets and a material proportion of their total assets. The following types of controls are necessary: 1. Physical controls designed to safeguard the inventory from theft, damage, loss from fire, spoilage, etc. These include secure warehouses, locked display cases, inventory security tags, etc. 2. Assigning of responsibilities to specific employees so that appropriate parties can be held responsible for specific duties. For example, having a single employee responsible for receiving goods in the warehouse or a single employee responsible for approving shipment of goods. 3. Separation of duties to reduce the likelihood of misappropriation of assets. For example, the responsibilities for purchasing inventory, receiving inventory, accounting for the purchase, and authorizing and making the payment for the goods, should all be assigned to different employees so that each acts as a check on the activities of the other. 4. A good system of internal control designed so that the work of one employee provides a reliable cross-check of the work of another without unnecessary duplication of effort. This limits the ability of a single employee to carry out and hide fraudulent activities. Companies often have independent inventory counts carried out to verify the quantity of inventory on hand. 5. Proper documentation of all activities is required so that a “trail” is left that can be followed to determine where errors have been made and improvements in systems can be implemented. An effective recordkeeping and accounting system is necessary so that information is captured on a timely basis, back-up documents are handled and stored appropriately, only authorized employees have access to the records, and the accounting results and actual assets such as inventory on hand, for example, can be compared and reconciled.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-1(Continued) Implementation of these controls is necessary to meet objectives of an internal control system. LO 7 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP7-2

The shipping terms that are required by Big Mart Ltd. are FOB destination. This means that the vendor owns that inventory until it is received by Big Mart. It also means that the vendor pays for the freight. Any goods that are in transit at year-end would be included in the vendor company’s inventory.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP7-3 As a loan officer, I would be very interested in the retailer’s inventory, particularly if the loan was to finance an increase in working capital. It is the collection of cash from the sale of the inventory that provides the operating cash flows that the company will use to pay the interest and repay the loan principal. In addition, I would also be interested because the inventory on the statement of financial position would be a source of cash for the bank in the event the company defaults on a loan, provided the inventory is used as collateral. If the company is not able to pay the loan (i.e., it defaults on the loan payments), the bank can seize the inventory, sell it, and use the proceeds to repay the defaulted loan. The absolute dollar investment in inventory, while important, is only part of the picture. Because cash is generated from cash sales and collections of the accounts receivable that arise from the sale of the inventory, I would want to look at the inventory turnover and/or days to sell inventory ratios to assess the effectiveness of inventory management and the prospects for sales from this asset. I would be interested in the mark-up or gross margin made on these goods and could find out about that from the relationship between the cost of goods sold and sales and/or gross margin and sales. I would also be interested in the make-up of current assets and the extent to which cash is tied up in accounts receivable. An accounts receivable turnover ratio would be useful to see how long, on average, it takes the company to turn its receivables from sales into cash.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-3 (Continued) Closely related is the working capital position of the company and so I would want to calculate the current ratio (current assets divided by current liabilities). This is because the cash generated from sale of the inventories and collection of accounts receivable also has to be used to pay suppliers and other current obligations. I would be interested in the company’s cash budget for the year and the amount of cash expected to be generated from operating and other activities to repay any loan the bank advances. The bank usually compares the ratios developed from its clients’ financial statements to industry averages. I would also be interested in knowing more about the inventory numbers on the statement of financial position. This information might include some or all of the following, depending on the situation: • Insurance coverage on the inventory • Internal controls around inventory • The accounting policies – periodic/perpetual system; cost formula chosen, pricing policies, extent of inventory write-downs to lower of cost and net realizable value and any subsequent reversals • Extent to which existing assets are already used as collateral in support of other loans LO 1 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-4 a. For this business, I would recommend that Brandon use the specific identification cost formula, with presentation in the financial statements at the lower of cost and net realizable value. b. The use of the specific identification cost formula is required whenever inventory is made up of unique, identifiable items. Brandon’s output is a limited number of unique pieces of furniture, so the costs can be accumulated for each piece separately. In addition to the fact that it is required by accounting standards, it is also the best method for managing the production process, controlling the costs and for use in price-setting. Having good records for each unique piece provides excellent information for determining the lower of cost and net realizable value. Selling prices likely have been determined and contracted for before each piece is begun, and the remaining costs to be incurred to complete the piece and the sale can be readily determined from the cost estimates developed when pricing the piece originally for the customer. Cost records also prove valuable in determining appropriate selling prices for new items of custom furniture, and contracts with each customer could incorporate a clause that allows for prices to vary depending on resin price increases. With only 50 or so unique pieces each year, the cost of keeping the detailed records for each item of inventory will not be onerous. c. If the cost of resin were decreasing, I would still recommend the same accounting policies as above. Accounting standards would still require the use of the specific identification cost formula, and the advantages given for calculating the lower of cost and net realizable value and the perpetual system for management control still apply. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-5 A company’s real gross margin is determined when the cost of all the goods sold is deducted from the total of all its sales (both cash and sales on account). On a per unit basis, the gross margin represents the mark-up applied to the cost of each unit. A paper trail is initiated when a sale is made on credit, but often is not necessary when sales are made for cash. A company that would like to reduce its income reported in order to pay less tax to the Canada Revenue Agency might be tempted, therefore, to withhold cash sales from its total sales revenue reported, but include the full cost of all its sales – both those made on credit and those sold for cash. With only some of the sales reported but all of the cost of sales, the gross margin and the gross margin percentage of sales are lower than they should be. The Canada Revenue Agency (CRA) could determine from the company’s records what its pricing policies are, specifically what the standard mark-up on cost is that it uses. This would allow the CRA to determine what the gross margin percentage should be on its statement of income. To the extent that the statement of income produces a lower rate, this could be investigated. In addition, the CRA could compare the company’s gross margin ratio to other companies’ ratios in the same industry and to previous years’ ratios for the same company. LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP7-6 If the raw material and production costs remain the same as well of the selling price, when the rolls decrease by 25 sheets, the unit cost of each roll will decrease which will decrease the cost of goods sold which will increase gross margin. As cost of goods sold decreases, cash flows from operating activities will increase as less product is needed for each unit sold so the amount of cash spent over the year will decrease, assuming sales level remain constant. LO 6 BT: C Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-7 The CFO is explaining that in spite of an increase in sales, the gross margin did not have a corresponding increase. The reason why gross margin decreased is that the extra sales were of a category of goods that generates a lower gross profit ratio than the average of all groceries sold. LO 6 BT: C Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

UP7-8 While sales and gross margin are exactly 25% or one quarter of the annual amounts in the second and third quarter, the low performance in the first quarter is made up for in the fourth quarter. During the last quarter, the buildup of inventory which took place in the third quarter allows for increased sales due to seasonality. Specialty items related to the Christmas season generate on average higher gross margin than during the rest of the year. If inventory management is optimal, there should be sufficient inventory on hand to meet the higher demand but not too much inventory that seasonal items are left over after the Christmas season. Any leftover merchandise would be sold at reduced prices and corresponding reduced gross margins. LO 6 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-9 a. Ratio i. Average inventory Inventory turnover: COGS/average inventory ii. Number of days sales in inventory: 365 days/inventory turnover iii. Gross margin: Sales - COGS Gross margin ratio: Gross margin/ Sales revenue

iii. cont.

2024

2023

($1,300,000+$1,410,000)/2 ($800,000+$1,300,000)/2 = $1,355,000 = $1,050,000 $4,970,000/$1,355,000 = 3.7 times

$4,490,000/$1,050,000 = 4.3 times

365/3.7 = 98.6 days

365/4.3 = 84.9 days

$6,046,000 - $4,970,000 = $1,076,000

$5,500,000 - $4,490,000 = $1,010,000

$1,076,000/$6,046,000 = 17.8%

$1,010,000/$5,500,000 = 18.4%

2022 Gross margin = $4,160,000 - $3,300,000 = $860,000 Gross margin ratio = $860,000 / $4,160,000 = 20.7%

I agree with part of what the owner of the company indicates about the company’s success over the past three years. The company has increased its sales revenue significantly, from $4,160,000 to $6,046,000. This is a 45% increase in revenue and a 25% increase in gross margin (from $860,000 in 2022 to $1,076,000 in 2024). This is commendable. However, there are some worrying aspects related to inventory management that should be considered before any expansion plans are made. For example, in 2023 the inventory turned over 4.3 times. This means that it took, on average, about 85 days to sell the inventory. In 2024, the inventory turned over only 3.7 times, taking well over 3 months on average for the inventory to sell. My other concern is that each dollar of sales in 2024 is providing only 17.8 cents to cover all other expenses and to contribute to profit. In 2023, each dollar of sales provided 18.4 cents and in 2022, contributed 20.7 cents ($860,000/$4,160,000). The reasons for the significant deterioration in each of these ratios should be found and fixed before any expansion is considered. If these changes are a result of a specific change in strategy to increase the volume of goods sold, revenues and bottom line income, then this may not be as serious as it looks.

UP7-9 (Continued)

Burnley, Understanding Financial Accounting, Third Canadian Edition

However, the significant increase in inventory levels (76% since 2022 with only a 45% increase in revenue) and the reduced turnover numbers need to be investigated further. LO 6,8 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-10

The following ratios should prove useful in any analysis of retail companies: Ratio

Usefulness of ratio

Percentage of These ratios provide information about the significance of inventory to inventory to each company. current assets and to total assets These ratios are similar in the story they tell about the Inventory turnover efficiency of inventory management and the dollars ratio and the days invested in inventory. Because too high an inventory is to sell inventory costly to store and finance, it may be more profitable to ratio keep lower levels and reorder more often. The results of the ratio should be compared to the previous years, the budget for the current year, to industry averages and to the ratios of competitors. The inventory turnover ratio provides additional useful information when combined with accounts receivable turnover ratio – in assessing the length of the cash-to-cash cycle. Ratio of cost of goods sold to sales and/or ratio of gross margin to sales

The cost of goods sold is usually the single largest expense of a retail organization. The lower the percentage of COGS to sales, the more from each sales dollar is left to cover other expenses and contribute to profit. Similar information is available by looking at the gross margin to sales percentage. This tells you directly how much is left from each dollar of sales to cover all other expenses and contribute to profit. Because of this, controlling the cost of inventory is very important to retail organizations.

LO 6,8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-11 There is a concern when inventory turnover decreases because it means that it is taking longer to sell inventory in the current year than in the prior year. This could indicate a slowdown in sales or potential spoilage of the product. Given that the apples in inventory may spoil if they sit too long before being processed and the juices and sauces will also have a limited shelf life, it is important to keep the inventory turnover up. With an inventory turnover of 9.7 times, it means that the company’s inventory is turning over every 38 days, so it is unlikely that spoilage is an issue at this point. LO 8 BT: AN Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

UP7-12 a. Estimate of cost of inventory on hand at March 31, 2024: Cost of goods available for sale, in Q1 $100,000 + $400,000 = Less estimate of cost of goods sold in Q1 (100% - 35%) = 65%; 65% X $700,000 = Estimate of ending inventory, March 31, 2024 =

$500,000 455,000 $ 45,000

The accounting records indicate that the goods available for sale total $500,000, the sum of the opening inventory and purchases during the quarter. The $500,000 of costs must be in one of two places – either in cost of goods sold or in ending inventory. We don’t know either one of these two amounts, but can estimate the cost of goods sold for the quarter by knowing the total sales and the relationship between sales and cost of goods sold (the cost-to-sales ratio). The sales of $700,000 at selling prices can be converted to an estimate of the cost of goods sold at cost prices by multiplying sales by the cost-to-sales ratio. Once we have an estimate of the cost of goods sold for the quarter, the remainder of the cost of goods available for sale must have been in ending inventory.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-12(Continued) b. Estimate of cost of inventory on hand at March 31, 2024, if the gross margin on sales ratio is 30% instead of 35%: Cost of goods available for sale, in Q1 $100,000 + $400,000 = Less estimate of cost of goods sold in Q1 (100% - 30%) = 70%; 70% X $700,000 = Estimate of ending inventory, March 31, 2024 =

$500,000 490,000 $ 10,000

If the actual gross margin ratio was closer to 30%, then the estimate of the ending inventory is only $10,000. For a 5% difference in the relationship between sales and cost of goods sold, there is a $35,000 difference in the estimate of ending inventory. Therefore, each 1% change in the ratio results in a $7,000 difference in the ending inventory. c. The gross margin estimation method of estimating ending inventories works well only if there is no change in the mark-up on each product, the product mix stays the same, and the extent of spoilage, breakage and theft of inventory items remains the same as in previous years. These conditions rarely, if ever, exist. An accurate ending inventory amount can be obtained only by physical count. Management, the auditors, employees, creditors, shareholders and potential investors all would want to have assurance that the amounts in the books and records of the company are accurate and that the year-end inventory as reported on the statement of financial position faithfully represents the inventory actually on hand. Therefore, it is essential that, on a regular basis, the physical amounts are checked against the books and records and that the accounts are adjusted to the actual amounts.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-12(Continued) d. Assuming Slick Snowboards Company actually retails snowboards, a highly seasonal product, I would expect its March 31 inventory to be considerably lower than its December 31 inventory. Companies tend to increase their inventory holdings in the period leading up to their busiest season. In this case, I would expect a buildup of snowboard inventory during late October and November in preparation for the brisk Christmas selling period and then for customer demand during January and early February, dwindling by the end of February and into March. I also expect there is more discounting of the product selling prices in February and March as the end of the season approaches and the company attempts to clear out the existing inventory. This would have the effect of producing a lower gross margin ratio during the first quarter of the year than the company had for the entire previous year. Therefore, I would probably prefer the lower estimate of the ending inventory determined by using the lower gross margin ratio. Because of the likelihood of the March 31 inventory being the lowest in the fiscal year, this is also the best time to take a physical inventory of what is left on hand. LO 8 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP7-13 As the insurance adjuster I would want to see the most recent prepared financial statements to determine what gross margin percentage should be used in the estimate. I would also want to see the evidence of sales and purchases made during the year to support the information used in the estimation calculation. I would also want to see the report from the fire inspector to ensure that all the inventory was actually destroyed in the fire. I would want to make sure that inventory held outside of the warehouse was properly excluded from the calculation as well as merchandise in transit if purchased FOB shipping point or sold FOB destination. I would want to know what costing formula is used to calculate inventory and cost of goods sold since, if costs are increasing and the insurance provides replacement cost, the estimate might not accurately reflect that. LO 8 BT: AN Difficulty: H Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK IN PROGRESS WIP7-1 1) 2) 3)

The company is using a consignee (not consignor) to sell goods. The consignee (not consignor) takes a cut of the profit for its efforts (a consignment fee). Consignees (not consignors) do not take possession of the inventory, they just sell it on behalf of a company.

LO2 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP7-2 1)

In the periodic inventory system, cost of goods sold and inventory are not recorded when a sale occurs; cost of goods sold is calculated and recorded at the period end, based on the ending inventory count. In the perpetual inventory system, cost of goods sold and inventory are recorded with every purchase and sale, so the inventory and cost of goods sold accounts are always up to date. In a periodic system, different accounts are used; purchases, purchase discounts, freight-in for example. In a perpetual system, all of these transactions would affect the inventory account.

LO3 BT: C Difficulty: E Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP7-3 1)

In the periodic system, inventory is counted on a periodic basis, typically at the end of the fiscal year, to determine the cost of goods sold and inventory levels for financial reporting purposes. An inventory count can be performed more frequently, at month end for example, to adjust the cost of goods sold and inventory levels for financial reporting purposes if there are very few items in inventory. In the perpetual inventory system, inventory counts are not required to determine inventory levels or cost of goods sold as they are recorded with every purchase and sale, but it is required that inventory counts be performed at least annually to make sure all inventory has been recorded properly and to adjust inventory for any shrinkage or loss.

LO3 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP7-4 Cost formulas are necessary because the prices a company pays to purchase or manufacture its inventory change. Different units of inventory will have different costs due to changes in raw materials costs, volume purchase discounts, changes in shipping costs and so on. As a result, companies need to determine which unit costs will be allocated to cost of goods sold and which will be allocated to ending inventory. The 3 cost formula used to allocate inventory and cost of goods sold are: specific identification, weighted-average, and first-in, first out (FIFO). The choice of cost formulas impacts the company’s gross profit, net income and ending inventory and should be selected based on the best match to the actual flow of inventory. LO 4 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP7-5 Cost formulas are necessary because the prices a company pays to purchase or manufacture its inventory change. Different units of inventory will have different costs due to changes in raw materials costs, volume purchase discounts, changes in shipping costs and so on. As a result, companies need to determine which unit costs will be allocated to cost of goods sold and which will be allocated to ending inventory. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP7-6 Inventory turnover of 1.63 times means that the company only sells through its inventory stock less than twice per year (365 days / 1.63 = 224 days). This appears to be quite low and most companies would aim to have higher turnovers. However, turnover varies by industry and it will depend on what the company sells. A company selling clothing that sells hundreds of different products and has to keep large volumes on hand would have a much lower turnover than a restaurant that is turning over their food inventory quickly. LO 8 BT: AN Difficulty: H Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI7-1 a. and b. Ratio

2020 2019 (millions of Canadian $)

Inventory turnover ratio = Cost of goods sold ÷ Ending inventory

$2,539.2/$616.2 = 4.1 times

$2,362.6/$537.0 = 4.4 times

Gross margin = Sales revenue - COGS Gross margin ratio = Gross margin ÷ Sales revenue

$3,623.2 - $2,539.2 = $1,084.0

$3,304.1 - $2,362.6= $941.5

$1,084.0 /$3,623.2 = 29.9%

$941.5/$3,304.1 = 28.5%

CAE Inc. experienced a decline in its inventory turnover ratio in its year ended March 31, 2020. In 2019, the company sold out its inventory every 365/4.4 = 83 days, while in 2020, it took 365/4.1 = 89 days – 7% longer. This negative change would be of interest to management and to investors. It is of note that the work-in-progress inventory was significantly higher in 2020, possibility due to the stage of progress on specific equipment being manufactured. The gross margin ratio increased, from 28.5% to 29.9%. While this may seem to be a small percentage, 1.4%, in this case, translates into an increase in gross margin of $50.7 million (1.4% x $3,623.2) that can be used to cover remaining expenses and to increase income before tax. Even small percentage changes should be analyzed by management.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-1(Continued) c.

The fact that the reported revenue includes revenue from the delivery of services as well as from the manufacture and sale of products could significantly influence the gross margin ratio. This is because there is no cost of goods sold for service revenues which means that the reported gross margin is higher than was actually realized from the sale of products. Therefore, the service revenue amount should be deducted from the revenue amount (the denominator) as well as the gross margin amount (the numerator). For example, if the revenue numbers reported contained $300 of service revenue in 2019 and only $100 in 2020, what would happen to the gross margin ratios calculated above? Revised gross margin ratio calculations: 2020 $1,084.0 - $100 = $984.0

2019 $941.5 - $300 = $641.5

Revised revenue amount

$3,623.2 - $100 = $3,523.2

$3,304.1 - $300 = $3,004.1

Revised gross margin %

27.9%

21.4%

Revised gross margin amount

As the revised numbers illustrate, a very different picture emerges. By combining the sales and service revenues on the face of the statement of income, it is impossible to determine whether management has performed well in this area or not. However, from the company’s perspective, management would prefer to keep the figures combined so that its competitors and customers cannot determine its mark-up policies.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-1(Continued) d.

Because CAE designs, manufactures and sells unique products for specific customers, the specific identification cost formula is appropriate for its work in process and any finished goods inventory. Each product has unique costs and a unique selling price, so for cost control and the evaluation of management performance, specific identification would be the most appropriate method to use. It is appropriate to use a method other than specific identification for CAE’s raw material inventories because the raw materials are likely generic items such as wire, paint, welding supplies, aluminum, nickel, or steel that could go into any number of the contracted pieces of equipment the company produces. There would be many such items and it would be difficult and costly to maintain a specific identification cost formula system for them. In addition, these items that go into production are very likely not specifically identifiable in any case.

LO 6,8 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-2 a.

The categories that should be used in determining the company’s inventory turnover ratio are the raw materials and supplies, work in process and finished goods. I included all of the raw materials, supplies, and work in progress because these costs are required to be incurred by Waterloo Brewing as part of the production cycle and their costs end up eventually in cost of goods sold. The ratio should provide information on how long it takes to recover the costs put into the goods that are sold, and this includes not only the inventory that has reached a completed state (finished goods) Waterloo Brewing’s (WB) accounting policies related to inventory include the following: What WB includes in cost: WB includes all costs necessary to acquire its inventory items, plus the costs to put them in place in WB’s plant, and ready them for use. For work in process and finished goods, this includes direct materials, direct labour, and variable and fixed overhead. Overhead costs are allocated based on normal capacity. What cost formula WB uses: The raw materials and supplies are assigned costs based on the first-in, first-out cost formula; and the work in process and finished goods are assigned average costs. How WB values its inventory on the statement of financial position: WB reports their inventory at the lower of its carrying amount and net realizable value. Any subsequent reversal of a write-down is reported in cost of goods sold when the reversal occurs.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-2 (Continued) c. Ratio

2021

2020

Inventory turnover ratio: COGS ÷ average inventory

$57,956,234/$14,344,496 = 4.04 times

$35,585,217/$10,482,912 = 3.39 times

Days to sell inventory ratio: 365/4.04 365 days ÷ = 90.3 days Inventory T/O ratio

365/3.39 = 107.7days

From the above calculations, we see that WB’s inventory turnover ratio increased in 2021 meaning that it was selling its inventories more quickly than in the prior period. In fact, it took 17.4 fewer days (107.7- 90.3=17.4) for WB to turnover its inventory in 2021. d. Current ratio 2021 = $24,944,817 $54,396,558

= 0.46

2020 = $16,246,586 $30,999,384

= 0.52

WB’s current ratio has worsened slightly. The company had $0.46 in current assets for every $1 in current liabilities. All the current assets and current liabilities increased in 2021 from 2020, with the exception of the prepaid expenses and current portion of long-term debt.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-2 (Continued) Quick ratio 2021 = $9,871,061 $54,396,558 2020 = $4,976,226 $30,999,384

= 0.18

= 0.16

WB’s quick ratio improved slightly although it remains extremely low. LO 2,8 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI7-3 a.

($ amounts in thousands of Canadian dollars) Ratio 2021 Inventory turnover ratio: COGS ÷ average inventory Days to sell inventory ratio: 365 days ÷ Inventory T/O ratio

2020

$530,100/ (($241,812 + $215,114) / 2) = 2.32 times

$500,000/ $241,812 = 2.07 times

365/2.32 = 157.3 days

365/2.07 = 176.3 days

The turnover of Indigo’s inventory is very slow, with the company selling through its inventory every 157-176 days – between 5 and 6 months. The inventory turnover and days to sell ratios improved from 2020 to 2021. b. Given the slow turnover of its inventory, I would expect Indigo to have significant accounts payable to its suppliers (i.e. book publishers and distributors). Longer payment terms would be required given the length of time it takes Indigo to sell the books it purchases. The company did have significant accounts payable at April 3, 2021, owing its suppliers $145,193 thousand, which is less than in 2020.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-3 (Continued) c. Indigo’s accounting policies related to inventory include the following: What Indigo includes in cost: Indigo includes all direct and reasonable costs incurred to acquire its inventory items and to bring them to the store’s premises. The cost is adjusted at each reporting date for any shrinkage (theft, etc.) that likely occurred between the date the inventory was counted and the reporting date. This reduction is based on historical experience with shrinkage. In addition, inventory costs are adjusted by an estimate of any probable additional costs that will be incurred when outstanding disputes are settled with its suppliers. This, too, is based on historical experience. In addition, inventory cost is reduced by any expected vendor rebates, as is the selling price of the inventory used in determining net realizable value. What cost formula Indigo uses: The company uses a perpetual system and a weighted-average cost formula. It is a perpetual system because Indigo discloses that it uses a moving average cost and this occurs with a perpetual system. The weighted-average price changes with each new purchase. How Indigo values its inventory on the statement of financial position: Indigo reports its inventory at the lower of its cost and net realizable value. Net realizable value is the expected selling price of the items. This amount is reduced by any expected future markdowns that will reduce the net realizable value below cost. Any reduction in NRV due to expected losses on obsolete merchandise is also recognized. Indigo follows a policy of reversing any write-downs if the NRV subsequently improves, but no such reversals were recognized in the last two years. LO 2,8 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-4 a.

The categories of inventory that should be included in the inventory turnover calculations are those categories that are available for sale in the year and those whose costs will end up directly or indirectly in cost of goods sold. In this way, the ratio will be calculated using amounts for the numerator and denominator that are related to one another. These would definitely include finished goods, both procured and manufactured, and raw and semi-finished material. To the extent that the “supplies, repair parts and other” inventories also end up in overhead that is charged to finished goods and then to cost of sales, these inventories should also be included.

b. and c. High Liner’s (HL) accounting policies related to inventory valuation include the following: What HL includes in cost: HL includes the costs to acquire its inventory, the costs to bring the inventory items to their existing location and condition, and their conversion costs. Manufactured and work-in-process inventories are assigned overhead production costs based on HL’s normal operating capacity. Costs will also include realized gains and losses on foreign currency hedges related to the purchase of inventory. What cost formula HL uses: HL uses the first-in first-out cost formula for its manufactured and work-in-process inventories and a weighted-average cost formula for its raw materials and items purchased that do not require further processing (i.e. finished goods that have been purchased). The reason for using the first-in first-out method for the manufactured items is likely because this corresponds to the physical flow of the goods. In the food business, freshness is a factor (even if the product is frozen), so the company would tend to sell the older inventory before the newer inventory. While it is reasonable to assume that the raw materials and procured finished goods would also be used in the same pattern, the company uses the weighted-average cost formula for them. This might be because of the difficulty and cost of separately keeping track of the changing costs of the raw materials and procured finished goods, or because HL would prefer to average out these costs over the year because their input costs fluctuate considerably from one month to another due to factors outside the control of management.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI7-4 (Continued) In addition, much of HL’s raw material and procured finished goods is purchased in foreign currency. It is less costly to include hedged currency gains and losses in calculating an average cost than assigning them to specific purchases in determining FIFO costs throughout the year. How HL values its inventory on the statement of financial position: HL reports its inventory at the lower of its cost and net realizable value, with net realizable value defined as estimated selling prices less costs to complete and sell. d.

($ amounts in thousands of US dollars) Ratio 2021 Inventory turnover ratio: COGS ÷ ending inventory Days to sell inventory ratio: 365 days ÷ Inventory Turnover ratio

2020

$649,529/$250,861 = 2.59 times

$756,364/$294,913 = 2.56 times

365/2.59 = 140.9 days

365/2.56 = 142.6 days

For a food-based organization, even one dealing in frozen products, the turnover appears to be a little low (i.e. around 3 times a year) and the days to sell appears higher than expected (i.e. almost four months). The ratios are getting better. LO 2,5,8 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI7-5 Answers will vary based on company selected. LO 2,5,8 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASES SOLUTIONS C7-1

Report on Advantages of a Perpetual Inventory System For Stanley Storage Systems (SSS) There are two types of accounting systems available to companies to internally account for their inventory – a periodic system, which SSS currently uses, and a perpetual system. A periodic inventory system is one that captures all the costs of inventory purchased throughout the accounting period in one “purchases” account, but, as its name suggests, relies on periodically taking a physical count of the actual inventory left on hand at the end of the period in order to accurately determine the cost of goods sold, the gross margin, and income earned for the period. A perpetual inventory system is one that continually, or perpetually, keeps tracks of the cost of inventory on hand by recording the cost of all purchases as additions to the inventory account and the cost of all goods sold as reductions to the inventory account. While a perpetual inventory system would be more expensive to develop and to maintain than the periodic system we now have, the benefits of a perpetual system far outweigh its additional cost. These benefits include the following: • Because records are kept for each significant type of inventory item used, SSS could reduce the occurrence of stock-outs. This will improve labour efficiency and production times in our manufacturing operations, and improve our operating capabilities and customer relations. • A perpetual system would allow us to account for the manufacture of customer contracts on an individual basis by accumulating the specific costs incurred on each. This would allow us to better control costs and improve our cost estimation abilities for bidding on other contracts in the future. • The expression “what gets measured gets managed” is very true, and a perpetual system permits us to be on top of what inventory we should have at all times. This has the advantage of reducing the likelihood of losses due to theft, spoilage and obsolescence.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-1 (Continued) • Finally, a perpetual system reduces the need for physical inventory counts to establish the cost of inventory on hand. The system updates the inventory accounts for purchases, for goods placed into production, for goods transferred to finished goods, and for goods removed from the warehouse and sold to customers. An annual inventory count would still be required to ensure that the inventory information in our accounting system corresponds with our actual inventory on hand. These advantages also offer the ability to more accurately determine the gross profit and net income earned each month. This makes our financial statements more reliable for presentation to the bank in support of our outstanding loans and reduces the need for significant year-end adjustments. On a personal level, it also allows for a more accurate determination of my monthly bonus and reduces the uncertainty of me having to repay amounts previously received when the financial statements are prepared at year end. Based on the extent of the net benefits associated with the perpetual inventory system, I recommend that we move to this superior method for Stanley Storage Systems. Please let me know if you have any questions. LO 3 BT: C Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

C7-2

Dear Chris Park: I enclose my report in which I set out a variety of options that you might consider in helping to resolve your company’s cash flow problems. I have prepared a ratio analysis (See Appendix A) upon which many of the options put forward are based, and this forms an important part of the report. Please let me know if you have any questions on this or related matters. Regards, Consultant

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-2 (Continued) Report for Park Avenue Tire Company Cash Flow Issues Park Avenue Tire Company (PA) appears to have a working capital problem as evidenced by inadequate cash available to take advantage of supplier discounts. As can be seen from Appendix A, company’s current ratio has declined from $4.21 of current assets per $1.00 of current liabilities in 2022 to $2.97 to $1.00 in 2024. Ordinarily, having almost $3 of current assets for every $1 of current obligations would be more than sufficient, but the concern with PA is the make-up of its current assets. The accounts receivable and inventory have grown at a much greater rate than have sales. Based on the figures for credit sales, sales have actually decreased by 10% since 2022. However, receivables have grown by 67% and the inventory on hand has grown by 46% over this same period. This resulted in a cash flow problem as follows: when you purchase inventory, you pay your supplier almost immediately. However, your inventory is not sold until about 545 days later and then it takes another 31 days to collect from your customer. This means it takes just over 19 months before you see any cash back into the company. The company’s cash-tocash cycle is far too long. The company’s liquidity problems are highlighted by looking at the quick ratio. This indicates a decline from $1.05 of quick (or liquid) assets per $1.00 of current liabilities in 2022 to $0.37 per $1.00 in 2024. Here are a number of suggestions to consider following. Those related to changing inventory policies will have the most significant effect, while those relating to your accounts receivable and credit policies will have only marginal benefits. • In the short term, a line of credit could be obtained to meet cash flow needs. The inventory could be used as collateral for the loan. • Selling inventory at reduced prices would free up some of the cash tied up in inventory. Based on the turnover ratios, much of the inventory has been sitting for well over a year. It might be better to sell it at a discount than to continue to incur the costs of warehousing it. • Analyze your inventory of tires to determine whether some are obsolete and should be written off.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-2 (Continued) • Arrange longer credit terms with your suppliers and stretch your payment to suppliers until the results of other changes begin to take effect. Supplier discounts are usually well worth taking, and you could aim to return to this practice when your cash flows improve. • Analyze past sales and determine which tires account for the majority of your sales. Often, 20% of inventory items account for 80% of the sales dollars. It appears PA is maintaining too wide a choice of tire or too high a quantity of specific tires. Develop a plan to streamline the types and quantities of tires carried. • Contact your suppliers and find out if they will accept returns of some tires, either for credit or on a cash basis. • For suppliers situated in Winnipeg, make arrangements to take delivery of tires on a same-day basis. Going forward, this reduces your investment in inventory and delays when you have to pay the supplier. • Enter into agreements with other similar-sized companies to share the brands you carry. This might work well for brands that fewer customers require, so that you can acquire them for same day service from the other companies, as the other companies can do from your inventory. This would have advantages to each company included in the agreement. • Consider a change in strategy, from competing with giants such as Walmart and Canadian Tire where you have to stock such a wide variety of tires, to being a niche player. That is, compete on a basis other than the variety of available stock. • Investigate the use of VISA or Mastercard type credit cards instead of providing your own credit department. These cards provide you with instant cash, so you do not have to wait 31 days on average for your customers to pay. While this would also eliminate PA having to administer a credit system, it comes at a cost levied by the credit card companies that may be higher than the amount the faster payment is worth to you, as your credit sales and receivable balances are not large. • Offer your customers a small discount for paying cash.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-2 (Continued) The solution to your cash flow problems definitely lies with inventory management. Look for solutions that deal with reducing the quantity and variety of your stock that you hold, as it will generate an increase in turnover of the stock you carry. Look to new strategies to increase your sales. Appendix A Ratio

2024

Current ratio: Current assets ÷ current liabilities

$200,000/$67,400 = 2.97 to 1

$177,000/$54,000 = 3.28 to 1

$163,000/$38,725 = 4.21 to 1

Quick ratio: Quick assets ÷ current liabilities

($200,000 $169,000 - $6,000) /$67,400 = .37 to 1

($177,000 $122,000 - $8,000) /$54,000 = .87 to 1

($163,000 $116,000 $6,500)/$38,725 = 1.05 to 1

Receivables turnover ratio: Sales ÷ average accounts receivable

$160,000/$13,500* $175,000/$10,500** = 11.9 times = 16.7 times

$177,000/$8,500*** = 20.8 times

* ($12,000 + $15,000)/2 = $13,500

**($9,000 + $12,000)/2 = $10,500

*** ($8,000 + $9,000)/2 = $8,500

365/11.9 = 30.7 days

365/16.7 = 21.9 days

365/20.8 = 17.5 days

Average collection period: 365 days ÷ Receivables T/O ratio Inventory turnover ratio: COGS ÷ average inventory Days to sell inventory ratio: 365 days ÷ Inventory Turnover ratio

2023

2022

$97,000/$145,5001 $93,000/$119,0002 = .67 times = .78 times

$95,000/$107,5003 = .88 times

($122,000 + $169,000)/2 = $145,500

($116,000 + $122,000)/2 = $119,000

365/.67 = 545 days

365/.78 = 468 days

365/.88 = 415 days

($99,000 + $116,000)/2 = $107,500

LO 8 BT: AN Difficulty: H Time: 60 min. AACSB: Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-3 a. Historical cost represents the out-of-pocket costs to acquire the inventory and to transport it to Wascana’s location plus any costs incurred to bring it to a condition suitable for sale. It is an “entry” price, that is, the amount paid when inventory comes into the business. Net realizable value on the other hand, is an “exit” price – the amount expected to be received from selling the inventory reduced by any additional costs that must be incurred to complete the sale. b. Description

Lower of cost and NRV/unit ($)

Quantity

Nikon D1300 body Nikon D5200 with zoom lens Nikon 80-200mm/2.8 lens Canon EOS 60 body Canon EF 24-70mm/2.8 zoom lens Olympus E5 body Pentax K3 body

350 1,500 1,100 1,600 2,300 1,700 1,050

4 2 2 2 1 3 6

Inventory value ($) 1,400 3,000 2,200 3,200 2,300 5,100 6,300 $23,500

c. Inventory must be reported on the statement of financial position at the lower of cost and net realizable value for a good reason. It provides information that investors and creditors want from the financial reports; information that is useful in assessing the future cash flows of the company. Investors and creditors are interested in earning a cash return from their investments. Because inventories will be sold in the ordinary course of business, it is important that they be valued on the statement of financial position at no more than the amount of cash they will generate upon their sale. If the entity will realize more cash than the inventory’s cost, it will be valued at cost. However, if its net realizable value is less than its cost, then the lower, NRV is reported. LO 5 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-4 a. When inventory items are unique and each can be distinctively identified, the specific identification cost formula must be used to determine the cost of the items sold and those remaining in inventory. This method would work well for Sally French and her Ford dealership since each of the cars in inventory has a vehicle identification number and can therefore be specifically identified. However, it would be difficult and time consuming to account for the parts and accessories inventory using this method since there are many more items and no cost effective method of identifying each inventory item. When there are multiple units of many different inventory items which cannot be specifically identified, a cost formula is chosen to account for the flow of the inventory. The parts and accessories inventory at the Ford dealership and the inventory at Jason Mount’s grocery store are examples of the types of inventory where the use of a cost formula other than specific identification would be appropriate. If Sally is moving to a just-in-time approach for her parts inventories, it probably doesn’t make much difference whether she uses the FIFO cost formula or a weighted-average cost formula as far as the statements of income and financial position are concerned. This is because there will be very small amounts of inventory maintained and all inventory remaining on hand will have been recently acquired and therefore, assigned almost identical costs. I might suggest that a FIFO cost system be used for costing of ending inventory because it is likely the ending inventory is actually made up of the most recent purchases. However, Sally might benefit from keeping her parts inventory on a perpetual system in units only. With JIT, it is very important to control the number of units carefully. While accounting standards require that ending inventory be fairly representative of recent costs, there is some flexibility between the use of the FIFO method and weighted-average approach. The nature of the grocery business and its inventory would suggest that the FIFO method would more appropriately represent the physical flow of goods, and therefore, should be maintained. This may be why Jenna has not suggested a change. However, small business owners often prefer methods that report a lower income and therefore, lower income taxes.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-4 (Continued) If no audit opinion is required on the grocery business’ financial statements, if there are no significant creditor interests affected, and if there really is a significant difference in the income reported, Jenna should support the change to the weighted-average method. This assumes that Jason is well aware of the latest prices being charged by his suppliers and has a pricing policy that ensures that he recovers the replacement cost of the goods the store sells, not their weighted-average cost. b.

MEMORANDUM To: Sally French From: Jenna Scharmann Increasingly, businesses are looking for ways to reduce their investment in inventories without reducing their ability to service their customers’ needs and losing sales. Using a just-in-time inventory is one such system that works well when properly managed. This method requires a strict system of inventory management with considerable attention to the flow of inventory into and out of production and co-ordination with suppliers. For this reason, it tends to be used in manufacturing facilities where the parts required can be identified ahead of time, as well as when they will be needed. Automobile manufacturers are one such industry that uses JIT systems. You should also know that there are considerable risks associated with such a system. Uncontrollable transportation delays, for instance, can bring a production line to a halt. If you can be assured of prompt delivery times from suppliers that are close by, and have an effective control system over inventory quantities, I support a move to more JIT purchasing.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-4 (Continued) c.

MEMORANDUM To: Jason Mount From: Jenna Scharmann Re: FIFO Cost flow assumption In periods of rising prices, you are correct that weighted-average costs will lead to a higher cost of goods sold and therefore lower income and a lower tax burden. For management purposes, however, it is likely more useful for management to be aware of the most current input prices, as required by FIFO, so that the selling prices are set to recover something close to their replacement cost. Once a choice of accounting method is made, companies are usually required to continue its use unless circumstances change, so that the company’s financial statements can be used for identifying trends and comparing one year to the next. Use of a weighted-average method does come at a cost in that it requires you to keep good records from which to determine the weighted-average cost. This includes records to track the number of units purchased in the year as well as the total cost of those units. The FIFO system merely requires that you have the most recent invoice prices covering the volume still in inventory. You should also consider whether you would be prepared to stay with the weighted-average method if costs flatten out or even are reduced in the future. The Canada Revenue Agency would not allow you to change back and forth depending on the effect on bottom line income. You should determine what the tax savings will be on a go-forward basis and judge whether the benefits are worth the additional costs. Remember that any lowering of taxes in one period will be offset by high taxes in a following period as eventually all costs flow through the statement of income. Particularly because you do not require audited financial statements, and there are no external creditors who rely on your financial statements, a change could be made to the weighted-average approach. If you still want to make the change after weighing the advantages and disadvantages, please let me know. I would be happy to help with the system change.

LO 4 BT: C Difficulty: M Time: 50 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-5

REPORT To: Nikki Obomsawin From: Consultant Re: Inventory control and cost and reporting systems Issue 1: Periodic or perpetual inventory system The first issue to be dealt with is whether you need to keep track of the cost of the individual pieces of jewellery separately so that your books and records provide you with up-to-date information about what you have on hand and the costs of the pieces sold. This information is for two purposes – one, of course, for preparing financial reports on how the business is doing financially, but, perhaps more importantly, so that you can control and manage your inventory on an ongoing basis to prevent unnecessary losses such as you have in the recent past. Your business is small at the moment, so you do not need complicated systems in place that you will be tempted to circumvent instead of maintain! A periodic system requires only that you keep track of all your purchases of the inputs to your jewellery. At the end of the year (but likely more frequently in your case), it requires that you take a physical count of all your inventory still on hand, deduct it from the costs associated with all the items that were available for use and sale in the period in order to determine your year-end inventory and the cost of goods that you sold. This is sufficient information for financial reporting purposes. It is a simple, low cost system. However, in your current situation, because records are not kept of the inventory of valuable gems and gold chains, etc. that should be on hand, it is easier for these pieces to be lost or stolen. Without good records, it takes a while before the missing inventory is noticed and by then it may be too late to do anything about it. Although a perpetual inventory system requires a little more paperwork than a periodic system, it also has real benefits which I think are important to you and your business. A perpetual system requires you to keep track of the cost of incoming valuable gems and jewellery, similar to what you are doing now, although this would become part of your accounting records. As you design and craft the finished pieces, the cost of all the significant gems that go into

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-5 (Continued) each specific piece would be transferred to a unique record for the specific piece. An estimate could also be made of the weight and cost of the findings that are used for each piece. This information reduces the weight and cost of the “raw material” findings inventory and is added to the cost record of the unique piece it was used on. Each time one of your creations or gold chains is sold, the costs that have accumulated on its cost card are transferred to a separate record representing the cost of the items sold. By reviewing your cost records, you should have a complete record of the cost of your inventory on hand and the cost of the pieces you have sold. A quick check on an ongoing basis can confirm this inventory is still on hand. This, combined with some increased physical controls over the valuable pieces, provides you with excellent information to significantly reduce the likelihood and the cost of theft. I recommend use of a perpetual system for each item of significant value. Issue 2: What inventory cost formula should be chosen? Two different cost approaches could be used advantageously: a specific identification method for single items that are unique and separately identifiable such as the individual gems; and a weighted-average cost method for items that are not distinguishable from one another, such as the findings and the gold chains. Combined with a perpetual inventory system as described above, this would give you the required information for control purposes and for financial reporting purposes, all at an appropriate level of record keeping. The weighted-average cost method is fairly representative of how the inventory physically moves through your operations, and is not an expensive system to maintain. The records that you would maintain would not have to be part of a complex computer-based accounting system, but can be designed to be quite basic, even to the extent of a manual card-based inventory file to begin with. As your business grows, the systems can be converted to relatively straightforward accounting software.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-5 (Continued) Issue 3: Inventory valuation and net realizable value. At the end of each accounting period when you want, or need to determine your financial position and performance, your inventory records should provide a basis for your inventory on hand and the cost of the items sold. The items that should be in inventory should be proven by taking a physical inventory count of items on hand. By comparing the records and the count, you have an accurate measure of the cost of any losses from spoilage, theft, etc. A physical examination of the items remaining in inventory will also alert you to any items that may not be able to be sold for as much as their accumulated costs. In such a case, you will need to estimate the item’s net realizable value, that is, what you expect you can sell it for, less any additional costs to complete and sell it. The inventory items are reported at the lower of the accumulated costs and their net realizable value. This is so your inventory is not reported at any more than the amount of cash that could be received in exchange for it. Issue 4: Internal controls All businesses that want to succeed, grow, and continue in operation need to have policies in place to protect their assets from such hazards as wastage, spoilage, theft, and other types of shrinkage, to ensure the efficiency and effectiveness of their day-to-day operations, and to maintain accounting records that will result in complete and accurate financial reports. Without such controls in place, there is no management of the many risks and losses that may befall the entity, and investors will not support and finance such operations, nor will employees be as productive. Although you have a very small operation starting out, there are safeguards you need to take to help ensure you will continue in business. One of these is the need to safeguard your inventory from losses due to theft. While you keep excellent record of the valuable gems you purchase for inventory, they are not adequately stored to protect their value. I suggest that, after cataloging them,

Burnley, Understanding Financial Accounting, Third Canadian Edition

C7-5 (Continued) they should be placed on trays and, at a minimum, be kept in locked drawers to which access is restricted. The gems should be stored carefully so that they are not damaged and so that they retain their value. The gold chains are kept in a display case now, but this case should be kept locked, again, with limited access. The display case and all gems should be carefully handled and not be permitted to be left where customers can freely handle them without being watched. While the findings are not individually valuable, they too should be adequately protected from unauthorized handling. Issue 5: Inventory counts Frequent counts of the inventory on hand should be carried out and the results compared with the accounting records. This is important to ensure proper controls are in place and functioning to safeguard the existence and value of your inventory, and to provide accurate information in your financial reports. Employees need to know that controls are in place and that any missing items will be uncovered promptly and responsibility assigned. LO 3,4,5,7 BT: C Difficulty: M Time: 50 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Copyright © 2022 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved. The data contained in these files are protected by copyright. This manual is furnished under license and may be used only in accordance with the terms of such license. The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd. MMXXI xii F1

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 8 LONG-TERM ASSETS

Learning Objectives 1. Identify and distinguish between the various types of long-term assets. 2. Describe the valuation methods for property, plant, and equipment, including identifying costs that are usually capitalized. 3. Explain why property, plant, and equipment assets are depreciated. 4. Identify the factors that influence the choice of depreciation method and implement the most common methods of depreciation. 5. Describe and implement changes in depreciation estimates and methods. 6. Explain what it means if property, plant, and equipment assets are impaired. 7. Account for the disposal of property, plant, and equipment. 8. Explain the accounting treatment for intangible assets, including amortization. 9. Explain the accounting treatment for goodwill, including impairment. 10. Explain the accounting treatment for right-of-use and biological assets. 11. Assess the average age of property, plant, and equipment; calculate the fixed asset turnover ratio; and assess the results.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5 6.

2 3 2 2 3 2

1. 2. 3. 4.

2 2 2 4

1. 2. 3.

2 2 3

1. 2

3,4 3,4

Item

Item LO

Item

Discussion Questions C 7. 3,4 C 13. 5 C 19. 7 C 25. C 8. 4 C 14. 4 C 20. 4 C 26. C 9. 4 C 15. 4 C 21. 4 C 27. C 10. 4 C 16. 4 C 22. 8,9 C 28. C 11. 4 C 17. 3 C 23. 8 C 29. AP 12. 4 C 18. 6 C 24. 8 C 30. Application Problems K 5. 4 AP 9. 4,7 AP 13. 5 AP 17. AP 6. 4 AP 10. 4,7 AP 14. 5 AP AP 7. 4 AP 11. 4,7 AP 15. 4,5,7 S AP 8. 4,7 AN 12. 4,7 AP 16. 8 AP User Perspective Problems C 4. 3 C 7. 7 C 10. 6 C 13. C 5. 2 C 8. 6,9 C 11. 10 AN 14. C 6. 7 C 9. 2 C 12. 2 C 15. Work in Process C 3. 4 C 5. 4 C 7. 4 C C 4. 4 C 6. 4 C Reading and Interpreting Published Financial Statements AN 2. 8,9 C 3. 10 AN 4. 10 AN 5. Cases C 2. 1,2,4 E 3. 2 AN 4. 4 S 5.

LO BT 9 9 9 10 10 10

C C C C C C

8,9 AP

2 2,9 9

C C C

10 AM 4

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ8-1

An asset’s (or any accounting element’s) “carrying amount” is its balance in the books of account, and therefore the amount reported in the financial statements. If the asset is land, its carrying amount is likely the same as its cost. However, most items of PP&E, originally recognized and recorded at their cost, are subsequently depreciated on a regular basis and they are then carried at cost less accumulated depreciation. Contra accounts such as Accumulated Depreciation are deducted from the PP&E asset account in determining the PP&E’s carrying amount. Impairment losses, if applicable, are also accumulated in a separate contra account and further reduce the asset’s carrying amount.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-2

When a company acquires a PP&E asset that will provide benefits to the entity over a number of future accounting periods, it wouldn’t be reasonable to deduct the whole cost of that asset from current year’s revenues as a current year expense. The entity still has an economic resource – an asset – at the end of the current year. Therefore, such assets are depreciated to allocate their cost to the accounting periods in which the assets’ economic benefits are used up and that benefit from their use.

LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-3

Accounting standards require that all costs necessary to acquire equipment, get it in position, and ready it for use be capitalized. These costs would include the invoice price, non-refundable taxes, import duties, legal costs associated with the purchase, shipping costs, installation costs, cost of test runs, and any other costs that meet the criteria.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-4

If a cost incurred is capitalized as part of PP&E, the cost of the asset is increased. It also means that the cost is not expensed, and therefore does not reduce the current period’s net income. Therefore, both the current statement of financial position and the income statement are affected, as are the future statements of financial position and income statements over the useful life of the asset. If capitalized, the cost is spread out over the useful life of the asset, thereby increasing depreciation expense in each future year it is used. At the same time, the carrying amount of the asset on the statement of financial position decreases.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-5

There are a number of reasons why it is necessary to allocate the purchase price of a basket purchase to the individual assets. If land and building and equipment are acquired for a single price, the costs are assigned to each component because the cost of the land does not depreciate, and the cost of the equipment and the building probably need to be depreciated over very different periods of time, and perhaps using different methods of depreciation. IFRS requires that depreciation be recognized for asset components using appropriate patterns and reasonable useful lives for each. Also, if some assets are sold and some remain, it is important to be able to determine the cost and carrying amount of those disposed of to properly calculate any resulting gain or loss on disposal. The cost of those assets remaining will also affect the balances reported on the statement of financial position.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-6

The cost of a basket purchase is allocated to the items on the basis of their relative fair values. If there were three items (A, B, and C) purchased for a single price of $1,000 and the fair values of the three items were $300 (A), $400 (B), and $500 (C) then the cost of the three items is allocated as follows: Percentage of Fair Value A: $300 / $1,200 = 25.0% B: $400 / $1,200 = 33.3% C: $500 / $1,200 = 41.7% Cost 25.0% x $1,000 = $250 33.3% x $1,000 = $333 41.7% x $1,000 = $417

LO 2 BT: AP Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-7

The purpose of depreciation is to allocate the asset’s economic benefits over the periods in which these benefits are expected to be consumed or used up. The allocation is over the asset’s estimated useful life using a rational and systematic method. There are three methods of depreciation. The straight-line method which allocates the costs evenly over the life of the asset, an accelerated method (such as diminishing balance) that allocates more of the asset’s costs early in the life of an asset and less in later years, or a method based on the actual usage of the asset (units-of-activity or units-of-production method). In practice, the straight-line method and the diminishing-balance method are most commonly used.

LO 3,4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-8

While the straight-line method is relatively simple to apply, some assets do not provide their benefits equally each accounting period. Therefore, the straight-line method would not be representative of how the company expects to consume the asset’s economic benefits, so another method of depreciation (i.e. diminishing balance or units-ofproduction) would be used.

LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-9

Companies should choose the depreciation method that most closely represents the pattern by which the asset’s economic benefits will be consumed or used up. The economic benefits of many assets, such as most buildings for example, are consumed or used up evenly over their useful lives making the straight-line method of depreciation the most appropriate. It is the most commonly used method. However, it is not always obvious which pattern is most appropriate. In some situations, an accelerated depreciation method produces the best allocation of costs as more of the asset’s economic benefits are consumed early in its useful life and less as time goes by. This method allocates larger amounts of depreciation expense in the early years and less in later years. For some assets, it is possible to link the consumption of economic benefits directly with its use. A unit of activity, such as the number of units it can produce or the number of kilometers that can be driven, can be determined and used as the basis for allocating the asset’s cost. In these cases, an activity approach such as units-of-production results in the best allocation of the asset’s costs to the periods in which its economic benefits are being consumed or used up.

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-10

An asset’s residual value is management’s estimate of the net amount that would be received today if the asset were now as old and in the same condition it is expected to be at the end of its useful life. Because depreciation is a process of allocating the cost of an asset to expense over its useful life, any costs expected to be recovered at the end of its useful life should not be part of the depreciation expense. Therefore, the residual value is considered in determining how much cost should be recognized each period as an expense.

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-11

Estimated residual value and estimated useful life are used directly in the straight-line method. The estimated residual value is subtracted from the original cost of the asset to determine the depreciable amount of the asset, i.e. the amount of the cost that is to be depreciated over the life of the asset. The depreciable amount is then divided by the asset’s estimated useful life to determine the depreciation expense to be allocated to each period. For the units-of-production method, the estimated residual value is also subtracted from the original cost of the asset to determine its depreciable amount. Rather than determining the estimated useful life in years (as is the case with the straight-line method), it is estimated in terms of the number of units of use or output that the asset will produce (i.e. units, km, hours, tonnes, m3). Dividing the depreciable amount by the estimated useful life in units determines the depreciation expense per unit. Finally, depreciation expense for the period is calculated by multiplying the depreciation expense per unit by the asset’s actual use or output for the period. Under the diminishing balance method, the estimated useful life is used to determine the depreciation rate. For example, under the double diminishing balance method the rate is equal to: (1/estimated useful life) x 2. This rate is then applied to the asset’s net book value (i.e. cost – accumulated depreciation) to determine depreciation expense for the period. The diminishing-balance method does not explicitly incorporate the estimated residual value in the calculation of depreciation expense. Instead, it is used as a constraint in setting the depreciation schedule. After determining the depreciation expense for the period, the revised net book value is determined and compared to the estimated residual value. As an asset cannot be depreciated below its estimated residual value, for the period in which the net book value falls below the estimated residual value, depreciation expense must be adjusted. The maximum depreciation expense for that period will be equal to the difference between the net book value at the start of the period and the asset’s estimated residual value.

LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-12

Some assets have a useful life that is a function of the activity associated with the asset. In this case, a units-of-activity or units-ofproduction approach results in the best allocation of the asset’s economic benefits. The “units” referred to could be units of input, such as kilowatt hours used, kilometers driven, flight hours, or they could be output-related such as customers contacted or units produced (i.e. units, tonnes, m3).

LO 4 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-13

Companies must periodically revisit the estimates for useful life and residual value of assets to ensure they remain valid. Changes in such accounting estimates are handled prospectively (i.e. into the future). They are not treated retrospectively (i.e. no adjustments are made to prior periods). For example, if the straight-line method of depreciation is being used at the time of the estimate change, the company determines the carrying amount of the asset at the time of change, subtracts (if applicable) the revised estimate of its residual value, and allocates this amount over the estimated remaining useful life. There is no restatement of prior periods with a change of estimate, nor is any “catch-up” adjustment made.

LO 5 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-14

By selecting to depreciate their production equipment on a diminishing balance basis at the rate of 5% per year, management is expecting the equipment to have a relatively long useful life. If the expected useful life was shorter, a higher percentage would be used for the rate. Since the diminishing balance method is being used, depreciation expense each year that will decline modestly from year to year over the useful life of the equipment. In using an accelerated depreciation method like diminishing balances, management expects that a greater proportion of the production equipment’s economic benefits will be consumed early in its useful life and less as time goes on.

LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-15

The straight-line method results in the higher net income in the year an asset is purchased because the depreciation expense is lower in the first year than it would be under the diminishing-balance method. The diminishing-balance method results in larger amounts of depreciation expense early in the life of the asset and lower amounts over time, whereas the straight-line method has equal amounts spread over the asset’s useful life.

LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-16

Diminishing balance would result in the greatest reduction in the carrying amount of a piece of equipment in the year of its acquisition as this depreciation method is designed to have the most depreciation expense taken in the first few years of use whereas straight-line is the same amount every year.

LO 4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-17

The carrying amount of equipment is based on multiple estimates as depreciation expense is calculated based on the estimated useful life of the equipment and the estimated residual value of the equipment. Depreciation expense affects the amount of accumulated depreciation and the carrying amount is the cost less accumulated depreciation, so the carry amount is based on multiple estimates. The carrying amount of equipment may also be subject to impairment testing if indications of impairment are present. If this is the case, estimates related to future cash flows and the estimated fair value less estimated selling costs would be considered.

LO 3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-18

When management determines that one of its pieces of manufacturing equipment is impaired, it means that the company is unlikely to recover the asset’s carrying amount either by continuing to use the equipment in operations or by selling the asset. The amount of the impairment would become a loss in the current period as the asset no longer embodies all the future economic benefits that had been expected to flow from it.

LO 6 BT: C Difficulty: H Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-19

If a company records a gain on the disposal of a piece of equipment, we know that the proceeds received for it, net of any costs to dispose of the equipment, were greater than the carrying amount of the equipment. The carrying amount is the cost of the equipment less accumulated depreciation less any accumulated impairment losses as well as any depreciation expense recorded to bringing its depreciation up-to-date as of the date of disposal. This also tells us that management’s estimates regarding its useful life and/or residual value were incorrect and that depreciation expense in prior periods had been overstated (too high).

LO 7 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-20

The Canada Revenue Agency’s (CRA) version of depreciation is capital cost allowance (CCA). CCA is based on specific rates that may or may not coincide with management’s assessment of the asset’s useful life. The CRA sets CCA rates to meet economic objectives, to encourage corporate investment in productive assets, and to standardize the method and rates permitted for all taxpayers in calculating their taxable income. The use of CCA rates removes much of the management judgement involved in depreciation calculations (i.e. depreciation method, estimated useful life and estimated residual value).

LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-21 • •

• •

Key differences between the CCA system and accounting depreciation include: Companies estimate the useful life of assets which is used to determine the rate of depreciation, whereas under the CCA system, the CCA rate is specified by the Canada Revenue Agency. The CCA rate is the maximum rate that may be used, but it is possible for companies to use less than this maximum rate. Companies are not able to do this when determining depreciation expense for accounting purposes. The CCA system ignores an asset’s estimated residual value, whereas it is a key component in depreciation calculations. The CCA system follows an accelerated method similar to diminishingbalance method, whereas other methods (i.e. units-of-production or straight-line) are commonly used for determining depreciation for accounting purposes.

LO 4 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-22

Intangible assets can be recorded if they are purchased from outside parties, using the same general capitalization principles that are applied to PP&E. Intangibles that are developed internally by a company, such as processes that may eventually be patented, cannot be capitalized unless management is assured the intangible being developed will deliver economic benefits to the company. Typically, costs paid to third parties, such as legal and registration costs related to the patent, are capitalized as part of the cost of the intangible asset. Goodwill can be recognized only as a result of a business combination; that is, only when one company acquires a business and pays more for it than the fair value of the identifiable net assets of that business. Internally (self-generated) goodwill cannot be capitalized.

LO 8,9 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-23

Many intangible assets have a legal life (i.e. patents and copyrights), but often their useful life is shorter than their legal life. When an intangible asset is expected to provide economic benefits for an estimated period into the future, its cost is amortized over that useful period, similar to PP&E and depreciation. However, there are some intangible assets whose economic benefits are expected to continue for an indefinite period into the future (i.e. trademarks), and no specific useful life can be determined. In this case, the intangible is not amortized (as the future economic benefits it embodies are not being used up). Instead, it is examined regularly (annually) for impairment. This way, the asset is written down when it is determined that its carrying amount is unlikely to be recoverable (i.e. when the future economic benefits it embodies have been diminished).

LO 8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-24

While a patent protects its holder for a period of 20 years from the date the patent is filed, other factors may reduce its useful life to a much shorter period. This is especially true when the patent is based on specific technologies that are likely to be outdated long before the 20 years are up. Other factors such as changing consumer tastes and preferences, increased competition, newly developed processes, etc. can affect how long a patent will contribute to an entity’s revenues and cash flows.

LO 8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-25

Goodwill is equal to the price paid to purchase a business less the fair value of the net assets acquired (i.e. the fair value of the assets acquired less the fair value of any liabilities assumed in the purchase). This excess amount may be paid because the business earns profits in excess of what the average business in the industry earns. This, in turn, may be due to such factors as a productive workforce, very capable management, or an excellent business reputation. Goodwill can be recognized in the accounts only when one business acquires another and pays more for than the fair value of the net assets acquired.

LO 9 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-26

Internally generated goodwill is not recognized as an asset in the accounts because of measurement uncertainty. What would be its cost? Which expenditures resulted in the goodwill? What would you capitalize? What are the economic benefits that result from specific expenditures? These questions are difficult, if not impossible, to answer. In addition, goodwill is likely the result of training and educating employees and hiring very capable management. Not only is it impossible to determine which of these expenditures should be capitalized as goodwill, but the employees and top management that may contribute significantly to the excess earnings and goodwill are not controlled by the entity, a condition necessary to meet the definition of an asset. Employees and management can leave and seek employment elsewhere. Therefore, the costs incurred, even if known, cannot be recognized as an asset.

LO 9 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-27

Goodwill is based on numerous estimates, as estimates of the fair values of the assets and liabilities being purchased are used to calculate goodwill. Estimates of the fair value of assets including land, building, equipment, accounts receivable, inventory, etc. are required before goodwill can be determined. Estimates of the fair value of any liabilities assumed (such as accounts payable or long-term debt) are also required to determine goodwill. Estimates are needed determine the benefits that will be received from purchasing the company. This amount is added to the estimated values of the assets and liabilities to arrive at a purchase price.

LO 9 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-28

Right-of-use assets are different from property, plant, and equipment in that they include any type of assets that is being leased for a period beyond a year. They therefore can include leased space for any purpose, such as stores, warehouses and offices. They are presented as a separate class of asset on the statement of financial position so that the user can distinguish them from property, plant, and equipment that is owned.

LO 10 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ8-29

Biological assets are living plants and animals whose biological transformation or growth is being managed. Biological assets are different from property, plant, and equipment in that they are reported on the statement of financial position at their fair value less any estimated selling costs. Property, plant, and equipment, on the other hand are generally reported at historical cost less accumulated depreciation.

LO 10 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ8-30

Climate change could have a significant impact on the value of longlived assets. Since biological assets are valued at fair value, they face the risk related to weather conditions, that could intensify factors affecting this fair value. For the forestry industry, these factors include damage by fire, insect infestation, disease, prolonged drought, windstorms, flooding and other weather conditions, and natural and man-made disasters. Another example would be warming ocean temperatures that affect the aquacultural companies.

LO 10 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP8-1A a.

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

b. 11.

Land Land Land Building Land Improvements Land Improvements (but may also be expensed) Equipment If non-recoverable – Equipment; if GST or HST – no effect on an asset or an expense account. Equipment Equipment Expense Equipment Expense Expense

Expense – minor repairs of equipment only maintain the equipment in its original state, it is merely keeping the equipment operational, it is not a betterment

13.

Expense – routine maintenance of equipment only restores the equipment to its original state, it is merely keeping the equipment operational, it is not a betterment

14.

Expense (or a Loss account) – replacing the broken windows only restores them to their original state; it is not making the asset more efficient or resulting in it lasting longer than it would have before it was broken.

LO 2 BT: K Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-2A

Amount paid for land, hangar and paving, and amount to be allocated to the components = $6,500,000*

Component

Fair Value

Percentage

Land $3,410,000 Building 2,480,000 Land Improvements 310,000 Total $6,200,000

Cost

Allocated Cost

55%1 X $6.5M $3,575,000 40%2 X $6.5M 2,600,000 5%3 X $6.5M 325,000 100% $6,500,000

1 – $3,410,000/$6,200,000 = 55% 2 – $2,480,000/$6,200,000 = 40% 3 – $310,000/$6,200,000 = 5% * It could be argued that the $300,000 excess of cost over the appraisal values of the components of the basket purchase should be written off as a loss, rather than capitalized, because the company should have paid no more than the fair value for the components. The key concept to bear in mind in this type of situation is that the recorded cost of an asset should not exceed its fair value. The $300,000 premium paid can legitimately be capitalized in this situation because of the added economic benefits of the property to Touch and Go Academy. Because the location has the effect of reducing the cost of student acquisition, the property provides additional future asset benefits to the company. This treatment is further supported by the fact that the bank accepted the higher valuation for purposes of financing. The purchase price must be allocated because land does not depreciate, and the useful life of the building and the land improvements (such as runway paving and landscaping) are significantly different. Therefore, it is necessary to recognize the cost of each component separately. NOTE: The $300,000 premium is not considered ‘Goodwill’ because the purchase is only of individual assets and not an entire business or business segment. LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-3A a. Total basket purchase = $236,000

Equipment A Equipment B Total

Fair Value $111,000 259,000 $370,000

Percentage Cost Allocated Cost 1 30% X $330,000 $ 99,000 2 70% X $330,000 $231,000 100.0% $330,000

1 –$111,000/$370,000 = 30.0% 2 – $259,000/$370,000 = 70.0% Apr. 07

Equipment (A) Equipment (B) Cash

330,000

Apr. 10

Equipment (A) 1,200* Equipment (B) 2,800* Cash 4,000 * using the same ratio as the initial basket purchase Apr. 28

99,000 231,000

Equipment (B) Cash

9,000 9,000

Equipment A depreciation: Double-diminishing-balance rate = (1/8) x 2 = .25 or 25% ($99,000+ $1,200) x 25% x 8/12 = $16,700 Equipment B depreciation: [($231,000 + $2,800 + $9,000) – $17,800] ÷ 6 x 8/12 = $25,000 Dec. 31 Depreciation Expense 16,700 Depreciation Expense 25,000 Accumulated Depreciation, Equipment (A) Accumulated Depreciation, Equipment (B)

16,700 25,000

(NOTE: The debits to Depreciation Expense can be combined, however the credits to Accumulated Depreciation must be kept separate.) LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-4A a. i. Straight-line method depreciation [($150,000 – $12,000) / 5] = $27,600 per year ii. Units-of-production method depreciation ($150,000 – $12,000) / 115,000 = $1.20 per unit Year 2024 $1.20 x 15,000 2025 $1.20 x 24,000 2026 $1.20 x 30,000 2027 $1.20 x 28,000 2028 $1.20 x 18,000 Total units 115,000

= = = = =

$18,000 $28,800 $36,000 $33,600 $21,600

iii. Double-diminishing-balance method depreciation Rate = (1/5) x 2 = .4 or 40% Year 2024 ($150,000 – $0) x 40% = 2025 ($150,000 – $60,000) x 40% = 2026 ($150,000 – $96,000) x 40% = 2027 ($150,000 – $117,600) x 40% = 2027 Carrying amount = $150,000 – $130,560 = Less: Residual value Depreciation for 2028 b.

$60,000 36,000 21,600 12,960 $130,560 $19,440 (12,000) $ 7,440

The company should choose the depreciation method that best reflects the pattern in which the economic benefits embodied in the asset are expected to be used up or consumed. LO 4 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-5A Year 2 Depreciation Expense Straight-line method: ($40,000 - $4,000) ÷ 4 =

$ 9,000

Units-of-production method: ($40,000 - $4,000) ÷ 100,000 Km. = $ .36/km. 27,500 km. x $ .36 =

$ 9,900

Double-diminishing-balance method: Rate = (1/4) x 2 = .5 or 50% Year 1: $40,000 x 50% = $20,000 Year 2: ($40,000 - $20,000) x 50% =

$10,000

LO 4 BT: AP Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-6A a. i. Straight-line method: [($100,000 – $10,000) / 4] = $22,500 per year ii. Units-of-production method: ($100,000 – $10,000) / 200,000 = $0.45 per unit Year 2024 2025 2026 2027

Units 40,000 x $0.45 = $18,000 50,000 x $0.45 = $22,500 60,000 x $0.45 = $27,000 50,000 x $0.45 = $22,500

iii. Double-diminishing-balance method: Rate = (1/4) x 2 = .5 or 50% Year 2024 ($100,000 – $0) x 50% 2025 ($100,000 – $50,000) x 50% 2026 ($100,000 – $75,000) x 50%

= = =

2027 Carrying amount = $100,000–$87,500 Less: Residual value Depreciation expense, 2027

$50,000 $25,000 $12,500 $87,500 $12,500 (10,000) $ 2,500

i. Over 1st 2 years

Straight-line

Units-ofproduction

Double-diminishingbalance

$45,000*

$40,500**

$75,000***

ii. Over all 4 years $90,000 $90,000 * ($22,500 x 2) = $45,000 ** ($18,000 + $22,500) = $40,500 *** ($50,000 + $25,000) = $75,000

$90,000

The double-diminishing-balance method records highest depreciation expense during the first two years, but the total expense over all four years is the same under all the methods. LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-7A Rate of depreciation (units-of-production method): ($1,200,000 - $150,000) ÷ 14,000 flying hours = $75/flying hour 2024 depreciation expense: 1,400 flying hours X $75/hr. = $105,000 2025 depreciation expense: 1,650 flying hours X $75/hr. = $123,750 Carrying amount of helicopters, December 31, 2025: $1,200,000 – ($105,000 + $123,750) = $971,250 LO 4 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-8A a. Statement of Income

Decrease in Net Income

(by the amount of the loss, $37,000-$45,000) Statement of Financial Position

Decrease in Assets

[difference between proceeds ($37,000) and carrying amount of equipment, ($45,000) and decrease in shareholders equity (as retained earnings would decrease by amount of loss)] Statement of Cash Flows

Increase in Cash

(by selling price, $37,000)

b. Statement of Income Statement of Financial Position

No effect No net effect

(as cash would decrease by $218,000 and equipment would increase by $218,000) Statement of Cash Flows

Decrease in Cash

(by amount of purchase price) c. Statement of Income

Decrease in Net Income

(by amount of depreciation expenses) Statement of Financial Position

Decrease in Assets

(as carrying amount of equipment would decrease) and decrease in shareholders equity (as retained earnings would decrease) Statement of Cash Flows

No effect

LO 4,7 BT: AN Difficulty: H Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-9A a. Jan. 1, 2024 Machinery Cash

37,000 37,000

Dec. 31, 2024, 2025, and 2026 Depreciation Expense* 3,300 Accumulated Depreciation, Machinery

3,300

*($37,000 - $4,000) /10 years = $3,300/year b. Jan. 1, 2024 Machinery Cash

37,000

Dec. 31, 2024 Depreciation Expense* 7,400 Accumulated Depreciation, Machinery

37,000

7,400

Rate = (1/10) x 2 = .2 or 20% *$37,000 x 20% = $7,400

Dec. 31, 2025 Depreciation Expense* 5,920 Accumulated Depreciation, Machinery

5,920

*($37,000 - $7,400) x 20% = $5,920 Dec. 31, 2026 Depreciation Expense* 4,736 Accumulated Depreciation, Machinery *($37,000 - $7,400 - $5,920) x 20% = $4,736

4,736

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-9A (Continued)

c. Oct. 31, 2024 Machinery Cash

37,000 37,000

Dec. 31, 2024 Depreciation Expense* 550 Accumulated Depreciation, Machinery

550

*($37,000 - $4,000) /10 years x (2/12) 1 = $550 1 – 2 months (i.e. November and December)

Dec. 31, 2025 Depreciation Expense 3,300 Accumulated Depreciation, Machinery 3,300 Mar. 31, 2026 Depreciation Expense* 825 Accumulated Depreciation, Machinery

825

*($37,000 - $4,000)/10 years x (3/12)2 = $825 2 – 3 months (i.e. January through March)

Cash Accumulated Depreciation, Machinery* Loss on Disposal Machinery

28,000 4,675 4,325 37,000

*$550 + $3,300 + $825= $4,675

LO 4,7 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-10A Depreciation expense: ($180,000 - $30,000) / 5 years = $30,000 per year or /12 = $2,500 per month Carrying amount of equipment on June 30, 2026: Cost, April 2, 2024 $180,000 Depreciation expense recognized and balance of accumulated depreciation on June 30, 2026: April 2/24 to June 30/26 = 9+12+6 = 27 months $2,500 x 27 = ( 67,500) Carrying amount $112,500 Proceeds of sale Carrying amount at June 30, 2026 Loss on disposal

$100,000 112,500 ($ 12,500)

LO 4,7 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-11A Cost Equipment: Jan. 1, 2021 Balance, Jan. 1, 2024 ($40,000 - $4,000) /6 X 3 yrs. Depreciation Jan. 1 to Mar. 31/24 ($40,000 - $4,000) /6 X 3/12

Accumulated Depreciation

$40,000 $18,000 1,500 $19,500

Mar. 31/2024 Depreciation Expense Accumulated Depreciation, Equipment Mar. 31/2024 Cash Accumulated Depreciation, Equipment Equipment Gain on Disposal Apr. 12/2024 Equipment Cash

1,500 1,500 29,000 19,500 40,000 8,500

82,000 82,000

Dec. 31/2024 Depreciation Expense* 9,000 Accumulated Depreciation, Equipment

9,000

*($82,000 - $10,000) / 6 x (9/12) = 9,000 Trucks—Depreciation Expense Determine rate: (1/4) x 2 = .5 or 50% 2023: $60,000 x 50% = 2024: ($60,000 - $30,000) x 50% = Dec. 31/2024 Depreciation Expense Accumulated Depreciation, Trucks

$30,000 $15,000

15,000 15,000

LO 4,7 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-12A a. Mar. 1, 2023 Machinery Cash Notes Payable

80,000

b.Dec. 31, 2023 Depreciation Expense* 6,667 Accumulated Depreciation, Machinery * [($80,000 – $8,000) / 9] x 10/12 Dec. 31, 2024 Depreciation Expense* 8,000 Accumulated Depreciation, Machinery * [($80,000 – $8,000) / 9] Oct. 30, 2025 Depreciation Expense* 6,667 Accumulated Depreciation, Machinery * $8,000 x 10/12 = $6,667 Oct. 30, 2025 Cash 62,000 Accumulated Depreciation, Machinery* 21,334 Gain on Disposal Machinery * ($6,667 + $8,000 + $6,667) = $21,334

20,000 60,000

6,667

8,000

6,667

3,334 80,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-12A (Continued) c. i. Year

Opening Carrying Amount

Rate

Depreciation Ending Expenses carrying amount

$80,000

x 22.22%

$17,776

$62,224

x 22.22%

$13,826

$48,398

x 22.22%

$10,754

$37,644

2023

10/12 x $17,776 = $14,813

2024

2/12 x $17,776 = $ 2,963 10/12 x $13,826 = $11,522 $14,485

2025

2/12 x $13,826 = $2,304 8/12 x $10,754 = $7,169 $9,473*

ii. Oct. 30, 2025 Depreciation Expense* Accumulated Depreciation, Machinery

Cash Accumulated Depreciation, Machinery Gain on Disposal Machinery 1

9,473 9,473

62,000 38,7711 20,771 80,000

($14,813 + $14,485 + $9,473) = $38,771

LO 4,7 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-13A

Cost of machinery, Jan. 1, 2024 Depreciation expense, 2024, and accumulated depreciation Jan. 1, 2025 ($3,600,000 - $0)/ 4 years = Equipment’s carrying amount, Jan. 1, 2025 Depreciation expense, 2025: ($2,700,000 - $0) / 5* remaining years = * Total 6 less one year

$3,600,000

(900,000) $2,700,000

$ 540,000

LO 5 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP8-14A

Initial depreciation for Years 1 and 2: ($66,000 – $6,000) ÷ 150,000 units = $0.40 per unit Carrying amount at end of Year 2 = $66,000 – (45,000 x $0.40) =$48,000 Revised depreciation calculation in Year 3: (Carrying amount – Residual value) ÷ Remaining useful life ($48,000 – $6,000) ÷ (120,000 – 45,000) = $0.56 per unit Depreciation expense for Year 3 = $0.56 x 25,000 units = $14,000

LO 5 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-15A July 1, 2020 Machinery Cash

140,000 140,000

Dec 31, 2020 Depreciation Expense 1 6,650 Accumulated Depreciation, Machinery 1

($140,000 – $7,000) / 10 = $13,300 per year $13,300 per year x 6/12 = $6,650

Dec 31, 2023 Depreciation Expense2 11,750 Accumulated Depreciation, Machinery 2

9,792

$11,750/ year x (10/12) = $9,792

Nov 1, 2024 Cash Accumulated Depreciation, Machinery4 Loss on Disposal Machinery 4

11,750

A. Determine carrying amount at time of change $140,000 – ($6,650 + $13,300 + $13,300) = $106,750 B. Determine depreciation expense using revised estimated residual value and revised estimated useful life ($106,750 – $1,000) / 9 = $11,750

Nov 1, 2024 Depreciation Expense3 9,792 Accumulated Depreciation, Machinery 3

6,650

83,000 54,792 2,208 140,000

$6,650 + $13,300 + $13,300 + $11,750 + $9,792 = $54,792

LO 4,5,7 BT: S Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-16A a.

Licences

Customer Lists

Patents

Copyrights

Purchase cost

$80,000

$60,000

$160,000

$250,000

Legal fees

12,000

Total cost

$92,000

$60,000

$160,000

$250,000

Amortization period

N/A

6 years

8 years

10 years

Annual amortization*

N/A

$10,000

$20,000

$ 25,000

*Assuming the straight-line method is appropriate for all intangibles with a limited or finite useful life. b.

Intangible assets, at cost less accumulated amortization Copyrights $ 150,000 * Patents 80,000 ** Customer Lists 20,000 *** Licences 92,000 Total intangible assets $ 342,000 * [$250,000 – ($25,000 x 4)] ** [$160,000 – ($20,000 x 4)] *** [$60,000 – ($10,000 x 4)]

LO 8 BT: AP Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-17A a. Goodwill Purchase Price Less: Inventory Accounts Receivable Machinery Patents Add: Accounts Payable Loan Payable Goodwill

$9,746,000 (1,456,000) (856,000) (3,654,000) (730,000) 895,000 809,000 $4,754,000

b. Amortization Expense Accumulated Amortization, Patents

91,250 91,250

Patent $730,000/8 = $91,250 (use 8 years as it is expected the patent will be obsolete in 8 years. LO 8,9 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-1B a. Amount to be capitalized: Land

Building

Jan. 2

Purchase of land

$ 75,000

Jan. 6

Fees related to land purchase

1,200

Jan. 11

Clearing the land

4,000

Jan. 15

Purchased equipment

Jan. 17

Building permit

$ 900

Jan. 20

Temporary fencing

2,500

Jan. 22

Construction started and estimated total cost is noted - This is not recorded.

Jan. 25

Delivery of equipment

Feb. 1

Payment for equipment and delivery - This reduces the liabilities that would have been recorded on January 13 and January 25.

Feb. 28

Architect’s fees

11,000

May 9

Completion of building

380,000

May 11

Tearing down fencing

800

May 14

Installing equipment

May 24

Party to celebrate Record as an expense

June 7

Setting up equipment

Equipment

$120,000

3,500

2,500

700

June 10 Advertising for workers record as an expense $ 80,200

$395,200

$126,700

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-1B (Continued)

b. The cost of the party and the cost of advertising for workers should be treated as current period expenses. They were not necessary costs of acquiring or preparing the land, building or equipment for use. LO 2 BT: K Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-2B

Amount paid for land, building and land improvements, and amount to be allocated to the components = $4,800,000

Component

Fair Value

Percentage

Cost

Land Building Land Improv. Total

$1,518,900 2,714,100 747,000 $4,980,000

30.5%1 X $4,800,000 54.5%2 X $4,800,000 15.0%3 X $4,800,000 100%

Allocated Cost $1,464,000 2,616,000 720,000 $4,800,000

Land – $1,518,900/$4,980,000 = 30.5% Building – $2,714,100/$4,980,000 = 54.5% 3 Land Improv. – $747,000/$4,980,000 = 15.0% 1 2

The purchase price must be allocated because land does not depreciate, and the useful life of the building and the land improvements (such as paving and landscaping) are significantly different. Therefore, it is necessary to recognize the cost of each component separately. LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-3B a. Total basket purchase = $590,000

Processing Packaging Total 1 2

Fair Value $320,000 284,000 $604,000

Percentage Cost 1 53% X $590,000 47%2 X $590,000 100.0%

Allocated Cost $312,700 $277,300 $590,000

$320,000/$604,000 = 53% $284,000/$604,000 = 47%

May 19

Processing Equipment Packaging Equipment Cash

590,000

Processing Equipment 11,660* Packaging Equipment 10,340* Cash 22,000 * using the same ratio as the initial basket purchase Processing Equipment Packaging Equipment Cash

312,700 277,300

5,040 1,680 6,720

Processing equipment depreciation expense: Straight-line [($312,700 + $11,660 + $5,040) - $36,000] ÷ 6 x 7/12 = $28,525 Packaging equipment depreciation expense: [($277,00 + $10,340 + $1,680) – $18,000] ÷ 5 x 7/12 = $31,654 Dec. 31 , 2024 Depreciation Expense 60,179 Accumulated Depreciation, Processing Equipment Accumulated Depreciation, Packaging Equipment

28,525 31,654

(NOTE: The debits to Depreciation Expense has been combined, however the credits to Accumulated Depreciation must be kept separate.) LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-4B a.

i. Straight-line method depreciation [($386,000 – $28,000) / 4] = $89,500 per year ii. Units-of-production method depreciation ($386,000 – $28,000) / 286,400* = $1.25 per unit Year 2024 $1.25 x 102,400 = 2025 $1.25 x 32,200 = 2026 $1.25 x 97,300 = 2027 $1.25 x 54,500 = Total tonnes *286,400

$128,000 $ 40,250 $121,625 $ 68,125

iii. Double-diminishing-balance method depreciation Rate = (1/4) x 2 = .5 or 50% Year 2024 ($386,000 – $0) x 50% 2025 ($386,000 – $193,000) x 50% 2026 ($386,000 – $289,500) x 50%

= = =

$193,000 96,500 48,250 $337,750

2026 Carrying amount=$386,000–$337,750 = 48,250 Less: Residual value (28,000) Depreciation for 2027 $20,250

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-5B Year 2 Depreciation Expense Straight-line method: ($196,000 - $12,000) ÷ 8 =

$23,000

Units-of-production method: ($196,000 - $12,000) ÷ 230,000 Km. = $ .80/km. 31,600 km. x $ .80 =

$25,280

Double-diminishing-balance method: Rate = (1/8) x 2 = .25 or 25% Year 1: $196,000 x 25% = $49,000 Year 2: ($196,000 - $49,000) x 25% =

$36,750

LO 4 BT: AP Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-6B a. i. Straight-line method: [($388,000 – $38,000) / 4] = $87,500 per year ii. Units-of-production method: ($388,000 – $38,000) / 2,500,000 = $0.14 per unit Year 2024 2025 2026 2027

Units 710,000 x $0.14 = $99,400 688,000 x $0.14 = $96,320 595,000 x $0.14 = $83,300 507,000 x $0.14 = $70,980

iii. Double-diminishing-balance method: Rate = (1/4) x 2 = .5 or 50% Year 2024 ($388,000 – $0) x 50% 2025 ($388,000 – $194,000) x 50% 2026 ($388,000 – $291,000) x 50%

= = =

2026 Carrying amount = $388,000 – $339,500 = Less: Residual value Depreciation expense, 2027

$194,000 $97,000 $48,500 $339,500 $48,500 (38,000) $10,500

b. Straight-line i. Over 1st 2 years

$175,000*

Units-ofproduction $195,720**

ii. Over all 4 years $350,000 $350,000 * ($87,500 x 2) = $175,000 ** ($99,400 + $96,320) = $195,720 *** ($194,000 + $97,000) = $291,000

Double-diminishingbalance $291,000*** $350,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-7B Rate of depreciation (units-of-production method): ($2,465,000 - $949,000) ÷ 18,950 flying hours = $80.00/flying hour 2024 depreciation expense: 1,280 flying hours X $80.00/hr. = $102,400 2025 depreciation expense: 5,150 flying hours X $80.00/hr. = $412,000 Carrying amount of airplane, December 31, 2025: $2,465,000 – ($102,400 + $412,000) = $1,950,600 LO 4 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-8B a.

Statement of Income

Increase in Net Income

(by the amount of the gain $159,000 - $138,000) Statement of Financial Position

Increase in Assets Increase in Shareholders’ Equity

[difference between the proceeds ($159,000) and carrying amount of equipment ($138,000) and increase in shareholders’ equity as retained earnings would increase (by amount of gain)] Statement of Cash Flows

Increase in Cash

(by selling price, $159,000) b.

Statement of Income

No effect

Statement of Financial Position

No net effect

(as cash would decrease by $1,118,000 and equipment would increase by $1,118,000) Statement of Cash Flows

Decrease in Cash

(by amount of purchase price) c.

Statement of Income

Decrease in Net Income

(by amount of depreciation expense) Statement of Financial Position

Decrease in Assets Decrease in Shareholders’ Equity

(as carrying amount of equipment would decrease) and decrease in shareholders’ equity (as retained earnings would decrease) Statement of Cash Flows

No effect

LO 4,7 BT: AN Difficulty: H Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-9B a.

Jan. 1, 2024 Equipment Cash

48,800 48,800

Dec. 31, 2024, 2025, and 2026 Depreciation Expense* 11,100 Accumulated Depreciation, Equipment

11,100

*($48,800 - $4,400) /4 years = $11,100/year

Jan. 1, 2024 Equipment Cash

48,800 48,800

Dec. 31, 2024 Depreciation Expense* 24,400 Accumulated Depreciation, Equipment 24,400 Rate = (1/4) x 2 = .5 or 50% *$48,800 x 50% = $24,400

Dec. 31, 2025 Depreciation Expense* 12,200 Accumulated Depreciation, Equipment

12,200

*($48,800 - $24,400) x 50% = $12,200 Dec. 31, 2026 Depreciation Expense* 6,100 Accumulated Depreciation, Equipment *($48,800 - $24,400 - $12,200) x 50% = $6,100

6,100

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-9B (Continued) c. May 12, 2024 Equipment Cash

48,800 48,800

Dec. 31, 2024 Depreciation Expense* 7,400 Accumulated Depreciation, Equipment

7,400

*($48,800 - $4,400) /4 years x (8/12) 1 = $7,400 1 – 8 months (i.e. May through December)

Dec. 31, 2025 Depreciation Expense 11,100 Accumulated Depreciation, Equipment

11,100

Sept.25, 2026 Depreciation Expense* 8,325 Accumulated Depreciation, Equipment

8,325

*($48,800 - $4,400)/4 years x (9/12)2 = $8,325 2 – 9 months (i.e. January through September)

Cash Accumulated Depreciation, Equipment* Loss on Disposal Equipment

19,900 26,825 2,075 48,800

*$7,400 + $11,100 + $8,325 = $26,825 LO 4,7 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-10B Depreciation expense: ($448,000 - $28,000) / 5 years = $84,000 per year or /12 = $7,000 per month Carrying amount of equipment on May 28, 2027: Cost, June 22, 2024 Depreciation expense recognized and balance of accumulated depreciation on May 28, 2027: June 22/24 to May 28/27 = 6+12+12+5 = 35 months $7,000 x 35 = Carrying amount

$448,000

Proceeds of sale Carrying amount at May 28, 2027 Loss on disposal

$167,000 $203,000 ($ 36,000)

May 28/27 Cash 167,000 Accumulated Depreciation, Equipment 245,000 Loss on Disposal 36,000 Equipment

(245,000) $203,000

448,000

LO 4,7 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-11B Cost Equipment: Jan. 1, 2024 Balance, Jan. 1, 2025 ($255,000 - $15,000) /5. Depreciation Jan. 1 to Nov. 21/2025 ($255,000 - $15,000) /5 X 11/12

Accumulated Depreciation

$255,000 $48,000 44,000 $92,000

Nov 21/2025 Depreciation Expense 44,000 Accumulated Depreciation, Equipment

44,000

Nov. 21/2025 Cash Accumulated Depreciation, Equipment Loss on Disposal Equipment

255,000

Nov. 26/2025 Equipment Cash

151,000 92,000 12,000

389,000

Dec. 31/2025 Depreciation Expense * 7,500 Accumulated Depreciation, Equipment

389,000

7,500

*($389,000 - $29,000) / 4 x (1/12) = 7,500 Trucks—Depreciation Expense Determine rate: (1/4) x 2 = .5 or 50% 2023: $148,000 x 50% = 2024: ($148,000 - $74,000) x 50% =

$74,000 $37,000 $111,000 2024: Carrying Amount ($148,000 - $111,000) = $37,000 Less residual value: (26,700) Depreciation for 2025 $10,300

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-11B (Continued) Dec. 31/2025 Depreciation Expense Accumulated Depreciation, Trucks

10,300 10,300

LO 4,7 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP8-12B a. June 6, 2024 Equipment Cash

426,000 426,000

b. Dec. 31, 2024 (not required) Depreciation Expense* 57,750 Accumulated Depreciation, Equipment *[($426,000 – $30,000) / 4 x 7/12] = $99,000 x 7/12 Dec. 31, 2025 (not required) Depreciation Expense 99,000 Accumulated Depreciation, Equipment June 21, 2026 Depreciation Expense* 49,500 Accumulated Depreciation, Equipment * $99,000 x 6/12 = $49,500 June 21, 2026 Cash Accumulated Depreciation, Equipment Loss on Disposal Equipment 1

($57,750 + $99,000 + $49,500) = $206,250

57,750

99,000

49,500

174,000 206,2501 45,750 426,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-12B (Continued)

c. i. Year

Opening Carrying Amount

Rate

Depreciation Expenses

Ending carrying amount

$426,000

x 50%

$213,000

x 50%

$106,500

x 50%

$53,250

2024 7/12 x $213,000 = $124,250 2025 5/12 x $213,000 = $ 88,750 7/12 x 106,500 = $ 62,125 $150,875 2026 5/12 x $106,500 = $44,375 1/12 x $53,250 = $ 4,438 $48,813

ii. June 21, 2026 Depreciation Expense 48,813 Accumulated Depreciation, Equipment 48,813

Cash Accumulated Depreciation, Equipment Gain on Disposal Equipment 1

174,000 323,9381 71,938 426,000

($124,250 + $150,875 + $48,813) = $323,938

LO 4,7 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-13B

Cost of equipment, Jan. 1, 2024 Accumulated depreciation Dec.31, 2026 ($94,000 - $18,000)/ 5 x 3 yrs =15,200 x 3 yrs Equipment’s carrying amount, Jan. 1, 2027 Depreciation expense, 2027: ($48,400 - $12,000) / 5* remaining years = *Total 8 – 3 years

$94,000 (45,600) $48,400

$7,280

LO 5 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

AP8-14B

Initial depreciation for 2024 and 2025: ($903,000 – $18,000) ÷ 1,770,000 units = $0.50 per unit Carrying amount Dec. 31, 2025 = $903,000 – (1,015,000 x $0.50) =$395,500 Revised depreciation calculation in 2026: (Carrying amount – Residual value) ÷ Remaining useful life ($395,500 – $15,500) ÷ (2,202,500 – 1,015,000) = $0.32 per unit Depreciation expense for 2026 = $0.32 x 468,000 units = $149,760

LO 5 BT: AP Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-15B Oct. 8, 2021 Equipment Cash

368,000 368,000

Dec 31, 2021 Depreciation Expense 1 20,400 Accumulated Depreciation, Equipment 1

($368,000 – $41,600) / 4 x 3/12 = $81,600 per year x 3/12 = $20,400

Dec 31, 2024 Depreciation Expense2 49,200 Accumulated Depreciation, Equipment 2

32,800

$49,200/year x (8/12) = $32,800

Aug. 28, 2025 Cash Accumulated Depreciation, Equipment 4 Gain on Disposal Equipment 4

49,200

A. Determine carrying amount at time of change $368,000 – ($20,400 + $81,600 + $81,600) = $184,400 B. Determine depreciation expense using revised estimated residual value and revised estimated useful life ($184,400 – $36,800) / 3 = $49,200

Aug. 28, 2025 Depreciation Expense3 32,800 Accumulated Depreciation, Equipment 3

20,400

105,000 265,600 2,600 368,000

$20,400 + $81,600 + $81,600 + $49,200 + $32,800 = $265,600

LO 4,5,7 BT: S Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-16B a. Trademarks

Customer Lists

$150,000

$220,000

$360,000

Amortization period

N/A

5 years

6 years

Annual amortization

N/A

$44,000

$60,000

Purchase cost

Patents

Intangible assets, at cost less accumulated amortization Trademarks $ 150,000 Patents 120,000 * Customer Lists 44,000 ** Total intangible assets $ 314,000 * [$360,000 – ($60,000 x 4)] ** [$220,000 – ($44,000 x 4)]

LO 8 BT: AP Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP8-17B a. Goodwill Purchase Price Less: Inventory Accounts Receivable Prepaid Expenses Equipment Building Land Patents Add: Accounts Payable Warranty Provision Bank Loan Payable Goodwill

$8,546,000 (974,000) (529,000) (71,000) (1,897,000) (1,628,000) (1,600,000) (1,360,000) 661,000 468,000 1,820,000 $3,436,000

b. Patents Amortization Expense 170,000 Accumulated Amortization, Patents

170,000

$1,360,000/8 = $170,000 (use 8 years as it is expected the patent will be obsolete in 8 years. LO 8,9 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE PROBLEMS UP8-1 In theory, all expenditures resulting in economic benefits that extend past the current year should be capitalized. However, the amounts paid for the small tools are not significant and the cost-benefit and materiality concepts should be applied in this case. The cost-benefit concept says that professional judgement should be exercised in applying accounting standards because the cost of applying some standards may outweigh the potential benefits associated with the information that would be reported. In this case, the amounts involved are not significant to a reader’s analysis and decisions (i.e. the items and the related depreciation expense are not material). The company’s accounting treatment is appropriate and does not violate accounting standards (IFRS). The qualitative characteristics in the IFRS conceptual framework would definitely support application of the costbenefit and materiality concepts in this situation. LO 2 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP8-2 In theory, all expenditures that increase the future economic benefits of an asset beyond the current fiscal year should be capitalized. This relates to expenditures that increase an asset’s capacity, its efficiency, its residual value, and its useful life, etc., and excludes those that simply restore an asset to its previous condition. Many companies, based on cost-benefit considerations (internally) and materiality (relative to user decisions), set an arbitrary dollar threshold on expenditures of a capital nature. For example, even though expenditures may, in theory, provide for long-term future economic benefits, no expenditure under $500 or $1,000 or $5,000, etc. will be capitalized. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-3 If a company were to report land and building as a single amount, the users would be unable to determine the extent of resources the company had invested in each type of asset. This information is important for users to know, as buildings are normally used to generate income, whereas land may be idle while it is held as future development site, etc. In addition, building have a finite life and will eventually be substantially renovated or torn down. This is not the case for land. It is also important to understand that the process of depreciation has nothing to do with the value of an asset. Instead, it is a rational allocation of asset’s cost to net income as the economic benefits from that asset are consumed or used up. It would not make sense to treat land and buildings in the same way, as the economic benefits from a building are used up over time, while the land’s economic benefits remain. As such, only the building’s cost should be expensed over time, which necessitates that the costs of buildings be accounted for separately from the costs of land. Most informed users understand that property, plant and equipment are not normally presented in the financial statements at their fair value or at their replacement cost. If users and analysts require this information, they must obtain it from the company (i.e. users like banks could request this) or make their own estimates and draw their own conclusions. In the case of the building, full disclosure requires information on its historical cost and accumulated depreciation to be reported on the face of the statement of financial position or in the notes. In this way, the user can determine the age of the assets, and estimate future cash outflows that may be required to replace them. Under IFRS, land and buildings are usually reported at historical cost because this is the most verifiable amount, as no two appraisers would necessarily agree on their fair values. The amount expected to be received when property is sold in the future is not relevant in most cases. Generally, it is the value of the land that increases rather than the value of the buildings situated on it. It is common for buildings to be torn down or substantially renovated after their useful life and for new structures using new technology, current building codes, and up-to-date requirements to be built in their place.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-3 (Continued) Thus, it is reasonable to recognize a portion of the building’s cost as an expense each year it is used, while not depreciating the carrying amount of the land. IFRS does allow property to be measured at a revalued amount (using the revaluation method) but this method is used mostly by companies situated in countries experiencing rapid price increases. In such a case, the qualitative characteristics of faithful representation and relevance are weighted more heavily in the measurement decision. It is interesting to note that the revalued assets continue to be depreciated, using the revalued amounts. In other words, revaluation does not eliminate the requirement to depreciate assets such as buildings. LO 3 BT: C Difficulty: H Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP8-4 There are many other items on the statement of income that are not on a cash basis (ie. Sales on account, expenses on account, etc.), so if your interest is on cash flows from operations, you should be determining this from the statement of cash flows rather than the statement of income. Although it doesn’t have a direct effect on the cash flow, depreciation expense is a valid expense that needs to be reported on the Statement of Income. Depreciation represents the consumption or usage of long-term assets being used to generate revenue. Without these assets, revenues would not be generated. Consequently, the expense related to this usage of these assets needs to be recognized so that the users of the financial statements can see all of the expenses that had to be incurred to generate the revenues for the period. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP8-5 1.Historical cost is the most verifiable measure, because independent parties can agree very closely on this amount. Users know about its limitations, but also know that companies expect to recover future cash flows equal, at a minimum, to the amount reported on the statement of financial position. Alternatively, fair value measures can be subject to management’s opinions and bias. Use of fair values also presents measurement challenges as even independent appraisers can arrive at different values for same piece of property, plant and equipment.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-5 (Continued) 2. Measuring and reporting PP&E at historic cost is an easier method to use, and less costly to administer. Obtaining fair value amounts for PP&E assets can be very expensive on a continuing basis, and the amounts reported are subject to a variety of judgements about how specific assets will be used. The use of fair values can also cause the financial statements to fluctuate significantly if fair values are increasing and decreasing significantly. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP8-6 The accountants are correct: if the proceeds of selling property, plant and equipment are in excess of its carrying amount, a gain is reported and this increases net income. The excess is reported as a “gain” instead of “revenue” because the term revenue is reserved for regular operating activity transactions involving the sale of goods and provision of services or from allowing others to use our assets. Since the company is not in the business of selling property, plant and equipment, revenue cannot result from this type of transaction. If the company was in the business of selling property, plant and equipment, the items sold would have been classified as inventory rather than property, plant and equipment. Users need to understand that such gains (and losses) arise from transactions peripheral to the major on-going operations of the company, and that they are not earnings that can be expected to continue in future periods. Therefore, users are better able to predict future earnings and cash flows if gains and losses are presented separately from revenue. LO 7 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-7 The gain reported was determined as the excess of the proceeds on disposal over the carrying amount or undepreciated cost of the equipment on our books. It is properly called a gain because the term revenue is reserved for regular operating activity transactions involving the sale of goods and provision of services or from allowing others to use our assets. There was no problem with our prior financial statements. Accounting for most assets relies on estimates. Examples include estimating how much of our receivables will not be collected, estimating what the net realizable value of our inventory is, judging whether our PP&E are impaired based on estimated, but unknown future cash flows, etc. Depreciation expense is an excellent example of an estimate because the amount of expense charged to each year is the result of making three estimates: the pattern in which the asset’s benefits are provided, the asset’s useful life, and its residual value. Accounting is so reliant on estimates that it would not be reasonable to go back and adjust prior reports every time an actual amount is later found to be different from the estimate. Instead, users of financial statements understand that management’s best estimates are necessary for accounting measurements and that estimates are used throughout financial accounting and reporting. The fact that there was a gain on the sale of the equipment indicates that the estimates used for useful life and/or residual value were incorrect. The useful life was either longer than had been estimated and/or the residual value was higher than estimated. This means that depreciation expense recorded was higher than it would have been had the estimates been precisely correct. Again, management uses its best estimates, but actual results understandably vary. LO 7 BT: C Difficulty: H Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-8 In making a long-term loan to a company, long-term assets such as property, plant, and equipment and goodwill offer comfort to the lender so long as the company is operating as a going-concern, and does not appear to be experiencing financial difficulties. In this case, the long-term assets will generate cash flows in order to service and extinguish the long-term loan. However, if the ability of the company to continue into the future is in doubt, then the goodwill likely offers less comfort to the lender than does the property, plant and equipment. The liquidation value of these assets will likely be much less than their value in use, although items of property, plant and equipment tend to hold some of their value for resale purposes. In contrast, the liquidation value of goodwill is likely zero as it is not separable from the business as a whole. For this reason, when looking for security for such a loan, lenders will generally exclude goodwill. LO 6,9 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP8-9 As a lender, I’d be interested in the company’s ability to service its debts in future periods (i.e. pay interest and repay principal) as well as the amount of collateral that would be available if the company were to default on its loans. In terms of servicing its debts, a lender would be interested in the asset’s value in use. This is most closely linked with the use of historic costs in that this results in long-term assets being carried at their cost less accumulated depreciation. The carrying amount for these assets would be the greater of the future economic benefits that are expected to flow from their use and the asset’s fair value less selling costs. As such, this value illustrates management’s expectations in terms of the asset’s ability to contribute to future earnings that can be used for debt service. In determining whether there is enough collateral value to cover the outstanding balance of the loan, historic cost is also relevant. This is because this valuation has been subject to impairment reviews, and at a minimum, is no higher than the asset’s recoverable amount to the company. If the asset is seized as security for non-payment of a debt, the asset may have to be sold in a forced sale, so a conservative estimate may be better than a valuation based on fair value. Fair value measures would be useful in terms of assessing the collateral value if it was necessary to seize the assets and liquidate them to repay the loan if the company defaults. LO 2 BT: C Difficulty: H Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-10 As an auditor, you assess the fairness of the value of a company’s plant, property, and equipment by examining the nature of each asset and assessing management’s estimates of the assets’ useful life and residual value. Other factors such as physical condition, usage, age, technological change, competition, and management’s plans and strategic direction should also be considered. If there is any indication that an asset might be impaired, I would also want to review management’s calculations of the asset’s recoverable amount – both its value in use and its fair value less costs to sell. LO 6 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001, caa-t004 CM: Reporting and Audit

UP8-11 Airline 1 is depreciating its airframes, plane engines, and buildings over a longer time period than Airline 2. Airline 1 will have a lower depreciation expense per item each year than Airline 2, and this will lead to higher net income for Airline 1. In addition, Airline 1’s carrying amounts of these assets will be higher on their statement of financial position. Once these items are fully depreciated by Airline 2 (i.e. After 40 years for buildings) it will have a higher net income than Airline 1 as it will have no depreciation expense related to them, while Airline 1 will still be depreciating their assets. LO 10 BT: AN Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP8-12 If it seems unlikely that you will meet your target this year then it would be to your advantage to write-off the equipment in the current year. Next year you will not have this write-off and therefore will show higher earnings. If you have been depreciating the asset over time then you will also not have the depreciation expense associated with this asset next year, making it easier to meet your target. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: Ethics CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-13 As an accounting manager, you allocate the purchase price between the land and the building on the basis of their relative fair values. Although municipal tax assessment records are not always based on full fair value, they might give you an idea of the relative values of the land and the building. An independent appraisal might be another costlier way to get information on their relative values. You must allocate the purchase price between the assets because the land is not depreciated while the building is. Future earnings would be distorted if you failed to allocate the cost in an appropriate manner. In addition, the allocation used for accounting purposes is also used for income tax purposes. For tax purposes, your incentive would be to allocate the maximum amount possible to the building so that you can deduct as much capital cost allowance as possible over time. For reporting purposes, there is an incentive to capitalize more of the cost as a part of the land because this results in higher net income being reported (due to less depreciation expense being recognized) and this reflects favourably on your performance. LO 2 BT: C Difficulty: M Time: 25 min. AACSB: Ethics CPA: cpa-t001 CM: Reporting

UP8-14 1. Depending on their age, none of the long-term assets will likely be reported at their current fair value on the books of the candidate company. The most suspect, however, might be goodwill. Its value depends on preparing a separate valuation of the business, or part of it, and the net assets to which the goodwill relates. It is likely that you can make a fair assessment of the physical assets by looking at market prices or doing an appraisal, but goodwill and the intangible assets are much more difficult to evaluate since there is often no active market in which they trade. 2. There may be intangible assets that are not represented on the books of the company. Many (or all of) the costs associated with internally generated intangible assets such as patents, trademarks, human capital, customer lists, etc. will have been expensed as incurred and will not be identified as assets on the statement of financial position. The costs associated with any internally generated goodwill also will not appear in the records as they are also expensed as incurred. LO 2,9 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP8-15 It’s debatable whether this is a fair way to present the impairment charge. Goodwill is an asset that is recognized, measured and recorded when a company purchases another company and pays more than the fair value of the net assets. The company has already paid for this asset, and recording an impairment loss will not effect cash as it is a reduction of the asset’s carrying amount. The writedown does show that an asset the company paid for at the time of the acquisition no longer has the value management determined it had at that time. Financial statement users should understand that this may indicate that the company overpaid at the time of acquisition or that management has not been able to safeguard this asset’s value through its actions. Down playing it as a non-cash charge may understate its significance. LO 9 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Work in Progress WIP8-1 Companies depreciate equipment over time because they are using equipment over time to generate revenue, so they need to recognize the usage of the equipment over time. The straight-line method assumes equipment is used at the same rate over its useful life. The carrying amount is the cost of the equipment less the accumulated depreciation taken on the equipment. In summary, companies do not depreciate assets because they lose value and the carrying amount does not equal fair value for sale purposes. Depreciation is merely a cost allocation method. LO3,4 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP8-2 Companies depreciate their equipment because they expect to use their equipment over a certain time (useful life) and need to reflect the usage of the equipment used generate revenue as an expense on the income statement. Depreciation expense of equipment is similar to the treatment of other assets like supplies and inventory when they are consumed or sold. When they are no longer assets, they become expenses. The only difference is that depreciation takes place over several accounting periods. In summary, companies do not depreciate to arrive at resale values and the carrying amount does not represent the fair value of the asset. Depreciation is merely a cost allocation method. Carrying amount represents the portion of the asset’s cost that has yet to be expensed. LO3,4 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP8-3 Incorrect – “Companies depreciate their capital assets over time because they understand capital assets immediately begin to lose value from the date of purchase” Corrected -Companies depreciate capital assets over time because they are used for longer than a year to generate revenue and their cost needs to be allocated to expense in the periods in which they are used. Incorrect – “Depreciation accounts for this loss” Corrected – Depreciation accounts for the usage of the asset during the year. Incorrect- “The straight-line method is a method of evaluating depreciation which assumes that a capital asset loses its value at the same rate over a given period of time.” Corrected – While it is correct that the capital asset is depreciated at the same rate over a given period, it is not for the purpose of recording a loss in value for the asset. Rather, depreciation is a cost allocation method to recognize the consumption of the asset at the same rate, when using straight-line method. Corrected– “In other words depreciation expense should be the same every period as long as the capital asset is being used.” LO4 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP8-4

The purpose of recording depreciation is not to record loss of value or the decline in the asset’s market value but to record an allocation of the cost of a long-lived asset. Property, plant, and equipment are reported on the statement of financial position at amortized cost. The carrying amount represents the amount of the cost of the asset that will be expensed in the future when the asset generates revenue. A new car being driven out of the dealer lot loses its resale value because it is no longer new. The loss of resale

value is not recorded in the accounts. LO4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP8-5 By design, the diminishing-balance depreciation method will have higher amounts of depreciation expense and corresponding lower net income in the initial years of depreciating compared to the straight-line method. The diminishing-balance method purposely allocates more of the cost of the asset at the beginning of the useful life. At the end of the asset’s useful life, the diminishing balance method will have lower depreciation expense and higher net income than the straight-line method. Over the life of the asset the same total amount of depreciation will be taken, regardless of the depreciation method used. LO4 BT: C Difficulty: M Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP8-6 Although the carrying amount of equipment decreases over time as the equipment is being used, this decrease is not a reflection of the equipment’s devaluation. Depreciation is merely a cost allocation method (i.e. it is allocating a portion of the asset’s cost to each period in which it has been used to help generate revenue). It is not an asset valuation method. LO4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

WIP8-7 While many of the statements made by your classmate are true, there are some statements that need rectifying. Accelerated depreciation is not normally used for assets that are fully paid for at the time of purchase. The asset can have been acquired for cash, debt or shares in the company. The way in which the purchase of an asset is settled has no bearing on the method of depreciation that is being used for that asset. While it is true that the carrying amount represents the depreciation expense that will be recorded for the asset in future periods, there is an amount that will not be depreciated and that is the residual value. LO4 BT: C Difficulty: M Time: 10 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS RI8-1 Reitmans (Canada) Limited Note: all dollar amounts are in thousands. a. Average age percentage of Reitmans’ property and equipment = Total accumulated depreciation___ Property and equipment - Land =

$81,796_____ $147,908 - $5,860

= $81,796 = 57.6% $142,048 Average percentage of Dollarama’s property and equipment Dollarama’s ratio for its property, plant and equipment (Appendix A) is 45.8%, calculated as follows: = Total accumulated depreciation Property and equipment - Land =

$539,562 _ $1,249,031 - $70,345

$539,592 = 45.8% $1,178,686

This suggests that Dollarama is able to go longer without replacing its assets because its ratio is lower compared to Reitmans.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-1 (Continued) b.

The annual straight-line rate (expressed in years) used by Reitmans for its fixtures and equipment is between 3 and 20 years. As such, the company is using a straight-line rate of between 5% (i.e. 1/20) and 33% (i.e. 1/3).

Until assets are ready for use and are being used, their economic benefits are not being consumed or used up. Until this is the case, there should be no depreciation recorded.

Reitman’s fixed asset turnover ratio is: Sales Revenue _ Average Net Property, Plant and Equipment =

$533,362______ ($66,112 + $88,090) ÷ 2

$533,362 $77,101

= 6.92 times

Dollarama’s fixed asset turnover ratio (Appendix A) is 5.95 times, calculated as follows: Sales Revenue _ Average Net Property, Plant and Equipment =

$4,026,259_____ ($709,469 + $644,011) ÷ 2

$4,026,259 $676,740

5.95 times

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-1 (Continued) This means that in its fiscal year ended January 31, 2021, Reitmans generated, on average, approximately $6.92 of sales from each $1 it had invested in property, plant and equipment. In comparison, Dollarama generated about $5.95 in sales from each $1 investment in property, plant and equipment. It appears that Reitmans is more effective in using its investment in property, plant, and equipment than is Dollarama. However, because Reitmans’ fixed assets are older and have been more heavily depreciated than Dollarama’s, the net carrying amount of Reitmans’ PP&E (and, therefore, the denominator of the formula) is relatively low compared to Dollarama’s. In interpreting the fixed asset turnover ratio, differences that affect the carrying amount of the assets have to be taken into consideration. This includes such things as the method of depreciation, the rate of depreciation, and the age of the assets. LO10 BT: AN Difficulty: M Time: 45 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-2 Metro Inc. a. Metro holds the following finite intangible assets: leasehold rights, software, retail network retention premiums, and customer relationships. It also holds banners, private labels and loyalty programs which are considered to have indefinite useful lives. Intangible assets with finite useful lives are amortized over their estimated lives. When the life of an intangible asset is considered to be indefinite, it is expected to continue to help generate revenues for the foreseeable future. The asset, therefore, it is not amortized. Instead, it is evaluated each year to determine whether there has been any impairment in its carrying amount. If there has been an impairment, the asset’s carrying amount is reduced and an impairment loss is recorded on the income statement. If there is no impairment, the asset remains at its current carrying amount until the following year end, when it will be evaluated again, or earlier if there are any indications that the asset may be impaired. b. Amortization is merely a cost allocation method. Metro records intangible assets with reasonably definite useful lives at cost and then amortizes them on a straight-line basis over their useful lives. The amortization method and estimate of the useful lives are reviewed annually. This allocates the cost of these assets to the periods when the assets’ economic benefits are being consumed or used up. Although the legal life is often longer than the useful life, such as with patents, such intangibles may become obsolete, out of style, or replaced by newer designs and products. For this reason, management wants to allocate the costs of these intangible assets to only those periods in which they produce economic benefits (i.e. over their estimated useful life rather than over their legal life). c. A major part of Metro is the operation of its pharmacies. Prescription files are the records of the orders taken by the pharmacy from medical professionals and relate to individual Metro customers. Careful maintenance of prescription files is required by law, and is also a valuable aspect of customer service for a pharmacy. As in most situations where a pharmacy is located in a grocery or personal products store, pharmacy customers who come in to pick up their prescriptions also purchase other products. Therefore, there is a symbiotic relationship between the grocery and other product sales and those of the pharmacy. They support one another. Prescription files are similar to a customer list for other types of operations. Metro refers to this asset as customer relationships.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-2 (Continued) d. Goodwill arises from accounting for a business merger or combination, when one entity purchases another business. It represents the excess of the purchase price over the fair value of identifiable net assets acquired in that business combination. Goodwill is not amortized; it is tested for impairment annually or more often if events or changes in circumstances indicate that goodwill might be impaired. LO8,9 BT: C Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

RI8-3 Note: all dollar amounts are in thousands. a.

Average age percentage of Maple Leaf’s property, plant and equipment: = Total accumulated depreciation . Buildings and Machinery & equipment =

$1,357,135 _ $1,051,165 + $1,481,617

= $1,357,135 = 53.6% $2,532,782 Dollarama’s ratio for all of its property, plant and equipment (Appendix A) is 45.8%, calculated as follows: = Total accumulated depreciation Property and equipment - Land =

$539,562 _ $1,249,031 - $70,345

$539,592 = 45.8% $1,178,686

This suggests that Dollarama is able to go longer without replacing its assets because its ratio is lower compared to Maple Leaf.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-3 (Continued) b.

The annual straight-line rate (expressed in years) used by Maple Leaf for its machinery and equipment is between 3 and 20 years. As such, the company is using a straight-line rate of between 5% (i.e. 1/20) and 33% (i.e. 1/3).

Maple Leaf begins depreciating its property, plant and equipment as soon as they are available for use as it is only then that the asset begins to help generate revenues. At this point, some of the asset’s future economic benefits are being consumed, so a portion of its cost should be allocated to that period.

Since buildings, machinery and equipment are used in the production of the meat products, the depreciation on these assets is a cost of production and in added to the cost of the inventory, which ultimately becomes cost of goods sold.

Maple Leaf’s fixed asset turnover ratio is: Sales Revenue _ Average Net Property, Plant and Equipment

$4,303,722 = ($1,721,487 + $1,386,482) / 2

$4,303,722 $1,553,985

2.77 times

This means that in its fiscal year ended December 31, 2020, Maple Leaf generated, on average, approximately $2.77 of sales from each $1 it had as a net investment in property, plant and equipment. In comparison, Dollarama generated $5.95 in sales from each $1 investment in long-term PP&E assets (Appendix A) calculated as follows: =

$4,026,259 = ($709,469 + $644,011) / 2

$4,026,259 $676,740

5.95 times

The results of the ratios demonstrate that Dollarama did a better job of using its long-term assets to generate revenue.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-3 (Continued) One must take into consideration that Dollarama is a retailer and Maple Leaf is a manufacturer. Manufacturers typically require a higher capital investment as the ratios above reveal. In interpreting the fixed asset turnover ratio, differences that affect the carrying amount of the assets have to be taken into consideration. This includes such things as the method of depreciation, the rate of depreciation, and the age of the assets. LO10 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI8-4 Spin Master Corp. Note: all dollar amounts are in millions. a. Average age percentage of Spin Master ’s moulds, dies and tools: =

Accumulated depreciation of moulds, dies and tools Total cost of moulds, dies and tools

$130.6 $152.5

= 85.6%

Due to the short estimated useful lives of moulds, dies and tools of 2 years, it makes sense that the assets on hand are 85.6% depreciated. b.

Spin Master depreciates its computer hardware over 3 years, while Dollarama depreciates its over 5 years. One plausible reason for this may be that Spin Master makes significant use of IT in the design and development of its products and therefore needs to have the latest technology. This would lead to the replacing their computer hardware more frequently than Dollarama does.

Management is saying that the machinery and equipment have more of their economic benefits consumed in the earlier years of their useful life with diminishing benefits consumed in subsequent years.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI8-4 (Continued) d. Spin Master ’s fixed asset turnover ratio is: Sales Revenue _ Average Net Property and Equipment =

$1,570.6 = ($53.4 + $66.8) / 2

$1,570.6 $60.1

26.13 times

This means that in its fiscal year ended December 31, 2020, Spin Master Corp. generated, on average, $26.13 of sales revenue from each $1 it had as a net investment in its property, plant and equipment assets. This is not an unusual ratio for a company in an industry that requires relatively low capital investment. LO10 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI8-5 Financial Statement Disclosures - company of your choice Answers to this question will depend on the company selected. LO10 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C8-1 Manuel Manufacturing Company The $40,000 repair is an expense or a loss. It is not part of the machine’s cost. 1. and 3. Accounting standards require that all costs necessary to get equipment in place and ready for use be capitalized as part of the equipment’s cost. Examples include the invoice price, shipping costs, installation costs, cost of test runs, and any other costs that meet the criteria. When the machine was purchased, $40,000 of repair costs were not considered “necessary” to get it in place and ready for use. The invoice cost of the asset was for an asset already capable of being used. The costs associated with an accident during the transportation of the asset brought it back only to the condition it was in prior to the accident – the costs did not increase the benefits it would provide. Therefore, it is inappropriate to capitalize the costs of the repair. 2. The transportation and installation costs are appropriately capitalized because they both result in adding economic value to the machine acquired in Montreal. Manuel Manufacturing needs the machine in its Hamilton factory and to have it installed there before the company can begin to benefit from the economic benefits the machine contains. LO 2 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-2 Rolling Fields Nursing Home a. and b. The following costs should be capitalized: a. Type of cost incurred

b. Account

Cost of land, including title search and survey

Land

Barn removal and levelling costs

Land

Streets, sidewalks, water mains, storm drains, Land Improvements sewers, to the extent not the responsibility of the municipal government Street lighting installation, green spaces, landscaping

Land Improvements

Construction costs: 30 X $180,000

Buildings

Interest costs during construction from direct borrowings to finance construction

Buildings

c. Land improvements: These are depreciated over the useful life of each, using a pattern of depreciation that corresponds to how the asset’s economic benefits are used up or consumed. Engineering estimates are developed for each type to determine its estimated useful life and the costs should be separately recorded for each component. The above-ground lighting, green spaces and landscaping should be recognized as separate components, and the useful life of each component used in determining the periodic depreciation charge. To the extent that there are components with similar useful lives and patterns of economic benefit use, these could be combined for record keeping purposes. It is unlikely that residual values would be significant for land improvement-type assets.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-2 (Continued) Buildings: If all the homes are similar in quality, size, and cost, and are expected to have similar useful lives, residual values, and the pattern in which their economic benefits are used up or consumed, then the full cost of all buildings (homes) could be aggregated and depreciated as a single asset group. However, if any of these variables differs, the company may want detailed information by type of home so that they can develop cost and profitability data by type of construction. In either case, the principle underlying the depreciation calculation is the same: recognize the depreciable cost of the assets over their useful lives using a method that best corresponds with the economic benefits used up by the type of asset. The straight-line method is often used for buildings. LO 1,2,4 BT: E Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-3 Maple Manufacturing a. The cost of a basket purchase is allocated to the individual assets on the basis of their relative fair values at the time of acquisition. Determination of relative fair values: Fair Asset Value (FV) Percent of total FV Building Land 1 1

$435,000 500,000 $935,000

$435,000  935,000 $500,000  935,000

= 46.5% = 53.5%

$125,000 per hectare x 4 hectares

Allocation of the purchase cost: Building $850,000 x 46.5% Land $850,000 x 53.5%

= =

$395,250 $454,750 $850,000

NOTE: Rounding may cause allocations to vary slightly. b. The company’s accountant probably wanted to allocate more cost to the building because capital cost allowance (CCA or tax depreciation) can be claimed on the building, thereby reducing taxable income and income taxes payable. CCA cannot be claimed on the land. Given that Maple Manufacturing had significant taxable income in the past, management probably would like to reduce the company’s tax liability through higher capital cost allowances. A higher cost allocated to the building, therefore, reduces the taxes Maple pays. LO 2 BT: AN Difficulty: M Time: 30 min. AACSB: Ethics and Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-4 Preakness Consulting and Bellevue Services a. Depreciation Schedules: Preakness Preakness uses straight-line depreciation therefore annual depreciation is constant for each year. $660,000 – $30,000 = $126,000 per year 5 years Bellevue Bellevue uses the double-diminishing-balance method, which leads to higher depreciation in the early years and lower depreciation in later years. DB Rate = (1/5) X 2= .40 or 40%

Year Balance Accumulated Carrying Calculation In PP&E Depreciation Amount of Expense

Depreciation Expense

$660,000

$0 $660,000 40% x 660,000 = $264,000

660,000

264,000 396,000 40% x 396,000 =

158,400

660,000

422,400 237,600 40% x 237,600 =

95,040

660,000

517,440 142,560 40% x 142,560 =

57,024

660,000

574,464

85,536 40% x 85,536 =

34,214 + 21,322 1 55,536

To reduce the carrying amount to $85,536 - $55,536 = $30,000, its residual value, at the end of year 5.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-4 (Continued) b.

Preakness Consulting Statement of Income For the year ended December 31, 2024 Revenue.......................................................... Expenses: Salaries and wages expense ....... $750,250 Rent expense .................................. 44,800 Other operating expenses.............. 110,670 Depreciation expense .................... 126,000 Income before income tax .............................. Income tax expense—25% ............................ Net income .....................................................

$1,500,000

1,031,720 468,280 117,070 $ 351,210

Bellevue Services Statement of Income For the year ended December 31, 2024 Revenue.......................................................... Expenses: Salaries and wages expense ....... $747,500 Rent expense .................................. 46,400 Other operating expenses.............. 109,790 Depreciation expense .................... 264,000 Income before income tax ............................... Income tax expense—25% .............................. Net income ......................................................

$1,500,000

1,167,690 332,310 83,078 $ 249,232

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-4 (Continued) c. An unsophisticated investor might believe that Preakness is a stronger company because its reported net income is higher than Bellevue’s. However, both companies are equally profitable with the only substantive difference being how they have chosen to depreciate the computer system. If all other factors remain constant, Bellevue’s net income will still be lower than Preakness’ in year 2, but by a much smaller difference, and in years 3, 4, and 5, Preakness’ income will be lower than Bellevue’s because its depreciation expense will remain at $126,000 while Bellevue’s will decline below this amount. Note that while “accounting” depreciation is not deductible for tax purposes, the total of depreciation expense and CCA over the life of the specific asset pool will be identical since the same capital cost of the asset is written off for both accounting purposes and for tax purposes. Although there are timing differences between the tax expense and the accounting expense in each year, the income tax expense reported on the income statement is generally based on the expenses reported under accounting standards. This topic is explained in more detail in an intermediate financial accounting course. LO 4 BT: S Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-5 a. Carrying amount on Jan. 1, 2024 = $312,500 [$400,000 – ($400,000 - $50,000) / 20 x 5] b. At the beginning of 2024, if management concludes that the asset will no longer be used and that it is to be sold, the classification of the asset changes from an item of PP&E to an asset “held for sale.” No further depreciation is taken. At this time, the asset is remeasured to the lower of its carrying amount and its fair value less costs of disposal (net realizable value). In early 2024, because its carrying amount and net realizable value are the same amount, no adjustment is necessary to its $312,500 carrying amount. By December 31, 2024, however, the warehouse must be written down to the lower net realizable value of $260,000. The following entry is needed: Loss on Impairment 52,500 Accumulated Impairment Losses, Buildings *

52,500

* Alternatively, the Buildings account could be credited. Both approaches reduce the carrying amount of the asset. On the December 31, 2024 statement of financial position, the warehouse is separately classified and reported as “held for sale” at $312,500 - $52,500 = $260,000. c. The following entry is then made at the time of sale in 2025: Cash Accumulated Depreciation, Buildings 1 Accumulated Impairment Losses, Buildings Loss on Disposal Buildings 1

($350,000 / 20) x 5

220,000 87,500 52,500 40,000 400,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-5 (Continued) d. What the financial vice-president is suggesting is as follows: • Continue to carry the warehouse as an operating asset during and at the end of 2024. • Take normal 2024 depreciation expense of [($400,000 - $50,000)/20] = $17,500, reducing the asset’s carrying amount to $312,500 - $17,500 = $295,000. This carrying amount would continue to be reported as PP&E on the December 31, 2024 statement of financial position. • Pretax income would be higher by the difference between the loss of $52,500 and depreciation expense of $17,500; therefore, pretax income would be $35,000 higher if this treatment were followed. • In 2025, when the warehouse is sold, a loss of $220,000 - $295,000 = $75,000 is recognized as a loss on disposal. This approach, therefore, results in pretax income that is $35,000 higher in 2024, a balance sheet value that is also $35,000 higher ($295,000 versus $260,000) at December 31, 2024, and having the warehouse reported as an item in the company’s productive PP&E assets. In 2025, when the warehouse is sold for $220,000, a loss of $75,000 ($220,000 – NBV $295,000) is reported rather than a loss of $40,000 (per item c. above). In effect, this transfers a $35,000 loss from 2024 to 2025. From a shareholder’s perspective, if the dollar amounts of the building and potential loss were material in relation to the company’s assets and earnings, the treatment of the building suggested by the financial VP could make a difference in a decision. This is because the shareholder has no indication of the impaired state of the warehouse and the fact that the company will not be able to recover the carrying amount from the asset’s use or disposal. The user assumes that the asset is still functioning as a productive asset and contributing to earnings. If the amounts were significant enough, a shareholder’s decision to hold or sell the company’s shares could be influenced by the difference in reported earnings and assets.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C8-5 (Continued) Note: There is a flaw in the financial vice-president’s suggestion. Because the warehouse’s carrying amount is higher than its recoverable amount at December 31, 2024, accounting standards would require Conservative Company to recognize an impairment loss in 2024 of $295,000 - $260,000 = $35,000. This write down is required regardless of whether the asset is classified as held for sale. LO 4 BT: E Difficulty: H Time: 50 min. AACSB: Ethics and Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

MMXXI xii F1

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 9 CURRENT LIABILITIES Learning Objectives 1. Explain why current liabilities are of significance to users. 2. Describe the valuation methods for current liabilities. 3. Identify the current liabilities that arise from transactions with lenders and explain how they are accounted for. 4. Identify the current liabilities that arise from transactions with suppliers and explain how they are accounted for. 5. Identify the current liabilities that arise from transactions with customers and explain how they are accounted for. 6. Identify the current liabilities that arise from transactions with employees and explain how they are accounted for. 7. Identify the current liabilities that arise from transactions with government and explain how they are accounted for. 8. Identify the current liabilities that arise from transactions with shareholders and explain how they are accounted for. 9. Calculate the accounts payable turnover ratio and accounts payable payment period and assess the results.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5.

1 2 3 3 3

1. 2. 3.

1 3 3

1. 2.

5 3

BT Item LO

Discussion Questions K 6. 3 C 11. 5 C 16. 5 C 21. 6 C 7. 3 C 12. 5 K 17. 5 K 22. 6 C 8. 4 C 13. 5 C 18. 5 K 23. 6 C 9. 5 C 14. 5 C 19. 6 K C 10. 5 K 15. 5 C 20. 6 K Application Problems C 4. 5 AP 7. 5 AP 10. 3 AP 13. 5 AP 5. 5 AP 8. 6 AP 11. 5,6 AP 14. 5,6 AP 6. 5 AP 9. 6 AP 12. 5,6 AP 15. 5,6 User Perspective Problems AP 2. 5 C 3. 3 C 4. 9 AN 5. 9 Work in Process AN 2. 5 C 3. 5 C 4. 5 C 5. 4,9 Reading and Interpreting Published Financial Statements C 3. 5 C 5. 5 C 7. 4,9 AN C 4. 6 C 6. 4,9 AN Cases C 2. 6 C 3. 3,5 C

BT C C K

AP AP AP AN C

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ9-1 The three essential characteristics of a liability are: 1. It is an entity’s present obligation – that is, the obligation exists at the reporting (statement of financial position) date. 2. The obligation is expected to be settled through a transfer of economic resources (assets), the performance of services, or the conferring of some other benefit at a future date. 3. The underlying transaction or event that gives rise to the obligation has already occurred. LO 1 BT: K Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-2 Liabilities are initially measured at their fair value, that is, at the present value of the obligation. The interest or discount rate used should reflect the type of liability, the duration of the obligation, and the company’s creditworthiness. However, in the case of current liabilities which will be paid in the near term, the difference between the undiscounted amount (its face value) and its fair or present value is so small that the face value amount is used. This makes the accounting entries more straightforward and does not produce materially different amounts. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-3 A line of credit is one way that companies deal with temporary cash shortages. In this case, the bank assesses the company’s ability to repay short-term debts and preapproves borrowing up to an amount the bank thinks is reasonable. If cheques written by the company exceed its cash balance in the bank, the bank covers the excess by immediately activating the line of credit and establishing a short-term loan. The bank uses subsequent cash deposits by the company to repay the loan. A bank line of credit provides the company with greater flexibility and freedom to take advantage of business opportunities and/or to settle debts. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-4

When creditors such as banks, financial intermediaries, and other investors lend money to a company, they look for ways to reduce the risk associated with possible non-repayment in the future. The most common way to reduce this risk is to sign an agreement with the company that allows the creditor to seize specific company assets, or gives them a general claim to assets, if the company fails to repay the amounts owed. In this way, the creditor can sell the seized assets and recover any outstanding amounts by converting the asset into cash, usually through sale, if a property, plant and equipment asset or inventory, or through collection, if the asset is a receivable. The company’s assets are used as collateral or security for the loan. Liabilities of a company subject to such agreements are known as secured liabilities. If amounts are loaned to a company without such an agreement in place, the company’s liability is “unsecured.” The creditor has loaned the money based only on the good faith and reputation of the company.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-5

A working capital loan represents funds advanced to a company, usually by a financial institution such as the company’s bank, to provide cash for its day-to-day operating requirements. Companies often need cash to pay their suppliers for amounts owing for inventory purchases before goods are sold on account and the resulting accounts receivable are collected. Employees are paid before the work they have done results in sales and the collection of accounts receivable. To finance this lag in the cash-to-cash cycle, companies borrow funds known as working capital loans. Working capital loans are generally secured by the underlying inventory and accounts receivable the loan was taken out to finance. If the company is growing and the inventory and receivables increase, so does the total amount the company is permitted to borrow under the working capital loan. When the inventory is sold and cash is received as the receivables are collected, the loan is paid down. Therefore, a working capital loan is considered a secured borrowing.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-6

The current portion of long-term debt is that portion of the liability that is due and payable within one year from the date of the statement of financial position. It is reported with current liabilities because this amount of longterm debt is expected to be paid off or retired within one year. In order to present users of financial statements with a fair picture of all existing liabilities that will require cash outflows within one year of the statement of financial position date, the current portion of long-term debt must be classified within current liabilities.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-7

The entry to recognize the current portion of long-term debt is a reclassification entry because all the entry does is recognize a change in the placement of the liability on the statement of financial position. The current portion moves from being a long-term liability to a current liability. There is no change in the type of accounting element (asset, liability, revenue, expense, or equity), in the measurement of the amount, in the creditor, or in the total amount owed to the creditor. The entry is important to make because it affects the company’s current ratio and any assessment of its liquidity. The current ratio looks at the relationship between the existing current assets and the existing current liabilities at the reporting date. Current liabilities should represent those liabilities of the company that will require the use of current assets (usually cash) within 12 months from the reporting date. The reclassification entry therefore is necessary to ensure that the current portion of any long-term liabilities is included with current liabilities.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-8

Accounts payable are often referred to as “free debt” because this form of short-term credit arrangement usually does not carry an explicit interest charge. If, for example, the account has a credit period of 30 (or 60) days, there is no interest charged if the account is paid within this 30 (or 60) day period. Therefore, during the term of the credit period, the amount outstanding is “interest free” debt.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-8 (Continued) However, if a supplier has 30-day terms but offers a discount if paid within a shorter period – say 10 days – then the reality is that there is an interest or penalty charge after day 10. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-9

The answer to this question differs depending on which two liabilities are chosen to be described and explained. The following are described in the chapter: deferred/unearned revenue, gift card liability, customer loyalty provision, and provision for warranty claims. In the case of deferred/unearned revenue, gift card liability, and customer loyalty program provisions, a liability is recognized because the entity has an obligation at the reporting date as a result of receiving payments or issuing rewards in advance of performing what is required to earn the revenue. The provision for warranty claims is recognized because of the company’s obligation, which exists at the reporting date, to repair, replace, or otherwise make good on defective products that have been sold. It is also based on recording the warranty expense in the same period as the related sales revenue.

LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-10

The term “provisions” refers to liabilities where there is uncertainty about the timing or the amount of the existing obligation. The obligations resulting from such activities as customer loyalty programs and warranties, for example, are only estimates of the liabilities and there is uncertainty about when the obligations will be settled. These are referred to as provisions.

LO 5 BT: K Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-11

Deferred revenues represent amounts received from customers in advance of the company meeting the criteria for revenue recognition. Deferred revenue is a synonym for unearned revenue. A common example is a payment received by a magazine publisher for a subscription for future copies of a magazine. This payment in advance of providing the contractedfor magazines does not meet the revenue recognition performance criteria when received and is thus deferred for future recognition. Deferred revenues are recognized as liabilities on the books of the seller until the obligation under contract has been satisfied, at which time the liability is reduced and revenue is recognized.

LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-12 Breakage is a term used for gift cards that will never be used by their owners. It is estimated that 10% to 15% of all gift cards in Canada will never be used. Breakage revenue is recognized proportionately as the other gift cards sold in the period are redeemed. LO 5 BT: K Difficulty:E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-13 There are two types of loyalty programs: 1) Loyalty points redeemable only by the company making the sale – The points earned by customers participating in these programs are a separate performance obligation. A portion of the transaction price must be allocated to the points. The stand-alone selling price of the points is estimated using the stand-alone selling price of the goods or services that can be purchased, and management’s expectation of the points being redeemed. When the points are earned, the company records an obligation to provide the goods or service that can be redeemed with the points. 2) Loyalty points redeemable by another party – the participating company purchases the loyalty points from another party. The points are a separate performance obligation and a portion of the transaction price must be allocated to the points. The stand-alone selling price of the points is determined by using the cost of purchasing the points. When the points are earned, the company records an obligation to purchase those points from another party. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-14 An assurance-type warranty is a warranty that provides customers with assurance that the product will perform as expected and protects them against any defects with the product that existed at the time of sale. A servicetype warranty is a warranty that provides customers with assurance beyond the basic product performance and may provide protection related to wear and tear occurring after the purchase or provide an additional level of service. A service-type warranty is an optional warranty that a customer pays extra for where as an assurance warranty would be included with the purchase of the product. Service-type warranties are considered to be separate performance obligations, while assurance-type warranties are not. LO 5 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-15 Assurance warranty expense is an estimate of the assurance warranty costs to be incurred by a company that are related to current period product sales. The costs are incurred when the products sold in the current period require repairs at a later date, and the company is obligated to perform these repairs at no charge. Because the revenues from the product sales are recognized in the current period, a warranty expense and a warranty liability must also be recognized since that is the period in which they have been incurred. The warranty costs must be estimated in the year of the product sale and reported in the same period as these revenues to determine income or profit. The warranty liability must be recognized because the company has an obligation to make good on the warranties as soon as the product is sold. The actual payment by the company for the repair costs will occur in periods after the sale of the product, when the customer brings back the damaged product. For a service-type warranty, the warranty expense is recorded in the period when claims are made under the warranty. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-16 The costs associated with an assurance-type warranty should be recognized in the period in which the revenue is earned. At the same time, the company’s obligation (liability) to repair or replace the product is recorded. Both the liability and the expense should be recorded in year 1 when the product is sold. Because the full expense and warranty liability are recognized in year 1, the costs incurred in the future related to making good on the warranty are a reduction of the liability, rather than an expense of the future period. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-17 Three ways that companies can settle their estimated obligations/liabilities are: 1. Product replacement or repair 2. Cash, gift card, or credit refund with the product returned 3. Expiration of the warranty period

warranty

LO 5 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-18 If a company is reporting deferred warranty revenue, the company sells service-type warranties to their customers. LO 5 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-19 Source deductions are the amounts an employer deducts, as required by legislation or contract, from an employee’s earnings to arrive at the net amount payable to the employee. The employer is required, by law, to remit any legislated source deductions (e.g., income taxes, CPP/QPP, EI) to the government along with the employer’s required amounts. Other source deductions may be required, under contract, to be remitted to other entities such as union, health care provider or company pension plan. Contracts specify whether there is any employer matching of these amounts. LO 6 BT: K Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-20 Gross pay is total pay before any deductions and includes all wages, salaries, bonuses, overtime, commission, etc. earned by the employee for that pay period. For instance, gross pay is the salary you earn at your job or the amount of money you earn per hour times the number of hours worked. Net pay is the amount of cash you will take home after all payroll withholdings have been deducted. Therefore, net pay is the actual amount of your paycheque. Typical deductions from gross pay to arrive at net pay include personal federal and provincial income taxes, Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) contributions, Employment Insurance (EI) contributions, pension plan contributions, and union dues. LO 6 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ9-21 The employer’s wage expense will be more than the gross wages earned by its employees because of the legal and contractual requirements for the employer to make additional payments based on the gross wages to the government (e.g., for CPP/QPP, EI, workers’ compensation, health-related taxes) and to company pension plans and health-related benefit providers. These amounts are in addition to the gross earnings of the employees. LO 6 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-22 Employers often object when the government increases CPP/QPP or EI rates because such changes increase labour costs and make it more expensive for companies to hire additional employees. These increased rates make it more expensive for employers because the employer is required to make a separate contribution to the government for CPP/QPP and EI for all employees in addition to the employees’ contributions, which are deducted from each employee’s paycheque. As a result, both the employer and the employee will pay more when these rates are increased. LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ9-23 Suppliers would prefer to do business with companies that have higher accounts payable turnover as it means they are paying their suppliers more frequently than a company with lower accounts payable turnover. LO 9 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP9-1A a. Current – the line of credit is revolving and will be paid off in the next 12 months. b. Current – the accounts payable will be paid for within the next 12 months. c. Current – the loan is due within the next 12 months. d. Current – the warranty is for a 1-year period. e. Current and Long-term – $2,000 is current as it is due in 2025 and then the remaining $23,000 is long-term, as it is due more than a year from December 31, 2024. f. Current – the company needs to remit the CPP, EI and income taxes within the next 12 months. g. Current – the goods will be delivered within the next 12 months. LO 1 BT: C Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP9-2A a. Current ratio = $125,000/$50,000 = 2.5 prior to recording the accrued interest and the reclassification of the current portion of the long-term loan, which meets the bank’s minimum current ratio of 2.0. b. Interest Expense1 4,000 Interest Payable 1 ($100,000 x 6% x 8/12 = $4,000)

4,000

c. Long-Term Loan Payable 25,000 Current Portion of Long-Term Debt 25,000 To reclassify the current portion of long-term debt as $25,000 of principal is due each year. d. Current ratio = $125,000/$79,0002 = 1.58 after the reclassification which does not meet the bank’s minimum current ratio of 2.0. 2 ($50,000 + $4,000 +$ 25,000) = $79,000 LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-3A July 1

Cash

150,000

Long-Term Loan Payable 150,000 To record the 15-year 13% loan with annual payments including $10,000 principal repayments. Oct 31

Oct 31

Interest Expense Interest Payable ($150,000 x 13% x 4/12 = $6,500)

6,500

Long-Term Loan Payable 10,000 Current Portion of Long-Term Debt To reclassify the current portion of the loan.

LO 3 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

6,500

10,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-4A a.

Warranty expense = 6% X 9,000 units X $60/unit = Less: 2022 actual expenditures

$32,400 (5,000)

Estimated warranty provision account, Dec. 31, 2022

$27,400

2023 Warranty expense = 6% X 12,000 units X $60/unit = $43,200 2024 Warranty expense = 6% X 17,000 units X $60/unit = $61,200

Estimated Expenditure 2022 - $32,400 X 1/3 $10,800 2023 - $43,200 X 1/3 $32,400 X 1/3

2024 - $61,200 X 1/3 $32,400 X 1/3 $43,200 X 1/3

Actual Expenditure $ 5,000

Over (under) $ (5,800)

14,400 10,800 $25,200

16,000

(9,200)

20,400 10,800 14,400 $45,600

37,000

(8,600)

The company’s estimates with respect to warranty expenditures are consistently higher than the actual costs the company is incurring. The company should decrease its estimates of defect rates or the average cost to repair or replace a defective unit. However, the information provided does not allow us to determine if it is the pattern of when the items are discovered to be defective that is the problem, or the number of units that prove defective or the average cost to rectify the deficiency that is the source of the lower than expected warranty costs in the above analysis. Further information is required. LO 5 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-5A

a. Warranty Expense Warranty Provision (1-month warranties)

40,000

Warranty Provision Inventory Cash (1-month warranties)

36,000

Cash (800 x $100) Deferred Warranty Revenue (2-year extended warranties sold)

80,000

Warranty Expense Inventory (2-year extended warranties)

31,000

Deferred Warranty Revenue Warranty Revenue1 1 ($80,000 ÷ 2 years)

40,000

30,000 6,000

80,000

31,000

40,000

Note: the $80,000 charged to customers for the extended warranties will become revenue to the company as it provides the warranty coverage. The amount of revenue is recognized evenly over the two-year warranty period as claims are expected evenly over this time. The accounting for this type of warranty differs from the accounting for the warranty that was provided as part of the original sales price. The one-month warranty was merely to correct any deficiencies with the product when it was sold. The sale of the extended warranty is a separate performance obligation of Computers Galore Ltd. It therefore recognizes the revenue from this type of warranty transaction as it is earned.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-5A (Continued) b.

Computers Galore should classify the one-month warranty provision obligations as current liabilities because these obligations are expected to require the use of current assets and expire within one month. With the two-year warranties and the deferred warranty revenue, part of this liability is current and part is long-term as the warranty costs can be incurred by the company as late as 2026. Based on experience, Computers Galore should be able to estimate the portion of the deferred revenue that will require current resources, and the portion that will not be claimed within 12 months from the reporting date of December 31, 2024.

If the actual warranty costs incurred by Computers Galore under the extended warranty are less than the amount collected from customers for the extended warranty revenue (and it is expected they will be), then the difference between the annual costs and annual revenue recognized represents the profit or income on the company’s warranty operations.

LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-6A

a. Transaction journal entries July/Aug Cash

20,000

Deferred Revenue Received for advertising revenue. Sept.

Cash

20,000

24,000

Deferred Revenue (2,000 x $12) Received for subscriptions Dec.

Cash

24,000

26,000

Sales Revenue (13,000 x $2) Received for single copies to Dec. 31 Dec.

Dec

26,000

Operating Expenses Accounts Payable

42,000

Accounts Payable Cash

38,000

Miscellaneous Expense Cash

2,000

42,000

38,000

2,000

b. Adjusting journal entries Dec. 31 Deferred Revenue Advertising Revenue1 1 ($20,000 x 4/8)

10,000

Deferred Revenue Subscription Revenue2 2 ($24,000 x 4/8)

12,000

10,000

12,000

Alternatively, the original entries for advertising and subscriptions could have been recorded as revenues, and an adjustment made to reduce the revenues and recognize one half of these amounts as deferred revenues at December 31.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-6A (Continued) c. University Survival Magazine Ltd. Statement of Income For the six months ended December 31, 20XX Revenues: Subscription revenue Single-copy sales revenue Advertising revenue Total revenues

$ 12,000 26,000 10,000 48,000

Expenses: Operating expenses Miscellaneous expense Total expenses

42,000 2,000 44,000

Net income

$4,000

d. Cash balance = $20,000 + $24,000 + $26,000 – $38,000 – $2,000 = $30,000 Cash 20,000 24,000 26,000

38,000 2,000 30,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-6A (Continued) e. To: University Survival Magazine Owners From: Your name, Accountant Re: Results of operations to December 31 The results of operations for the six months ended December 31 is net income of $4,000. This is substantially less than the current positive bank balance of $30,000. The reasons for this $26,000 difference are twofold. First, revenues are recognized as part of your income (loss) only when they are earned: $12,000 of the cash received on subscriptions won’t be recognized in income until the next term, nor will $10,000 of the advertising revenue received in cash be recognized until the January to April period. The cash from both the subscriptions and the advertising was put in the bank when it was received, but $22,000 of revenue from these two items won’t be recognized in income until the next year. The second reason is that your expenses (which reduce reported income) include $4,000 of amounts that are still payable. They have not yet been paid for in cash. The total of the $22,000 related to revenue and the $4,000 related to expenses explains why your cash balance is $26,000 more positive than your reported net income. This amount can be seen as the sum of the accounts payable of $4,000 and the deferred revenue of $10,000 + $12,000 on your statement of financial position. LO 5 BT: AP Difficulty: M Time: 60 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-7A

a. Dec.

Cash

7,500

Gift Card Liability Cash received for gift cards. Jan.

7,500

Gift Card Liability Sales Revenue Gift cards redeemed for merchandise.

5,000

Cost of Goods Sold Inventory

3,000 3,000

Gift Card Liability Sales Revenue1 To record breakage 1 (95% x $7,500) = $7,125; $7,500 - $7,125 =$ 375; ($5,000/$7,125) x $375 = $263 Feb.

263 263

Gift Card Liability Sales Revenue Gift cards redeemed for merchandise.

1,500

Cost of Goods Sold Inventory

1,000

1,500

1,000

Gift Card Liability Sales Revenue 2 To record breakage 2 (95% x $7,500) = $7,125; $7,500 - $7,125 =$ 375; ($6,500/$7,125) x $375 = $342 $263 = $79 b.

5,000

79 79

Emile's Electronics – Statement of Income (Partial) December January February

Sales revenue Cost of goods sold Gross margin

$0 0 $0

$ 5,263 3,000 $ 2,263

$ 1,579 1,000 $ 579

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-7A (Continued) c. Gift Card Liability reported as a current liability: Balance, December 1 Gift cards sold to customers Gift cards redeemed Balance, December 31 Gift cards sold to customers Gift cards redeemed Gift card breakage Balance, January 31 Gift cards sold to customers Gift cards redeemed Gift cards breakage Balance, February 28

0 7,500 0 $ 7,500 0 (5,000) (263) $ 2,237 0 (1,500) (79) $ 658

LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP9-8A a. Employees’ net wages: Gross wages Less source deductions: CPP EI Employee income taxes Net wages

$30,000 $1,485 490 4,600

6,575 $23,425

October 31: Wages Expense 30,000 CPP Payable EI Payable Employee Income Taxes Payable Wages Payable

1,485 490 4,600 23,425

Wages Expense CPP Payable ($1,485 X 1) EI Payable ($490 X 1.4)

1,485 686

2,171

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-8A (Continued) November 2: Wages Payable Cash

23,425

November 15: Employee Income Taxes Payable CPP Payable ($1,485 + $1,485) EI Payable ($490 + $686) Cash

4,600 2,970 1,176

23,425

8,746

LO 6 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP9-9A a. Employees’ net wages: Gross wages Less source deductions: CPP EI Employee income taxes Net wages b.

$45,000 $2,230 730 6,900

9,860 $35,140

March 31: Wages Expense 45,000 CPP Payable EI Payable Employee Income Taxes Payable Cash

2,230 730 6,900 35,140

Wages Expense CPP Payable ($2,230 X 1) EI Payable ($730 X 1.4)

2,230 1,022

April 17: Employee Income Taxes Payable CPP Payable ($2,230 + $2,230) EI Payable ($730 + $1,022) Cash

3,252

6,900 4,460 1,752 13,112

LO 6 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-10A After the bank loan, the maximum amount that can be declared as a dividend is $25,000, because the current balance of retained earnings is $125,000 ($125,000 less minimum balance of $100,000). Assuming the dividend payment is made, the balances appearing on the Statement of Financial Position would be as follows: Current Assets $125,000 ($100,000 + $50,000 - $25,000) Non-current Assets 550,000 ($400,000 + $150,000)

Total Assets

$ 675,000

Current Liabilities $85,000 ($75,000 + $10,000) Long-term Liabilities 390,000 ($200,000 + $190,000) Common Shares 100,000 Retained Earnings 100,0001 Total Liabilities and $675,000 Shareholder’s Equity 1

($125,000 - $25,000 dividend)

Current ratio after the loan and dividend = $125,000/$85,000 = 1.47 which is above the bank requirement of 1.25. Because the current ratio meets the debt covenant, the board is able to pay out a dividend up to $25,000 and still be in compliance with the terms of the loan. LO 3 BT: AP Difficulty: H Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-11A a. 1.

Inventory Accounts Payable

466,000

Accounts Payable Cash

206,000

Wages Expense Employee Income Taxes Payable1 CPP Payable EI Payable Cash 1 ($344,000 x 24%) = $82,560

344,000

Wages Expense CPP Payable EI Payable ($5,610 x 1.4)

24,882

Employee Income Taxes Payable 2 CPP Payable ($17,028 x 2) x 11/12 EI Payable ($5,610 + $7,854) x 11/12 Cash 2 ($82,560 x 11/12) = $75,680

75,680 31,218 12,342

Warranty Expense3 Warranty Provision 3 ($2,300,000 x 1.5%)

34,500

Warranty Provision Cash

24,000

Cash Deferred Revenue

45,000

466,000

206,000

82,560 17,028 5,610 238,802

17,028 7,854

119,240

34,500

24,000

45,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-11A (Continued) b. Current Liabilities: Accounts payable ($466,000 - $206,000) Employee income taxes payable ($82,560 – $75,680) CPP payable ($17,028 + $17,028 - $31,218) EI payable ($5,610 + $7,854 – $12,342) Warranty provision ($34,500 - $24,000) Deferred revenue LO 5,6 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

$260,000 6,880 2,838 1,122 10,500 45,000 $326,340

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-12A a. 1.

Equipment Accounts Payable Cash

32,000

Inventory Accounts Payable

93,000

Accounts Payable Cash

86,000

Rent Payable Rent Expense Prepaid Rent Cash

10,000 10,000 10,000

Deferred Revenue Service Revenue

5,000

Wages Expense ($2,000 x 3) Wages Payable

6,000

Warranty Expense Warranty Provision

16,000

Warranty Provision Cash

10,000

28,000 4,000

93,000

86,000

30,000

5,000

6,000

16,000

10,000

b. Current Liabilities: Accounts payable1 Wages payable Deferred revenue ($14,000 - $5,000) Warranty provision ($12,000 + $16,000 - $10,000)

$120,000 6,000 9,000 18,000 $153,000 1 ($85,000 + $28,000 + $93,000 - $86,000) =$120,000

LO 5,6 BT: AP Difficulty: E Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-13A a. Virtual Chef will record the amount of $780,000 as deferred revenue for the current year. However, at the end of January the company has provide one month of service of two meals a week for four weeks. By providing a bonus for the month of December the company is essentially provide 13 months worth of meals. As such the balance in the deferred revenue account at the end of January should be $720,000 ($780,000 – ($780,000/13)). In December, the company would record as revenue the equivalent of two months or $120,000. There is no additional liability as a result of the bonus meals offered to subscribers. The difference relates to how revenue is recognized over the equivalent of 13 months as opposed to 12 months. b. The transaction price of the rewards program and the grocery sales:

Performance Obligation Grocery Sales Rewards Program

Stand-Alone Selling Price $1,500,000 $135,000*

% of Total SA Selling Price 91.7% 8.3%

Contract Price X $1,500,000 X $1,500,000

Allocation of Contract Price $1,375,500 $124,500

$1,635,000 100% $1,500,000 *$1,500,000 sold x ($1.00/$10.00) x 90% redemption rate = $135,000 In the first year, 76% of the credit amounts were redeemed and revenue of $94,620 [(.76) x $124,500] could be recognized related to them. The remaining liability related to credits granted after redemption is $29,880 ($124,500 - $94,620). c. The current portion of the debt – $50,000 – reported as a current liability. The long-term liability amount is zero as it will be fully repaid in 2025. d. The company increases a liability for amounts received as deposits and reduces the same liability for amounts paid back to its customers when the returnable containers are returned. Assuming the liability qualifies as a current liability, the balance of this current liability account will be $20,000 higher at its current year end than the balance at the end of the previous year ($245,000 - $225,000).

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-13A (Continued) e. The company should record (credit) a warranty provision of $160,000 (4,000 x 2% x $2,000) related to the current year’s sales. If the $150,000 cost of making good on the product warranties in the current year related to the sales of product in the current year, the $150,000 would be debited to (and therefore, would reduce) the warranty provision account. The balance at the end of the year would be $10,000, but insufficient information is provided about what part of this is a current liability and what part is a long-term liability. LO 5 BT: AP Difficulty: H Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-14A 2024 Dec.1

Cash Bank Loan Payable

180,000

Wages Expense Employee Income Taxes Payable CPP Payable EI Payable Wages Payable

16,000

Wages Expense CPP Payable EI Payable ($253 x 1.4)

1,226

180,000

Dec. 31

Dec. 31 Interest Expense1 Interest Payable 1 ($180,000 X 7% X 1/12)

2025 Jan. 2

3,200 872 253 11,675

872 354

1,050 1,050

Bank Loan Payable Current Portion of Long-Term Debt ($180,000 X 16.67%)

30,000

Wages Payable Cash

11,675

Jan. 14 Employee Income Taxes Payable CPP Payable ($872 + $872) EI Payable ($253 + $354) Cash

30,000

11,675 3,200 1,744 607 5,551

LO 5,6 BT: AP Difficulty: E Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-15A 2024 Dec 1.

Cash

700,000 Bank Loan Payable

Dec 31.

Wages Expense 5,000 Employee Income Taxes Payable CPP Payable EI Payable Wages Payable Wages Expense CPP Payable EI Payable ($79 X 1.4)

Dec 31.

2025 Jan 3.

Jan 17.

700,000

1,100 273 79 3,548

384 273 111

Interest Expense 1,750 Interest Payable ($700,000 x 3% x 1/12 months = $1,750)

1,750

Bank Loan Payable 100,000 Current-Portion of Long-Term Debt ($700,000 x 0.1429 = $100,000)

100,000

Wages Payable Cash

3,548

Employee Income Taxes Payable CPP Payable ($273 + $273) EI Payable ($79 + $111) Cash

1,100 546 190

3,548

1,836

LO 5,6 BT: AP Difficulty: E Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-1B 1. 2. 3.

4. 5. 6. 7.

Current – the company will be paying the dividend within the next 12 months Current – the company will likely provide goods to the customers within the next 12 months. Current and Long-term – $2,000 as current as it is due in 2025 and then the remaining $8,000 is long-term as it is due more than a year from December 31, 2024. $417 of interest payable is a current liability, ($10,000 x 10% x 5/12) to be paid within the next 12 months. Current – the employee deductions will be paid in the next 12 months. Current and Long-term – $8,000 (1/5 x $40,000) will be current and the remaining amount ($32,000) will be long-term. Current – as the gift cards can be used at any time, the liability is classified as current. Long-term– the loan principal is due in 3 years, however, if the current ratio is breached it needs to be reclassified to current as they may need to repay the loan immediately.

LO 1 BT: C Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP9-2B a. Current ratio = $200,000/$50,000 = 4.0 before the reclassification which meets the bank’s minimum current ratio of 2.5. b. Interest Expense1 20,000 Long-Term Loan Payable 40,000 Cash 60,000 1 ($400,000 x 10% x 6/12 = $20,000) ($400,000/10 semi-annual payments = $40,000 principal) c. Long-Term Loan Payable 80,000 Current Portion of Long-Term Debt 80,000 To reclassify the current portion of long-term debt as $80,000 of principal is due each year (2 semi-annual payments of $40,000).

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-2B (Continued) d. Current ratio = $140,0002/$130,0003 = 1.08 after the reclassification which does not meet the bank’s minimum current ratio of 2.5. 2 ($200,000 - $60,000) =$140,000 3 ($50,000 + $80,000) =$130,000 LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP9-3B a. April 1

Cash

June 30

Interest Expense 1 8,750 Interest Payable 1 ($500,000 x 7% x 3/12 = $8,750)

8,750

Long-Term Loan Payable 25,000 Current Portion of Long-Term Debt To reclassify the current portion of the loan.

25,000

June 30

500,000 Long-Term Loan Payable 500,000 To record the 20-year 7% loan with annual payments including $25,000 principal repayments.

Reclassifying the current portion of long-term loan will decrease the current ratio as it will increase the current liabilities which is the denominator of the current ratio, therefore, lowering the ratio.

LO 3 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-4B a.

Warranty expense matched to 2020 revenue: = (1% + 2% + 2% + 3%) = 8% total cost and total 2020 expense Therefore, the expense = 8% X 7,000 units X $40/unit = $22,400 Alternatively, Expected to be defective in 2020: 7,000 x 0% x $40 = $ 0 Expected to be defective in 2021: 7,000 x 1% x $40 = 2,800 Expected to be defective in 2022: 7,000 x 2% x $40 = 5,600 Expected to be defective in 2023: 7,000 x 2% x $40 = 5,600 Expected to be defective in 2024: 7,000 x 3% x $40 = 8,400 Total 2020 expense $22,400 Less: 2020 actual expenditures Warranty provision for 2020

(500) $21,900

Warranty expense matched to 2021 revenue: = (1% + 2% + 2% + 3%) = 8% total cost and total 2021 expense Therefore, the expense = 8% X 9,000 units X $40/unit = $28,800 Alternatively, Expected to be defective in 2021: 9,000 x 0% x $40 = $ 0 Expected to be defective in 2022: 9,000 x 1% x $40 = 3,600 Expected to be defective in 2023: 9,000 x 2% x $40 = 7,200 Expected to be defective in 2024: 9,000 x 2% x $40 = 7,200 Expected to be defective in 2025: 9,000 x 3% x $40 = 10,800 Total 2021 expense 28,800 Less: 2020 actual expenditures Warranty provision for 2021

(16,000) $12,800

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-4B (Continued) Warranty expense matched to 2022 revenue: = (1% + 2% + 2% + 3%) = 8% total cost and total 2022 expense Therefore, the expense = 8% X 10,000 units X $40/unit = $32,000 Alternatively, Expected to be defective in 2022: 10,000 x 0% x $40 = $ 0 Expected to be defective in 2023: 10,000 x 1% x $40 = 4,000 Expected to be defective in 2024: 10,000 x 2% x $40 = 8,000 Expected to be defective in 2025: 10,000 x 2% x $40 = 8,000 Expected to be defective in 2026: 10,000 x 3% x $40 =12,000 Total 2022 expense $32,000 Less: 2022 actual expenditures (30,000) Warranty provision for 2022 2,000 Estimated warranty provision account, Dec. 31, 2022 $36,700 ($21,900 + $12,800 + $2,000 = $36,700) b.

Warranty expense matched to 2023 revenue: = (1% + 2% + 2% + 3%) = 8% total cost and total 2023 expense Therefore, the expense = 8% X 12,000 units X $40/unit = $38,400 Alternatively, Expected to be defective in 2023: 12,000 x 0% x $40 = $ 0 Expected to be defective in 2024: 12,000 x 1% x $40 = 4,800 Expected to be defective in 2025: 12,000 x 2% x $40 = 9,600 Expected to be defective in 2026: 12,000 x 2% x $40 = 9,600 Expected to be defective in 2027: 12,000 x 3% x $40 =14,400 Total 2023 expense $38,400

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-4B (Continued) c. 2020 2021: on 2020 sales on 2021 sales 2022: on 2020 sales on 2021 sales on 2022 sales

Estimated Expenditure $ 0

Actual Expenditure $ 500

Over (under) ($ 500)

2,800 0 $2,800

16,000

(13,200)

5,600 3,600 0 $9,200

30,000

(20,800)

5,600 7,200 4,000 0 $16,800

24,000

(7,200)

8,400 7,200 8,000 4,800 0 $28,400

12,000

16,400

2023: on 2020 sales on 2021 sales on 2022 sales on 2023 sales

2024: on 2020 sales on 2021 sales on 2022 sales on 2023 sales on 2024 sales

Except for 2024, the company’s estimates with respect to warranty expenditures are consistently lower overall than the actual costs the company is incurring. The company should increase its estimates of defect rates or the average cost to repair or replace a defective unit. However, the information provided does not allow us to determine if it is the pattern of when the items are discovered to be defective that is the problem, or the number of units that prove defective or the average cost to rectify the deficiency that is the source of the discrepancy. Further information is required. LO 5 BT: AP Difficulty: M Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-5B a. Warranty Expense Warranty Provision (3-month warranties)

38,000 38,000

Warranty Provision Inventory Parts Inventory (3-month warranties)

25,000

Cash (500 x $150) Deferred Warranty Revenue (3-year extended warranties sold)

75,000

Warranty Expense Inventory (3-year extended warranties)

15,000

Deferred Warranty Revenue Warranty Revenue1 1 ($75,000 ÷ 3 years)

25,000

19,000 6,000

75,000

15,000

25,000

Note: the $75,000 charged to customers for the extended warranties will become revenue to the company as it provides the warranty coverage. The amount of revenue is recognized evenly over the three-year warranty period as claims are expected evenly over this time. The accounting for this type of warranty differs from the accounting for the warranty that was provided as part of the original sales price. The three-month warranty was merely to correct any deficiencies with the product when it was sold. The sale of the extended warranty is a separate performance obligation ARL. It therefore recognizes the revenue from this type of warranty transaction as it is earned.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-5B (Continued) b. ARL should classify the three-month warranty provision as current liabilities because these obligations are expected to require the use of current assets and expire within one year. With the three-year warranties and the deferred revenue, part of this liability is current and part is long-term, as the warranty costs can be incurred by the company as late as 2027. Based on experience, ALR should be able to estimate the portion of the deferred revenue that will require current resources, and the portion that will not be claimed within 12 months from the reporting date of December 31, 2024. c. If the actual operating costs incurred by ARL under the extended warranty are less than the amount collected from customers for the extended warranty revenue (and it is expected they will be), then the difference between the annual costs and annual revenue recognized represents the profit or income on the company’s warranty operations. LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP9-6B

a. Transaction journal entries Jan/Apr. Cash

74,880 1

Deferred Revenue ($6,240 x 12) = $74,880 Received for membership of teams

74,880

Apr/Jun. Cash

15,000

Deferred Revenue Received for advertising Apr/Jun. Cash

15,000

1,440

Deferred Revenue Received for medical insurance service Apr/Jun. Cash

1,440

5,000

Deferred Revenue Received for end of season awards ceremony

5,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-6B (Continued) Apr/Jun

Cash

4,500

Service Revenue (300 x $15) Drop-in games June.

June

4,500

Operating Expenses (3 x $6,500) Accounts Payable

19,500

Accounts Payable Cash

13,500

Miscellaneous Expense Cash

9,000

19,500

13,500

9,000

b. Adjusting journal entries June 30 Deferred Revenue Membership Revenue 1 ($74,880 x 3/6) – for memberships

37,440

June 30 Deferred Revenue Advertising Revenue2 2 ($15,000 x 3/6)

7,500

June 30

Deferred Revenue Service Revenue 3 ($1,440 x 3/6) – for insurance

37,440

7,500

720 720

Alternatively, the original entries for advertising, memberships and services could have been: • Recorded as revenues, and an adjustment made to reduce the revenues and recognize one half of these amounts as deferred revenues at June 30.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-6B (Continued) c. Women’s Summer Hockey Ltd. Statement of Income For the six months ended June 30, 20XX Revenues: Registration revenue Service revenue1 Advertising revenue Total revenues

$ 37,440 5,220 7,500 50,160

Expenses: Operating expenses Miscellaneous expense Total expenses

19,500 9,000 28,500

Net income

$21,660

($4,500 + $720) = $5,220

d. Cash balance = $74,880 + $15,000 + $1,440 +$5,000 +$4,500 – $13,500 – $9,000 = $78,320 Cash 74,880 15,000 1,440 5,000 4,500 78,320

13,500 9,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-6B (Continued) e. To: Women’s Summer Hockey Ltd. Owners From: Your name, Accountant Re: Results of operations to June 30 The results of operations for the six months ended June 30 is a net income of $21,660. This is substantially less than the current positive bank balance of $78,320. The reason for this $56,660 difference is due to deferred revenues. First, revenues are recognized as part of your income only when they are earned: $37,440 of the cash received on memberships won’t be recognized in income until the next term, nor will $7,500 of the advertising revenue, the medical insurance service revenue of $720 and the $5,000 for the year-end awards ceremony received in cash be recognized until the July to September period. The cash from the above was put in the bank when it was received, but $50,660 of revenue from these items won’t be recognized in income until the period. The second reason is that your expenses (which reduce reported income) include $6,000 of amounts that are still payable. They have not yet been paid for in cash. LO 5 BT: AP Difficulty: M Time: 60 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-7B

a. Feb.

Cash

20,000

Gift Card Liability Cash received for gift cards.

Mar.

20,000

Gift Card Liability Sales Revenue To record breakage

1,000

Gift Card Liability Sales Revenue Gift cards redeemed for merchandise.

2,000

Cost of Goods Sold Inventory

1,000

2,000

500 500

Gift Card Liability 174 1 Sales Revenue To record breakage 1 92% x 20,000 = $18,400; $20,000 - $18,400 = $1,600; ($2,000/$18,400) x $1,600 = $174 Apr.

Gift Card Liability Sales Revenue Gift cards redeemed for merchandise.

15,000

Cost of Goods Sold Inventory

5,000

Gift Card Liability Sales Revenue 2 To record breakage 1 ($15,000/$18,400) x $1,600 = $1,304

1,304

174

15,000

5,000

1,304

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-7B (Continued) b.

Be My Valentine Ltd – Statement of Income (Partial) February March April

Sales revenue Cost of goods sold Gross margin

$ 1,000 0 $ 1,000

$ 2,174 $ 16,304 500 5,000 $ 1,674 $ 11,304

c. Gift Card Liability reported as a current liability: Balance, February 1 Gift cards sold to customers Gift cards redeemed Gift card breakage Balance, February 28 Gift cards sold to customers Gift cards redeemed Gift card breakage Balance, March 31 Gift cards sold to customers Gift cards redeemed Gift cards breakage Balance, April 30

$ 1,000 20,000 0 (1,000) $ 20,000 0 (2,000) (174) $17,826 0 (15,000) (1,304) $ 1,522

LO 5 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-8B

a. Employees’ net wages: Gross wages Less source deductions: CPP EI Employee income taxes Net wages

$100,000 $4,950 1,630 25,000

31,580 $68,420

b. December 31: Wages Expense 100,000 Employee Income Taxes Payable CPP Payable EI Payable Wages Payable

25,000 4,950 1,630 68,420

Wages Expense CPP Payable ($4,950 X 1) EI Payable ($1,630 X 1.4)

7,232 4,950 2,282

WCB Expense ($100,000 x 6.54%) Cash Payment to the WCB of BC

6,540

Feb 10: Wages Payable Cash Feb 24: Employee Income Taxes Payable CPP Payable ($4,950 + $4,950) EI Payable ($1,630 + $2,282) Cash Payment to the government

6,540

68,420 68,420

25,000 9,900 3,912 38,812

LO 6 BT: AP Difficulty: E Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-9B a. Employees’ net wages: Gross wages Less source deductions: CPP EI Union dues Employee income taxes Net wages

$75,000 $3,700 1,222 650 18,750

b. May 31: Wages Expense 75,000 CPP Payable EI Payable Union Dues Payable Employee Income Taxes Payable Cash Wages Expense CPP Payable ($3,700 X 1) EI Payable ($1,222 X 1.4) June 17: Employee Income Taxes Payable CPP Payable 3,700 + $3,700) EI Payable ($1,222 + $1,711) Cash Payment to the government Union Dues Payable Cash Payment to the union

24,322 $50,678

3,700 1,222 650 18,750 50,678

5,411 3,700 1,711

18,750 7,400 2,933 29,083

650 650

LO 6 BT: AP Difficulty: E Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-10B Once the loan is taken out and the equipment is purchased, the balances appearing on the Statement of Financial Position would be as follows: Current Assets $500,000 Current Liabilities $190,000 ($350,000 + $150,000) ($150,000 + $40,000) Non-current Assets 4,650,000 Long-term Liabilities 2,260,000 ($4,000,000 + $650,000) ($1,500,000 + $760,000) Common Shares 2,260,000 Retained Earnings 440,000 Total Assets $5,150,000 Total Liabilities and $5,150,000 Shareholder’s Equity Since the retained earnings balance is $440,000, potentially a dividend of $75,000 could be declared without breaching the terms of the agreement. However, in order to achieve a 2.5 current ratio, current assets need to total 2.5 X $190,000 or $475,000. Consequently, the maximum dividend that could be declared and paid is $25,000 ($350,000 + $150,000 - $475,000). The bank’s requirement to maintain a minimum retained earnings balance of $375,000 would also be met. LO 3 BT: AP Difficulty: H Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-11B a. 1.

Cash Deferred Revenue

60,000

Wages Expense Employee Income Taxes Payable1 CPP Payable EI Payable Cash 1 ($340,000 x 20%) = $68,000

340,000

Wages Expense CPP Payable EI Payable ($5,540 X 1.4)

24,556

Employee Income Taxes Payable 2 CPP Payable ($16,800 x 2 x 10/12) EI Payable ($5,540 + $7,756) x 10/12 Cash 2 ($68,000 x 10/12) = $56,667

56,667 28,000 11,080

Inventory Accounts Payable

356,000

Accounts Payable Cash ($356,000 – $46,000)

310,000

Cash Deferred Revenue

40,000

60,000

68,000 16,800 5,540 249,660

16,800 7,756

95,747

356,000

310,000

b. Current Liabilities: Accounts payable Employee income taxes payable ($68,000 - $56,667) CPP payable ($16,800 x 2) - $28,000 EI payable ($5,540 + $7,756 - $11,080) Deferred revenue – contracts Deferred revenue – gift cards LO 5,6 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

40,000

$46,000 11,333 5,600 2,216 60,000 40,000 $165,149

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-12B a. 1.

Rent Payable Rent Expense Prepaid Rent Cash

64,000 32,000 32,000

Deferred Revenue Service Revenue

20,000

Dividends Payable Cash

5,000

Equipment Accounts Payable Cash

260,000

Wages Payable ($4,000 x 4) Cash

16,000

Inventory Accounts Payable

75,000

Accounts Payable Cash

100,000

b. Current Liabilities: Accounts payable ($89,000 + $250,000 + $75,000 – $100,000) Wages payable ($16,000 - $16,000) Rent payable ($64,000 - $64,000) Deferred revenue ($104,000 - $20,000) Dividends Payable ($10,000 – $5,000)

128,000

20,000

5,000

250,000 10,000

16,000

75,000

100,000

$314,000 0 0 84,000 5,000 $403,000

LO 5,6 BT: AP Difficulty: E Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-13B a. The gift cards, when sold, are considered deferred revenue, as the company owes the gift card holders the cash value of the gift cards. The breakage on the cards is expected to be $2,000 (the amount of gift cards that will go unclaimed). This breakage will be recognized as the remaining $18,000 of gift cards are redeemed. b. As none of the employees has taken vacation during the year, they would all be owed the two weeks of vacation to which they are entitled for working the year. The company should report an accrued vacation payable liability for $20,000, which reflects the two-weeks each employee is owed. c. As the membership fee is refundable (it is acting like a deposit until the member terminates their service) the remaining collected memberships fees would be recorded as a current liability of $400,000 ($500,000 $100,000). d. The current portion of the debt - $50,000 would be reported as a current liability along with the interest accrued from November 1, 2024 to December 31, 2024 is $200 ($1,200 x 2/12). e. The transaction price of the loyalty program and the satellite services need to be allocated: Stand-Alone % of Total Performance (SA) Selling SA Selling Contract Allocation of Obligation Price Price Price Contract Price Satellite Service $7,500,000 97.1% X $7,500,000 $7,282,500 Loyalty Program $225,000* 2.9% X $7,500,000 $217,500 $7,725,000 100% $7,500,000 *1,500,000 points earned x $0.25/point x 60% redemption rate = $225,000 In the first year, 500,000 points were redeemed and revenue of $72,500 [(500,000 / 1,500,000) x $217,500] could be recognized related to them. The remaining liability related to loyalty points after redemption is $145,000 ($217,500 - $72,500). LO 5 BT: AP Difficulty: H Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-14B 2024 Dec.1

Dec 31

Bank Loan Payable Interest Expense ($5,000 x 6% x 11/12) Interest Payable ($5,000 x 6% x 1/12) Cash Cash Sales Revenue Customer Loyalty Provision

1,000 275 25 1,300 500,000 492,000 8,000

$500,000 x 2% x 80% redemption rate = $8,000 $500,000 + $8,000 = $508,000 $500,000 / $508,000 = 98.4% $8,000 / $508,000 = 1.6% $500,000 x 98.4% = $492,000 $500,000 x 1.6% = $8,000 Dec. 31

Dec. 31

2025 Jan. 2

Wages Expense ($3,000 x 2) Employee Income Tax Payable CPP Payable EI Payable Wages Payable

6,000 1,320 327 95 4,258

Wages Expense CPP Payable EI Payable ($95 x 1.4)

460

Interest Expense Interest Payable ($4,000 X 6% X 1/12)

327 133

Bank Loan Payable Current Portion of Long-Term Debt ($5,000 X 1/5)

1,000

Wages Payable Cash

4,258

1,000

4,258

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-14B (Continued) Jan. 10

Jan. 17

Customer Loyalty Provision Sales Revenue

8,000

Cost of Goods Sold Inventory

3,200

Employee Income Taxes Payable CPP Payable ($327 + $327) EI Payable ($95 + $133) Cash

8,000

3,200 1,320 654 228

LO 5,6 BT: AP Difficulty: E Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

2,202

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP9-15B 2024 May 1.

Cash

40,000 Bank Loan Payable

May 31.

June 5. June 15.

40,000

Wages Expense 30,000 Wages Payable Employee Income Taxes Payable CPP Payable EI Payable

21,891 6,000 1,635 474

Wages Expense CPP Payable EI Payable ($474 x 1.4)

2,299 1,635 664

Interest Expense Interest Payable ($40,000 x 10% x 1/12 months = $333)

333

Bank Loan Payable 10,000 Current-Portion of Long-Term Debt ($40,000 ÷ 8 x 2 = $10,000) Wages Payable Cash

21,891

CPP Payable ($1,635 + $1,635) EI Payable ($474 + $664) Employee Income Taxes Payable Cash

3,270 1,138 6,000

333

10,000

21,891

10,408

LO 5,6 BT: AP Difficulty: E Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP9-1

Financial impact of rate changes: $6,000,000 / 100 employees = $60,000 per employee on average. (a) Effect on the average employee's net pay New rates Old rates Increase

CPP 5.70% of $60,000 = $3,420 5.45% of $60,000 = $3,270 $ 150

EI 1.74% of $60,000 = $1,044 1.58% of $60,000 = $ 948 $ 96

Net effect = $150+$96 = $246 additional cost per employee/year. Therefore, the average employee's net pay is $246 less. (b) Effect on the company's payroll costs CPP New rates 5.70% of $6 million = $342,000 Old rates 5.45% of $6 million = $327,000 Increase $15,000 1 2

EI 2.436%1 of $6 million = $146,160 2.212%2 of $6 million = $132,720 $13,440

1.74% x 1.4 = 2.436% 1.58% x 1.4 = 2.212%

Net effect = $15,000 + $13,440 = $28,440 total additional cost, or $284.40 per employee ($28,440 / 100). Note that the additional employer cost of $38.40 per employee (i.e., $284.40 - $246) is a result of the requirement to pay 1.4 times the employee rate for EI (i.e., $96 X .4). LO 6 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP9-2

It is a common practice to offer ‘coffee cards’ as a customer loyalty program at coffee shops. In order to follow proper revenue recognition, the total proceeds from the 10 cups should be allocated over the 11 cups of coffee delivered to customers. Therefore, for each of the 10 cups of coffee customers pay for, only 10/11th of the amount should be recognized in revenue, and be credited to an income statement account such as Coffee Sales Revenue.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP9-2 (Continued) The other 1/11th should be recognized as a partial payment for the 11th cup which won’t be provided until later. The 1/11th from each coffee should be accumulated in an deferred revenue liability account such as Deferred Coffee Revenue. It is earned only when the 11th cup is provided to the customer. After the 10th cup has been sold, the electronic system has deferred a total of 10/11th of the selling price of one cup of coffee into the Deferred Coffee Revenue account. When the 11th cup is “sold” the electronic system will recognize the “free” coffee and will automatically debit the liability account (Deferred Coffee Revenue) and credit the income statement account (Coffee Sales Revenue) for an amount equal to 10/11ths of the regular price of a coffee – the same amount that was deferred and also same amount recognized in revenue for each of the preceding 10 cups that were paid for. To summarize, the revenue associated with each of the 11 cups of coffee should be recognized when the company provides each of the 11 cups to the customer. This includes the 11th “free” cup. In reality, many customers start a coffee card but never finish it. This means that the chain will not be distributing 11 cups of coffee for the price of 10 to everyone who swipes a “Coffee Club” card. From past experience, the chain can probably estimate what percentage of the swiped cards will actually be redeemed for a free cup. If so, the percentage of the amount paid for each of the 10 cups that is credited to revenue could be increased above 10/11th, with less than 1/11th going into the deferred revenue liability account. A precise estimate will be difficult to determine because the proportion of “free” coffees in each store is likely to be somewhat different from others in the chain. Also, if coffee prices charged to customers increase, the deferred revenue account will be a mix of amounts. Because the amounts deferred may not be sufficiently material to justify keeping such detailed accounting records, the electronic system may be kept in units only so that managements’ best estimate of the deferred revenue related to future redemptions could be made as an adjusting entry at each accounting period end. LO 5 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP9-3

The commercial lender is proposing that the maximum amounts loaned be based on a predetermined percentage of the borrower’s balances of its accounts receivable account and inventory account. The “margin limitation” (maximum percentage of each account) is specified because if the lender had to seize its security (the receivables and the inventory) for non-payment by the borrower, it is unlikely that the lender could get 100 cents on the dollar when converting receivables or inventory to cash. The receivables and inventory serve as collateral to reduce the risk to the lender, and this risk is further reduced because the amount of the loan is based on a less-than100% of each type of asset. The balance of the working capital loan can fluctuate, but cannot be in excess of the percentage margin limits for the receivables and inventory owned and reported by the borrower. As inventory is sold and converted to accounts receivable, and the receivables are collected in cash, the cash is used to reduce the operating loan. However, if the cash collections are diverted to other purposes and are not being used to pay down the loan, the agreement stipulates that the lender is entitled to demand repayment immediately (i.e., repayable on demand). This feature also provides more security for the lender because borrower would not want the lender to call the loan. The financial reporting implications are twofold: 1. The borrowing company’s financial statements must indicate that the accounts receivable and inventory are not freely available to general creditors if the company were to experience difficulties, but instead the borrower must report that the commercial lender has a prior secured interest in these assets. 2. In addition, even though there is no maturity date to use in determining whether the loan should be a current liability or a long-term liability, the fact that it is repayable on demand usually means the loan is reported in current liabilities.

LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP9-4

The accounts payable turnover ratio is calculated by dividing the amount of a company’s total credit purchases by its average accounts payable balance, and refers to the number of times each period that a company pays off its accounts payable to suppliers, on average. The accounts payable payment period provides a measure similar to the accounts payable turnover ratio, except that it is expressed in the average number of days it takes a company to pay its payables. It is calculated by dividing 365 days by the accounts payable turnover ratio. Assuming my company paid the supplier when the accounts payable was exactly 30 days old, the turnover ratio for the credit purchases from this supplier would be 12 (that is, once each month and 12 times each year) and the average age of its accounts payable would be 365/12 = 30 days. If my company decides to take advantage of the 2% cash discount by paying this supplier’s invoices on day 10, the turnover ratio for this supplier would increase to 36 (that is, three times a month X 12 months) and the average age of its accounts payable would be 365/36 = 10 days. Therefore, the turnover ratio increases by a factor of 3 and the average age of the accounts payable for this supplier is 1/3 of what it had been. However, if my company does not take advantage of the 2% discount, the ratio and average age of payables would not change because the payments would continue to be made at 30 days.

LO9 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

UP9-5

The fact that the company’s accounts payable turnover ratio is significantly higher than all the comparative companies in the retail sector could be a positive factor or it could be a negative factor. First, however, I would want to know whether this is a one-year phenomenon or whether it is a recurring one. If it is just a one-year anomaly, I would look for the reason to understand why this is so.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP9-5 (Continued) Then I would check out the variables in the calculation of the ratio. The numerator of the ratio should represent the total credit purchases made by the company whose suppliers are represented in the accounts payable accounts. It is often difficult to determine the total credit purchases amount because it is not a number that companies report on their financial statements. Analysts estimate the total purchases made in the year by deducting opening inventory from cost of goods sold and adding the ending inventory. However, there are a number of other expenses/purchases made on account with suppliers that are included in accounts payable, such as for supplies, for electricity, for heat, for repairs and maintenance, for insurance, and for furniture and equipment, etc. If this purchase information is available for this company and not others, the numerator might be larger and the resulting turnover higher for this company as it is divided in all cases by the average accounts payable. If I cannot identify a calculation difference, and assume that this company’s operations are similar to others in the industry, I might think a high accounts payable turnover is favourable. This might indicate that the company has very healthy cash flows that allow it to pay off its outstanding accounts early to take advantage of supplier discounts. Supplier discounts for early payment are usually advantageous to a company, reducing the net cost of the merchandise purchased and the cost of goods sold, and increasing the gross margin. Even if the company has to borrow from the bank to finance the early payments, the benefit of the discount taken is ordinarily more than the cost of financing paid to the bank. Alternatively, if there are no discounts offered and the company is simply paying its suppliers before the end of the regular credit period offered by its suppliers, I would be concerned. Because the regular credit period offers “interest-free” financing, a company that does not take full advantage of this is mismanaging its cash. LO9 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIP9-1

Three items that are correct: • This is important because if not done, users of the financial statements would not be able to estimate the expected cash flows for the following year. • By failing to make the reclassification entry, the company’s current liabilities would be understated (perhaps by a significant amount), while its long-term liabilities would be overstated. • Total liabilities would be correct with or without the reclassification entry being made. Three items that are incorrect: • The reclassification of current portion of debt changes this portion of the liability from long-term to current, not current to long-term. • Without the reclassification entry, the company’s working capital would appear stronger, not weaker than it actually is. • The current ratio would be higher, not lower, than it should because current liabilities are understated. The quick ratio would be affected in the same manner.

LO9 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

WIP9-2

Items that are correct: • Breakage represents the value of the gift cards that we don’t expect that customers will ever redeem. • The breakage amount will be recognized as revenue. Items that are incorrect: • The amount we don’t expect to honour is not recognized in the period in which the gift cards are sold, it is recognized proportionately as the gift cards are redeemed.

LO 5 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP9-3 The points earned by customers participating in these programs are considered to be a separate performance obligation. Companies estimate the stand-alone value of the loyalty points by taking the amount of points they issue in an initial sales transaction and multiplying this amount by their cash value and the expected redemption rate to get the stand-alone selling price of the points. This amount is then used to determine the percentage value they represent of the combined performance obligation of the total contract price of the sales transaction. Finally, the percentage amount is multiplied by the contract price and recorded to the Customer Loyalty Provision account until they are redeemed. As the loyalty points are redeemed, revenue is recorded and the liability is reduced. The expense related to the revenue being recognized is recorded when the revenue is recognized, not in the period in which the points were obtained in the initial sale. LO 5 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP9-4 The expenses and liability related to assurance-type warranties are accrued at the time the related product is sold. When the warranty claims are satisfied, the liability is reduced by the costs related to satisfying the claim. A service-type warranty is recorded differently. It is considered a separate performance obligation. When sold, it is recorded as deferred warranty revenue which is recognized into revenue over the term of the warranty or as the expenses to service the claims against these warranties are incurred. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP9-5 A company’s suppliers prefer to sell to companies with high accounts payable turnover ratios rather than low ratios. This is the opposite of the statement made by the classmate. The accounts payable turnover ratio indicates how many times a year, on average, a company pays all of its credit suppliers and is calculated by dividing total credit purchases by the average accounts payable balance. When the turnover number is divided into 365, and expressed in days, this tells you how many days on average a company takes to pays its suppliers. Suppliers need cash to operate their businesses, so they would want the company to pay any amounts owed as quickly as possible. The ability of a supplier to have a high accounts payable turnover indicates that they have sufficient cash to pay invoices on time. LO 4,9 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI9-1 UNIVERSITY OF SASKATCHEWAN a. Deferred revenue represents the outstanding obligation a company or other organization has to customers, clients, or students in this case, for amounts received from them for goods or services purchased but which have not yet been delivered or provided. In the University of Saskatchewan’s case, the deferred revenues were likely for tuition received at the beginning of the January 2020 term for the courses and programs to be provided in the 2020 winter term. At March 31, some of the term’s revenue had not yet been earned by the University. Other types of likely transactions that could give rise to the deferred revenue include student prepayments for residence, parking, food services, hospitality services and the bookstore. These latter examples would be included in the deferred revenue from ancillary operations. b. Answer to this requirement depends on the institution the student attends. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

RI9-2 NEW LOOK VISION GROUP INC. a. A revolving credit facility is a “pre-approved” loan which can provide financing for operations at any time subject to the overall limit of $85 million. It can also be repaid at any time. New Look’s revolving credit facility is most likely with a bank, but could be with another type of financial institution. As the day to day need for cash to settle obligations may fluctuate from time to time, the revolving credit facility is used provide the necessary liquidity to operate efficiently. This day-to-day requirement for liquidity is for operations and for the settlement of current liabilities with current assets. This is why the revolving credit facility is financing working capital. b. A standby fee charged by the bank is a charge to compensate the bank for agreeing to “stand by” and provide additional funds up to the agreed upon limit whenever the borrowing company requires it. Because the bank must limit the total it promises to all its customers, this compensates the financial institution for the part of the revolving credit that is reserved for the company but is not used and is not earning interest for the bank. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI9-3 Canadian Tire Corporation, Limited a. Canadian Tire accounts for its sales and warranty returns as follows: Based on historical experience for returns, an estimate is made of the items sold in the 2020 fiscal year that are expected to be returned, either as a straightforward sales return, or a return of defective goods, or for items requiring replacement parts. This estimate also includes an estimate of defective goods in current store inventories. The estimate increases the provision (liability) account and reduce sales revenue. The accounting policy note is not clear about whether the estimates are based on selling prices or costs and the provision may be a combination of retail (for sales returns) and cost prices (for warranties). The company is clear that the associated charges against income are made in the same period as the related sales are reported. When making good on returns and warranties during the year, the provision (liability) account is reduced. New provisions in fiscal 2020 increased the liability account and reduced net income by $585.5 million. During the 2020 fiscal year, the company incurred costs of $571.9 million making good on obligations previously provided for and reduced the provision liability by the same amount. This resulted in the provision account at the end of the year being higher than the balance at the beginning of the 2020 year. b. The customer loyalty program is accounted in a similar way to the sales and warranty returns. When Canadian Tire sells merchandise to its customers and the customers earn cash rewards redeemable on future purchases, the company recognizes the fair value of the rewards earned (again, based on historical redemption patterns) and increases (credits) the deferred revenue account for customer loyalty programs. Revenue is deferred as unearned. When the rewards are awarded to customers, the deferred revenue in the provision (liability) account is reduced and the sales revenue account (statement of income) is increased. LO 5 BT: C Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI9-4 Gamehost Inc. a. ($ amounts in millions) CPP percentage of total wages and salaries: $0.5/$10.4 = 4.8% EI percentage of total wages and salaries: $0.2/$10.4 = 1.9% CPP and EI remittances = 6.7% of the company’s wages and salaries. b. Other human resource-related expenses as a percentage of wages and salaries: $0.4/$10.4 = 3.8% c. In total, employee benefits cost a total of 10.5% of wages and salaries. (i.e., 6.7% + 3.8%) If wages and salaries increased to $17.8 million the CPP, EI and other human resource-related expenses would be estimated at 10.5% of this = $1,869,000. LO 6 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI9-5 Sleep Country Canada Holdings Inc. Deposits made by customers for future delivery of product is recorded as a current liability, in a deferred revenue account. The deposit is a liability as Sleep Country has a performance obligation to deliver product in the future and the revenue has not yet been earned. The liability is current because the delivery of the product is often within a few days and so the deposit is a liability for a short period of time. Once the product is delivered, the deposit amount is applied against the amount owed on the sale. The deferred liability account is debited for the amount of the deposit. Should a non-refundable deposit not be redeemed on a sale, Sleep Country, based on its past records, estimates the percentage of deposits that are not redeemed and uses this information to determine an appropriate balance of the deferred revenue account. The adjustment to reduce (debit) the deferred revenue account for the estimate of the amount that will never be redeemed, is taken into (credited to) revenue. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI9-6 Goodfood Market Corp. a.

Latest period accounts payable turnover ratio Credit purchases, 2020 fiscal year: (in $000s) Cost of sales $198,953 Deduct opening inventory ( 4,735) Add ending inventory 6,962 Credit purchases $201,180 Average accounts payable: (in $000s) $40,878 + $30,704 = $35,791 2 Accounts payable turnover ratio: $201,180/$35,791 = 5.6 times Average payable payment period: 365 days/5.6 = 65.2 days

b. 2020

2019

Current ratio: Current assets/current liabilities

$116,608/$58,977 = 2.0

$52,735/39,471 = 1.3

Quick ratio: Quick assets*/current liabilities

($104,402 +$4,464) ($45,149 + $2,605) /$58,977 /$39,471 = 1.8 = 1.2

*Quick assets: these represent the current assets that can be turned into cash relatively quickly. In this case, the total current assets were reduced by the inventories and by other current assets.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI9-6 (Continued) Goodfood’s 2020 current ratio and quick ratio have both improved significantly over the 2019 results and indicate that the company does not appear to have liquidity problems. As indicated in part a. above, Goodfood has been able to delay the payment to its suppliers to an average of 65.2 days. Whether this slow turnover of payables is due to a long credit period imposed on its suppliers or an internal Goodfood’s operating policy is not known, although there may be information on this in the Management Discussion & Analysis section of the company’s annual report. In any case, the accounts payable make up a relatively large portion of the current liabilities. LO 4, 9 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI9-7 Gildan Activewear Inc. a. (in US$000) Working capital = current assets – current liabilities

2020

2019

$1,544,473 - $359,606 $1,514,173 - $422,404 = $1,184,867 = $1,091,769

b. 2020

2019

Current ratio: Current assets/current liabilities Quick ratio:

$1,544,473/$359,606 = 4.3

$1,514,173/$422,404 = 3.6

Quick assets*/current liabilities

($701,744/$359,606 = 2.0

$385,057/$422,404 = 0.9

*Quick assets = Current Assets – Inventory – Prepaid Expenses – Income tax receivable 2020 = $1,544,473 - $727,992 - $110,105 – $4,632 = $701,744 2019 = $1,514,173 - $1,052,052 - $77,064 = $385,057

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI9-7 (Continued) The current and quick ratios show very strong liquidity. The current and quick ratio improved during 2020. Both ratios remain very high. c. 2020 accounts payable turnover ratio: Credit purchases, 2020 fiscal year: (in $000s) Cost of sales $1,732,217 Deduct opening inventory (1,052,052) Add ending inventory 727,992 Credit purchases $1,408,157 Average accounts payable (and accrued liabilities): (in $000s) $343,722 + $406,631 = $375,177 2 Accounts payable turnover ratio: $1,408,157/$375,177 = 3.8 times Accounts payable payment period: 365 days/3.8 = 96 days In this case, note that the “accounts payable and accrued liabilities” reported most likely include payables related to expenses other than cost of sales. This has the effect of understating the turnover ratio and overstating the accounts payable payment period. Therefore, the ratios would have to be used with caution. LO 4, 9 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C9-1 Greenway Medical Equipment Corporation Memorandum To: Dr. Clarise Locklier, Board of Directors From: Robert Ables, CFO Re: Draft financial statements Dr. Locklier, I am happy to respond to your questions, and I thank you for taking such an interest in the financial statements of the company. 1. Deferred revenues refer to revenues collected in advance; that is, situations where cash has been received but the goods and services have not yet been provided to the customer. The revenue is not yet earned. For example, we may require customers to pay deposits to us prior to shipping the equipment being purchased. We cannot record these receipts as revenue until we have earned the revenue by shipping the goods. The revenue collected in advance is a liability to our company because we are obligated to either ship goods to the customer or return their cash prepayment. 2. Warranty expenses are accrued in the year in which the related sales are recorded, since this is when they are incurred (i.e. these estimated costs are considered to be a cost of generating the sale). Because actual warranty costs may not be known by the end of the year, we have to estimate any remaining costs we expect to incur after year-end. The estimate is reported as a liability on our financial statements because the company has an obligation to make good on products sold in the year, even though the costs may be paid in the future. When these costs are eventually paid in future years, the warranty liability is reduced. To record an expense again in the future would double-count the expense.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C9-1 (Continued) 3.

The current portion of long-term debt reported in current liabilities represents the portion of a long-term obligation that will have to be paid within the next fiscal year. The total debt owed is the sum of the amount reported as a current liability plus the amount reported as a long-term liability. The current portion is reported separately as a current liability to provide investors with a better presentation of the current liquidity position of the company. I appreciate your interest in the financial statements and that you took the time to contact me about your questions. Please contact me if I can be of any further assistance.

LO 5 BT: C Difficulty: M Time: 25 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

C9-2 Hanson Consulting Jenny: The net pay that is deposited into your bank account each month is not the same as the salary you (and the other consultants) earn or the expense to the company. The Canadian government requires the company to withhold certain amounts from your pay and to remit them to the Canada Revenue Agency on your behalf. For the salary you earn, Hanson Consulting is legally required to deduct specific contributions to the Canada Pension Plan (CPP), Employment Insurance (EI), and income taxes from the gross pay and remit these amounts to the government on your behalf. Although you receive $4,000 cash per month, the gross salary you earn is actually much higher. In addition, the company is required to match, dollar for dollar, your (and all employees’) contributions to the Canada Pension Plan and to pay 1.4 times the employee contribution to Employment Insurance. These company contributions are required to be paid to the government. They are additional payroll costs borne by the company and are also included in consulting salaries expense on the statement of income.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C9-2 (Continued) Because the salaries expense includes the contributions we make on your behalf as well as the additional payroll costs, the consulting salaries expense reported is always considerably higher than the net pay received by you and the other employees. LO 6 BT: C Difficulty: E Time: 15 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

C9-3 Slip-n-Slide Water Park Kelly and Derek: My recommendations for the appropriate accounting treatment for the items you have raised are outlined below. Ice cream coupons: The coupons were given out to promote the water park and are in the nature of a promotion expense. Once given out, however, the Park took on an obligation to provide, free of charge, 1,000 free ice cream cones at a potential cost of 1,000 X $0.50 = $500. At July 31, assuming you have made no accounting entries related to this ice cream promotion yet, you are required to recognize the outstanding liability related to the number of free ice cream cones you expect will be redeemed after July 31. Although 800 coupons are outstanding, it is not likely that all 800 will be redeemed. Some will be lost or thrown away, or the holders may not come to the park until a later date. Therefore, you need to estimate how many are likely to be redeemed in the future. For example, if you expect only 500 more free cones will be given out, the liability should be reported as 500 X $0.50 = $250. The July 31 entry would be: Expense (such as Promotion Expense) 250 Liability (such as Provision for Free Cones)

250

Burnley, Understanding Financial Accounting, Third Canadian Edition

C9-3 (Continued) But what about the 200 free cones you have already given out? After you make the July 31 adjusting entry related to ice cream purchases, inventory and cost of goods sold, the cost of the 200 free cones (200 X $0.50 = $100) will end up automatically in the cost of goods (ice cream) sold. Therefore, to keep track separately of the cost of your ice cream promotion, this cost ideally should be transferred to an account such as Promotion Expense: Expense (such as Promotion Expense) Cost of Goods Sold (ice cream)

100 100

This entry is not required to be made, but otherwise the cost of goods sold includes the cost of ice cream that was not sold, but instead was given away as a promotion. The following related accounts will then be reported on your July 31 financial statements: Provision for Free Cones (a liability) $250 This represents the cost of the obligation to provide an estimated 500 remaining free cones Promotion Expense (an expense) $350 (This represents the cost of the 700 free cones in total that were or that you expect will have to be provided. Note that the cost of these free cones is not included in cost of goods sold for the ice cream cones; instead it is in Promotion Expense.) Season Passes: When sold, the season passes generated cash assets that represent revenue that the park has not yet earned. The entire amount (300 passes X $60 = $18,000) should be recorded as deferred revenue as received: Cash

18,000 Deferred Revenue

18,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

C9-3 (Continued) At the end of July, two months of the time the passes relate to have expired, you have provided services to the pass-holders for two months, and therefore two months of revenue ($18,000 x 2/3) should be recognized: Deferred Revenue 12,000 Revenue (such as Revenue from Passes)

12,000

Bank Loan: You are both partially correct on how the loan should be reported. The portion of the principal amount of long-term debt that is due within the 12 months after the July 31 reporting date should be reported as a current liability and the remaining principal balance should be reported as a longterm liability. Therefore $6,000 ($500 x 12 months) should be included as the current portion of long-term debt under current liabilities, and the remaining $54,000 should be reported as long-term debt in the long-term liability section. Any outstanding interest to July 31 on the principal amount that remains unpaid at that date is reported as a current liability. LO 3,5 BT: C Difficulty: M Time: 45 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 10 LONG-TERM LIABILITIES Learning Objectives 1. Explain why long-term liabilities are of significance to users. 2. Identify the long-term liabilities that arise from transactions with lenders and explain how they are accounted for. 3. Identify the long-term liabilities that arise from transactions with other creditors and explain how they are accounted for. 4. Identify the long-term liabilities that arise from transactions with employees and explain how they are accounted for. 5. Identify the long-term liabilities that arise from differences between accounting standards and income tax regulations or law. 6. Explain what commitments and guarantees are and how they are treated. 7. Explain contingencies and how they are accounted for. 8. Calculate leverage and coverage ratios and use the information from these ratios to assess a company’s financial health.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO BT Item LO BT Item LO BT Item LO 1. 2. 3. 4. 5 6. 7.

2 2 2 2 2 2 2

C C C C C C C

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

2 2 2 2 2 2 2

1. 2 AP 2. 2 AP 3. 2 AP

4. 2 5. 2 6. 2

1. 2. 3. 4.

5. 6. 7. 8.

2 2 2 2

C C C C

2 3 3 3

Discussion Questions C 15. 2 C 22. 4 C 16. 2 C 23. 4 C 17. 3 K 24. 4 C 18. 3 C 25. 5 C 19. 3 C 26. 5 C 20. 4 K 27. 7 C 21. 4 C 28. 6 Application Problems AP 7. 2 AP 10. 2 AP 8. 2 AP 11. 2 AP 9. 2 AP 12. 3 User Perspective Problems C 9. 4 C 13. 4 C 10. 4 C 14. 6,7 C 11. 4 C 15. 5 C 12. 4 C 16. 5 Work in Process C 4. 4 C 5. 7

BT Item

LO BT

C C C C C C C

29. 30. 31.

8 6 8

C C C

AP AP AP

13. 14. 15.

8 8 8

AN AN AN

C C C C

1. 2 C 3. 3 C 6. 8 C 2. 2 C Reading and Interpreting Published Financial Statements 1. 8 AN 3. 2 C 5. 2 C 7. 8 AN 9. 7 C 2. 2 C 4. 2 C 6. 5 C 8. 6 C 10. 5,6,7,8 AN Cases 1. 2,3 C 2. 2 C 3. 3 C 4. 3 C 5. 4 C

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ10-1

A mortgage (loan) is simply a long-term debt with a capital asset— such as land with a building or piece of equipment—pledged as collateral or security for the loan. If the borrower fails to repay the loan according to the specified terms, the lender has the legal right to have the asset seized and sold, and the proceeds from the sale applied to the repayment of the outstanding debt. Mortgages are usually instalment loans. This means that payments are made periodically rather than only at the end of the loan. Also, the periodic payments are usually blended payments, consisting of both interest and principal components. LO 2 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-2

If a loan requires blended payments, it is repaid on an instalment basis and the instalment payment is made up of both interest and a partial return of principal. An instalment basis means that payments are made periodically rather than only at the end of the loan. The total amount of the payment is the same each period, but the portion of each payment that represents interest gets smaller with each payment, as the principal amount of the loan outstanding is reduced with each payment.

LO 2 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-3

Loan covenants are requirements written into a legal loan agreement that set out conditions required of the borrower, by the creditor, during the term that the loan is outstanding. Failure to comply with the covenants usually allows the creditor to call in the loan. The covenants are inserted in the agreement to protect the creditor and reduce the risk of non-collection.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-4

Covenants written into a loan agreement can be either financial or non-financial in nature. Examples of financial covenants include the requirement to maintain a current ratio of at least 1 to 1, or a debt-to-equity ratio of no greater than 50%. With financial covenants, company management is often motivated to seek accounting methods and choices that will keep the company within the limits set out in the agreement. Non-financial covenants are other requirements that do not depend on accounting measures, such as requiring interim financial statements be sent to creditor or requiring annual audit to be conducted.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-5

Loan covenants are carefully adhered to by borrowers. Failure to meet loan covenants could lead to severe consequences. A lender could call the loan should covenants not be met. Calling the loan means that the full balance of the loan becomes due and payable within an extremely short period of time. In the case of a demand on a loan, the borrower is desperate to find sources of cash to pay off the debt. Remedies could range from securing more expensive debt, issuing more shares or selling off assets to generate the necessary cash. These short-term remedies could have long lasting negative effects on future operations.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-6

Indenture agreement: A formal agreement between a borrowing entity and lender that specifies the terms of the contract. In the case of a bond offering, it specifies (among other things) the face value, the maturity date, the contract interest rate, the collateral, if any, and the covenants. Collateral: Assets that the borrower pledges to the lender in the event that the borrower defaults on the loan. Face value: The measure of denomination of a debt instrument. For example, typically a single bond has a face value of $1,000. The face value also determines the cash principal payout at maturity and is used to calculate the periodic interest payments. Contract rate: The contract rate is the rate of interest that is written into an indenture agreement. This is the interest rate the borrower agrees to pay the bond holder and it is applied to the face value of the bonds to determine the interest payment. Maturity date: The date at which borrower pays back the face value to the bondholder and the date at which the interest payments cease.

LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-7 Green bonds are issued by corporations or financial institutions with the proceeds of the issuance being used to fund green projects. These projects have to be consistent with the International Capital Market Association’s Green Bond Principles. Regular bonds would not have this restriction. Green bonds are issued at lower rates of interest than other bonds, resulting in reduced borrowing costs for the issuer. Green bonds are wellreceived by lenders in spite of the reduced interest yield because the borrower is being proactive in dealing with climate change. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-8 • • •

•

Three typical ways in which bonds differ from other loans include: Bonds are held by many creditors, whereas loans are usually held by a single creditor. Investors in bonds can sell the bonds in an active secondary market, similar to the stock exchange for equity investments, while loans are not normally bought and sold in a secondary market. Interest payments are usually made semi-annually and the principal is repaid at maturity, which is usually at the end of the term of the debt. On the other hand, loans usually pay interest on a monthly basis, and the principal payments could be blended with the interest, or made on a variety of payment dates before entire loan is repaid. In addition, bonds tend to have a much longer term to maturity (as much as 40 years) than loans (usually 1 to 5 years).

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-9

The yield rate (often referred to as the effective rate, or market rate) of interest with respect to a bond issue is the interest rate required by the buyer for investing in the debt instrument. The yield rate is affected by the rate of interest the buyer could obtain from similar instruments with similar payments, timing of payments and level of risk.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-10

The stated or nominal rate of interest on a bond is also known as the contract interest rate. The contract rate determines the amount of the semi-annual interest payments (face value x annual contract rate x 6/12). This rate is written into the indenture contract. It is not the same as the effective or yield rate of interest unless the bond is sold at par. The yield rate is the interest rate required by the buyer and it is determined by taking into account a combination of the actual interest paid/received under the bond contract and any premium or discount on the bond when making the investment. The yield rate is the return (the discount rate) that equates the amount paid for the bond with the present value of the cash receipts promised in the indenture.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-11

When a company wants to borrow money using a bond issue, it contacts an investment banker. With the help of the investment banker, the company structures the bond offering with terms that will have the most appeal to investors while still satisfying the company’s objectives. This includes setting the contract rate of interest at a rate that the investment banker thinks investors require for a bond with the risk characteristics of the company and this rate is written into the bond indenture. The investment banker then sells the bonds to its customers and when all the bonds are sold, they can then be traded on the bond market. The price the investor pays for the bond investment depends on what has happened to market rates of interest since the bond indenture and the contract rate were finalized. If market interest rates for other debt instruments with similar risk have increased, investors will be unwilling to pay face value for these bonds. They will buy the bonds, but will pay less than face or par value. In this way, the cash flows returned to the investor will represent a higher rate of return than the contract rate specified in the indenture. If market rates have fallen below the contract rate promised, the price of the bonds (which pay a higher rate) will be bid up and the investors will pay a premium to purchase these bonds. In this way, the cash flows returned to the investor will represent a lower rate of return than the contract rate. In all cases, however, the price of the bond will be equal to the present value of the future cash flows, discounted at the market/yield/effective rate when the bond is acquired. The price of the bonds in the secondary market will continue to change as market rates/yields wanted by investors change.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-12 The par value of a bond is the same as its face value and maturity value. Most individual bonds have a par value of $1,000. Bonds will be bought and sold at this par value only when the contract rate of interest promised in the indenture is the same as the yield, market or effective rate required by investors. If the yield, market, or effective rate falls below the contract rate, investors will bid up the price of the bond above $1,000 because this bond has agreed to pay a rate higher than is available elsewhere for similar instruments. The price will get bid up to a value that makes the cash flows promised by the indenture provide a yield to the investor equal to the current market rate on the cost of the bond to the investor. This bond will sell at a premium, that is, at an amount above $1,000. However, if the yield, market, or effective rate rises above the rate promised by the bond indenture, investors will pay less than $1,000 for the bond because this bond has agreed to pay a rate lower than the rate investors can achieve elsewhere. The price will be reduced to a value that makes the cash flows promised by the indenture provide a yield to the investor equal to the current market rate on the cost of the bond to the investor. This bond will sell at a discount, that is, at an amount less than $1,000. To summarize, the terms par, premium, and discount refer to whether the selling price of a bond is equal to, above, or below the face value of the bond. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-13

If bonds are issued at a discount, the cash received on issuance is less than the face value of the bonds. Because the investor pays less than par but will receive an amount equal to par or face value on maturity, the yield to the investor (and the interest cost to the issuer) is increased above the contract rate of interest promised in the indenture.

LO 2 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-14 If bonds are issued at a premium, the cash received on issuance is more than the face value of the bonds. Because the investor pays more than par but will receive only the par or face value on maturity, the yield to the investor (and the interest cost to the issuer) is below the contract rate of interest promised in the indenture. LO 2 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-15 When the interest rate required by the market (i.e. investors) is greater than the contract interest rate promised by the bond, the bond will sell for less than its face value (at a discount). Bond interest payments are fixed based upon the face value of the bond and the contract interest rate. By paying less than the face value of the bond while receiving the stated interest payment, the investors effectively earn a return that is higher than the contract interest rate stated on the bond. It is necessary to sell bonds at a discount when alternative investments with similar risk will provide a higher interest rate for investors. A discount on a bond refers to the amount by which the current market price differs from (is less than) the face value. The face value refers to the amount that will be paid on the maturity date of the bond. The current market value is the present value of the maturity payment plus the present value of the interest payments that the bond will make over its life, both discounted at the current market rate of interest. When the bond is recorded on the books of the borrower, the accountant records the present value of bond at its issuance which is equal to face value of the bond less the discount.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-15 (Continued) Since the issuing company must repay the bond’s face value on maturity, the amount in the bond (note) liability account at the maturity date must equal the face or maturity value of the bond. Therefore, the carrying amount in the bond (note) account must increase over time and be equal to the face value at the maturity date (the opposite is true for bond premiums). The periodic increase in the liability account over time is referred to as the amortization of the discount. In terms of the accounting entry to record the cash outflow and the expense related to the interest payments, the amortization of the discount results in the cash outflow for the interest payments being less than the interest expense and consequently the carrying amount of the bond (note) liability is increased. The following journal entry demonstrates this: Interest Expense Notes Payable Cash

XXXX XXXX XXXX

LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-16

Bonds will be issued at a discount whenever market/yield rates required by investors exceed the contract rate of interest promised by the bond indenture. The difference between the face or maturity value that the investors will receive at maturity and the discounted issue price the investors pay for the bonds equals the discount amount. This represents an additional cost of borrowing to the issuing company and a bonus or additional return to the investors. When the discount amount and the contract interest payments are added together, the company’s interest cost, and the investors’ return on the bond investment are equal to the higher market/yield rate when the bond was issued. Therefore, the effect of issuing bonds at a discount is to increase the interest expense recognized by issuing company above contract rate of interest. In the accounts, the effect is recognized as the discount is amortized whenever interest is paid or payable: Interest Expense XXX Cash or Interest Payable Notes Payable

XXX XXX

The discount is amortized by increasing the note liability account over the term of the bond, from its discounted amount at issuance to its par value at maturity, as seen in the above entry. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-17 Companies may lease capital assets rather than purchase them outright for a number of reasons: • Company does not have sufficient cash for outright purchase, or the cash it does have is required for other purposes • The company may have reached its borrowing limits and therefore, cannot borrow the cash that would be required to purchase the asset • Some assets, such as technology assets, become obsolete after a relatively short time. Rather than purchase this type of asset and then have to deal with its subsequent disposal and replacement, it may be more effective for the company to lease the assets and have the lessor replace them on a periodic basis. • Some assets, such as buildings or parts of buildings may be required for only a small portion of the asset’s useful life. In this case, it may be more cost effective to lease asset for the period the asset is needed. LO 3 BT: K Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-18 Virtually all the leases entered into by public companies result in a right-of-use asset and a lease liability being recorded. Accounting for a lease is identical to accounting for borrowing of funds on a long-term basis and using the proceeds to acquire the capital asset. The asset is recognized as a right-of-use asset and the longterm obligation to make lease payments is recognized as a longterm lease liability. The right-of-use asset is then depreciated, and the lease payments typically involve blended payments for the interest expense and the reduction of principal of the lease liability. The statement of financial position reports the right-of-use asset, net of accumulated depreciation within the PP&E section; and the lease liability outstanding is split between its current portion (in current liabilities) and long-term portion (in long-term liabilities). Interest expense and depreciation expense are reported on the statement of income. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-19 If the low-value lease exemption is used (which is for leases of assets with a value of $5,000 US or less when new), the lease payments can be treated as rent expense in the period they are incurred. With the low-value lease exemption, there is nothing reported on the statement of financial position related to the lease. This differs from the normal lease treatment of setting up a rightof-use asset and lease liability. This supports the cost constraint from the conceptual framework, where the cost of capturing and reporting financial information exceeds the benefits of reporting it. LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-20 Defined contribution pension plans are plans in which the employer agrees to contribute a prescribed amount each period to the retirement fund of the employee. There is no guarantee by the employer as to the level of the benefits that the employee will receive upon retirement. The benefits depend on the investment success of the pension fund itself. Therefore, the employee bears the risk of inadequate pension assets on retirement. A defined benefit plan, on the other hand, is one in which the employer agrees to provide a prescribed amount of benefits upon retirement. The benefits are usually determined using a benefit formula that incorporates the number of years of service of the employee and some measure of the amount of salary earned. If the assets in the fund are not sufficient to pay the prescribed benefits when employees retire, the employer is required to make up any deficiency. The employer bears the risk in this type of plan. LO 4 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-21 A hybrid pension plan differs from a defined benefit pension plan in that the employer and the employee share the risk of inadequate pension fund assets. Under a hybrid plan, either the targeted benefits could be reduced, or both the employer and employee together would be responsible for making up a pension deficiency. LO 4 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-22 There are benefits to both defined benefit plans and defined contribution plans. Under a defined benefit plan, the employee can better plan for retirement as it is easier to determine how much pension income s/he will receive, the pension is payable for life, the retiree does not have to worry about using up all the pension assets during the retirement period, and the employer takes on the risk if there are economic downturns in the future. On the other hand, if the economy is strong, the assets in an employee’s defined contribution account can grow to provide a larger pension than would have been provided under a defined benefit plan (although there is an offsetting downside risk that the opposite will happen). Individual employees have more control over how their pension assets are invested. However, investments managed by individuals rarely do as well as those in a defined benefit plan. When a retiree dies, the assets remaining in the defined contribution pension plan funds can be passed down to the heirs of the retiree’s estate. Under a defined benefit plan, the pension stops on the death of the retiree (with provision for some continuance to a spouse, perhaps) and no assets are returned to the retiree’s estate if the retiree dies after the guaranteed period has expired. Therefore, if the employee expects to have a long life, a defined benefit plan is probably preferred, whereas if a short life is expected, a defined contribution plan might be preferred. A hybrid plan has the benefit of the employees and employer working together to address any pension deficiency rather than simply leaving it as is (which would be the case with a defined contribution plan). These plans are more of a shared risk model.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-22 (Continued) My thinking would likely change somewhat if I was considering this from the perspective of an employer. A defined contribution plan would likely be my preferred choice as the company’s obligations are satisfied when the contributions to the plan are made. Once these contributions have been made, there are no ongoing obligations if the returns in the plan are poor. LO 4 BT: C Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-23 Vesting is important to an employee because it means that the employee is entitled to the pension benefits promised (under a defined benefit plan) or to the employer’s contributions made into the plan for the employee (under a defined contribution plan) even if the employee leaves the company. Pension plans represent an obligation of the company to provide retirement benefits in the future to its employees. When a pension plan is fully funded, it means that the assets held in the pension fund equal the present value of the company’s obligation at the reporting date for those future benefits. Funding provides a measure of safety for the employee. If the employer company experiences financial difficulties and it has an underfunded plan the employer may not be able to meet its obligations in relation to the plan. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-24 While the employer’s contribution to the pension fund, and thus the amount of the expense, are known directly for defined contribution plans, the measurements associated with a defined benefit plan are much more difficult. This is because the company must estimate its present obligation for benefits that will be paid far into the future to determine its current pension expense. This is done through a complex calculation using such variables as the employees’ length of service, best salary years, amount of salary earned in those years, turnover rates, and so on. Two of the most difficult variables to estimate are the long-run rate of return expected to be earned on the pension assets and the discount rate in determining the present value of these pension obligations. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-25 Deferred income taxes arise because income tax expense on the statement of income is based on the accounting income determined according to accounting standards, while the income taxes payable to the government (i.e. income taxes payable reported on the statement of financial position) are based on taxable income determined under the Income Tax Act and its regulations. A company may deduct an expense in the current period (e.g., warranty expense on an assurance-type warranty) when the related sale is made, but this amount is not deductible for tax purposes until a future period when the actual warranty expenditures are made. In the future, when the expenditures are made, the company can reduce its taxes owing by the amount of tax on the actual warranty expenditures. Therefore, there is a tax benefit associated with the warranty expenditures that won’t be realized until a future period – the tax effect related to recognizing warranty expense now is deferred until the future. This is reported as a deferred (or future) income tax asset on statement of financial position.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-25 (Continued) Alternatively, a company may have deducted more capital cost allowance (CCA) for tax purposes than depreciation expense on its statement of income. This gives rise to a temporary difference between the income tax expense reported and the income tax payable reported. In effect, in the future when the company deducts more depreciation expense than CCA, the company will increase its taxable income and pay more income tax to the government than it recognizes as expense on the statement of income. In effect, it is deferring the tax liability to a future year. This is reported as a deferred (or future) income tax liability on the current statement of financial position. Deferred income tax assets and liabilities, therefore, represent the future income tax effects of the company’s temporary differences between its past incomes reported under accounting standards (i.e. IFRS or ASPE) and taxable incomes reported under Income Tax Act. LO 5 BT: C Difficulty: H Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-26 Deferred income taxes are not amounts currently owing to the government. Any taxes owing to the government would be presented as income taxes payable on the statement of financial position. Deferred income taxes can meet the definition of a liability if it is probable that differences between accounting and tax treatment for certain items (i.e. depreciation versus CCA or the treatment of warranties) will result in net income for tax purposes being higher than net income for accounting purposes in future periods. This will result in income taxes payable (determined using net income for tax purposes) being higher than income tax expense (determined using net income for accounting purposes). There will be a future outflow of economic benefits which can be measured reliably and results from actions already taken, thus the definition of a liability is met. It should be noted that deferred income taxes can also be an asset if net income for accounting purposes will be higher than net income for tax purposes in the future. LO 5 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-27 Uncertainty is what distinguishes a contingent liability (which is not recognized in the accounts) from a liability (which is recognized on the statement of financial position). This uncertainty may be in relation to whether an obligation exists, or it may be uncertainty with respect to the measurement of the obligation. A contingent liability is something that may become an actual obligation (i.e. liability) in the future, depending upon some future event (i.e. a court decision). It is not a present obligation at the reporting date. Therefore, it is not reported on the statement of financial position as a liability. Similarly, if the amount of the obligation cannot be reliably measured, no liability can be recorded. Contingent liabilities become recognized liabilities and expenses when it is probable, at the reporting date, that there will be a future sacrifice of economic benefits and when the amount can be reasonably measured. Accounting standards require companies to disclose information about contingent liabilities in the notes to their financial statements. LO 7 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-28 A financial statement user would be interested in reviewing a company’s contractual commitment note because it contains information about significant transactions the entity has committed itself to in the future. These could be contracts to purchase certain quantities of raw materials at specified fixed prices, contracts for significant capital acquisitions, etc. These contracts usually commit the company to spending large amounts of cash in the future. This information would be important to any financial user interested in the future cash flows of the company. LO 6 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-29 The debt to equity ratio provides a measure of the relationship between a company’s debt financing and equity financing, or the proportion of a company’s assets that are financed by creditors (debt) rather than by owners (equity). Too high a proportion is risky for an entity as it might not be able to meet its interest and principal payments as they come due. Too small a proportion means that the owners are not making effective use of leverage – the ability to increase returns for shareholders by earning a higher return on debt-sourced funds than must be paid out as interest on borrowed funds. The interest coverage ratio measures a company’s ability to meet its interest payment from operating income. This ratio is also a risk-related measure, because if the company barely earns enough income to cover its interest charges, it runs the risk of not being able to meet this important commitment and underlying assets securing the debt could be seized by the creditors. The higher is the ratio, the lower the risk. LO 8 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ10-30 From the perspective of the investor, a higher degree of leverage is preferable than a lower one. This is because it would mean that the company is using the capital of others (creditors) to generate higher returns for the investors. There is a point where investors would consider a company to be over-leveraged, resulting in a higher risk of the company defaulting on its debt obligations and being forced into bankruptcy. LO 8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ10-31 A loan covenant that stipulates a maximum debt to equity ratio would be required by a lender to ensure that a company remains solvent during the loan period. Solvency is important to the lender who requires assurance that the principal and interest in the loan will be paid on time by the borrower. Failure by the borrower to maintain the stipulated a maximum debt to equity ratio can result in the lender calling the loan before the solvency of the borrower gets any worse. LO 8 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP10-1A a. The interest expense decreases each month because the monthly payment includes a payment on the principal as well as interest. Therefore, the outstanding balance of the loan is reduced with each payment so the interest portion of the next payment reduces. Interest expense is calculated as the carrying amount (outstanding principal balance) times the interest rate for the loan. Since the carrying amount of the loan decreases with each blended payment, the interest expense portion of each payment also decreases, while the principal portion of each payment increases. b. Oct. 1

Oct. 31

Nov. 30

Cash Mortgage Payable

1,000,000 1,000,000

Interest Expense Mortgage Payable Cash

5,000 14,333

Interest Expense Mortgage Payable Cash

4,928 14,405

19,333

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-2A a. 1) Amount is given = $10,956 Payment = Interest + Principal = $3,750 + $7,206 = $10,956 2) Ending Mortgage Balance = $750,000 - $7,206 = $742,794 3) Ending Mortgage Balance = Beginning Mortgage Balance = $742,794 4) Principal = $10,956 - $3,714 = $7,242 5) Interest = $735,552 x 6% x 1/12 = $3,678 6) Ending Mortgage Balance = $735,552 - $7,278 = $728,274 7) Beginning Mortgage Balance = Ending Mortgage Balance (previous payment) = $728,274 8) Principal = $10,956 - $3,641 = $7,315

b. Inception of the mortgage: Cash

750,000 Mortgage Payable

750,000

Payment 1: Interest Expense Mortgage Payable Cash

3,750 7,206 10,956

Payment 2: Interest Expense Mortgage Payable Cash

3,714 7,242 10,956

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-3A a. Face value of the bonds issued: $80,000,000 Interest payments= $80,000,000 x 10% x 6/12 = $4,000,000 Given the bonds were issued at par, the Oct 1, 2024 entry: Cash 80,000,000 Notes Payable 80,000,000 b. On December 31, 2024, Deleau’s year end, it is necessary to accrue interest expense for the three months since bonds were issued, even though it does not coincide with an interest payment date. As of December 31, there is an obligation (liability) related to three months interest. The liability for interest and interest expense both accrue with the passage of time. The interest payable and the interest expense for October, November and December must be recorded for inclusion in year-end financial statements. Interest expense and interest payable at December 31, 2024 for October, November and December 2024: $80,000,000 x 10% x 3/12 = $2,000,000 Note that amount payable and expense are the same in this case because bonds were issued at par or face value. Journal entry on December 31, 2024: Interest Expense 2,000,000 Interest Payable 2,000,000 March 31, 2025 entry: Interest expense for the first six months: $80,000,000 x 10% x 6/12 = Less amount recognized in 2024 Expense for Jan. 1 – March 31 Interest Expense Interest Payable Cash

$4,000,000 2,000,000 $2,000,000

2,000,000 2,000,000 4,000,000

Interest entry, September 30, 2025: Interest Expense Cash

4,000,000 4,000,000

LO 2 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-4A a.

Investors were not willing to pay $50 million for the bonds for one of two reasons. The risks associated with Spring Water Company Ltd. may have increased since the terms of the bond indenture were fixed, so that the investors required a higher yield on their investment than the contract rate written into the bond indenture. Alternatively, the risk associated with Spring Water Company might be unchanged, but the yield rate demanded in the general economy for an investment of the same risk might have increased, so that the alternative investments to the company bond were providing a higher yield. In either case, the yield required ended up being 5% when the bonds were issued and this exceeded the contract interest rate offered on the bonds (4.5%). Consequently, the bonds sold at less than their par or face value, and the company was not able to raise the $50 million that it had hoped for.

Journal entry for issuance: Cash

48,050,000 Notes Payable

48,050,000

Calculations for interest expense in 2025: Interest payments: $50,000,000 x 4.5% x 6/12 = $1,125,000 Interest expense on June 30, 2025: $48,050,000 x 5% x 6/12 = $1,201,250 Discount amortized, June 30, 2025: $1,201,250 - $1,125,000 = $76,250 Interest expense on Dec. 31, 2025: ($48,050,000 + $76,250) x 5.0% X 6/12 = $1,203,156 Discount amortized, Dec. 31, 2025: $1,203,156 - $1,125,000 = $78,156

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-4A (Continued) Total interest expense for Year 1 = $1,201,250 + $1,203,156 = $2,404,406 June 30 Interest Expense Cash Notes Payable December 31 Interest Expense Cash Notes Payable d.

1,201,250 1,125,000 76,250

1,203,156 1,125,000 78,156

The amount reported for the bond (notes) payable at December 31, 2025 = $48,050,000 + $76,250 + $78,156 = $48,204,406. LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP10-5A a.

The proceeds on the issuance of the bonds = $300,000,000 X .94848 = $284,544,000 Journal entry for the issuance of the bonds (notes): Cash

284,544,000 Notes Payable

284,544,000

Investors will want to pay less than the face value for the bonds because the bond’s contract interest rate is lower than the market rate (the return they would receive had they chosen the next best investment). The bond price gets bid down in this situation until the yield to the investor equals the higher market rate.

The bond notes were issued at a discount (since the bond contract or stated rate is lower than the market or yield rate). Thus, the initial carrying amount of the bonds is lower than the face value of the bonds. The carrying value will increase over the period to maturity as the discount is amortized until the carrying value is equal to the face value of the bonds. This will occur at maturity.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-5A (Continued) d.

Interest entry for the first interest payment: Interest Expense1 Notes Payable Cash2

6,404,240 404,240 6,000,000

Interest Expense = Carrying Value x Yield Rate x Time = $284,544,000 x 4.5% x 6/12 = $6,404,240 2 Cash paid = Face Value x Contract Rate x Time = $300,000,000 X 4.0% x 6/12 = $6,000,000 Interest entry for the second interest payment: Interest Expense 2 Notes Payable Cash 2

6,411,290 411,290 6,000,000

Interest Expense = Carrying Value x Yield Rate x Time = ($284,544,000 + $402,240) x 4.5% x 6/12 = $6,411,290

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-6A a.

Journal entry for the issuance of the bonds (notes): Cash Notes Payable

57,069,000 57,069,000

The face value of the bonds: Issue price $57,069,000 / 1.2682 = $45,000,000 Investors are willing to pay more than the face value for the bonds because the bond’s contract interest rate is higher than the market rate (the return they would receive had they chosen the next best investment). The bond price gets bid up in this situation until the yield to the investor equals the lower market rate.

Interest entry for the first interest payment: Interest Expense1 Notes Payable Cash2

1,712,070 312,930 2,025,000

Interest Expense = Carrying Value x Yield Rate x Time = $57,069,000 x 6% x 6/12 = $1,712,070 2 Cash paid = Face Value x Contract Rate x Time = $45,000,000 X 9% x 6/12 = $2,025,000 Interest entry for the second interest payment: Interest Expense3 Notes Payable Cash 3

1,702,682 322,318 2,025,000

Interest Expense = Carrying Value x Yield Rate x Time = ($57,069,000 - $312,930) x 6% x 6/12 = $1,702,682

The carrying value of the bond will decrease over time. The bond was issued over face value. However, when the bond matures, the bond carrying value needs to be the face value (what will be paid back to the investor), so the carrying value will decrease over time.

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-7A a.

The proceeds on the issuance of the bonds = $80,000,000 X 0.978 = $78,240,000 Journal entry for the issuance of the bonds (notes): Cash Notes Payable

78,240,000 78,240,000

b. Interest entry for the first interest payment: Interest Expense1 Notes Payable Cash2

1,956,000 156,000 1,800,000

Interest Expense = Carrying Value x Yield Rate x Time = $78,240,000 x 5% x 6/12 = $1,956,000 2 Cash paid = Face Value x Contract Rate x Time = $80,000,000 X 4.5% x 6/12 = $1,800,000 Interest entry for the second interest payment: Interest Expense3 Notes Payable Cash 3

1,959,900 159,900 1,800,000

Interest Expense = Carrying Value x Yield Rate x Time = ($78,240,000 + $156,000) x 5% x 6/12 = $1,959,900

c. At December 31st of the first year, the statement of financial position will report notes payable as long-term liabilities of: $78,240,000 + $156,000 + $159,900 = $78,555,900 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-8A a.

The proceeds on the issuance of the bonds = $118,112,500 (given in the question) The bonds were issued at 94.4900 ($118,112,500 ÷ $125,000,000) Journal entry for the issuance of the bonds (notes): Cash Notes Payable

118,112,500 118,112,500

b. Interest entry for the first interest payment: Interest Expense1 Notes Payable Cash2

7,677,313 177,313 7,500,000

Interest Expense = Carrying Value x Yield Rate x Time = $118,112,500 x 13% x 6/12 = $7,677,313 2 Cash paid = Face Value x Contract Rate x Time = $125,000,000 X 12% x 6/12 = $7,500,000 Interest entry for the second interest payment: Interest Expense3 Notes Payable Cash 3

7,688,838 188,838 7,500,000

Interest Expense = Carrying Value x Yield Rate x Time = ($118,112,500 + $177,313) x 13% x 6/12 = $7,688,838

c. At December 31st of the first year, the statement of financial position will report notes payable as long-term liabilities of: $118,112,500 + ($177,313 * 5/6) = $118,260,261 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-9A a. The cash proceeds on the issuance of the bonds

= $120,000,000 X 1.0399 = $124,788,000 b. Journal entry for the issuance of the bonds (notes) on August 1, 2024:

Cash Notes Payable c.

124,788,000 124,788,000

Interest entry for the interest payment on January 31, 2025: Interest Expense1 Notes Payable Cash2

2,807,730 192,270 3,000,000

Interest Expense = Carrying Value x Yield Rate x Time = $124,788,000 x 4.5% x 6/12 = $2,807,730 2 Cash paid = Face Value x Contract Rate x Time = $120,000,000 X 5.0% x 6/12 = $3,000,000 Interest entry for the interest payment on July 31, 2025: Interest Expense3 Notes Payable Cash 3

2,803,404 196,596 3,000,000

Interest Expense = Carrying Value x Yield Rate x Time = ($124,788,000 - $192,270) x 4.5% x 6/12 = $2,803,404

At July 31, 2025, the statement of financial position will report bonds payable as long-term liabilities of: $124,788,000 - $192,270 - $196,596 = $124,399,134 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-10A a.

Amount of cash received: i. At 5.0%, the market or yield rate equals the bond contract rate. Therefore, the full-face value ($250,000,000) will be received. ii. At 4.5%, issued at 105.43 (or 105.43% of face value): Cash received = $250,000,000 X 1.0543 = $263,575,000 iii. At 5.5%, issued at 94.915 (or 94.915% of face value): Cash received = $250,000,000 X .94915 = $237,287,500

i. Cash

250,000,000 Notes Payable

250,000,000

Cash interest paid quarterly: $250,000,000 X 5% X 3/12 = $3,125,000 First interest: Interest Expense Cash

3,125,000

Second interest: Interest Expense Cash

3,125,000

ii. Cash Notes Payable First interest: Interest Expense1 Notes Payable Cash 1

3,125,000

3,125,000 263,575,000 263,575,000 2,965,219 159,781

Interest expense: $263,575,000 x 4.5% x 3/12 = $2,965,219

3,125,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-10A (Continued) b. ii (Continued) Second interest: Interest Expense2 Notes Payable Cash

2,963,421 161,579 3,125,000

Interest expense: ($263,575,000 - $159,781) x 4.5% x 3/12 = $2,963,421 iii. Cash Notes Payable First interest: Interest Expense 3 Cash Notes Payable

237,287,500 237,287,500 3,262,703 3,125,000 137,703

Interest expense: 3 $237,287,500 x 5.5% x 3/12 = $3,262,703 Second interest: Interest Expense 4 Cash Notes Payable

3,264,597 3,125,000 139,597

Interest expense: ($237,287,500 + $137,703) x 5.5% x 3/12 = $3,264,597 LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-11A a.

Cash received on issuance of bonds at 89.322 or 89.322% of face value: = $75,000,000 x 0.89322 = $66,991,500 Cash Notes Payable

66,991,500 66,991,500

Interest paid each payment: $75,000,000 x 6% x 6/12 = $2,250,000 First interest: Interest Expense1 Cash Notes Payable

2,344,703 2,250,000 94,703

Interest expense: $66,991,500 x 7% x 6/12 = $2,344,703 Second interest: Interest Expense2 Cash Notes Payable

2,348,017 2,250,000 98,017

Interest expense: ($66,991,500 + $94,703) x 7% x 6/12 = $2,348,017 The carrying value on the bonds one year after issuance, just after the second semi-annual interest payment is: $66,991,500 + $94,703 + $98,017 = $67,184,220 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-12A a.

Bountee’s statement of financial position would include a right-of-use leased capital asset and a corresponding lease liability. The right-ofuse asset would be initially recorded at $537,800 (the present value of the lease payments under the lease) and a lease liability would be recorded in the same amount. The right-of-use asset would be depreciated, so its carrying value at the end of January would be: $533,318 [$537,800 – ($537,800/10 years / 12 months = $4,482)]. The lease liability at the end of January would be: The lease liability January 1, 2024 $537,800 Monthly repayment January 2024: Total monthly payment amount $6,525 Less interest ($537,800 x 8% x 1/12) 3,585 Principal repayment $2,940 (2,940) The lease liability at the end of January $534,860

Bountee’s statement of income for the one month ended January 31, 2024 would show: Depreciation expense $4,482 Interest expense 3,585 LO 3 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-13A a. Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$675 – $75 = 1.20:1 $500 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$675 - $75 $500 + $675 - $75

= 55% or 0.55:1

b. If Ingenuity acquires SkyEye their debt would increase by $175 million, the updated ratios are: Debt to Equity = $675 + $175 - $501 $500

= 1.6:1

($75 less $25 which is the difference between the acquisition price of $200 and the financed amount of $175) Ingenuity would exceed the 1.50:1 ratio set by the lender. Net Debt as a Percentage of Total Capitalization = $675 + $175 - $75 $500+ $675 + $175 - $75 = 61% or 0.61:1 Ingenuity would not exceed the 0.8:1 ratio set by the lender. Ingenuity cannot acquire Sky Eye with a new debt issue of $175,000,000 and remain in compliance with its existing debt covenants. LO 8 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-14A a. 2024 Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$500,000 + $200,000 + $50,000 – $245,000 = 0.36:1 $1,400,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$500,000 + $200,000 + $50,000 - $245,000 = 0.27:1 $1,400,000 + $500,000 + $200,000 + $50,000 - $245,000

2023 Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$800,000 + $275,000 + $60,000 – $260,000 = 0.69:1 $1,275,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$800,000 + $275,000 + $60,000 - $260,000 = 0.41:1 $1,275,000 + $800,000 + $275,000 + $60,000 - $260,000

b. In 2024 the debt to equity ratio has improved significantly from the perspective of potential purchasers of the company’s bonds. The ratio has reduced to 0.36:1 from 0.69:1. The net debt as a percentage of total capitalization has also improved to 0.27:1 from 0.41:1. LO 8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-15A a. Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$50,000 – $20,000 = 0.33:1 $90,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$50,000 - $20,000 $90,000 + $50,000 - $20,000

= 0.25:1

If Taube borrows $35 Million, the updated ratios would be: Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity = $50,000 + $35,000 – $20,000 = 0.72:1 $90,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$50,000 + $35,000 - $20,000 $90,000 + $50,000 +$35,000 - $20,000

= 0.42:1

c. If Taube issues $35 million in bonds at 90.61, they would receive $31,713,500. As a result, they would need to use $3,286,500 ($35,000,000 - $31,713,500) of their $20 million in cash balance to fund the balance of the equipment purchase. This would result in the company having a cash balance of $16,713,500 ($20,000,000 $3,286,500). Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$50,000 + $31,713.5 – $16,713.5 = 0.72:1 $90,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-15A (Continued) Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$50,000 + $31,713.5 - $16,713.5 $90,000 + $50,000 +$31,713.5 - $16,713.5

= 0.42:1

d. The bonds would be a better option as they would have a lower interest rate (8%) than the bank loan (10%). They would have to pay less interest over the six-year life of the debt. However, the company would not receive the entire $35 million (as the bonds were issued at a discount) and there would be additional costs incurred to issue bonds instead of borrowing from the bank. The company would also have to use $3,286,500 of its cash to fund the balance of the equipment purchase. LO 8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-1B a.

Interest expense decreases each month because the monthly payment includes a payment on the principal as well as interest. Therefore, the outstanding balance of the loan is reduced with each payment and so the interest portion on the next payment reduces. Interest expense is calculated as the carrying amount (outstanding principal balance) times the interest rate for the loan. Since the carrying amount of the loan decreases with each blended payment, the interest expense portion of each fixed dollar payment also decreases, and principal portion of each payment increases.

b. May 1

May 31

Jun. 30

Cash Mortgage Payable

800,000

Interest Expense Mortgage Payable Cash

3,333 15,090

Interest Expense Mortgage Payable Cash

3,270 15,153

800,000

18,423

LO 2 BT: AP Difficulty: S Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-2B a. (1) Amount is given Payment = Interest + Principal = $1,667 + $6,156 = $7,823 (2) Interest = $493,844 x 4% x 1/12 = $1,646 (3) Principal = $7,823 - $1,646 = $6,177 (4) Ending Mortgage Balance = $487,667 – $6,197 = $481,470 (5) Opening Mortgage Balance = (4) = $481,470 (6) Interest = $481,470 x 4% x 1/12 = $1,605 b. Inception of the mortgage: Cash

500,000 Mortgage Payable

500,000

Payment 1: Interest Expense Mortgage Payable Cash

1,667 6,156 7,823

Payment 2: Interest Expense Mortgage Payable Cash c. Final Payment (72): Interest Expense1 Mortgage Payable Cash 1 ($7,823 - $7,797)

1,646 6,177 7,823

26 7,797 7,823

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-3B a. The cash received on issuance was equal to the face value of the bonds issued ($100,000,000) as the bond was issued at par. The yield is 6%. Interest payments= $100,000,000 x 6% x 6/12 = $3,000,000 b.

Given the bonds were issued at par, the May 1, 2024 entry: Cash 100,000,000 Notes Payable 100,000,000 Journal entry on October 31, 2024 Interest expense 3,000,000 Cash 3,000,000 On December 31, 2024, Morneau’s year end, it is necessary to accrue interest expense for two months since the last interest payment. As of December 31, an obligation (liability) exists related to two months interest. The liability for interest and interest expense both accrue with the passage of time. The interest payable and the interest expense for November and December must be recorded and reported on the yearend financial statements. Interest expense and interest payable at December 31, 2024 for November and December 2024: $100,000,000 x 6% x 2/12 = $1,000,000 Note that amount payable and expense are the same in this case because bonds were issued at par or face value. Journal entry on December 31, 2024: Interest Expense 1,000,000 Interest Payable 1,000,000 April 30, 2025 entry: Interest expense for second period of six months: $100,000,000 x 6% x 6/12 = $3,000,000 Less amount recognized in 2024 1,000,000 Expense for Jan. 1 – April 30 $2,000,000 Interest Expense Interest Payable Cash

2,000,000 1,000,000 3,000,000

LO 2 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM:

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-4B a. Investors were not willing to pay $150 million for the bonds for one of two reasons. The risks associated with Volta Desalination Ltd. may have increased since the terms of the bond indenture were fixed, so that the investors required a higher yield on their investment than the contract rate written into the bond indenture of 3% (calculated using the interest payment amount of $2,250,000 ÷ the face amount of the bonds $150,000,000 x 2 = 1.5% x 2 = 3% annual interest rate). Alternatively, the risk associated with Volta Desalination might be unchanged, but the yield rate demanded in the general economy for an investment of the same risk might have increased, so that the alternative investments to the company bond were providing a higher yield. In either case, the yield required ended up being 3.54% when the bonds were issued and this exceeded the contract interest rate offered on the bonds of 3%. Consequently, the bonds sold at less than their par or face value, and the company was not able to raise the $150 million that it had hoped for and did not raise enough funds for the construction of their water desalination facility. b.

Journal entry for issuance: Cash Notes Payable

141,600,000 141,600,000

Calculations for interest expense in 2025: Interest payments: $150,000,000 x 3% x 6/12 = $2,250,000 Interest expense on March 31, 2025: $141,600,000 x 3.54% x 6/12 = $2,506,320 Discount amortized, March 31, 2025: $2,506,320 - $2,250,000 = $256,320 Interest expense on September 30, 2025: ($141,600,000 + $256,320) x 3.54% X 6/12 = $2,510,857 Discount amortized, Sept 30, 2025: $2,510,857 - $2,250,000 = $260,857

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-4B (Continued) March 31 Interest Expense Cash Notes Payable September 30 Interest Expense Cash Notes Payable d.

2,506,320 2,250,000 256,320

2,510,857 2,250,000 260,857

The amount reported for the bond (notes) payable at December 31, 2024 = $141,600,000 + 128,160* = $141,728,160.

*December 31 is 3 months from issue. The first interest expense payment Oct 1 to March 31 is $2,506,320 so from Oct 1 to Dec 31 is 3 months or half of the first interest payment: $2,506,320 / 2 = $1,253,160. The interest payable would also be half the interest payment $2,250,000/2 = $1,125,000. The discount amortization for the 3 months is $1,253,160 - $1,125,000 = $128,160. LO 2 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-5B a. Date

Interest Payment (5%)

Interest Expense (4.45%)

Issuance Payment 1 $1,750,000 $1,650,950 Payment 2 1,750,000 1,648,746 Payment 3 1,750,000 1,646,493 Payment 4 1,750,000 1,644,190

Amortization of Bond Premium

$99,050 101,254 103,507 105,810

Balance of Bond Premium

Carrying Value of the Bond

$4,200,000 4,100,950 3,999,696 3,896,189 3,790,379

$74,200,000 74,100,950 73,999,696 73,896,189 73,790,379

b. Investors are willing to pay more than the face value for the bonds because the bond’s contract interest rate is higher than the market rate (the return they would receive had they chosen the next best investment). The bond price gets bid up in this situation until the yield to the investor equals the lower market rate. The bond notes were issued at a premium (since the bond contract or stated rate is higher than the market or yield rate). Thus, the initial carrying amount of the bonds is higher than the face value of the bonds. The carrying value will decrease over the period to maturity as the premium is amortized, until the carrying value is equal to the face value of the bonds. This will occur at maturity. c. The carrying value of the bonds at the end of payment 4 is $73,790,379. d. Interest entry for the fourth interest payment: Interest Expense Notes Payable Cash

1,644,190 105,810 1,750,000

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-6B a.

Journal entry for the issuance of the bonds (notes): Cash Notes Payable

102,393,000 102,393,000

The face value of the bonds: Issue price $102,393,000 / 1.1377 = $90,000,000

The bonds have been issued at a premium. Investors are willing to pay more than the face value for the bonds because the bond’s contract interest rate is higher than the market rate (the return they would receive had they chosen the next best investment). The bond price gets bid up in this situation until the yield to the investor equals the lower market rate. The carrying value of the bond will decrease over time. The bond was issued over face value. However, when the bond matures, the bond carrying value needs equal the face value (what will be paid back to the investor), so the carrying value will decrease over time.

Interest entry for the first interest payment: Interest Expense1 Notes Payable Cash2

3,629,832 195,168 3,825,000

Interest Expense = Carrying Value x Yield Rate x Time = $102,393,000 x 7.09% x 6/12 = $3,629,832 2 Cash paid = Face Value x Contract Rate x Time = $90,000,000 X 8.5% x 6/12 = $3,825,000 Interest entry for the second interest payment: Interest Expense3 Notes Payable Cash 3

3,622,913 202,087 3,825,000

Interest Expense = Carrying Value x Yield Rate x Time = ($102,393,000 - $195,168) x 7.09% x 6/12 = $3,622,913

LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-7B a.

(1) Issue date May 1, 2024 Carrying of bonds = $100,000,000 x 0.955 = $95,500,000 (2) October 31, 2024 Interest payment = $100,000,000 x 10.2% x 6/12 = $5,100,000 (3) April 30, 2025 Interest expense = $95,533,125 x 10.75% x 6/12 = $5,134,905 (4) Oct. 31, 2025 Amortization of bond discount ($5,100,000 - $5,136,782 = $36,782) (5) Carrying value April 30,2026 after interest payment ($95,604,812 + $38,759) = $95,643,571

Interest entry October 31, 2025: Interest Expense Notes Payable Cash

5,136,782 36,782 5,100,000

At December 31st 2025, the statement of financial position will report notes payable as long-term liabilities of $95,604,812 +($38,759 * 2/6) = $95,617,732. LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-8B a.

The face value of the bonds = $197,000,000 carrying value + $3,000,0000 discount = $200,000,000 Journal entry October 1, for the issuance of the bonds (notes): Cash Notes Payable

197,000,000 197,000,000

Interest entry for December 31 accrual: Interest Expense1 Notes Payable Interest Payable2

7,564,800 64,800 7,500,000

Interest Expense = Carrying Value x Yield Rate x Time = $197,000,000 x 15.36% x 3/12 = $7,564,800 2 Interest payable = Face Value x Contract Rate x Time = $200,000,000 X 15% x 3/12 = $7,500,000

At December 31st of the first year, the statement of financial position will report notes payable as long-term liabilities of: $197,000,000 + $64,800 = $197,064,800 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-9B a.

The cash proceeds on the issuance of the bonds = $150,000,000 X 1.0697 = $160,455,000 The yield is $9,675,437/$160,455,000 = 6.03% x 2 = 12.06% Journal entry for the issuance of the bonds (notes) on November 1, 2024:

b. Cash Notes Payable

160,455,000 160,455,000

c. Interest entry for the interest payment on April 30, 2025: Interest Expense1 Notes Payable Cash2

9,675,437 74,563 9,750,000

Interest Expense = Carrying Value x Yield Rate x Time = $160,455,000 x 12.06% x 6/12 = $9,675,437 (also given) 2 Cash paid = Face Value x Contract Rate x Time = $150,000,000 X 13% x 6/12 = $9,750,000 d.

At October 31, 2025, the statement of financial position will report bonds payable as long-term liabilities of: $160,455,000 - $74,563 - $79,060* = $160,301,377 *($160,455,000 – $74,563) x 12.06% x 6/12 = $9,670,940 $9,750,000 - $9,670,940 = $79,060 LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-10B a. Amount of cash received: i. At 7%, the market or yield rate equals the bond contract rate. Therefore, the full face value ($200,000,000) will be received. ii. Issued at 95.542 (or 95.542% of face value): Cash received = $200,000,000 X 0.95542 = $191,084,000 iii. Issued with a $9,500,000 premium Cash received = $200,000,000 + $9,500,000 = $209,500,000 b.

i. Cash

200,000,000 Notes Payable

ii. Cash

100,000,000 191,084,000

Notes Payable iii. Cash

191,084,000 209,500,000

Notes Payable c.

209,500,000

i. Cash interest paid semi-annually: $200,000,000 X 7% X 6/12 = $7,000,000 First interest payment (June 30, 2024): Interest Expense 7,000,000 Cash 7,000,000 ii. First interest payment (June 30, 2024): Interest Expense 7,165,650 Cash 7,000,000 Notes Payable 165,650 iii. First interest payment (June 30, 2024): Interest Expense 6,808,750 Notes Payable 191,250 Cash 7,000,000 LO 2 BT: AP Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-11B a. Date

Interest Expense (6%)2

Amortization of Discount

Issuance Payment 1 $1,700,000 $2,229,695 Payment 2 1,700,000 2,245,585

$529,695 545,585

1 2

Interest Payment (4%)1

Balance of Bond Discount $10,676,850 10,147,155 9,601,570

Carrying Value of Bonds $74,323,150 74,852,845 75,398,430

($85,000,000 x 4% x 6/12) = $1,700,000 ($74,323,150 x 6% x 6/12) = $2,229,695 ($74,852,845 x 6% x 6/12) = $2,245,595

Payment 1 interest journal entry: Interest Expense 2,229,695 Notes Payable Cash

529,695 1,700,000

Payment 2 interest journal entry: Interest Expense 2,245,585 Notes Payable Cash

545,585 1,700,000

The carrying value of the bond one year after issuance is $75,398,430. LO 2 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-12B a.

MUHC Ltd.’s statement of financial position would include a right-ofuse leased capital asset and a corresponding lease liability. The rightof-use asset would be initially recorded at $368,175 (the present value of the lease payments under the lease) and a lease liability would be recorded in the same amount. The right-of-use asset would be depreciated, so its carrying value at the end of January would be $357,948 [$368,175 – ($368,175 / 3 years / 12 months)]. The lease liability at the end of January would be: The lease liability January 1, 2024 $368,175 Monthly repayment January 2024: Total monthly payment amount $10,870 Less interest ($368,175 x 3% x 1/12) 920 Principal repayment $9,950 (9,950) The lease liability at the end of January $358,225

MUHC Ltd.’s statement of income for the one month ended January 31, 2024 would show: Depreciation expense $10,227 Interest expense 920 LO 3 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-13B If Ferguson Theatres borrows $475 million to fund their expansion in China, their ratios are: Debt to Equity = $650 + $475 - $100 $900

= 1.14:1

Ferguson would exceed the 1.10:1 ratio set by the lender. Net Debt as a Percentage of Total Capitalization = $650 + $475 - $100 $900 + $650 + $475 - $100 = 53% Ferguson would also exceed the 50% ratio set by the lender. Ferguson Theatres cannot borrow $475 Million and remain in compliance with its existing debt covenants. LO 8 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-14B a. 2024 Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$900,000 + $85,000 – $65,000 = 0.49:1 $1,875,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$900,000 + $85,000 - $65,000 = 0.33:1 $1,875,000 + $900,000 + $85,000 - $65,000

2023 Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$985,000 + $95,000 – $85,000 = 0.57:1 $1,750,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$985,000 + $95,000 - $85,000 = 0.36:1 $1,750,000 + $985,000 + $95,000 - $85,000

b. Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity = X – $65,000 = 0.75 $1,875,000 = X - $65,000 = $1,406,250 (0.75 x 1,875,000) X = $1,406,250 + $65,000 = $1,471,250 total debt

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-14B (Continued) Total debt – current debt = $1,471,250 – $900,000 - $85,000 = $486,250 amount of debt OPoole can issue and still remain compliant. LO 8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP10-15B a. Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity = $565,000 + $75,000 – $100,000 = 0.86:1 $625,000 Net Debt as a Percentage of Total Capitalization = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity + Interest Bearing Debt – Cash =

$565,000 + $75,000 - $100,000 $625,000 + $565,000 + $75,000 - $100,000

= 0.46:1

b. If Hopps borrows $235 Million, and uses it to fund development costs, the updated ratios would be: Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$565,000 + $75,000 + $235,000 – $100,000 = 1.24:1 $625,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP10-15B (Continued) c. If Hopps issues bonds at 1.277 the proceeds would be $300,095,000 ($235 million x 1.277). This would provide cash in excess of the $235 million required to fund the development costs. The excess cash would amount to $65,095,000 and the debt to equity ratio would be: Debt to Equity = Net Debt (Interest Bearing Debt – Cash) Shareholder’s Equity =$565,000 + $75,000 + $300,095 – $100,000 - $65,095 = 1.24:1 $625,000 c. Neither option results in the covenant being breached. The bonds would be a better option as they would have a lower interest rate (6.25%) than the bank loan (13%) and provide an additional $65.095 million in funding, that Hopps will be able to use. LO 8 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP10-1

With a blended payment for a mortgage, the total amount of each payment is the same, but the portion of each payment that represents interest is reduced as the principal balance is reduced. From a management perspective, the advantage of paying blended payments is that (1) there is not a large principal payment at the end of the term of the loan (as there is with a bond payable where the entire principal is paid at the end instead of over the term of the loan), thus making it easier to budget cash flows and debt repayment over time, and (2) the interest expense, and thus the cost of borrowing to the company decreases over time because the interest is calculated on the remaining outstanding carrying value (principal) of the loan, which decreases with each mortgage payment. In addition, lender may have a lower required rate of return on mortgage because risk of non-payment is reduced. Finally, some financial ratios will improve with the repayments reducing the debt load and with the reduced interest costs.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-2

From a lender’s perspective, the primary advantage of having long-term loans such as mortgages structured to be repaid through equal, blended monthly payments is the reduction of risk. The lender can require cash flows of repayment of the loan principal throughout the term of the loan instead of hoping that the borrower will be able to pay off a large significant loan in 20 or 25 years. Also, as capital assets used as security for the mortgage loan age and their fair value is reduced, the loan amount outstanding reduces as well.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-3

As a lender, a company’s property, plant and equipment gives me some level of comfort because it can be used as collateral for a long-term loan, although the value depends on how specialized and how marketable these assets might be. Goodwill gives a lot less comfort, as it is not an identifiable asset that can be sold apart from the company as a whole to generate cash to repay debt. Goodwill is often difficult to value and could even be a sign that company paid too much for acquiring another business. In addition to knowing about the carrying amount of the PP&E and goodwill assets on the statement of financial position, we would like to know their fair value, and whether the assets are presently being used as collateral for other creditors. As part of the valuation process, the condition of the property, plant and equipment can be determined as well as the evidence related to excess cash flows that underlie the valuation of the goodwill.

LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-4

Seniority is very important because, in the event of bankruptcy, the company must satisfy creditors in the order of their seniority. Some debt is secured by a first charge on specific assets, some by a second charge on specific assets, some by a general claim to all assets, some debt is senior debt and other is subordinate debt. These descriptions indicate the degree of security and the creditor’s rank in terms of rights to assets should the company experience financial difficulties. Since the most secured and senior obligations will be satisfied before unsecured and subordinate debt, the creditor takes on less risk the more senior its claims.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-5

Bond covenants attempt to provide protection to the bond investor by restricting the actions of management who might otherwise take actions in the best interests of the shareholders instead of the creditors. It is important for the bondholders because the more restrictive the covenants, the more protection is afforded to the bondholder against the company defaulting on its obligations. Examples include maintaining a minimum working capital level, maintaining a certain quick ratio, not exceeding a particular debt to equity ratio, restricting dividends paid to shareholders, and restricting the sale of certain assets.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-6 a. The effect of the use of this exemption has on the financial statements relates more to the statement of financial position than to the statement of income. On the statement of income, the effect is often insignificant because the rent expense recorded on the low-value exemption is similar in amount to the total of depreciation expense and interest expense recorded for leases. On the statement of financial position, the company’s contractual obligations to make rental payments into the future are not captured as liabilities under the low-value exemption and the assets being leased are not captured and reported as assets. Therefore, the debt to total assets ratio is understated and the return on total assets ratio is overstated. Because of this, the company appears to be using less debt in its financial structure than it is (and is perceived to be less risky), and it appears to be generating income on a smaller amount of assets than it is using for operations (and therefore appears more profitable). LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-7

Whether it is appropriate or not to include the computer equipment on the company’s statement of financial position depends on the nature and terms of the lease. Leases normally result in the leased assets being recorded as right-of-use assets and a corresponding lease liability. However, if the leases qualify for the low-value lease exemption, then they would not be recorded as right-of-use assets and no lease liability would be recorded. The shareholder should read the accounting policy notes to the financial statements that explain how the leases are accounted for. It is quite likely that large amounts of computer equipment are, in substance, asset acquisitions.

LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-8 I agree with this statement. It is possible that two separate companies could report the transaction in a different way if the computers met the criteria for a short term or low-value lease (12 months in length or less or $5,000 US in value or less when new). One company could elect to use the exemption while the other company could elect not to use it. LO 3 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-9 a. There are three main types of pension plans: defined contribution plans, defined benefit plans, and hybrid plans. In a defined contribution plan, the employer contributes a defined amount each period to the pension plan for each eligible employee. The amount that employees are entitled to on retirement is contingent upon the performance and management of the plan assets set aside over the employees’ working lives.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-9(Continued) In a defined benefit plan, the employer defines, usually by a formula that takes into consideration salary levels and years of service, the amount that employees are entitled to receive as a pension benefit in their retirement years. If there are insufficient assets in the pension fund to provide this level of benefit, the employer is responsible for making up the deficiency. In a hybrid plan, the employer and the employee share the risk of inadequate pension fund assets. These plans combine features of both defined contribution plans and defined benefit plans. They establish targeted benefit levels (similar to defined benefit plans) which are targets rather than guaranteed benefits. The contributions from the employee and employer are fixed (similar to defined contribution plans), but these can be adjusted by mutual consent. If need be, either the targeted benefits could be reduced, or both the employer and employer together could agree to change their contributions if this was necessary to make up a pension deficiency. b. From the perspective of company management, I would recommend a defined contribution plan. This is because the amount of company assets to be contributed into the plan is known and the employees bear the consequences (the risk) if the pension assets they are entitled to on retirement are not sufficient to provide an adequate pension. This type of plan is much easier to plan and budget for and has significantly lower risk. c. From the perspective of an employee, I would probably prefer a defined benefit plan. This is because the company that sponsors the plan is required to pay me the defined benefit I am entitled to and to make up any deficiency should the pension fund be underfunded. I can be certain about the benefit amount, regardless of economic conditions, interest rates, and the performance of plan assets. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-10 a. and b. Memo: Why authorize a pension plan? There are costs associated with implementing a pension plan for our employees, and the costs differ with the type of plan that we might authorize. Regardless of which type of plan may be decided on, a pension plan is an additional employee benefit. The costs can be shared with the employees (a contributory plan) or it could be a non-contributory plan where the company, as plan sponsors, absorbs the total cost. Increasingly, however, employer sponsors are assumed to also have responsibility for providing information to the employees on the type of plan they have and what should be considered in their pension planning. The benefit of introducing such a plan lies in the quality of employee we are able to attract. Most reputable companies now offer such plans and our company would be at a competitive disadvantage if we failed to offer this type of benefit. To be competitive, we would either have to offer a retirement plan of some sort or compensate the potential employee with additional salary that he or she could use to contribute to a similar plan outside the company. We would do better to sponsor our own plan as an indicator, that we are concerned about the financial health of our employees, that we recognize that such costs should be a normal cost of the salary package as the employee provides services currently, and that the plan will be beneficial in attracting and keeping good employees. Recommendation – a hybrid plan As you are likely aware, there have historically been two basic types of pension plans – defined benefit plans and defined contribution plans. Each has its advantages.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-10(Continued) A defined benefit plan is the type usually preferred by employees because the amount of the pension benefit that will be received by them on retirement is defined in the benefit formula. It is a function of the years of service and salaries earned (i.e. best or highest five years earnings). The company takes on considerable risk, however, because if insufficient assets have been set aside to fund the retirement benefits, the company must make up any deficiency. The pension costs to the company are difficult to estimate and the cash requirements can vary considerably over the life of the plan. A defined contribution plan is the type usually preferred by companies because the company’s only commitment is to make pension contributions for each employee into a pension fund, usually based on the gross salary of the employee. At retirement, the employee gets whatever has accumulated in the fund through contributions and investment income. The employer bears no risk associated with the potential insufficiency of assets to fund a certain level of pension. This type of plan has little variability in pension fund contributions and is much more straightforward for cash flow and budget planning. In recent years, a third type of plan, hybrid pension plans, have become increasingly common. This is the type of plan I am recommending for our company. Hybrid plans have some features of defined benefit plans and some features of defined contribution plans. Generally, this type of plan requires fixed contributions from both the employer and employee (it is usually a contributory plan), which are intended to fund specific pension benefits. If the fund is unable to meet the obligations related to those benefits, either the benefits are reduced or both the employee and employer share in funding the deficiency. In this way, both the risks and costs are shared between the employer and the employee, and the employee is more certain of the benefit outcomes that he or she can expect. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-11 There are three main types of pension plans: defined contribution plans, defined benefit plans, and hybrid plans. In a defined contribution plan, the employer contributes a defined amount each period to the pension plan for each eligible employee. The amount that employees are entitled to on retirement is contingent upon the performance and management of the plan assets set aside over the employees’ working lives. In a defined benefit plan, the employer defines, usually by a formula that takes into consideration salary levels and years of service, the amount that employees are entitled to receive as a pension benefit in their retirement years. If there are insufficient assets in the pension fund to provide this level of benefit, the employer is responsible for making up the deficiency. In a hybrid plan, the employer and the employee share the risk of inadequate pension fund assets. These plans combine features of both defined contribution plans and defined benefit plans. They establish targeted benefit levels (similar to defined benefit plans) which are targets rather than guaranteed benefits. The contributions from the employee and employer are fixed (similar to defined contribution plans), but these can be adjusted by mutual consent. If need be, either the targeted benefits could be reduced, or both the employer and employer together could agree to change their contributions if this was necessary to make up a pension deficiency. None of the three choices would require you to manage pension investments. This task would be delegated to a pension fund investment specialist in the field. As a start-up company, you might opt for the defined contribution plan as it will likely cost the company the least amount of funds over the long run. If you wish to remain competitive with your industry peers, it might be necessary to match the type of pension plan, even if it means going to the riskiest plan from your point of view, which is the defined benefit plan. If neither of these features are critical in your decision, the hybrid plan might be best. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-12 Defined benefit plans are the most beneficial plans for employees to have. They define how much the employees will receive in retirement and the employer bears the risk of making sure it is funded properly. This can cause pension envy among employees if they don’t have as good a pension plan or any at all. It is the defined benefit plan that would cause the most pension envy. LO 4 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-13 a. As a manager, I might prefer to record the cost of postemployment benefits as the expenditures are incurred, because I would not have to record obligations (liabilities) related to these future payments on my current statement of financial position nor large estimated expenses on the current statement of income. Also, it is difficult to estimate the present value of these obligations as they may not be settled for many years and amounts accrued will require adjustments. b. Requiring companies to record the obligation currently is supported by the conceptual framework. First, the obligation to pay post-employment benefits related to the services performed by employees to-date, less the amount of the obligation that has been funded to-date, meets the definition of a liability. If the obligation is not reported, the company’s liabilities are understated. In addition, accrual accounting requires expenses to be reported in the same period in which the employees earn the entitlement to the future benefits, that is, in the same period as the expenses are incurred. The cost of post-employment benefits is related to current period, and should thus be accrued. LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-14 a. Potential liabilities that might not appear on statement of financial position include uncertain contingent losses, potential product liability losses, obligations associated with commitments, and financing arrangements such as operating leases or factoring of accounts receivable when factor has recourse for amounts that cannot be collected. Uncertain contingent losses, including potential product liability losses, relate to lawsuits and potential litigation where the company may be required to incur future expenditures, but the outcome will not be known until a future date. At the reporting date, management and their legal advisors have concluded that it is not likely or probable that the company will be required to make future payments, or they have no basis on which to make an estimate. Contractual commitments are also entered into by companies, that can commit the company to significant outflows of cash in the future. This might be for large capital expenditures, fixing the purchase price of raw material for the next year, or other similar agreements where neither party to the contract has yet performed. Because there is no performance by either party at the reporting date, the obligation to pay out future funds is offset by the right to receive certain goods and services in the future. This is known as a mutually unexecuted contract with neither the obligation nor the asset being recognized on the statement of financial position. No liability would be reflected on the statement of financial position related to this. Financing related to operating leases is similar to a contractual commitment whereby the company has contracted to rent an asset in the future and has agreed to pay a certain amount to do this. Again, no liability would be reported.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-14 (Continued) The factoring of accounts receivable with recourse (the company is responsible to make good on the receivable if another party fails to) is similar to a contingent liability. b. Information included in the notes should identify contingent liabilities to the extent that these losses are probable but there is no basis for estimating or measuring them, or if the likelihood of the outcome cannot be determined. The notes should indicate an estimate of the possible financial effect they might have, an indication of the likelihood of occurrence and timing. Contractual commitments related to significant and unusual transactions, as well as operating leases and factoring, should also be disclosed in the notes with sufficient information that users can assess the potential future impact on the company. LO 6,7 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP10-15

Deferred income tax liabilities result from temporary differences between income amounts reported in a company’s financial statements and income amounts included in its taxable income, on which it pays income tax. For example, a company might sell land in the current year and report the gain on sale on the current statement of income. However, for tax purposes, the gain is not included in the current year’s taxable income because the cash has not yet been collected from the sale. When the cash is collected and the gain is “realized” in cash in the future, the company will report it in taxable income and pay tax on the gain in that future year. Alternatively, a company might use straightline depreciation for accounting purposes, but use the CCA declining-balance method for tax purposes. This means that taxable income and taxes payable will be lower than income and current income tax expense on the financial statements in an asset’s early years of use. In both cases, the company, in the current year, entered into transactions and events and reported revenue and expense that are consistent with accounting standards, but which will result in the related payment of income tax in a future year.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-15 (Continued) For example, when the cash is received in the future from the sale of land, taxable income will increase and income tax will be payable on the gain. And when the company takes less CCA (tax depreciation) than straight-line depreciation in the future, the company’s taxable income will be higher than its accountingreported income and the company will have to pay additional income tax. The additional tax really relates to the previous years when its actual taxes paid were reduced by taking more CCA than depreciation expense. In both cases, in the current year, the company reports the income taxes that will become payable in the future as a deferred income tax liability and includes the related future tax expense on the current year’s income statement. This matches the total tax expense with the decisions and transactions and amounts reported for accounting purposes in the current year. So, do deferred income taxes qualify as liabilities? From Chapter 9 we saw that a liability: • Is a present obligation of the entity, • Which the company expects to settle with an outflow of economic resources or other economic benefits, and • which results from a past transaction. Recognition criteria for a liability also require that it is likely that there will be an outflow of assets and that amount can be reasonably estimated. Are deferred taxes a present obligation at the reporting date? The answer to this question is yes: in the current year the company has sold land and reported a gain. When the cash is received in the future, additional taxes will have to be paid. Will the obligation have to be met with an outflow of economic resources (assets)? Yes, additional cash will have to be paid out to the government.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-15 (Continued)

Does the obligation result from a past transaction? Yes, the land was sold during the current year and this is what gives rise to the deferred income tax obligation. More CCA (tax depreciation) was claimed than book depreciation in the current period. This will require a reversal and more tax to be paid in the future. Are the recognition criteria met? Is it likely that cash will be received in the future on the sale of land and that less CCA will have to be taken in the future? The answer to both is “yes.” Can a reasonable estimate be made of the amount of future taxes that the company will be obligated to pay? The temporary differences between the books and the tax return are both known, as is the rate of tax. So, the recognition criteria are also met. Arguments have been made against the recognition of deferred tax accounts such as: • Changes in tax rules and rates are difficult to anticipate, so the deferred tax liability might not be an accurate measure of the assets that must be transferred in the future. • The company may use tax minimization opportunities such as continuing to buy plant and equipment that is subject to CCA, thus avoiding the future reversal of CCA • Because the reversal of the income or expense transaction that has caused the deferred taxes may indeed not be realized in the future, the argument can be made that the transaction or event that will cause the future payment of tax has not yet occurred. The arguments supporting the recognition of deferred income tax obligations as a liability outweigh arguments to the contrary. LO 5 BT: C Difficulty: H Time: 45 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP10-16

As a potential lender, I should look at a deferred tax liability as a legitimate obligation of the company to pay taxes in the future over and above the current income tax liability reported on the statement of financial position. Income taxes payable included in current liabilities (and making up only a portion of the income tax expense on the statement of income) is based only on the taxable income reported in the current year. Deferred income tax liability is a legitimate obligation as it relates to transactions reported in the current period that have tax consequences, but the tax consequences have been deferred to a future period. To omit these amounts as not being “real” obligations would understate the outstanding obligations related to transactions that occurred before the statement of financial position date. However, a deferred tax liability is different from a long-term bank loan because, unlike the bank loan, there is uncertainty regarding both the amount and the timing of the obligation. For example, the company can undertake tax planning activities which could defer the payment of the related tax far into the future. This cannot be done with a long-term bank loan which comes due on a stated date and then would have to be renegotiated, if possible. The CRA cannot demand payment of this deferred liability until the temporary differences reverse, and even then, the tax that would otherwise be payable could be deferred by other tax planning deductions. As a potential lender, I would be interested in finding out what type of transactions resulted in the deferred tax account so that I could better understand the likely reversals. This information is required to be disclosed by the company in the notes to its financial statements.

LO 5 BT: C Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK IN PROGRESS WIP10-1 a. Parts that are correct: • There is a 1% difference in the contract rate and the market yield rate. • The interest expense is calculated using the yield rate of 4% b. Parts that are incorrect: • When the contract rate is higher than the market rate, the bond is issued at a premium, not a discount. • The contract rate is desirable as it is higher than the market rate, so bond purchasers are willing to pay more than face value for the bond. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP10-2 Parts that are correct: • When the contract rate is 6% and the yield is 7% the bond is issued at a discount • When bonds are issued at a discount, the company’s interest expense will be greater than the cash interest payments made to the bondholder’s each period. Parts that are incorrect: • The interest expense will be calculated using the bond carrying value and the yield rate. It is the interest payment that is calculated by the face value of the bond and the contract rate. LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP10-3 Improvements to the answer: • There are more reasons why a company may lease an asset other than not having the cash to purchase it, others include: o Wanting to use cash for purposes other than purchasing assets. o It is unable or willing to obtain a loan to finance the purchase of the asset. o It only has a short-term need for the asset, that is, it will not need the asset for most of its useful life. o The asset is expected to quickly become obsolete and the company wants to be able to have the newest model without having to sell the old asset and purchase the latest one. • The financial statement effects are exactly the same if a company leases or borrows money and purchases the assets. Also, if the lease has a term of 12 months or less or is for an asset with a fair value of $5,000 US or less when new, the lease could be different as they could elect to use the short-term low-value exemption and treat the lease payments as rent expense. LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP10-4 Flaws: • A pension plan does not defer wage-related expenses to future periods, pension expense is recognized in the current year to reflect the pension benefit earning in the current period. Only a portion of the payment may be deferred if the company doesn’t fully fund its pension obligation. • A defined contribution plan, not a defined benefit plan, is better from the perspective of the company and its shareholders as they “fix” the amount of the company’s pension contributions rather than leaving the company exposed to the potential of making additional payments to the plan in the future to cover the pension benefits promised in a defined benefits plan. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP10-5 Flaws: The lawsuit creates a contingent liability. The need to record the liability is dependent upon the outcome of the case, or the settlement of the case out of court. To the extent that management has the view that a negative outcome is probable and can be reasonably be determined and measured, the amount must be recorded in the financial statements. In addition, details of any additional exposure in the matter would be discussed in the notes to the financial statements. If the probability of the occurrence of the liability could not established, or is low, or if the amount cannot be estimated, the contingent liability would only be disclosed in the notes to the financial statements. The company must not delay in the recognition and disclosure of the contingent liability merely based on an ongoing court case. LO 7 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP10-6 Items that are correct: • A low level of leverage reduces the company’s exposure to interest rate changes and there would be less repayment of interest and debt principal in future periods. • Items that are incorrect: The investors normally view a moderate level of leverage as a positive thing as it is the extent to which a company is using the funds provided by creditors to generate returns for shareholders that exceed their interest costs. Investors will not want an extremely high degree of leverage as the obligation for repayment of debt and interest can cripple a company. LO 8 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI10-1 Metro Inc. a. A revolving credit facility is a line of credit, with a pre-approved maximum borrowing, which can be drawn on at any time, and repaid when the company has available funds to do so. In Metro’s case, the maximum is $600 million. b. An unsecured liability has no specific assets pledged as collateral to secure repayment; in such cases, the creditors simply rely on the general creditworthiness (repayment record, as well as assets and cash flows) of the company. c. The Series C Notes mature on December 1, 2021. The Series F Notes mature on December 5, 2022. Series G Notes mature on December 6, 2027. Series B Notes mature on October 15, 2035. Series D Notes mature on December 1, 2044, Series H Notes mature on December 4, 2047. Series I Notes mature on February 28, 2050. d. Assuming the notes were issued at face value, the annual interest expense is calculated using the fixed nominal rate: Series C: $300 million x 3.20% = $9,600,000 Series F: $300 million x 2.68% = 8,040,000 Series G: $450 million x 3.39% = 15,255,000 Series B: $400 million x 5.97% = 23,880,000 Series D: $300 million x 5.03% = 15,090,000 Series H: $450 million x 4.27% = 19,215,000 Series I: $400 million x 3.41% = 13,640,000 Total interest expense = $104,720,000 e. Percentage of non-current debt to total of non-current debt and equity (using interest-bearing debt only, excluding current portion): $2,612.0 = 29.8% $2,612.0 + $6,155.4

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-1 (Continued) Metro’s non-current debt to total capital ratio is well below the 50% limit. It may set this objective to control the risk associated with having too much debt that requires regular interest and principal repayments. If the ratio is too high, company runs the risk of not being able to meet its commitments and the creditors will require higher interest rates to compensate them for additional risk they take on. LO 8 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-2 Cascades Inc. a. A revolving credit facility is a loan arrangement with a financial institution that sets a maximum amount that can be borrowed, but the amount outstanding at any one time could be anywhere between $0 and the maximum amount specified. It is referred to as “revolving” because the balance goes up and down as the company needs extra cash and when it has extra cash to pay it down. b. At December 31, 2020 there was nil used on the revolving credit facility. Accounts receivable and inventories totaling approximately $798 million as well as property, plant, and equipment totaling approximately $246 million are pledged as collateral for the revolving credit facility. c. Because the notes were issued at 104.25%, an amount greater than 100 (par), the notes were issued at a premium. The amount of the expense will exceed the cash payments made to the note holders over the term of the note by the amount of the premium paid at the date of the issuance of the note. d. The refinanced note of US$200 million cost 5.55% or US$11.1 million in interest per year. The new note was issued at 104.25 The premium amount on the note is US$8.5 million ($200 million x .0425%). The interest rate on the note is 5.375% and the term is 8 years as the notes are due in 2028. The interest expense per year on US$200 million is $20,000,000 x .05375 amortization of premium. Assuming a straight-line method of amortizing the premium, the amount of the amortization is US$1,062,500 (US$8.5 million ÷ 8). Therefore, the annual interest expense is ($20,000,000 x .05375) - $1,062,500 = US$9,687,500. The annual savings in interest is US$1,412,500 ($11,100,000 million less $9,687,500). LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-3 University of Toronto a. When it states that the all the Series debentures are “senior unsecured debentures” it means that these unsecured debt instruments (i.e., debentures) have a priority claim to the organization’s assets before any unsecured subordinated debentures, should the University encounter difficulties repaying its debt. b. The debentures are carried on the Balance Sheet at $709 million. The debentures will be $710 million at maturity, as each will be at their face value at the point of maturity. The current balance of the net unamortized transaction costs is $1 million. Some of the debentures were issued at a premium as indicated in the notation: “Net unamortized transaction costs are comprised of premiums and transaction issue costs”. The net amount of these three items is a discount as the carrying value of the debentures is less than the face value. These will have been completely amortized by the maturity date. c. The amount of interest paid as per the contract rate was: Series A debenture $160 million x .0678 = $10,848,000 Series B debenture $200 million x .05841= 11,682,000 Series C debenture $75 million x .04937= 3,703,000 Series D debenture $75 million x .04493 = 3,370,000 Series E debenture $200 million x .04251 = 8,502,000 Total $38,105,000 d. The voluntary sinking fund is a fund that contains investments that have been accumulated and set aside specifically for the repayment of the debentures. The funds are not available for operations. The fact that it is voluntary means that it is not mandated by conditions in the debenture agreements. The university likely established this voluntary sinking fund to attract investors and to pay a lower rate of interest due to the reduced risk to the investors. LO 2 BT: C Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-4 Alimentation Couche-Tard Inc. a. Based on Couche-Tard’s two amounts of principal issued in 2020, the longer the term to maturity, the higher the interest rate required by investors. This would be important to me as an investor because the longer the term to maturity, the higher the risk of non-payment I take on. Also, because interest rates in the market may rise over time and reduce the fair value of my investment, I would want to be paid higher interest for a long-term bond than for one that matures in the near term. b. Couche-Tard may have wanted to spread its borrowing out across two principal amounts with different maturities to take advantage of the lower rates for the shorter-term debt. If the cash payback on the investment acquired with this financing takes place over in the 2030 and 2050 period, it makes sense to stagger the repayments to correspond to the cash inflows coming back into the company. Also, the staggered maturities reduce the risk associated with refinancing. c. The fact that the effective rates of interest are higher than the coupon rate for all notes tells us that all the notes were issued at a discount. LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-5 Rogers Sugar Inc. a. Rogers Sugar has defined benefit pension plans, as noted in the title to the schedule provided of note 20 to its financial statements. b. The total obligation for the defined benefit plans at October 3, 2020 was $145,667,000. c. The fair value of the defined benefit plan assets for Rogers Sugar is $103,373,000 at October 3, 2020 . d. The defined benefit plan is underfunded by $42,294,000 as the plan obligation is higher than the fair value of the plan assets. ($145,667,000 - $103,373,000 = $42,294,000) LO 2 BT: C Difficulty: H Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-6 Rogers Sugar Inc. a. Current and deferred income tax expense: Year

Source

Current

Deferred

2020

Earnings OCI Total

$11,290

$2,778 2,518 $5,296

$11,290

Total $14,068 2,518 $16,586

OCI = Other comprehensive income b. Rogers reported income taxes receivable in 2020 of $2,042 thousand on the statement of financial position. Income tax is receivable because it is likely that the amount of tax that was paid by instalment during the year exceeded the amount of the income tax expense. The excess amount will be refunded and is therefore a receivable at the end of the fiscal year. c. Given that a large deferred tax liability exists because of property, plant, and equipment assets, we know that, in the past, Rogers has taken more capital cost allowance (i.e., CCA or tax depreciation) for tax purposes than depreciation expense reported on the statement of income. In the future, when taxable income is being determined, Rogers Sugar will have to take less CCA than depreciation expense, increasing the amount of taxable income above the accounting income reported, and pay additional income taxes. This is because the company cannot deduct depreciation expense for tax purposes, it can only deduct CCA. In effect, the company has deferred its tax liability into the future because of its past decisions to claim more CCA than depreciation expense. LO 5 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-7 Big Rock Brewery Inc. a.

(i) 2020 EBITDA to long-term debt ratio = Net Debt = EBITDA 1 2

$3,554 1 - $252 $6142

= 5.4

Debt + license obligation: $2,479 + $470 + $420 + $185 = $3,554 2020 EBITDA = -$666 + $736 + $506 + $38 = $614 2019 EBITDA to long-term debt ratio = Net Debt = EBITDA 3 4

$5,6093 - $354 -$3,8544

= -1.4 therefore N/A

$2,935 + $1,979 + $510 + $185 = $5,609 2019 EBITDA = -$2,922 + $533 + $401 - $1,866 = -$3,854

(ii) 2020 EBITDA to interest, debt repayments and dividends: = EBITDA__________ Interest + debt repayments + dividends =

$614 $506 + $1,968 + $90 +$879+ $0

$614 = .18 $3,443

2019 EBITDA to interest, debt repayments and dividends: = EBITDA__________ Interest + debt repayments + dividends

-$3,854 = -$3,854 = -5.06 therefore N/A $401+ $15 + $346 + $0 $762

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-7 (Continued) b.

EBITDA to long-term debt: the way that Big Rock Brewery calculates this ratio indicates the relationship between the outstanding debt and the near-cash earnings generated to pay off the debt. The ratio in 2019 cannot be used as it is a negative multiple. For 2020, the ratio indicates it takes over 5.4 times the EBITDA to cover the net debt. For the EBITDA to interest, debt repayments and dividends, in 2019 the ratio is negative and cannot be used. For 2020, with the suspension of the payment of dividends, the ratio indicates that EBITDA is 18% that of interest charges plus repayment of debt. Ideally this ratio should be a multiple, and not a fraction, as is the case for Big Rock. This ratio is intended to indicate the earnings needed to meet the company’s returns to creditors and shareholders plus the repayment of long-term debt. Although the 2020 position is more favourable than in 2019, it is somewhat alarming. As debt and lease liabilities keep increasing, and losses accumulate to a substantial accumulated deficit, Big Rock has less flexibility in managing its capital structure.

LO 8 BT: AN Difficulty: H Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-8 Big Rock Brewery Inc. To supply the needs of customers and produce beer, the company contracts with suppliers to purchase raw materials for future deliveries, and, at the end of its 2020 fiscal year, had committed to a guarantee that it would purchase raw materials amounting to a minimum of $1,962 thousand during its next fiscal year. Other commitments include $239 thousand for marketing sponsorships and $30 thousand for utilities contracts. This note tells us that during the next fiscal year, Big Rock Brewery has no choice but to make good under these contractual commitments, thus it will spend at least $2,231 thousand acquiring raw materials, marketing sponsorships and utilities contracts. The raw materials will be accounted for as inventory purchases by the company and then into cost of goods sold as the beer is sold to customers. It also means that the company will incur liabilities of an equal amount, at a minimum, with these suppliers, and these amounts will require cash payments in the future. LO 6 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI10-9 Bombardier Inc. In Note 42 Bombardier is telling us two things. First, it is saying that lawsuits and legal proceedings, in general, are part of the normal course of business. Bombardier is currently involved in litigation resulting from product warranties and contract disputes and it cannot tell how they will be resolved. However, it judges that the outcome of such legal matters will not materially affect the financial position of the company. It does not tell us whether any related liabilities and losses have already been recognized in the financial statements, but indicates that, in effect, the outcomes will not be significant to the financial position as presented. Secondly, The government in Brazil is investigating and has brought charges against BT Brazil (a wholly owned subsidiary of the company) for cartel activity in the purchase of equipment and construction and maintenance of rail lines in Brazil. In 2019 BT Brazil was found guilty and was imposed a fine of approximately $4 million but was not disqualified to obtain future government contracts. The company strongly disagrees with the conclusion of the CADE Board and is contesting the decision. BT Brazil continues to vigorously defend itself against the allegations. LO 7 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

RI10-10 Choice of company Answers to this question will depend on the company selected. LO 5,6,7,8 BT: AN Difficulty: H Time: 90 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C10-1 Regal Cars Memorandum To: Mark Quaid, Regal Cars Ltd. From: Company Accountant Re: Long-term debt financing Mark, Based on the information you provided regarding the various financing options, they would be accounted for as follows: 1. Bank Loan—The bank loan would be considered long-term debt and be recorded on the statement of financial position at its full face value. The $100,000 principal repayment required in the next year would be recorded as a current liability. Interest paid on the loan would be expensed as it is incurred (i.e. with the passage of time). 2. Bond Issue—Bonds Payable will be recorded on the financial statements at their carrying amount (face value plus or minus any premium or discount). If similar bonds are providing a return of 10%, the 10% bond issue will sell at par. The $1,000,000 will be reported on the statement of financial position as long-term debt up to the end of year 9, at which time it will be recognized as a current liability. For these bonds, interest expense will be recognized at the 10% contract rate as the interest accrues. 3. Lease—it is considered the purchase of a PP&E asset, and the right-of-use asset and the related lease liability would be recognized at the signing of the lease. Both the PP&E asset and the lease liability would be recognized in the accounts and reported on the face of the statement of financial position. The asset would be depreciated, similar to other PP&E assets the company owns. The lease payments would be treated as blended payments of principal and interest, with interest expense at an 8% rate being recognized in the statement of income, along with the depreciation expense.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-1 (Continued) Each of these options will increase the long-term debt reported by Regal Cars. The increase in debt under the leasing option will be the lowest of the three, but remember that if the lease is selected, the company will not legally own the equipment. You may be restricted in terms of any modifications you can make to the equipment and you may be required to return the equipment at the end of the lease term, depending on the lease terms. However, if the asset is leased, the company will not have to be concerned with selling obsolete technology in 10 years and it may be easier to upgrade to new equipment. If the bank loan is selected, you should realize that with a personal guarantee, you could be required to repay the loan personally if Regal should default on the payments, or the bank could seize and sell your family estate to recover any outstanding portion of the debt and interest. I hope this information provides some guidance to you. If I can be of any further assistance, please contact me. LO 2,3 BT: C Difficulty: M Time: 35 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-2 Jonah Fitzpatrick Jonah, Great to hear from you. I hope these comments clarify things a little for you. Let me know if you have any further questions. 1.

The 8% stated rate of interest on the bonds, which is also known as the contract rate, is used to determine the cash interest payments that will be made each period. Because this rate is selected when the bond issue is being prepared, interest rates may change before the bonds are actually issued. The yield or market rate of interest is the interest rate in effect when the bonds are sold. If the stated rate and the market rate are the same, the bond is sold at its face amount. If the market rate has increased, as is the case with this bond, investors will not be willing to pay $1,000 for a bond that pays 8% when other investments in the market are paying 10%. The price of the bond will then start to decline. Because the amount the bond pays at maturity will always equal the $1,000 face amount, if an investor can buy the bond for less than $1,000, the return on the bond will actually increase above the 8%. The price on the bond will continue to decline until the actual return equals 10%. Therefore, it is always the yield or market rate of interest that should be used to evaluate your expected return on the bonds.

A bond sometimes carries collateral that a company can pledge to the lenders. However, a debenture bond carries no specific collateral and repayment is a function of only the creditworthiness of the company. Therefore, this bond will carry no specific security and if the company defaults on the bond you will only have a general claim on the company’s assets. However, the bonds you are looking at are senior debenture bonds, so they do have priority over other unsecured debt issued by the company in case of financial difficulties.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-2 (Continued) 3.

The purpose of an investment banker is to assist the company in selling the bond issue. They provide advice to the issuer on matters such as the selection of the appropriate interest rate and how best to market the issue. Most importantly, they are responsible for selling the issue. Although one investment dealer may sell the issue, several dealers or brokers will often work together. This group of investment dealers is referred to as a syndicate and is used to spread the risk associated with selling large dollar amounts of bonds over several companies.

Most bonds are sold in secondary bond markets. If this bond is traded in the public market you should be able to sell the bond at any given time over the five-year period. Remember, however, that the price of the bond will vary as market interest rates change so, like an equity investment, you will likely sell it at a profit or incur a loss.

Let me know if you need any additional information. Mike LO 2 BT: C Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-3 Wasselec’s Moving and Storage MEMO – to Dogan Yilmaz The advantages of leasing over buying include: 1. Periodic lease payments may be financially easier to budget and manage than having to find large amounts of cash to periodically replace vehicles after their 200,000 km, 10-year, or 15-year life. 2. The leasing company is very familiar with the best ways to handle returned vehicles after the leases are up. This would relieve the company of having to deal with these nonoperating decisions and transactions. 3. Leasing does not require increased amounts of bank debt. 4. Leasing would facilitate the replacement of our vehicles, perhaps at better points in their lifecycles, increasing the efficiency of their operation. 5. Vehicle maintenance may be easier and more efficient with leased vehicles. The disadvantages of leasing over buying include: 1. The company may be restricted in the make of the vehicle that it is able to lease. 2. The periodic payments and overall cost may be higher than they would be if the company borrowed the money to buy the vehicle. 3. There are likely few leasing companies engaged in leasing the type of equipment Wasselec needs, so we may not be able to negotiate a very competitive deal for the large vehicles, although the car lease should not be a problem. 4. The leasing company may have restrictions related to periodic maintenance, usage, etc., with additional significant costs charged to Wasselec if any requirements are contravened. LO 3 BT: C Difficulty: M Time: 30 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-4 Grant’s Ice Cream Shop Jack is incorrect in his lease assumption. The assets are capitalized and recorded as right-of-use equipment, measured at the present value of the minimum lease payments, and a lease liability is recorded in the same amount on the company’s statement of financial position. In this case, the lease payments are considered blended payments of interest and a reduction of the principal of the lease liability. The right-of-use asset will be depreciated using the same policy as equipment already owed by Grant’s Ice Cream Shop Ltd. The lease would have been treated differently if Grant’s Ice Cream Shop had been able to elect to use the short-term or low-value exemption and treat the lease payments as rent expense. The equipment does not qualify as it is not short-term because the lease is not 12 months or less in length and the equipment is not low-value because it has a fair value of more than $5,000, when new. LO 3 BT: C Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

C10-5 Peterson Corporation In a defined contribution pension plan, the employer agrees to make payments into an employee retirement fund. In the case of this type of plan, the monies are put in a fund managed by an independent trustee (i.e. someone from outside the company that has investment expertise). The fund keeps track of how much has been contributed for each individual employee. The assets are invested and the portion attributable to each employee is allocated to that employee’s “account” in the fund. When an employee retires, the amount of money that has accumulated in the employee’s “account” is paid out into some type of deferred tax arrangement to form the basis for generating pension income during that employee’s retirement. The vesting relates to which party is entitled to the employer’s contributions should an employee no longer work for the employer company.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-5 (Continued) Under Option 1, the company will contribute an amount equal to 10% of each employee’s gross wages into the fund. Employees are permitted to make separate contributions into the fund in order to build a bigger sum on retirement. These contributions will also be invested and the return on these investments will be added to the fund Employees are entitled to all of the benefits from the employer’s contributions into the fund from the first day he/she works because the plan indicates that there is immediate vesting. If the total of what is held in the fund for an employee is not enough to provide an adequate pension on retirement, the employer has no responsibility to help the employee. The employer is responsible only for contributing an amount equal to 10% of wages into the plan. Employees take the full risk if the amount that accumulates turns out to be insufficient. The defined benefit pension plan, on the other hand, promises employees a pension benefit at retirement calculated according to a pension benefit formula. Contributions into the plan are governed by law in most cases, and not by agreement of the employer with its employees. Unlike a defined contribution plan, no record is kept of how much of the employer’s contributions into the plan are designated for an individual employee. When an employee retires, the pension fund pays pension benefits as determined by the pension formula. If there are insufficient assets in the fund to meet this obligation, the employer is required to make up any deficiency. The employees know in advance how much they will receive when they retire.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C10-5 (Continued) Under Option 2, the defined annual retirement benefit is equal to 2% of the average of the highest five years of salary, per year of employment. For example, if the employee had an average salary of $50,000 during their five highest earning years and had worked for the company for 20 years the annual retirement benefit would be 2% X $50,000 X 20 years = $20,000. The employer will provide all the necessary funding and is responsible for ensuring this level of benefit. The vesting provisions under Option 2, however, are not as generous as under Option 1. Under the defined benefit plan, there is a vesting period of 5 years. That is, if an employee leaves the company at any time in the first five years, he or she will not be entitled to any pension benefit related to the service provided during that time. LO 4 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 11 SHAREHOLDERS’ EQUITY Learning Objectives 1. Explain why the shareholders’ equity section is significant to users. 2. Explain the components of the shareholders’ equity section of the statement of financial position. 3. Describe the different types of shares and explain why corporations choose to issue a variety of share types. 4. Describe the types of dividends, explain why one type of dividend may be used rather than another, and describe how dividends are recorded. 5. Describe what a stock split is and explain how it is accounted for. 6. Calculate and interpret the price/earnings ratio, dividend payout ratio, dividend yield, and return on shareholders’ equity ratio. 7. Identify the advantages and disadvantages of using equity financing.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO BT Item LO BT Item LO BT Item LO BT Item LO

Discussion Questions 1. 1

2. 3. 4. 5. 6.

K K C C C

8. 9. 10. 11. 12.

2 2 3 3 3

3 3 3 3 3 3

13.

19.

25.

C C K C K

14. 15. 16. 17. 18.

3 3 4 4 4

C C C C C

20. 21. 22. 23. 24.

5 4 5 6 6

C C C C C

26.

Application Problems 1. 3 AP

AP 13.

AP 17.

2. 3 AP 3. 3 AP 4. 3 AP

6. 7. 8.

4 4 4

AP AP AP

10. 11. 12.

4 4 4

AP 14. AP 15. AP 16.

4 4 5

AP 18. 4,5 AP AP 19. 6 AN AP

User Perspective Problems 1. 1

4. 4,5

AP 10.

2. 3 3. 3

C C

5. 4,5 AP 6. 4,5 C

8. 9.

5 4

C C

11.

Work in Process 1. 2

4,5

Reading and Interpreting Published Financial Statements 1. 3 C 2. 6 AN

3. 4.

6 6

AN AN

5. 6.

3 C 3,4 AN Cases

1. 6 AN

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ11-1

It is important to understand the shareholders’ equity section of a statement of financial position because it summarizes the components of the equity of the owners in the business and the source of the net assets of the corporation. Equity ownership is very common. Whether a personal investor, a corporate investor or as a member of a pension or other retirement fund, investors should understand what underlies their assets represented by their equity holdings. Understanding shareholders’ equity is significant to such investors because it allows them to understand how much risk they are taking on and their prospects for returns, to clarify what their ownership rights and privileges are, and to determine how changes in these items may affect the value of their investment holdings.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-2

Four different accounts that could be found in the shareholders’ equity section are: 1. Share capital. This represents the amounts of capital originally contributed by investors when the shares were first issued. 2. Retained earnings. In general, this account represents the accumulated profits (net income), in excess of amounts distributed to shareholders as dividends. 3. Accumulated other comprehensive income. This account represents the amount of specific types of unrealized revaluation gains and losses on specific types of assets and liabilities at the reporting date. Other comprehensive income is closed at the end of the fiscal year to Accumulated other comprehensive income. 4. Contributed surplus. This arises primarily from the company’s repurchase of its own shares.

LO 2 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-3

Four types of transactions that would affect a company’s shareholders’ equity are: 1. Issuing shares 2. Repurchasing shares 3. Declaration of cash or stock dividends 4. Transferring net income into retained earnings at the end of the year and other comprehensive income into accumulated other comprehensive income.

LO 2 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-4

A company’s market capitalization is the value of the company determined by multiplying the number of issued shares times the trading price of the company’s shares. This is different from the shareholders’ equity amount reported in the company’s financial statement, as shares in the financial statement are recorded at the amount at which they are initially issued, not at the current market price.

LO 3 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-5

The term IPO refers to a company’s “initial public offering”. This is the first time it offers its shares for sale to the public. Subsequent share sales are known as secondary offerings. Each time a corporation issues new shares to the investing public, it is required to prepare and provide legal documentation (known as a prospectus) that sets out information with the details and features of the shares to be issued. The prospectus must be presented to potential investors prior to the sale of the shares. This is usually carried out through a firm of investment bankers (underwriters).

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-6

A company’s articles of incorporation, required by the specific jurisdiction (federal or provincial) in which the business is being incorporated, identify the company’s name, place of registered office, types and the maximum number of shares of each class that are authorized, type of business that will be carried out, size of the board of directors and how it will operate, and other specific matters governing the transfer of shares and relations with shareholders. The articles of incorporation are important for accounting purposes primarily because they set out the terms and conditions attached to each type of share authorized and subsequently issued. For example, the articles specifically identify the dividend rights and limitations associated with each type of share as well as their voting rights and their rights and limitations on liquidation.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-7

Authorized shares: This is the number of shares of each type or class that the corporation is permitted to issue according to the company’s articles of incorporation. Issued shares: This is the number of each type of shares that have been issued (sold) to investors, net of any shares that have been reacquired and cancelled by the company. Outstanding shares: This is the number of each type of shares that have been sold to investors, net of any reacquired and cancelled by the company and those repurchased but not cancelled (i.e. treasury shares). In effect, this is the number of issued shares that are being held in the hands of investors. These are the shares that are entitled to dividends if they are declared.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-8 •

• •

A company may want to repurchase its shares for these reasons: When there are fewer shares outstanding, the company’s income is divided among fewer shares when calculating earnings per share (EPS). The EPS therefore rises if earnings stay the same. Because share price is positively associated with EPS (think of the P/E ratio), the share price might also increase. It may repurchase some of its shares because it wants to have the shares available to satisfy its stock option plans rather than having to issue new shares. If the share price has been relatively low because of general stock market conditions, a company may want to repurchase the shares, with the expectation the company will be able to resell them later at a higher price when the market recovers. (In most jurisdictions in Canada, repurchased shares must be cancelled immediately upon purchase. In a few jurisdictions, they are not cancelled and are held in the accounting system as treasury shares. They are considered issued but not outstanding.)

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-9

It is important for companies to distinguish treasury shares from other issued shares because treasury shares are not entitled to receive dividends, nor are they included in calculating earnings per share.

LO 3 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-10 Common shares carry a basic set of rights. The rights are to share proportionately (based on the number of shares that are held) in: • The distribution of earnings, if dividends have been declared • The management of the corporation. Common shareholders typically exercise their right to manage by voting in the election of the Board of Directors and other issues presented at shareholder meetings. • The distribution of assets upon liquidation. If the corporation decides to wind up or is forced out of business, the shareholders share in whatever assets are left after creditors and preferred shareholders have been paid. • In addition, common shareholders often are entitled to purchase new shares issued in proportion to their pre-issue percentage, before the shares become generally available to new investors (the pre-emptive right). This right must be stated explicitly in the company’s articles of incorporation. LO 3 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-11 Preferred shares differ from common shares in the following ways: • Preferred shares are given a preference with regard to dividends. The preferred dividend entitlement must be paid before common shares are entitled to receive dividends. • Preferred shares are typically non-voting. Therefore, most preferred shares are not entitled to take part in deciding on the management of the corporation. • Preferred shareholders have a preferential claim on assets on dissolution of the company (i.e. they receive a return of their capital when a corporation is wound up before common shareholders receive anything). LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-12 • • • •

A company might issue preferred shares for a number of reasons, including: Preferred shares enable a company to raise capital without having to dilute the ownership interests of their common shareholders. As dividends are at the discretion of the board, dividends can be postponed in periods of financial difficulty. This feature provides an advantage compared to financing with debt. Preferred shares provide new capital to a company while improving the debt to equity ratio, which is closely monitored by many financial statement users. Preferred shares do not result in the dilution of future earnings as preferred shareholders would only be entitled to their fixed or stated dividend regardless of any increase in earnings.

LO 3 BT: K Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-13

Preferred shares are referred to as hybrid securities as they include features of both debt and equity. Given that they are normally nonvoting, tend to pay fixed dividend rates and may have a maturity date (redemption provision), they are similar to bonds or other debt. On the other hand, preferred shares are similar to common shares in that they represent an ownership interest, the returns paid to investors are dividends (rather than interest) and they are normally reported as part of shareholder’s equity.

LO 3 BT: K Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-14

Perpetuals, floating rate and rate reset are the ways the dividend rate on preferred rates can be determined. Perpetuals – are preferred shares that pay a fixed dividend for as long as the shares remain outstanding Floating rate – are preferred shares that pay a dividend that is linked to a measure such as the prime rate, which means the amount of the dividend will change or ‘float’ as the measure they are linked to changes.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-14 (Continued) Rate reset – are preferred shares that pay a fixed dividend from their issue date until a pre-established reset date. At the reset date, a new fixed rate is established by the issuing company and remains in effect until the next reset date. This new fixed rate reflects the economic conditions and borrowing rates at the time. LO 3 BT: C Difficulty:M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-15

Participating – This feature means that preferred shareholders get to share in dividends above their stated rate if the dividends declared are high enough. For instance, if preferred shares with a stated rate of 5% are fully participating preferred shares and an 8% dividend is declared on the common shares, the preferred shares are entitled to receive an extra 3% dividend in addition to their 5%. Cumulative – This feature means that if a preferred dividend is not declared in one year, it is the first dividend that must be declared in the second year (if one is declared at all). The undeclared preferred dividends therefore accumulate and are referred to as dividends in arrears. All cumulative preferred dividends in arrears must be paid along with the current year’s preferred entitlement before common shareholders are entitled to receive any dividends in the current year. Convertible – This feature allows preferred shareholders to exchange their preferred shares for common shares, based on a ratio specified in the articles of incorporation. This feature is exercisable at the discretion of the preferred shareholder. Redeemable – The feature allows the corporation to buy back or redeem the preferred shares at a price and time set out in the articles of incorporation. This feature is exercisable at the discretion of the issuing company.

LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-16

Dividends are declared by a vote of the Board of Directors. On this date of declaration by the Board, payment of the dividends becomes a legal obligation (liability) of the corporation and a journal entry should be made in the accounting system to record the decrease in retained earnings and the increase in dividends payable. On the declaration date, a date of record is specified which is the date on which the investor must be the registered owner of the shares to receive the dividend. The date of record is usually at least two weeks following the declaration date. No accounting entry is made at the date of record. The payment date is the date on which the corporation writes cheques to pay the shareholders on the date of record. The payment date is also usually a minimum of two weeks following the date of record. The corporation makes an entry in the accounting system to record the decrease in cash and the decrease in the liability, dividends payable. Note that, because it takes three days to get new shareholders registered as the owners of the company’s shares, the shares sell “exdividend” two business days before the date of record. That is, a potential investor who wants to be entitled to a dividend that has been declared on specific shares must acquire those shares three business days before the date of record. This gives the system time to have the change in ownership recorded by the date of record.

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-17 A company may pay a “special” or one-time dividend to its shareholders because it has excess cash on hand and it may consider that the shareholders could invest the dividend to earn a higher return than the company can. The cash may have resulted from having sold a significant asset or product line, for example, and the company is not in a position to reinvest it at this time. Alternatively, perhaps the company does not want to set out a policy of declaring dividends on a regular basis, but is willing to distribute company assets when in a healthy cash position. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-18 The ex-dividend date is the date one business day prior to the date of record. Because it takes two business days for share trades to be completed, trades made in the business day prior to the date of record will not be completed until after the date of record. As such, investors purchasing shares on or after this date will not own the shares on the date of record and will not be entitled to receive the dividend. The dividend would be paid to the previous owner of the shares. To receive the dividend, an investor would need to purchase the stock before the ex-dividend date. The value of the shares normally decreases on the ex-dividend date, with the decrease approximating the amount of the dividend. LO 4 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-19 Companies might declare stock dividends because they like the effect a stock dividend has on their shareholders’ equity accounts – a transfer of the dividend amount from retained earnings to share capital. In effect, the “optics” are favourable as the company is seen to have increased its permanent or legal capital without any dilution of ownership. This may be seen by creditors as a reduction of their risk as the company’s retained earnings from which dividends are legally entitled to be paid has been reduced and converted to permanent capital. Corporations might issue stock dividends rather than cash dividends simply because they may not have sufficient cash on hand to pay for a cash dividend and/or they may need the cash for better investment opportunities. Although, in theory, the investor still owns the same percentage interest in the company’s net assets after the stock dividend as before the dividend and is no better off than before the dividend, shareholders may receive a benefit with a stock dividend. This is because the additional shares may sell in the market at a price higher than their theoretical lower price. This often happens with a stock dividend as the market considers the conservation of the company’s cash as a good management decision, the expectation being the company needs its cash for new, profitable investment opportunities. LO 4 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-20 A stock dividend and a stock split can be differentiated as follows: • Purpose: the purpose of a stock dividend is to give the existing shareholders additional shares in lieu of a cash dividend; whereas the purpose of a stock split is specifically to change the market price of a company’s shares. • Accounting: a stock dividend entails making accounting entries to change the amounts of retained earnings and share capital; whereas a stock split entails only memo entries to indicate the change in the number of shares issued and outstanding. • Effects on the statement of financial position: while both have no effect on total assets, total liabilities and total shareholders’ equity, the effects within shareholders’ equity differ. With a stock split, no dollar amounts change at all, only the number of shares issued and outstanding change. With a stock dividend, an amount equal to the fair value of the shares given as the stock dividend is added to the share capital account and deducted from retained earnings. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-21 With a stock dividend, a company “capitalizes a portion of its retained earnings” by transferring an amount equal to the fair value of the shares distributed to shareholders from retained earnings to the share capital account. The share capital account represents the permanent or legal capital of the company, whereas the retained earnings is significantly less permanent in nature. The retained earnings amount can be reduced by paying out company assets as dividends, so creditors’ risk would be reduced by having amounts transferred to the more permanent category of equity. Dividends cannot be paid out of the share capital account. LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-22 The usual reason for a company to split its shares is to significantly affect the price of its shares. In a regular stock split, such as a 2-for-1 split, twice as many shares will be outstanding, but each share’s market value will be one-half of what it was immediately before the split. This is advantageous to a company that likes to have its shares available to a larger investor group. Because shares usually trade in 100-share lots, it becomes difficult for many smaller investors to put together larger sums of money to acquire 100 shares that trade at a high market price per share. The Canadian banks, for instance, tend to split their shares when the price per share gets up around $100. Two-for-one splits are commonly used to bring the trading price down to a level that is more accessible to a wider range of investors. Alternatively, because a minimum share price of $1 per share, for example, is required to remain listed on a stock exchange, shares may undergo a reverse stock split to raise or keep the market price above this $1 floor. A company whose shares have plummeted in price to $0.70 per share may put a 10-to-1 reverse stock split into effect, reducing the number of outstanding shares by a factor of 10 and theoretically increasing the share price immediately to $7.00. LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ11-23 The price/earnings ratio tells you how much the market is willing to pay for $1 of earnings for a specific company. It indicates the relationship between the market price of a share and the amount of income attributable to each share. A company that has excellent growth prospects (or relatively low risk) is likely to have a high P/E ratio, whereas a company that is underperforming its peers and has low growth prospects (or a higher level of risk) will have a low P/E ratio. It can also be used to estimate what the share price of a company is likely to be if its earnings per share (EPS) increases by a certain amount. In the case where a company has a net loss, the P/E ratio is not applicable. LO 6 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-24 The dividend payout ratio indicates what percentage of the net income earned by common shares that is returned to common shareholders as a dividend. This can be calculated either in total or on a per share basis, with the same result. In total: total common dividends declared/paid ÷ net income attributable to common shares = % of net income earned that was paid out to common shareholders Per share: dividends declared/paid per common share ÷ earnings per share (EPS) = % of net income earned that was paid out to common shareholders. In contrast, the dividend yield percentage tells investors what rate of return the dividends paid by a company represents when related to the market price they’d have to pay to acquire the shares. Again, this can be calculated either on a total basis or a per share basis, with the same result. In total: total common dividends declared/paid ÷ the total market value of all the company’s common shares = the dividend yield Per share: dividends declared/paid per common share ÷ the market price per common share = the dividend yield LO 6 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-25 The return on shareholders’ equity (ROE) provides information on the rate of return earned by common shareholders. 1. ROE = (net income – preferred dividends) / average shareholders’ equity. 2. The numerator of the ratio (the income amount) is determined after deducting interest expense (the return to creditor interests) and by subtracting any entitlements shareholders other than the common shareholders have in the net income reported by the company. For example, preferred dividends are deducted from net income in determining the income amount for the numerator. 3. The denominator of the shareholders’ equity ratio is reduced by any interests of equity holders other than the residual common shareholders. The net amount represents the equity interests of only the common shareholders in company assets. 4. Therefore, the rate of return calculated compares the income attributable to common shareholders to the net equity investment of the common shareholders. Note that the common shareholders’ investment in the company is represented by the amounts contributed originally for the common shares issued plus the retained earnings balance plus any contributed surplus plus any accumulated other comprehensive income. Alternatively, and as a more straightforward calculation, the common shareholders’ investment is represented by total shareholders’ equity less the limited amounts to which the preferred shareholders are entitled. As common shareholders, they are the residual equity holders, and their investment and entitlement extends to everything that is left over after all creditor and preferred equity claims are met. LO 6 BT: C Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ11-26 The advantages of financing growth with equity capital are: • • •

Equity capital usually has no repayment requirements. It can be permanent in nature. There is no required periodic payment of a return on the funds invested by investors. Dividends may be declared and paid, but there is no legal obligation for the company to do so. Equity financing usually reduces the debt to equity ratio and results in lower risk to creditors and a lower cost of capital on borrowed funds.

LO 7 BT: K Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP11-1A

a. Shareholders’ equity, September 30, 2024: Share capital, preferred Share capital, common

$ 500,000 2,000,000

Retained earnings1

$2,500,000 1,605,650

Accumulated other comprehensive income2 Total shareholders’ equity 1

31,400 $4,137,050

$1,457,850 + ($265,400 - $62,600) – ($40,000 + $15,000) = $1,605,650

$43,700 - $12,300 = $31,400 b.

Income to common shareholders # of common shares outstanding

= Earnings per share

($265,400 - $62,600) - $15,000 = $1.878/share # of common shares outstanding $187,800__ = 100,000 shares $1.878/share LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP11-2A a.

Date Dec 31, 2023 1. issued common shares 2. preferred share dividends 3. 10% stock dividend on common shares

Number of common shares 5,200,000

Common shares $130,000,0001

200,000

6,000,0003

540,000 4. common share dividend 5a.net income for year 5b.other comprehensive (loss) for year 6. two-for-one stock split on common shares Dec 31, 2024 1

5,940,000 11,880,000

Number of preferred Shares 250,000

Preferred shares $5,000,0002

Accumulated other comprehensive income $525,000

Total $162,135,000 6,000,000

17,820,0005

. $153,820,000

(5,200,000 x $25) = $130,000,000 2 (250,000 x $20) = $5,000,000 3 (200,000 x $30) = $6,000,000 4 (250,000 x $2) = $500,000

Retained earnings $26,610,000

. 250,000 5 6

. $5,000,000

(500,000)4

(500,000)

(17,820,000)

(8,910,000)6

(8,910,000)

14,820,000

. $14,200,000

(145,000)

. $380,000

$173,400,000

(5,400,000 x 10%) x $33 = 54,000 shares x $33 = $17,820,000 (5,940,000 x $1.50) = $8,910,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP11-2A (Continued) b.

Dec 31, 2023 Common shares issued Cash dividends Stock dividend - common shares

Pharma Shop Ltd. Statement of Changes in Shareholders’ Equity Year Ended December 31, 2024

Number of common shares 5,200,000

Common shares $130,000,000

200,000

6,000,000

540,000

Number of preferred Shares 250,000

Preferred shares $5,000,000

17,820,000

Net income

Retained earnings $26,610,000

5,940,000 11,880,000

. $153,820,000

. 250,000

. $5,000,000

Total $162,135,000

(9,410,000)

6,000,000 (9,410,000)

(17,820,000)

14,820,000

Other comprehensive loss Stock split on common shares Dec 31, 2024

Accumulated other comprehensive income $525,000

. $14,200,000

(145,000)

. $380,000

$173,400,000

Understanding Financial Accounting, Third Canadian Edition

AP11-2A (Continued) Pharma Shop Ltd. Shareholders’ Equity December 31, 2024 Share capital $2 Preferred shares, 5 million shares authorized, 250,000 shares issued $ 5,000,000 Common shares, unlimited number of shares authorized, 11,880,000 shares issued 153,820,000 158,820,000 Retained earnings 14,200,000 Accumulated other comprehensive income 380,000 Total shareholders’ equity

$173,400,000

LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-21 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-3A 1. Cash

600,000

Common Shares Issued 30,000 common shares 2. Cash

600,000

75,000

Preferred Shares Issued 5,000 preferred shares

75,000

3. Common Shares1 60,000 Retained Earnings 12,000 2 Cash 72,000 1 ($600,000/30,000) x 3,000 = $20/share x 3,000 = $60,000 2 (3,000 x $24) = $72,000 Prince Observation Inc. Shareholders’ Equity December 31, 2024 Share capital 5% Non-participating, convertible preferred shares, 100,000 shares authorized, 5,000 shares issued $ 75,000 Common shares, 500,000 shares authorized, 27,000 shares issued 540,000 615,000 1 Retained earnings 738,000 Total shareholders’ equity 1

$1,353,000

($750,000 - $12,000) = $738,000

LO 3 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-22 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-4A a.

Common Shares1 Retained Earnings Cash (180,000 x $18.00) 1

2,520,000 720,000 3,240,000

($14,840,000 ÷ 1,060,000) x 180,000 = $2,520,000

Common Shares Contributed Surplus Cash (180,000 x $11.00)

2,520,000 540,000 1,980,000

LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-23 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-5A a. If assets sold for Distribution of proceeds: First, to creditors Remainder for shareholders Preferred shareholders’ entitlement Remainder for common shareholders

(i) $2,110,700

(ii) $5,000,000

(iii) $1,800,000

(85,000)

2,025,700

4,915,000

1,715,000

(1,000,000)

$1,025,700

$3,915,000

$ 715,000

Common shareholders are entitled to share in company’s net assets upon liquidation. While the creditors and preferred shareholders have prior claims to the assets on liquidation, their claims are fixed. The remaining net assets (or the residual amount) is then shared by the common shareholders. It may represent a significant profit to them, or a considerable loss. This is the nature of the risk of being a common shareholder. b. $2,110,700 represents the carrying amount of the assets that have been recognized, all measured according to generally accepted accounting principles (GAAP). It is unlikely that the proceeds on disposal would be the same as this amount for the following reasons: • Many assets are not carried at fair value or market value. • Most of the assets are measured using a cost basis, including perhaps being written down (through impairment) to their lower value in continued use to the company. The value in use may be higher than the amount the company could sell the assets for in a quick sale. In fact, some of the assets may have value only to Hightech Inc., and may not be of any value to others. • Intangibles such as patents often have a value significantly higher than their carrying amount on the books. When a company develops patents internally, most of the costs incurred are expensed as incurred because it isn’t known whether the research will result in future economic benefits to the company.

________________________________________________________________________________________________ Solutions Manual 11-24 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-5A (Continued) • Companies in the high technology business are often worth more as continuing businesses than their individual assets are worth. This is because their most important assets, the knowledge and expertise of their management and employees, are not captured on the statement of financial position. While assets can be sold off, the employees and management cannot. • Accounting measurements entail many estimates in determining asset values. Examples include the estimate of the doubtful accounts (accounts receivable), the lower of cost and net realizable value (inventory), residual values and estimated useful lives for depreciation and amortization (property, plant and equipment and intangibles). c. The common shareholders initially invested a total of 4 X $200,000 = $800,000 in the company. The rate of return earned by these investors is determined by comparing the amount of assets returned to them over the period in excess of their original investment. Total assets returned (after deducting original investment of $800,000) =

(i)

(ii)

(iii)

$225, 700

$3,115,000

$(85,000)

÷ original investment

$800,000

= Total rate of return on investment

= 28.2%

= 389.4%

= (10.6%)

Note that rates of return are normally provided as annual rates, but the rates calculated above are for the entire period the investment was held. LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-25 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-6A

The following entry would be made on March 1, June 1, September 1, and December 1 of 2024: Dividends Declared Dividends Payable

1,050,000 1,050,000

The following entry would be made on each of March 31, June 30, September 30, and December 31 of 2024: Dividends Payable Cash

1,050,000 1,050,000

No entries related to the dividend are made by the company on the ex-dividend date or on the date of record. LO 4 BT: AP Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-7A a. In order to have no dividends in arrears, Raclette Corporation would have to declare dividends of $0.40 per share on the 3.2 million outstanding preferred shares, for a total of $1,280,000. b.

Dividend available To preferred: $0.40 X 3.2 million shares To Common, Class A (see Note 1 below) Remainder to be split To Preferred and to Class A, Common (see Note 2 below) Total

Total $3,500,000

To Common, To Preferred Class A

(1,280,000) $ 1,280,000 (137,339) 2,082,661

( 2,082,661) $ 0

1,880,853 $3,160,853

137,339

201,808 $ 339,147

________________________________________________________________________________________________ Solutions Manual 11-26 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-7A (Continued) Note 1: The $0.40 dividend/share paid on the preferred shares represents a 5.49356% return on the preferred shareholders’ investment. This is calculated as $1,280,000/$23,300,000. The Class A Common shareholders are then allowed a dividend with the same return: $2,500,000 X 5.49356% = $137,339. Note 2: The remaining dividend should be allocated to both the preferred and common with an equal rate of return to each. The total capital invested = $2,500,000 + $23,300,000 = $25,800,000 and the total dividend remaining = $2,082,661. This represents a return of $2,082,661/$25,800,000 = 8.07233%. Therefore, each should be paid a return of this percentage: To preferred: $23,300,000 X 8.07233% = $1,880,853 (rounded) To common, Class A: $2,500,000 X 8.07233% = $201,808 Total # of shares Dividend per share

Total $3,500,000

Preferred Class A, Common $3,160,853 $ 339,147 3,200,000 2,000,000 $0.99

$0.17

Raclette might have this share structure in order to permit the Class A Common shares to control the company. This is possible because of the multiple votes attached to each share of this class of share. Perhaps the Class A Common shares are held by members of the family that started the company but needed additional equity financing as the company grew. While the holders of the Class A Common and the preferred shares earn an equal return as far as dividends are concerned, decision making is controlled by the family members.

On average, the Class A Common shareholders invested $2,500,000 ÷ 2,000,000 shares = $1.25 for each share. On average, the preferred shareholders invested $23,300,000 ÷ 3,200,000 shares = $7.28 for each share.

________________________________________________________________________________________________ Solutions Manual 11-27 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-7A (Continued) e. Total Number of votes available to be cast Portion of votes

Class A Common

Preferred

9,200,000 100%

3,200,000 34.78%

6,000,000 65.22%

Capital invested

$25,800,000

$23,300,000

$2,500,000

Portion of capital contributed

100%

90.31%

9.69%

This table illustrates very clearly the difference between the extent of equity financing and the control of decision-making in Raclette Corporation. LO 4 BT: AP Difficulty: H Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-8A a. Year 2022 2023 2024 b.

2022 Arrears Current 2023 2024 1 2

Preferred $75,000 $75,000 $75,000

Common $ 65,000 $140,000 $225,000

Total $140,000 $215,000 $300,000

$84,0001 42,0002 $126,000 $ 42,000 $ 42,000

$14,000 $173,000 $258,000

$140,000 $215,000 $300,000

2 years x $6 x 7,000 shares = $84,000 $6 x 7,000 shares = $42,000

LO 4 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-28 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-9A a. 2024 Dec 31 Stock Dividend Declared1 200,000 Stock Dividend Issuable 200,000 1 (40,000 shares issued x 20% dividend x $25/share = $200,000) 2025 Jan 15 Stock Dividend Issuable Common Shares

200,000 200,000

b. Retained earnings before stock dividend Less: Stock dividend declared Retained earnings after the stock dividend

$1,500,000 (200,000) $1,300,000

LO 4 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-10A a.

2023 arrears 2024

Preferred

Common

Total

no arrears $50,000 (25,000 x $2)

$75,000 (residual)

$125,000

Preferred

Common

Total

$50,000 (25,000 x $2) $50,000 (25,000 x $2)

$25,000 (residual)

$125,000

2023 arrears 2024

________________________________________________________________________________________________ Solutions Manual 11-29 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-10A (Continued) c. Cash

1,000,000

Common Shares 1,000,000 (200,000 common shares issued during year for $5/share) Dividends Declared Dividends Payable (Dividends declared)

125,000

Dividends Payable Cash

125,000

Income Summary 885,000 Retained Earnings 885,000 (Net income for the year closed to retained earnings) i.e. $760,000 (net change) + $125,000 (dividends) = $885,000 Retained Earnings 125,000 Dividends Declared 125,000 (Dividends Declared for the year closed to Retained Earnings) LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-30 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-11A a. Preferred Arrears 2022 $750,0001 Arrears 2023 750,000 Current 2024 750,000 $2,250,000 1 (150,000 shares x $5) = $750,000

Common

$2,750,000 $2,750,000

Total $750,000 750,000 3,500,000 $5,000,000

b. Common dividends per share = $2,750,000/750,000 = $3.67 c. The entries for the stock dividend would be: Stock Dividends Declared1 4,425,000 Stock Dividends Issuable 1 (750,000 shares x 10% x $59) Stock Dividends Issuable Common Shares

4,425,000

Retained Earnings Stock Dividends Declared

4,425,000

This reduces the company’s retained earnings and increases the share capital by the same dollar amount of $4,425,000. The number of common shares issued also increases by 75,000 shares. The total dollar amount of shareholders’ equity remains unchanged. d. The company could use the issuance of shares instead of cash as a way of satisfying their shareholders’ request for dividends while conserving their cash. It also has the positive effect of capitalizing an amount of retained earnings, recording the fair value of the shares issued as share capital. LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-31 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-12A a. Sequence Genome currently has 125,000 shares issued and 25,000 are held in treasury stock, so only 100,000 of the shares are eligible to receive a dividend. b. Cash dividend of $8 per share Date of declaration Dividends Declared1 Dividends Payable 1 (100,000 shares x $8 per share)

800,000 800,000

Date of record No journal entry, the shareholders who own the shares on this date get the dividend Date of payment Dividends Payable 800,000 Cash 800,000

c. 25% Stock dividend and the stock is trading at $25/share If declared and issued on the same date Stock Dividend Declared2 625,000 Common Shares 625,000 2 (100,000 shares x 25% x $25/share)

________________________________________________________________________________________________ Solutions Manual 11-32 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-12A (Continued) d. When a cash dividend is declared and paid, total shareholders’ equity decreases by the amount of the dividend. Because the shareholder’s equity decreases, the debt-to-equity ratio increases (as the denominator decreases) causing the debt-to-equity ratio to worsen. When a stock dividend is declared and distributed, there is no effect on total shareholder’s equity as it is a reallocation of the dividend amount from retained earnings to common shares so the debt-to-equity ratio would stay the same. e. If I were an investor, I would prefer to receive a cash dividend as I am taxed on both types of dividends received and so with a cash dividend, I would have the cash available to pay the taxes owing. LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-13A a. The board can declare a cash dividend only if they have the cash available and they do not put the company into jeopardy by using up all of the available cash. As the company has cash of $75,000, it could only declare a dividend for up to that amount. b. The board can legally declare a stock dividend up to the retained earning amount in the company which is $590,000 ($490,000 before closing net income of $100,000 to retained earnings). c. Cash dividend: Dividend Declared Cash Stock dividend: Stock Dividend Declared Common Shares

75,000 75,000

590,000 590,000

LO 4 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-33 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-14A a. 1. Information on the number of common and preferred shares authorized will be reported in the share capital note to the company’s financial statements. No journal entry is made until actual shares are issued. 2. Cash (300,000 x $6) Common Shares

1,800,000

3. Cash (35,000 x $10) Preferred Shares

350,000

1,800,000 350,000

4. Dividends Declared – Preferred Shares 105,000 Dividends Payable (35,000 x $3) 5. Dividends Payable Cash

105,000

105,000 105,000

6. Dividends Declared -- Common Shares (300,000 x $0.12) 36,000 Dividends Payable 7. Sales Revenue Income Summary

500,000 500,000

Income Summary Operating Expenses

330,000

Income Summary Retained Earnings

170,000

8. Dividends Payable Cash

36,000

330,000 170,000 36,000 36,000

9. Retained Earnings 141,000 Dividends Declared – Preferred Shares Dividends Declared – Common Shares

105,000 36,000

________________________________________________________________________________________________ Solutions Manual 11-34 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-14A (Continued) b.

Shareholders’ Equity, December 31, 2024 Preferred shares $3 (250,000 shares authorized, 35,000 issued) Common shares (2,500,000 shares authorized, 300,000 shares issued) Retained earnings * Total shareholders’ equity

$ 350,000 1,800,000 29,000 $2,179,000

* $170,000 – $105,000 – $36,000 = $29,000 c.

An investor would purchase common shares to participate in voting at shareholders’ meetings, for share price appreciation and/or dividends. An investor would choose to invest in preferred shares for the increased security of regular dividends (usually). Preferred share holdings also have less risk than common share investment holdings.

LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-35 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-15A a. Year 1 1. Cash Preferred Shares Common Shares 2. Land

650,000 150,000 500,000 150,000

Common Shares Year 2 3. Dividends Declared – Preferred Shares Dividends Payable (10,000 x $2.00) + (10,000 x $2.00)

150,000

40,000 40,000

Dividends Declared – Common Shares Dividends Payable (26,000 x $5.00)

130,000

Retained Earnings

170,000

130,000

Dividends Declared – Preferred Shares Dividends Declared – Common Shares January 15, 2025 (optional) Dividends Payable Cash

40,000 130,000

170,000 170,000

________________________________________________________________________________________________ Solutions Manual 11-36 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-15A (Continued) b.

Shares issued

Preferred Shares

10,000

Common Shares

150,000

20,000

500,000

650,000

6,000

150,000

Shares issued

Retained Earnings

Total $

Net income 2023

250,000

Pref. dividends

(40,000)

Common dividends

(130,000)

Net income 2024

175,000

10,000

150,000

26,000

650,000

255,000 1,055,000

Luna & Stella Corporation Shareholders’ Equity December 31, 2024 Share capital Preferred shares, $2 cumulative non-voting, 100,000 shares authorized, 10,000 shares Issued $ 150,000 Common shares, unlimited number authorized, 26,000 shares issued 650,000 Retained earnings 255,000 Total shareholder’s equity $1,055,000 c.

The owners would have designated the preferred shares as nonvoting in order to keep control of the corporation in the hands of the common shareholders, since they are the ones who bear the primary risk of ownership.

LO 4 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-37 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-16A a. Before the stock split the number of common shares issued and outstanding After the 5 for 4 stock split the number of Common shares issued (80,000 x 5/4) The number of shares distributed from the split

80,000 100,000 20,000

b. There is no accounting entry made; there is a note made in the share registry that the stock split occurred and the number of shares increased but there is no impact to any shareholder’s equity account balances. c. Given that the market price of $24 per share before the stock split, after the stock split the expected price would be $19.20 (80,000 x $24 / 100,000 = $1,920,000/ 100,000 new share number = $19.20) which would reflect the same market value of the company over 20,000 more shares. d. Del Rosso Winery Inc. Shareholders’ Equity December 31, 2024 Share capital Preferred shares, $7 cumulative non-voting, unlimited authorized, 200,000 shares Issued and outstanding $ 2,000,000 Common shares, 250,000 authorized, 100,000 shares issued 1,600,000 Retained earnings 2,500,000 Total shareholder’s equity $6,100,000 LO 5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-38 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-17A a. Before the stock split consolidation, the number of common shares issued 10,000,000 After the 1 for 20 stock split consolidation the number of Common shares issued (10,000,000/20) 500,000 The number of shares consolidated 9,500,000 b. Given that the market price of $0.60 is before the stock split consolidation, after the stock split consolidation the expected price would be $12/share ($0.60 x 20 stock split consolidation) which would reflect the same market value of the company over 9,500,000 fewer shares. c. Miz Corporation Shareholders’ Equity December 31, 2024 Share capital Common shares, unlimited authorized, 500,000 shares issued Retained earnings (deficit) Total shareholder’s equity

$50,000,000 (5,000,000) $45,000,000

d. There is no accounting entry made; there is a note made in the share registry that the stock split consolidation occurred and the number of shares decreases but there is no impact to any shareholder’s equity account balances. LO 5 BT: AP Difficulty: E Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-39 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-18A a. When declared: Stock Dividends Declared Stock Dividends Issuable (100,000 X 10% X $22) When issued: Stock Dividends Issuable Common Shares

220,000 220,000

b. No journal entry is required. The effect of a stock split in the accounts is an increase in the number of shares issued and outstanding. The reported dollar value of the common shares account is not changed. c. Because there are more shares outstanding representing the same net assets (shareholders’ equity) and the overall value of the company has not changed, we would expect the market price per share to be proportionately lower. Given the $22 share price before the transaction, the share price after the 10% stock dividend should = $22/1.10 = $20.00. Given a current market value of $22 per share before a two-for-one stock split, the share price after a 2-for-1 stock split would be $22/2 = $11. d. Based on a current market value of $22 per share, I would not expect the company to split its shares. A $22 price per share is still low enough to be within an active price range and high enough that it will be permitted to trade on recognized exchanges and be followed by stock analysts. LO 4,5 BT: AP Difficulty: E Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-40 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-19A a. Price/earnings ratio = market price per share/earnings per share 2022 = $5.07/$0.36 = 14.1 2023 = $6.83/$0.46 = 14.8 2024 = $11.80/$0.64 = 18.4 The increase in price/earnings ratio reflects a market perception that the company has the potential for further growth. b. Dividend payout ratio = dividends per share/earnings per share 2022 = $0.140/$0.36 = 38.9% 2023 = $0.150/$0.46 = 32.6% 2024 = $0.163/$0.64 = 25.5% Dividend yield = dividends per share/ price per share 2022 = $0.140/$5.07 = 2.8% 2023 = $0.150/$6.83 = 2.2% 2024 = $0.163/$11.80 = 1.4% Both the dividend payout ratio and the dividend yield are decreasing meaning that the company is paying out a smaller percentage of their earnings as dividends. The dollar amount of the dividends increased but this increase was outpaced by the increase in the market price per share. c. Return on equity = Net Income – Preferred Dividend / Average common shareholder’s equity. 2023 = $15,590 / (($157,736+ $147,375)/2) = 10.2% 2024 = $21,363/ (($177,317 + $157,736)/2) = 12.8% The company’s return on equity is increasing which means it is using its equity to generate returns more efficiently in 2024 than in 2023. LO 6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-41 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-1B a. Smokey Smith Inc. Statement of Changes in Shareholders’ Equity Year Ended December 31, 2024

Number of common shares 250,000

Jan. 1, 2024 Common cash dividend Preferred cash dividend Net income1 Other comprehensive income Dec. 31, 2024 1

250,000

Common shares $25,000,000

$25,000,000

Number of preferred Shares 50,000

50,000

Preferred shares $825,000

$825,000

Retained earnings $4,262,000 (450,600) (300,000) 1,777,000

Accumulated other comprehensive income (loss) $(17,000)

$5,288,400

($2,107,000 - $330,000) = $1,777,000 b. Income to common shareholders # of common shares outstanding $1,777,000 - $300,000 250,000

= Earnings per share

= $5.91/share

LO 3 BT: AP Difficulty: M Time: 20 min. AACSB Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-42 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

19,000 $2,000

Total $30,070,000 (450,600) (300,000) 1,777,000 19,000 $31,115,400

Understanding Financial Accounting, Third Canadian Edition

AP11-2B Major Communications Ltd. Statement of Changes in Shareholders’ Equity Year Ended September 30, 2024

Oct 1, 2023 Common shares issued Stock dividend - common shares Common Cash dividends Preferred cash dividend Net income Other comprehensive loss Sept 30, 2024

Number of common shares 1,500,000

Common shares $45,000,0001

400,000

12,800,0003

95,000

4,275,0004

1,995,000

$62,075,000

(1,500,000 x $30) = $45,000,000 2 (200,000 x $15) = $3,000,000 3 (400,000 x $32) = $12,800,000

Number of preferred Shares 200,000

Preferred shares $3,000,0002

Retained earnings $20,375,000

Accumulated other comprehensive income $1,000,000

Total $69,375,000 12,800,000

(4,275,000) (10,274,250)5 (240,000)6 25,000,000 200,000

$3,000,000

$30,585,750

(5,000,000) $(4,000,000)

0 (10,274,250) (240,000) 25,000,000 (5,000,000) $91,660,750

(1,900,000 x 5%) x $45 = 95,000 shares x $45 = $4,275,000 (1,995,000 x $5.15) = $10,274,250 6 (200,000 x $1.20) = $240,000 5

________________________________________________________________________________________________ Solutions Manual 11-43 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-2B (Continued) Major Communications Ltd. Shareholders’ Equity September 30, 2024 Share capital $1.20 Preferred shares, 1 million shares authorized, 200,000 shares issued Common shares, 10 million shares authorized, 1,995,000 shares issued Retained earnings Accumulated other comprehensive income Total shareholders’ equity

3,000,000 62,075,000 65,075,000 30,585,750 (4,000,000) $91,660,750

LO 3 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-3B a. Cash 10,000,000 1 Preferred Shares 10,000,000 Issued 3,000,000 preferred shares (5,000,000 – 2,000,000) 1 ($14,000,000 - $4,000,000) b. Common Shares2 Retained Earnings Cash3 2 3

5,000,000 1,000,000 6,000,000

($10,000,000/2,000,000 = $5/share; $5 x 1,000,000 = $5,000,000) (1,000,000 x $6) = $6,000,000 c. Income Summary Retained Earnings

11,000,000 11,000,000

LO 3 BT: AP Difficulty: H Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-44 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-4B

Common Shares1 Retained Earnings Cash (310,000 x $22.20) 1

6,200,000 682,000 6,882,000

($27,000,000 ÷ 1,375,000) x 310,000 = $2,520,000

Common Shares Contributed Surplus Cash (310,000 x $16.75)

6,200,000 1,007,500 5,192,500

LO 3 BT: AP Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-45 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-5B a. If assets sold for Distribution of proceeds: First, to creditors Remainder for shareholders Preferred shareholders’ entitlement Remainder for common shareholders

(i) $1,756,600

(ii) $4,835,600

(iii) $6,000,000

(550,000)

1,206,000

4,285,600

5,450,000

(1,206,000)

(2,000,000)

$2,285,600

3,450,000

Common shareholders are entitled to share in company’s net assets upon liquidation. While the creditors and preferred shareholders have prior claims to the assets on liquidation, their claims are fixed. The remaining net assets (or the residual amount) is then shared by the common shareholders. It may represent a significant profit to them, or a considerable loss. This is the nature of the risk of being a common shareholder. b. $4,835,600 represents the carrying amount of the assets that have been recognized, all measured according to generally accepted accounting principles (GAAP). It is unlikely that the proceeds on disposal would be the same as this amount for the following reasons: • Many assets are not carried at fair value or market value. • Most of the assets are measured using a cost basis, including perhaps being written down (through impairment) to their lower value in continued use to the company. The value in use may be higher than the amount the company could sell the assets for in a quick sale. In fact, some of the assets may have value only to Currie & Associates, and may not be of any value to others. • Intangibles such as patents often have a value significantly higher than their carrying amount on the books. When a company develops patents internally, most of the costs incurred are expensed as incurred because it isn’t known whether the research will result in future economic benefits to the company.

________________________________________________________________________________________________ Solutions Manual 11-46 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-5B (Continued) • Accounting measurements entail many estimates in determining asset values. Examples include the estimate of the doubtful accounts (accounts receivable), the lower of cost and net realizable value (inventory), residual values and estimated useful lives for depreciation and amortization (property, plant and equipment and intangibles). c. The windup return is the same to the common shareholders if the common shares were never paid as there is no obligation to pay dividends to the common shareholders so there would be no dividendsin-arrears related to the common shareholders. LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-47 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-6B

The following entry would be made on January 1 and July 1 of 2024: Dividends Declared1 1,500,000 Dividends Payable 1,500,000 1 (3 million shares x $0.50/share = $1,500,000) The following entry would be made on January 31 and July 31 of 2024: Dividends Payable Cash

1,500,000 1,500,000

No entries related to the dividend are made by the company on the ex-dividend date or on the date of record. The following entry would be made on October 31, 2024 for the stock dividend Stock Dividend Declared2 2,025,000 Common Shares 2,025,000 2 (3 million shares x 5% x $13.50/share = $2,025,000) LO 4 BT: AP Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-7B a. If McEwan didn’t pay dividends for 2022 and 2023 they would have 2 years in arrears for the preferred dividends. The number of preferred shares outstanding is 3,400,000 and the dividend per year is $0.15 so $510,000 per year or $1,020,000 for 2022 and 2023.

________________________________________________________________________________________________ Solutions Manual 11-48 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-7B (Continued) b. To Preferred Dividend available Arrears to preferred: $0.15 X 3.4 million shares x 2 years Preferred current (see Note 1) Subtotal 3% dividend for Class A and B, Common (see Note 1 below) Subtotal Remainder (see Note 2 below) Total Number of shares Dividends per share

Total $10,000,000

(1,020,000)

1,020,000

(510,000)

510,000

To Common, Class A

To Common, Class B

480,000

1,050,000

8,470,000

(1,530,000)

6,940,000

(6,940,000)

1,735,000

1,632,941

3,572,059

$3,265,000

$2,112,941

$4,622,059

3,400,000

8,000,000

1,000,000

$0.96

$0.26

$4.62

Note 1: $510,000 current dividend / $17,000,000 PS Capital = 3%. Class A and B get a 3% dividend before there is participation for the preferred shares. Class A: 3% x $16,000,000 = $480,000 Class B: 3% x $35,000,000 = $1,050,000

________________________________________________________________________________________________ Solutions Manual 11-49 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-7B (Continued) b. (Continued) Note 2: The remaining dividend will be allocated to the 3 types of shares, based on their proportion of total share capital. Preferred shares: $17 / $68 x $6,940,000 = $1,735,000 Class A shares: $16 / $68 x $6,940,000 = $1,632,941 Class B shares: $35 / $68 x $6,940,000 = $3,572,059

Excluding the arrears, each class of shares gets a 13.21% dividend, based on their share capital balance.

McEwan might have this share structure in order to permit the Class A Common shares to control the company. This is possible because of the multiple votes attached to each share of this class. Perhaps the Class A Common shares are held by members of the family that started the company, but needed additional equity financing as the company grew. So, they created a Class B for non family members. While the holders of the Class A Common and Class B earn an equal return as far as dividends are concerned, decision making is controlled by the family members.

On average, the Class A Common shareholders invested $16,000,000 ÷ 8,000,000 shares = $2.00 for each share. On average, the Class B Common shareholders invested $35,000,000 ÷ 1,000,000 shares = $35.00 for each share. On average, the preferred shareholders invested $17,000,000 ÷ 3,400,000 shares = $5.00 for each share.

________________________________________________________________________________________________ Solutions Manual 11-50 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-7B (Continued) e. Class A Common

Class B Common

0 0%

80,000,000 98.77%

1,000,000 1.23%

Capital invested

$17,000,000

$16,000,000

Portion of capital contributed

25.0%

23.5%

Preferred Number of votes available to be cast Portion of votes

Total 81,000,000 100%

$35,000,000 $68,000,000 51.5%

100%

This table illustrates very clearly the difference between the extent of equity financing and the control of decision-making in McEwen Corporation. LO 4 BT: AP Difficulty: H Time: 50 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-51 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-8B a. Year 2022 2023 2024 b.

2022 Arrears Current 2023 2024 1 2

Preferred $150,000 $150,000 $150,000

Common $375,000 $450,000 $600,000

Total $525,000 $600,000 $750,000

$350,0001 175,0002 $525,000 $175,000 $175,000

$0 $425,000 $575,000

$525,000 $600,000 $750,000

2 years x 7% x $2,500,000 = $350,000 7% x $2,500,000 = $175,000

LO 4 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-9B a.

2024 Oct 1 Stock Dividend Declared1 2,062,500 Stock Dividend Issuable 2,062,500 1 (55,000 shares issued x 30% dividend x $125/share = $2,062,500)

Oct 31

Stock Dividend Issuable Common Shares

2,062,500

b. Market value before stock dividend (55,000 shares x $125 per share) Divided by: Number of shares after stock dividend (55,000 + 16,500) = Market value per share after stock dividend

2,062,500 $6,875,000

71,500 $96.15

LO 4 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-52 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-10B a.

2023 arrears 2024

Preferred

Common

Total

no arrears $87,500 (875,000 x 10%)

$187,500 (residual)

$275,000

Preferred

Common

Total

$175,000 (875,000x 10%) x 2years) $87,500 (875,000 x 10%))

$12,500 (residual)

$275,000

2022 and 2023 arrears 2024 c.

Cash 3,750,000 Common Shares 3,750,000 (1,500,000 common shares issued during year for $2.50/share) Dividends Declared – Preferred Shares Dividends Declared – Common Shares Dividends Payable (Dividends declared )

87,500 187,500

Dividends Payable Cash

275,000

Income Summary 1,950,000 Retained Earnings 1,950,000 ($4,675,000 - $3,000,000 + $275,000) (Net income for the year closed to retained earnings) i.e. $1,675,000 (net change) + $275,000 (dividends) = $1,950,000 Retained Earnings 275,000 Dividends Declared 275,000 (Dividends Declared for the year closed to retained earnings) LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting ________________________________________________________________________________________________ Solutions Manual 11-53 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-11B a. Preferred Common 1 Arrears 2022 $787,500 Arrears 2023 787,500 Current 2024 787,500 $1,637,500 $2,362,500 $1,637,500 1 ($13,125,000 shares x 6%) = $787,500

Total $787,500 787,500 2,425,000 $4,000,000

b. Common dividends per share = $1,637,500/1,000,000 = $1.64 c. The entries for the stock dividend would be: Stock Dividends Declared1 19,500,000 Stock Dividends Issuable 1 (1,000,000 shares x 30% x $65) Stock Dividends Issuable Common Shares

19,500,000

19,500,000 19,500,000

Retained Earnings 19,500,000 Stock Dividends Declared 19,500,000 (Dividends Declared for the year closed to retained earnings) This reduces the company’s retained earnings and increases the share capital by $19,500,000. The number of common shares issued increases by 300,000 shares. The total dollar amount of shareholders’ equity remains unchanged. d. Market value of before stock dividend (1,000,000 shares x $65/share) Divide by: Number of shares after stock dividend (1,000,000 + (1,000,000 x 30%) = Market price per share after stock dividend

$65,000,000

1,300,000 $50/share

LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-54 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-12B a. Aquamanu Developments currently has 185,000 shares issued and 35,000 are held in treasury stock, so only 150,000 of the shares are eligible to receive a dividend. Cash dividend of $0.40 per share Date of declaration - March 1 Dividends Declared1 60,000 Dividends Payable 60,000 1 (150,000 shares x $0.40 per share) Date of record – April 15 No journal entry, the shareholders who own the shares on this date get the dividend Date of payment – May 1 Dividends Payable 60,000 Cash 60,000 b.

10% Stock dividend and the stock is trading at $50/share Date of declaration – March 1 Stock Dividend Declared2 750,000 Stock Dividend Issuable 750,000 2 (150,000 shares x 10% x $50/share) Date of record – April 15 No journal entry, the shareholders who own the shares on this date get the dividend Date of payment – May 1 Stock Dividend Issuable 750,000 Common Shares 750,000

c. When a cash dividend is paid, total shareholders’ equity decreased by the amount of the dividend. Because the shareholder’s equity decreases, the net debt as a percentage of total capitalization ratio increases (as the denominator decreases), causing the net debt as a percentage of total capitalization ratio to worsen. A stock dividend would not impact the ratio as shareholders’ equity is unchanged by a stock dividend. ________________________________________________________________________________________________ Solutions Manual 11-55 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-12B (Continued) d. Overall, a cash dividend will not impact the share price as the number of shares outstanding stays the same, the cash dividend is just a payment of earnings. The market price of the shares will increase by the value of the dividend between the declaration date and the ex-dividend date but should recover back close to the original value after. The market share price of shares will decrease with a stock dividend as there are now more shares outstanding and the value of the company stays the same. LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-13B a. The board can declare a cash dividend if they have retained earnings and the cash available. In this case, after the net loss in 2024 of $100,000, the company only has $45,000 available in retained earnings to pay out in dividends; they have enough cash ($400,000) to pay the dividend. This dividend would have to be split between the preferred and common shareholders. The preferred shareholders would receive $10,000 (10% x $100,000) and the common shareholders would receive the balance. b. The board can legally declare a stock dividend on the company’s common shares of $35,000. This is equal to the amount of retained earnings in the company which is $45,000 ($145,000 before closing net loss of $100,000 to retained earnings) less the preferred dividend of $10,000 (10% x $100,000) which would have to be declared and paid before any dividends on the common shares. c. i. Cash dividend: Dividends Declared – Preferred Shares Dividends Declared – Common Shares Cash

10,000 35,000 45,000

________________________________________________________________________________________________ Solutions Manual 11-56 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-13B (Continued) Retained Earnings 45,000 Dividends Declared – Preferred Shares 10,000 Dividends Declared – Common Shares 35,000 Retained Earnings Income Summary

100,000 100,000

ii. Stock dividend: Preferred shares get the dividend first Dividend Declared – Preferred Shares Cash

10,000 10,000

Stock Dividend Declared Common Shares

35,000

Retained Earnings Dividend Declared – Preferred Shares Stock Dividend Declared

45,000

Retained Earnings Income Summary

100,000 100,000

35,000

10,000 35,000

LO 4 BT: AP Difficulty: E Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

AP11-14B a. 1. Cash

8,250,000

Common Shares Issued 500,000 shares 2. Cash (200,000 x $12) Preferred Shares

8,250,000 2,400,000

3. Dividends Declared – Preferred Shares 312,000 Dividends Payable (2,400,000 x 13%)

2,400,000

312,000

________________________________________________________________________________________________ Solutions Manual 11-57 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-14B (Continued) 4. Dividends Declared -- Common Shares Dividends Payable (500,000 shares x $0.25) 5. Dividends Payable Cash 6. Dividends Payable Cash

125,000 125,000 312,000 312,000 125,000

7. Income Summary 2,100,000 Retained Earnings Retained Earnings 437,000 Dividends Declared – Preferred Shares Dividends Declared – Common Shares b.

125,000

2,100,000

312,000 125,000

Shareholders’ Equity, December 31, 2024 13% fixed dividend, cumulative, retractable, non-participating, non-voting preferred shares (unlimited shares authorized, 200,000 issued) $ 2,400,000 Common shares (2,000,000 shares authorized, 500,000 shares issued) 8,250,000 1 Retained earnings 1,663,000 Total shareholders’ equity $12,313,000 1

$2,100,000 – $437,000 = $1,663,000

The preferred shares are a hybrid security as they have a fixed dividend rate as well as being non-voting which makes them like debt since they get a fixed rate of return and they don’t have a vote in the operations of the business. However, it is a payment of dividends not interest so it is still an equity security. Typically, these types of securities would be recorded as both debt and equity, depending on the component.

LO 4 BT: AP Difficulty: M Time: 40 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-58 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-15B a. 2024 1. Cash 305,000 Preferred Shares 250,000 Common Shares 55,000 Issued 10,000 (10,000 x $25/share) preferred shares and 10,000 common shares 2. Equipment Common Shares Issued 60,000 common shares

300,000 300,000

3. Dividends Declared –Preferred Shares 35,000 Dividends Payable 10,000 preferred shares issued x $3.50/share 4. Dividends Payable Cash 5. Sales Revenue Income Summary

35,000 35,000 2,075,000 2,075,000

Income Summary Operating Expenses

1,825,000

Income Summary Retained Earnings

250,000

1,825,000

250,000

Retained Earnings 35,000 Dividend Declared – Preferred Shares 2025 6. Dividends Declared – Preferred Shares Dividends Payable (10,000 x $3.50) + (10,000 x $7.00) Dividends Declared – Common Shares Dividends Payable ($200,000 – $105,000)

35,000

105,000 105,000

95,000 95,000

________________________________________________________________________________________________ Solutions Manual 11-59 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-15B (Continued) 7. Dividends Payable Cash

200,000

8. Stock Dividends Declared Stock Dividends Issuable ((60,000 + 10,000) x 20% x $7.00)

98,000

Stock Dividends Issuable Common Shares 9. Sales Revenue Income Summary

200,000

98,000

98,000 98,000 2,100,000 2,100,000

Income Summary Operating Expenses

1,005,000

Income Summary Retained Earnings

1,095,000

Retained Earnings

298,000

1,005,000

1,095,000

Dividends Declared – Preferred Shares Dividends Declared – Common Shares Stock Dividends Declared

105,000 95,000 98,000

________________________________________________________________________________________________ Solutions Manual 11-60 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-15B (Continued) b.

Preferred Shares

Common Shares

10,000

250,000

10,000

55,000

305,000

60,000

300,000

Shares issued Shares issued

Retained Earnings

Total $

Pref. dividends - 2024

(35,000)

Net income - 2024

250,000

Pref. dividends - 2025

(105,000)

Common dividends - 2025

(95,000)

Stock dividend - 2025

14,000

98,000

(98,000)

453,000

1,095,000 1,012,000

Net income - 2025 10,000

250,000

84,000

c. The board can legally declare a dividend of up to $1,012,000 as that is the retained earnings balance but they also need to have the cash available to do so. d. Di Vidnd Corporation Shareholders’ Equity December 31, 2025 Share capital Preferred shares, $7 cumulative non-voting, redeemable, 75,000 shares authorized, 10,000 shares issued Common shares, unlimited number authorized, 84,000 shares issued Retained earnings Total shareholder’s equity

$ 250,000 453,000 1,012,000 $1,715,000

LO 4 BT: AP Difficulty: M Time: 60 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-61 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

· 1,095,000 1,715,000

Understanding Financial Accounting, Third Canadian Edition

AP11-16B a. The board should declare a stock split to reduce the market price to $50 per share or lower. If currently at $150, 150/50 = 3. If they issued a 3-for-1 stock split, the market price would reduce to $50. b. The expected market price would be $50 as each share would now be 3 shares and each share would be 1/3 of the previous market value of $150 or $50. c. There is no accounting entry made; there is a note made in the share registry that the stock split was declared and the number of shares increased but there is no impact to any shareholder’s equity account balances. d. Dolce Corporation Shareholders’ Equity December 31, 2024 Share capital Preferred shares, $9 non-cumulative, unlimited authorized, 200,000 shares Issued and outstanding $ 5,000,000 Common shares, unlimited authorized 750,000 shares issued and outstanding 7,500,000 Retained earnings 4,500,000 Total shareholder’s equity $17,000,000 LO 5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-62 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-17B a. Before the stock split consolidation, the number of common shares issued The total market value (600,000 x $0.30) $180,000 The number of shares needed to have $6 per share ($180,000/$6) Number of shares that need to be consolidated The amount of reverse stock split (600,000 / 30,000)

600,000 (30,000) ______ 570,000 1 for 20

b. The average issue price per share would be $120 ($3,600,000/30,000 shares) c. There is no accounting entry made; there is a note made in the share registry that the stock split consolidation was declared and the number of shares decreased but there is no impact to any shareholder’s equity account balances. d. The advantages of a reverse stock split are: • it increases the share market price which can remove the risk of a company being delisted from a stock exchange if the price drops below the minimum market value • it could make them remain eligible for certain institutional investors who have minimum stock values. • the higher value of shares will allow them to list on a public exchange The disadvantage of a reverse stock spilt is: • it may signal to investors that the company is struggling or doing poorly and devalue the company even more. LO 5 BT: AP Difficulty: M Time: 25 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-63 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-18B a. The stock split has no effect on retained earnings; it just changes the number of shares issued and outstanding. In this case, the number of shares would increase from 250,000 to 1,000,000, which would reduce the share price from $200 to $50 per share. A stock dividend reduces retained earnings and increases common shares by $15,000,000 (250,000 x 30% x $200). There is no impact to total shareholder’s equity. In this case, the number of shares would increase from 250,000 to 325,000 (250,000 x 1.3), which would reduce the share price from $200 to $153.85 ($200 / 1.3). b. No journal entry is required. The effect of a stock split in the accounts is an increase in the number of shares issued and outstanding. The reported dollar value of the common shares account is not changed. A four-for-one issue would increase the number of share from 250,000 to 1,000,000. c. When declared: Stock Dividends Declared 15,000,000 Stock Dividends Issuable (250,000 X 30% X $200) When issued: Stock Dividends Issuable Common Shares

15,000,000

15,000,000 15,000,000

d. The stock split would appear to be the better course of action for Pegahmagabow. This would have the effect of significantly reducing the share price (from $200 to $50). The 30% stock dividend would only reduce the share price to $153.85, which is likely insufficient to achieve the company’s objective of making its shares more affordable. LO 4,5 BT: AP Difficulty: E Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-64 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-19B a. Return on shareholder’s equity = Net income – preferred dividends/average common shareholder’s equity 2024 = $275,659/(($2,233,319+$1,379,197)/2) = 15.3% OCloud is doing worse compared to the average return of 19.8% for the Toronto Stock Exchange. The investor will see that their investment is providing a return lower than that of the average company on the exchange. b. Earnings per share = Net income/weighted average number of common shares outstanding 2023 = $284,477/242,926 = $1.17 per share 2024 = $275,659/253,879 = $1.09 per share Price/earnings ratio = Market price per share / earnings per share 2023 = $38.20 / $1.17 = 32.65 times 2024 = $40.93 / $1.09 = 37.55 times OCloud has experienced a reduction in its earnings per share from 2023 to 2024. When combined with a share price increase, the price/earning ratio increased. c. Dividend payout ratio = dividends per share/earnings per share 2023 = $0.415/$1.17 = 35.5% 2024 = $0.477/$1.09 = 43.8% Dividend yield = dividends per share/ price per share 2023 = $0.415/$38.20 = 1.1% 2024 = $0.477/$40.93 = 1.2%

________________________________________________________________________________________________ Solutions Manual 11-65 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

AP11-15B (Continued) c. (Continued) The dividend payout ratio has increased meaning that the company is paying out more of its earnings as dividends and reinvesting less of its net income back into the business. The dividend yield increased slightly. LO 6 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-66 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP11-1

The share issuance benefits the bank’s position as a creditor because the assets of the company increase as a result. Since claims of creditors must be satisfied prior to the claims of shareholders, the additional assets that result from the share issuance offer the bank more assurance that its loan is protected. This greater assurance or comfort is evidenced by a lower debt/equity ratio. Negative outcomes from the perspective of the bank include possibility that company is in trouble, or will use cash to finance highrisk projects.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP11-2

With the issuance of preferred shares, your claim on the assets upon liquidation has decreased below preferred shares. If there is a liquidation, creditors will have first right to assets, then preferred shareholders, then common shareholders have the residual. In terms of dividends, the preferred share holders have a right to cash dividends before the common share dividends. The preferred share holders will get their fixed rate dividend before the common shareholders receive any dividends. The board of directors may have opted to issued preferred shares to finance the acquisition of the new IT equipment as they do not have to pay the money back (unlike debt where the principal needs to be repaid) and only have to pay dividends when the cash is available (unlike debt where interest must be paid each year regardless of cash available). They may have opted for preferred shares over common shares as preferred shares do not get a vote (meaning the common shareholders still have the same vote % as before the preferred shares were issued). As a result, the ownership interest of the common shareholders has not been diluted. It appears that the company is planning significant dividends in the next few years and preferred shares are limited to the 4% fixed rate, with the residual paid to the common shareholders.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting ________________________________________________________________________________________________ Solutions Manual 11-67 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-3

If you are Class B shareholder you are only entitled to 1 vote per share owned whereas the Class A shareholders get 10 votes per share. So, although there are fewer Class A shares – 2,500,000, they get 25,000,000 votes compared to the Class B shares who only have one vote each – 6,300,000. If the Class A shares are closely held by a small group even though they have only provided 19% ($25 million / $135 million) of the equity capital. They essentially are controlling the company and the Class B shareholders will have little say in the management and operations of the corporation

LO 3 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP11-4 a. (i)

Cash dividend Personal financial position – before: Fair value of 10,000 shares of Yangtze Personal financial position – after: Fair value of 10,000 shares of Yangtze Cash ($1.50 X 10,000 shares)

(ii) Yangtze’s financial position – before: Net assets ($10,100,000 – $3,000,000) or ($3,000,000 + $4,100,000) (Cash dividend: $1.50/share X 1,000,000) Yangtze’s financial position – after: Net assets before cash dividend Less cash and retained earnings reduction

$150,000 $150,000 15,000 $165,000

$7,100,000

$7,100,000 1,500,000 $5,600,000

(iii) My financial position increased by $15,000, a 10% cash return on my investment in Yangtze. Yangtze’s financial position changed by a decrease in cash and net assets of $1,500,000. I own 1% of the company, and my cash dividend of $15,000 is 1% of the decrease in the company’s net assets of $1,500,000. Therefore, the company has distributed company assets to me in the same proportion as my ownership interest. I now hold the cash personally instead of within the company.

________________________________________________________________________________________________ Solutions Manual 11-68 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-4 (Continued) b. Stock dividend (Assumes that the fair value of the company’s shares is reduced by the proportion of the additional shares issued in the stock dividend) (i) Personal financial position – before: Fair value of 10,000 shares of Yangtze $150,000 Personal financial position – after: I hold 10,000 X 1.1 shares = 11,000 shares The fair value per share is now $15/1.1 = $13.6364 Fair value of 11,000 shares of Yangtze = 11,000 X 13.6364 = Cash ($0.0 X 10,000 shares) (ii) Yangtze’s financial position – before: Net assets ($10,100,000 – $3,000,000) or ($3,000,000 + $4,100,000) (Stock dividend: 10% X 1,000,000 X $15) Yangtze’s financial position – after: Net assets before cash dividend Change in net assets from stock dividend ($1,500,000 - $1,500,000)

$150,000 0 $150,000

$7,100,000

$7,100,000 0 $7,100,000

(iii) My financial position did not change in a direct way as a result of the stock dividend, nor did the financial position of Yangtze. I will need to pay income tax on the stock dividend. For shareholders, this is the main disadvantage of a stock dividend. c. I would prefer the cash dividend as both dividends are taxable, in the case of the cash dividend I would have received the cash needed to pay in income taxes on the income received, whereas with the stock dividend I have not. If I don’t have other sources of cash to pay the taxes, I would be forced to sell some of my shares to generate the cash to pay the taxes.

________________________________________________________________________________________________ Solutions Manual 11-69 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-4 (Continued) If I have a longer-term perspective, I might prefer the stock dividend, with the hopes that the company uses its cash for investment opportunities that will increase the value of my shares over time and generate more cash inflow to me in the future. d. My recommendation to Yangtze would also depend on the situation. Existing shareholders must have acquired the shares in the company knowing that the company does not pay dividends. This type of investor is probably looking at a longer time horizon and for returns based on the potential for capital appreciation and growth. This is more likely to happen if the company has profitable investment opportunities which are in the long-run best economic interests of its shareholders. In this situation, a stock dividend is preferred. However, if the board of directors have been telling shareholders to wait for cash dividends until the company was more financially stable, it appears that it is now in a good position. Therefore, a one-time cash dividend may now be appropriate. I might suggest, however, that a 10% dividend is a relatively high rate. e. The creditor who provided the long-term bank loan would prefer that the company issue a stock dividend. This conserves the company’s cash, strengthens the amount of permanent capital and provides an even larger cushion of safety for the creditors. f. i. No, Yangtze is not a good candidate for a stock split. Its shares are currently trading at $15 per share, well within the range of prices that allow for active trading by investors. ii. A stock split has no effect on my personal financial position or that of Yangtze. In my case, I would just have more shares representing the same ownership interest (1%), and the company would have more shares outstanding with no change in any other aspect of the company. LO 4,5 BT: C Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-70 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-5 a. 2013: purchase of shares 2017: 4-for-1 split 2019: 2-for-1 split 2022: 2-for-1 split

Number of shares 100 300 400 400 800 800 1,600

I would currently own 1,600 shares. b. 2021 dividend: 800 X $.075 X 4 2022 dividend: 800 X $.075 X 3 2022 dividend after Sept. split: 1,600 x $.075 x 1 2023 dividend: 1,600 X $.090 X 4 2024 dividend: 1,600 X $.108 X 1 Total amount of dividends received

$240.00 180.00 120.00 576.00 172.80 $1,288.80

c. The frequency of stock splits would indicate that the company’s share value was increasing rapidly, which indicates that the company was growing significantly, but retaining/reinvesting its cash to fund further expansion. The introduction of the quarterly dividend in December 2020 likely reflects that the company was maturing and there was less need to retain cash to fund growth. LO 4,5 BT: AP Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-71 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-6 a. There would be no cash payment or cash proceeds from the stock dividend. Additional shares were issued to existing shareholders, but no cash was involved in this transaction. b. Assuming no purchases or sales of shares by individual shareholders, each owns the same proportion of the company as in 2023. A stock dividend is issued to all shareholders based on their existing holdings. Before the stock dividend the market price of each of the shares was $18. After the dividend, the share price would have decreased immediately to $18/1.16 or $15.52. However, the price has increased to $16 per share since the stock dividend. Thus, the market value of your interest has increased from 5,000 X $18 or $90,000 before the stock dividend to 5,000 X 1.16 X $16 or $92,800 at December 31, 2024. c. Stock dividends give shareholders more shares to represent their identical proportionate interests in the net assets of the company. To this extent, you are correct in saying such dividends don’t give you anything you didn’t already have. However, the company’s permanent capital increases as retained earnings are capitalized when they are transferred to share capital, and often the market perceives such a dividend in a positive light. This may be because it appears less risky or it signals that the company wants to conserve its cash for profitable investment opportunities and growth. (This was the case in our situation with the upcoming plant expansion.) Because of this, the market price of a company’s shares is often bid up after a stock dividend. These are the reasons we issued the stock dividend. If the price rises by more than the percentage increase in the number of shares, you will be better off. Also, if future cash dividends are not reduced on a per share basis, again, you will be better off. d. If the company pays a cash dividend, then the company cannot require the shareholders to return that cash to the company in the form of new share purchases. The shareholders are free to use the cash in any way they want. The company will thus not conserve cash, if this was the objective of the stock dividend.

________________________________________________________________________________________________ Solutions Manual 11-72 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-6 (Continued) e. The company did not cut back on the dividend to you. Prior to the stock dividend, the dividend rate was $1.74 per share. To maintain dividends at an amount equal to the old rate, the new dividend was calculated at $1.74/1.16 or $1.50. Therefore, the total value of your dividend is unchanged when considering the increased number of shares you now hold. f. The expected cost of the plant expansion is only an estimate. There may be an increase in costs which cannot be foreseen, and the company is conservative and wishes to ensure that it can complete the expansion without any repercussion on cash flows should the expansion go over budget. In addition, management also must invest in additional working capital as the level of operations increases. LO 4,5 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP11-7 a. Calculation of common dividend expected: Total expected dividend ($2,100,000 x 35%) Preferred dividends: Arrears on Class B (10,000 x $7.50) Current year, Class A (50,000 x $8.00) Current year, Class B (10,000 x $7.50) Available for common shares

$735,000 (75,000) (400,000) (75,000) $185,000

$185,000/1,500,000 = $0.1233 per share $0.1233 x 100 shares = $12.33 total dividends You would expect to receive $12.33 from your purchase of 100 common shares.

________________________________________________________________________________________________ Solutions Manual 11-73 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-7 (Continued) b. If the Class B preferred shares are non-cumulative, you would expect to receive $17.33 on 100 common shares. Total expected dividend ($2,100,000 x 35%) Preferred dividends: Current year, Class A (50,000 x $8) Current year, Class B (10,000 x $7.50) Available for common shares

$735,000

Common shares outstanding Common dividends per share ($260,000 ÷ 1,500,000 shares) Common shares to be purchased Dividend on 100 common shares

1,500,000

(400,000) (75,000) $260,000

$0.1733 x 100 $ 17.33

LO 4 BT: AP Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP11-8 a. The current price/earnings ratio is 4, calculated as ($0.68 / $0.17). b. The current market value of the company is $6,324,000, calculated as (9,300,000 shares x $0.68). c. A company would want to reverse split its shares to bring to share price up. The share price of $0.68 (less than a dollar), is sometimes termed a "penny stock", which may have negative investor perceptions. A reverse stock split will decrease the number of shares outstanding, and thus increase the EPS and share price. d. Repurchasing the shares would not achieve the same results as a reverse split. Repurchasing the shares would decrease the number of outstanding shares, but may not proportionally increase the share price and the EPS. Also, repurchasing shares requires the use of company cash, and Peninsula Minerals may not be in position at this point to afford this.

________________________________________________________________________________________________ Solutions Manual 11-74 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-8 (Continued) e. Shares outstanding before the reverse split = 9,300,000 shares. After the 1-for-3 reverse split, there would be 3,100,000 (9,300,000 / 3) shares outstanding. f. The price/earnings ratio before the reverse split was 4 (see part a). If the ratio after the reverse split is also 4, then share price must be $2.04 ($0.68 x 3, since EPS will also increase by factor of 3). LO 5 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

UP11-9 a. If you were to purchase its shares, your prospects of receiving a dividend are slight because, although earnings per share has been increasing more than 14% in recent years, the expenditures in capital assets indicate that the company is growing, and is likely to reinvest the assets generated from its profitable operations (net income). Your reasoning that the company can declare a $3 or $4 dividend without making a dent in retained earnings overlooks the fact that cash is required to pay out the dividend. At the current time, the company can declare a maximum $0.92 dividend before exhausting its current cash balance. In addition, the $137,500 cash on hand is likely required to settle current liabilities as they become due. b. During the next five years, your prospects of getting a dividend are much higher because the company will likely generate a reasonable return on the capital assets it has recently invested in, and may no longer need to reinvest all its earnings to fund future growth. In general, mature companies are more likely to declare dividends than growth companies, because mature companies generate cash from operations in excess of what is needed to finance expansion.

________________________________________________________________________________________________ Solutions Manual 11-75 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-9 (Continued) c. If Stanley had been paying dividends in the past that might indicate that company is sensitive to maintaining good relations with shareholders. This is a positive sign. Nevertheless, past dividends are not necessarily an indication of future dividends, especially in the next few years as the company expands. If you have a longer- term investment horizon, the prospects for capital appreciation on an investment in shares of Stanley may prove more profitable than regular dividends. d. i. If Stanley were to enter into such a loan agreement, the prospect of getting a dividend is reduced because the company is required to comply with the debt covenant. With the additional long-term debt, the long-term debt to equity ratio based on December 31, 2024 numbers would be 1.3 to 1 ($4,000,000 / $3,066,000) with debt being 130% of equity. This significantly exceeds the 60% stipulated. ii. It will take a while for the ratio to come down below the 60% maximum specified. Over the next five years, if the company continues to be profitable, the retained earnings and total equity would continue to grow, and the ratio would decrease. However, the balance in retained earnings would have to almost triple its December 31, 2024 balance to meet the 60% ratio required. That is, the company needs $4,000,000/.60 = 6,666,667 of total equity at a minimum to just meet a debt to equity ratio of 60%. In the absence of issuing new share capital, retained earnings would have to increase from $2,066,000 to $5,666,667, an amount about 275% of the existing balance. No dividends could be paid until more than this amount is accumulated, because any cash dividends have the effect of reducing the equity. Note that this assumes the existing long-term debt is relatively new debt and is not due and payable within the fiveyear period. If it were paid down or paid off, the amount of earnings needed to be retained would be reduced. LO 4 BT: C Difficulty: M Time: 30 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-76 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-10

The P/E ratio compares the market price per share to the earnings per share of a company. If the P/E ratio increases, it means that the share price has become more expensive in relation to the company’s earnings per share. If it decreases, it becomes less expensive in relation to the company’s earnings per share. If you are trying to identify less expensive stocks, you would look for lower P/E ratios of companies in the same industry. A lower P/E ratio could indicate a company is undervalued in the market and it may be a good time to buy the shares.

LO 6 BT: C Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

UP11-11 a.

NOTE: For simplicity, the year-end amounts of assets and shareholders’ equity have been used throughout instead of using the average outstanding during the year. i. Return on assets = Net income / Total assets = $540,000 / $8,309,000 = 6.5% ii. Dividend payout ratio = Total dividends/Net income = ($50,000 + $300,000)/$540,000 = 64.8% iii. Return on common shareholders’ equity = (Net income – preferred dividends) / (Shareholders’ equity – preferred shares) = ($540,000 – $50,000) / ($6,363,000 – $700,000) = 8.7%

________________________________________________________________________________________________ Solutions Manual 11-77 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-11 (Continued) b.

i. Return on common equity with $1,400,000 equity rather than debt financing = (Net income + interest – preferred dividends) / (Shareholders’ equity + interest – preferred shares) = ($540,000 + $70,000 – $50,000) / ($6,363,000 + $1,400,000 + $70,000 – $700,000) = 7.9% ii. Windmere’s return on common equity is lower when the company uses more common shares and less long-term debt. This indicates that the company earns a higher rate of return on the funds invested in operating assets than it pays out in interest on the funds acquired through long-term borrowing. The excess return accrues to the common shareholders who are better off. In this case, the company’s use of debt financing, called leverage, increases the return to the shareholders. Also, the cash dividend per share could decrease due to the additional shares outstanding. iii. Debt financing (leverage) increases the return to the common shareholders whenever the company earns a higher return on the assets than the interest expense it incurs on the borrowed funds. On the other hand, if the interest expense exceeds the return earned on the assets acquired with the borrowed funds, then the return on common equity decreases.

c. i. Return on common equity without the preferred shares = Net income / Shareholders’ equity = $540,000 / $6,363,000 = 8.5%

________________________________________________________________________________________________ Solutions Manual 11-78 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

UP11-11 (Continued) ii. This is lower than the return calculated for the common equity with the preferred shares outstanding. This is because the return paid to the preferred shareholders is only $50,000 / $700,000 = 7.1%. This is less than the return earned on the common shareholders’ equity of 8.7%. Therefore, a reduction of preferred share financing and an increase in common shares would reduce the rate of return received by the common shareholders. iii. In this case, the company’s management is successfully using debt to increase the return to the common shareholders. As a result, the return on common shareholders equity is higher than the return on preferred shares. However, if there is no long-term debt and the overall rate of return earned on assets is lower than the preferred dividend rate, then the existence of the preferred financing reduces the rate of return to the common shareholders. LO 6 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-79 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

WORK IN PROGRESS WIP11-1

Obligations to creditors are finite as the borrowed funds must eventually be repaid. All loans have a maturity date, the date on which the principal amount of the loan needs to be repaid. The maturity date represents the end of the credit arrangement and as such, all creditor obligations have a finite life. Unlike debt, shares have no maturity date and remain equity of the company until they are repurchased by the company or the company is liquidated. As a result, the company’s obligations to its shareholders exist indefinitely, for the life of the corporation.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP11-2

Typically investors would want the preferred shares to have a fixed or stated rate because the company who issued them bears the risk of interest rates changing after the issuance of the shares and the shareholders have a predictable return. Retractable preferred shares are also desirable as they can be redeemed at the investor’s discretion; the investor can force the company to buy back their preferred shares at specified dates. The investor will also ideally like the preferred shares to be cumulative versus non-cumulative so if dividends aren’t declared in a year, the shareholder would have the right to dividend arrears which would need to be paid first out of any future dividends. If the shares were non-cumulative, if an annual dividend isn’t declared the dividend is lost. Another feature the investor may want is for the shares to be convertible into common shares. If convertible, they would become common shares on conversion date and the investor would not be limited to a fixed dividend rate. Conversion features provide preferred shareholders the opportunity to participate in the growth of the company and the right to vote.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-80 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

WIP11-3

My classmate is correct that neither stock dividends nor stock splits affect the amount of shareholders’ equity. My classmate is incorrect about retained earnings not being affected by stock dividends. A stock split simply increases the number of issued shares, while a stock dividend shifts retained earnings to share capital, while leaving total shareholders’ equity unchanged. My classmate is correct that there is no effect on the return on shareholders’ equity.

LO 4,5 BT: C Difficulty: E Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP11-4

The co-worker would only be correct if, after a stock dividend is declared, the market value of the shares adjusts perfectly to reflect the new number of shares. We would expect this to be the case as there is no increase in the value of the company but it doesn’t always happen. The co-worker is also correct in that the stock dividend is taxable and the shareholder needs to take personal cash to pay for the additional tax. However, in terms of the market price per share, typically stock dividends are viewed as a good thing in the market because the company has retained its cash and the market price of the shares tends to increase, making the investors investment increase as well.

LO 4 BT: C Difficulty: H Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

WIP11-5

When investors are identifying potential investments, they look for a lower P/E ratio which means that the company may be undervalued in the market compared to other companies in the industry with higher P/E ratios. A higher dividend yield is more desirable for investors because it represents a higher return on the investment. Your classmate has correctly interpreted a desired high dividend yield and incorrectly stated a higher P/E ratio, a lower is more desirable.

LO 6 BT: AN Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-81 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

READING and INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI11-1

a. i. Ability to influence the selection of management and to influence company decision-making. Note that the latest annual report indicates there are 51,004,076 Multiple voting shares issued and 59,435,079 Subordinate voting shares issued. Multiple voting shares Subordinate voting shares Multiple voting shares have a Subordinate shares have a total total of 510,040,760 votes at of 59,435,079 votes at March March 28, 2021. With 28, 2021. With approximately %1 approximately 90 of the total 10% of the total votes, this class votes, this class of shares of shares cannot control the controls the selection of selection of management and management and corporate corporate decision-making. decisions. The multiple voting shares are convertible at any time at the option of the holder into one subordinate share. 1 (510,040,760 / [(51,004,076 x 10) +59,435,079]

(510,040,760 / 569,475,839) = 90%

ii. Amount and priority of expected dividends Multiple Voting Shares Subordinate voting shares The multiple voting shares and The multiple voting shares and the subordinate voting shares the subordinate voting shares participate equally in any participate equally in any dividends declared. dividends declared.

________________________________________________________________________________________________ Solutions Manual 11-82 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

RI11-1(Continued) b. Votes, Multiple voting shares (51,004,076 x 10) Votes, subordinate voting shares Total votes

510,040,760 59,435,079 569,475,839

100,000 Multiple voting shares can vote 1,000,000(100,000 x 10)/569,475,839 = 0.18% of the votes. 100,000 Subordinate voting shares can vote 100,000/569,475,839 = 0.018% of the votes. c. Investors would choose to purchase Multiple voting shares over Subordinate voting shares as they are entitled to the same dividend and rights as the subordinate voting shares, only they have 10 times the voting right or control. However, it appears that the Multiple voting shares are only available to specific principal shareholders and if they sell them, they get converted automatically to Subordinate voting shares. Investors holding Subordinate voting shares are permitted to buy and resell their shares, which is an advantage over the investors holding Multiple voting shares. d. Shareholders holding Multiple voting shares may wish to convert their shareholdings into Subordinate voting shares to permit the reselling of their shares. LO 3 BT: C Difficulty: M Time: 35 min. AACSB: None CPA: cpa-t001 CM: Reporting

RI11-2 a.

2020

2019

2018

Market price per share Earnings per share

$26.91 $1.73

$19.87 $1.50

$19.83 $1.61

Price earnings ratio

15.55

13.25

12.32

The increasing trend in the price-earnings ratio reflects the market having a positive outlook regarding the company’s future.

________________________________________________________________________________________________ Solutions Manual 11-83 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

RI11-2(Continued) b.

2020

2019

2018

Dividends per share Earnings per share

$0.39 $1.73

$0.77 $1.50

$0.72 $1.61

Dividend payout ratio

22.5%

51.3%

44.7%

2020

2019

2018

$0.39 $26.91

$0.77 $19.87

$0.72 $19.83

Dividends per share Market price per share Dividend yield ratio

1.45%

3.88%

3.63%

Sleep Country increased its dividend payout and dividend yield in 2019 but had a dramatic decrease in these two ratios in 2020. This would make the stock less attractive to potential shareholders. c. Return on Equity 2020 Net income / Average common shareholders’ equity $63,307 / [($358,542 + $305,510) / 2] = 19.07% 2019 Net income / Average common shareholders’ equity $55,460 / [($305,510 + $303,744) / 2] = 18.21% Management’s effectiveness in using the equity of its shareholders to generate revenue has improved slightly from 2019 to 2020. LO 6 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-84 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

RI11-3 a. Price/earnings ratio, December 31, 2020: = market price per share/(basic) earnings per share = $67.42/$4.27 = 15.79 times b. Dividend payout ratio for 2020: = dividends per share/(basic) earnings per share = $0.36/$4.27 = .084 or 8.4% c. The return on shareholders’ equity is as follows: 2020: $279,133 = ($4,353,498 + $4,029,755)/2

$279,133 = $4,191,627

6.7%

$430,441 = $3,916,444

11.0%

2019: $430,441 = ($4,029,755 + $3,803,132)/2

With the large decrease in sales and net earnings has come a corresponding decrease in the return on shareholders’ equity. This trend is likely caused by Covid. LO 6 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-85 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

RI11-4 a. Companies today prefer having an unlimited number of authorized shares so that they do not have to go back and change their articles of incorporation. Changing this legal document would come at a cost and need to be explained to existing shareholders, and runs the risk of opposition from some groups of shareholders. In addition, an unlimited number of authorized shares gives the company more flexibility in its ability to grant stock options, stock dividends and stock splits. b. At December 31, 2020, Finning had 162,107,484 shares outstanding. These shares were issued initially for $566,000,000, giving an average issue price per share of $3.49. c. Finning reported net income of $232 million in 2020, and declared dividends of $133 million. Its dividend payout ratio, or percentage of its net income paid out as dividends, therefore, was $133/$232 = 57.3%. d. Return on equity, 2020: $232 ($2,115 +$2,206)/2

$232 $2,160.5

10.7%

$242 $2,112

11.5%

Return on equity, 2019: $242 ($2,109 + $2,115)/2

LO 6 BT: AN Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

________________________________________________________________________________________________ Solutions Manual 11-86 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

RI11-5 a. When Aritzia Inc. went public, it changed its capital structure from 5 types of authorized shares which were repealed: • Class A common • Class B common (none issued at that time) • Class C common • Class D common (none issued at that time) • Preferred (none issued at that time) These were replaced with the authorization of 3 types of shares: • Multiple voting shares • Subordinate voting shares • Preferred shares issuable in series (none issued) In addition, following this amendment of its authorized share capital, Artizia reduced the number of its outstanding shares on a one to 0.5931691091 basis, considerably reducing the number of total shares outstanding. b. Aritzia raised a total of $460.0 million from the IPO -- $400.0 million gross proceeds from the Oct 3rd issuance and another $60.0 million from the additional shares permitted through an over-allotment option to the underwriters. Total fees and expenses were $7.7 million. The fees and expenses reduced the total proceeds raised in the IPO by 1.7%. c. The 1 to 0.5931691091 consolidation of the outstanding shares prior to the closing of the IPO can be likened to a 0.5931691091 reverse stock split. Each share held by a shareholder was exchanged for 0.5931691091 of a share, so each shareholder ended up with a little less than sixty percent of the number of shares they had acquired in the IPO. The immediate effect would be to increase the market value of each share by a factor of 0.5931691091. If the share value was $10 before the consolidation, it would now have a market value of $10/0.5931691091 or $16.86.

________________________________________________________________________________________________ Solutions Manual 11-87 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

RI11-5(Continued) d. The amount of the increase in the market value of the common shares from the date of the IPO of $16.00 per share to June 30, 2021 of $37.08 per share is 132% ($37.08 - $16.00) ÷ $16.00. For an initial investment of 100 shares ($1,600.00) the market value at June 30, 2021 of $37.08 would be $3,708.00, an increase of $2,108.00. LO 3 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

RI11-6 Answers to this question will depend on the company selected. LO 3,4 BT: AN Difficulty: M Time: 80 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-88 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C11-1 Manonta Sales Company Expected Statement of Income for 2024: ($ in thousands) Income before income taxes (increase 10%) $44,000 Plus interest on debt saved ($90,000 x 6%) 5,400 Adjusted income before income taxes 49,400 Income taxes ($14,000/$40,000 = 35%) (17,290) Expected net income $32,110 Current number of shares ($26,000,000/$1.30) 20,000,000 To be issued on conversion of debt 9,000,000 Expected number of shares 29,000,000 Expected earnings per share ($32,110,000/29,000,000) Expected market price per share (multiple of 24) Current market price ($1.30 x multiple of 20) % increase

$ 1.107 $26.57 $26.00 2.2%

Decision: Sell, because the market price is expected to increase by less than 10%. LO 6 BT: AN Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-89 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-2 Tribec Wireless Inc. a. A cash dividend reduces assets (cash) and retained earnings. This reduction in net assets reduces the overall value of the company by paying cash resources out to the shareholders. At the time of declaration, a dividend payable is recorded because the company has a legal obligation to pay the cash once dividend has been declared. A stock dividend does not reduce the net assets and overall value of the company because a portion of the shareholders’ equity classification of retained earnings is simply transferred to share capital. There is no transfer of assets outside the company. Accounting for the stock dividend requires an entry to reduce retained earnings and increase common share capital by the amount of the dividend. Usually, the amount of the dividend is determined by multiplying the number of shares to be issued by the market price at the date of declaration. However, since there is no legal obligation to pay the dividend, the dividend may not be recorded in the accounting records until it is actually distributed to the shareholders. If recorded, the Stock Dividends Issuable account is reported within shareholders’ equity. It is not reported as a liability because it does not require the use of company assets. b. The drop in the share price is because there are now more shares outstanding, but the value of the company has remained the same. Before dividend was declared, book value per common shares was: Total shareholders’ equity Total number of common shares outstanding $5,958,476 = $2.98 per share 2,000,000

________________________________________________________________________________________________ Solutions Manual 11-90 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-2 (Continued) After the stock dividend is distributed, total shareholders' equity remains the same, but there are now more common shares outstanding: $5,958,476 = $2.71 per share 2,200,000 While the value per share has decreased, each shareholder has the same percentage of ownership of the company’s net assets as before the dividend. Each share is worth less, but shareholders now own more shares, so the value of their holdings should remain the same.

c. Cash dividends received: 2021 (5,000 shares x $0.75) 2022 (5,000 shares x $0.75) 2023(stock dividend only) 2024 (5,000 x 1.101 x $0.75)

$ 3,750 3,750 0 4,125 $11,625

This amount reflects the 10% increase in the number of shares due to the stock dividend issued in 2023. Market value of shares at December 31, 2024: 5,500 shares x $82 per share = $451,000 Market value of shares at inheritance (2021): 5,000 shares x $5 per share = $25,000 The value of the shares has increased by $426,000 (i.e. 17 times). LO 4 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-91 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-3 Blooming Valley Custom Landscaping a. Current earnings per share: Net income available to common shareholders Number of common shares outstanding $675,0001 = $2.25 300,000 1

$900,000 x (1–tax rate) = $900,000 x 0.75

Option 1 Net income available to common shareholders Number of common shares outstanding $1,102,5002 = $3.68 300,000 Net income before interest and taxes – interest expense – income tax expense = [($900,000 + $750,000) – ($2,000,000 x 9%)] x (1–0.25) 2

Option 2 Net income available to common shareholders Number of common shares outstanding $1,237,5003 = $3.09 400,000 3

Net income before taxes – income tax expense = ($900,000 + $750,000) x (1 – 0.25)

________________________________________________________________________________________________ Solutions Manual 11-92 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-3 (Continued) Option 3 Net income available to common shareholders Number of common shares outstanding $952,5001 = $3.18 300,000 Net income before taxes – income tax expense – preferred share dividends = ($900,000 + $750,000) x (1 – 0.25) – $285,000 1

Financing the expansion through the conventional bank loan would result in the highest earnings per share. b. Selling shares to venture capitalist will result in lowest earnings per share of three options. In addition, the venture capitalist wants to be involved in day-to-day operations of the business. Given the fact that business has always been family run, opening up the operations to scrutiny and opinion of an outsider may not be an attractive proposition. The preferred share issue may not be a good alternative. The $285,000 dividend that would have to be paid to the preferred shareholders represents a 14.24% return on the preferred’s $2,000,000 capital investment and a very high cost to Blooming Valley. Unlike interest expense, preferred dividends are not tax deductible (when calculating taxable income), so the company does not benefit in this way. The preferred shares are very much like debt, except that the principal does not have to be repaid. Although dividends do not have to be paid, the preferred dividends in this case are cumulative, which means that they carry an entitlement to company assets and all dividends owed to the preferred shareholders from previous years would have to be paid before the common shareholders could access any company assets in the form of dividends.

________________________________________________________________________________________________ Solutions Manual 11-93 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-3 (Continued) Borrowing will result in the highest earnings per share and return to common shareholders. This illustrates the positive use of leverage – using borrowed funds to earn a return on the additional assets invested that is higher than the cost of borrowing the funds*. The company currently has no debt and will likely be able to meet the required cash payments. Interest expense is also tax deductible, which will reduce the tax liability and income tax expense of the company. The owners should remember, however, that interest and principal payments are obligations of the company and the company is riskier than if it used equity because nonpayment would have serious consequences to the company. *Additional net income (return) earned (before interest expense) would be $750,000 X (1- 0.25) = $562,500. The additional assets invested = $2,000,000. This is a return of $562,500/$2,000,000 = 28.1%. The additional after-tax cost of borrowing the funds would be 9% X (1 – 0.25) or 6.75%. The difference between the additional return and the cost of borrowing the funds (both after tax) accrues to the common shareholders. I would recommend borrowing the $2,000,000 required for the expansion. The main reasons are that the company currently has no long-term debt, so it should be well able to handle the increased financial risk. The existing shareholders do not have to give up any of their equity under this financing arrangement, nor share information and votes with other parties. The required return paid to preferred shareholders under the preferred share arrangement is very high and not a tax deductible cost. The interest paid is tax deductible, resulting in an increased return to the Langer family. Lastly, the EPS is highest under this option. (Note: With reasonable support, students might recommend the preferred share option on the basis that it is an equity infusion of capital that has no say in management decisions or requirement to be repaid.) LO 7 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-94 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-4 Teed’s Manufacturing Corporation a. No dividends have been paid since the company was formed in 2022. Since the preferred dividends are cumulative, all preferred dividends in arrears from prior years, as well as the preferred dividend for the current year, must be paid before a dividend can be paid to the common shareholders. Cash dividends declared in 2024 ................... $160,000 Preferred dividends in arrears from 2022 and 2023 1 ............................... (64,000) Current year preferred dividend ....................... (32,000) Remaining for the common shareholders ........ $64,000 1

($2 x 16,000 shares x 2 years)

The preferred shareholders will receive $96,000 and the common shareholders will receive $64,000. b.

Memorandum To: Jan Barangé From: Student Re: Types of Shares and Dividends The major difference between preferred and common shares is that the common shareholders are the residual equity holders. This means that common shareholders are the last in line to be entitled to assets distributed as dividends and to assets on dissolution. The holders of preferred shares are entitled to both before the common shareholders. In return, the common shares carry the right to vote at shareholder meetings, a privilege the preferred shareholders usually are not given.

________________________________________________________________________________________________ Solutions Manual 11-95 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

C11-4 (Continued) Preferred shareholders will usually forego being able to vote in return for other benefits. For example, they receive dividends before any common dividends can be paid. In the case of Teed’s Manufacturing, the preferred shares are cumulative, which means that undeclared dividends on the preferred shares from previous years and dividends from the current year must also be paid before the common shareholders receive any current year dividends. This feature generally assures this class of shareholders a given return annually. While preferred shares usually do not benefit from any capital appreciation on their shares in good times, they also tend not to lose their capital if the company encounters financial difficulties. Owning preferred share is less risky than owning common shares. The preferred shareholders also receive preference in asset distribution upon liquidation of the company. For these reasons, preferred shareholders are often ready to forego the right to vote. The declaration date for dividends is the date on which the board of directors votes to issue a dividend to shareholders. It is when the amount of the dividend is specified as well as the date of record and the date of payment. Because shares are constantly being traded, there must be a specific date for the company to determine which shareholders should receive the dividend. The date of record is announced at the declaration date, so investors know that whoever owns the shares on the record date will receive the dividend. The payment date is the date the dividend is actually paid. If you own the shares of Teed’s Manufacturing on February 10, 2025, you can expect to receive the dividend soon after the February 28, 2025 payment date. The amount of your dividend should be ($64,000  60,000) x 500 = $533. Please feel free to contact me if you would like any further information. LO 4 BT: AN Difficulty: M Time: 40 min. AACSB: Communication CPA: cpa-t001 CM: Reporting

________________________________________________________________________________________________ Solutions Manual 11-96 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

________________________________________________________________________________________________ Solutions Manual 11-97 Chapter 11 Copyright © 2022 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission is strictly prohibited.

Burnley, Understanding Financial Accounting, Third Canadian Edition

CHAPTER 12 FINANCIAL STATEMENT ANALYSIS Learning Objectives 1. Understand and explain the process of financial analysis. 2. Identify the common contexts for financial statement analysis and explain why an awareness of context is essential to the analysis. 3. Explain why knowledge of the business is important when analyzing a company’s financial statements. 4. Identify the types of information used when analyzing financial statements and where it is found. 5. Explain the various perspectives used in financial statement analysis, including retrospective, prospective, trend, and cross-sectional analysis. 6. Identify the different metrics used in financial analysis, including common-size analysis and ratio analysis, and explain how they are used. 7. Identify, calculate, and interpret specific ratios that are used to analyze the liquidity, activity, solvency, profitability, and equity of a company. 8. Identify and explain the limitations of ratio analysis. 9. Identify and explain commonly used non-IFRS financial measures and other performance measures.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

BT Item LO

BT Item LO BT Item LO BT Item LO Discussion Questions 1. 1 C 6. 3 C 11. 7 AN 16. 7 AN 21. 8 2. 2 C 7. 4 C 12. 7 AN 17. 7 AN 22. 8 3. 1 C 8. 6 C 13. 7 AN 18. 7 AN 23. 9 4. 5 C 9. 6 C 14. 7 AN 19. 7 AN 24. 9 5. 2 C 10. 5 C 15. 7 AN 20. 7 C Application Problems 1. 6,7 AN 5. 7 AN 9. 7 AN 13. 7 AN 17. 7 2. 7 AN 6. 7 AN 10. 7 AN 14. 7 AN 18. 7 3. 7 AN 7. 7,8 AN 11. 7 AN 15. 6,7 AN 4. 7 AN 8. 7 AN 12. 7 AN 16. 7 AN User Perspective Problems 1. 5 C 3. 3 C 5. 8,9 C 7. 5,7 C 9. 9 2. 5 C 4. 8 C 6. 6,7 C 8. 6,7 C Work in Process 1. 7,8 C 2. 3,7 C 3. 7,8 C 4. 7,8 C Reading and Interpreting Published Financial Statements 1. 7 AN 2. 6,7 AN 3. 7 AN 4. 7 AN 5. 7 Cases 1. 5 C 2. 6,7 AN 3. 7 AN

BT C C C C

AN AN

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQ12-1

Financial statement analysis is the process of assessing a company’s financial position and financial performance based on the information provided in its financial statements, including the notes to the financial statements. An analyst might calculate ratios (both intra-statement and interstatement) and develop trend information. This information is then compared to other companies in the same industry, and supplemented with other information gleaned from the MD&A, an economic outlook for the industry, and insights obtained from company management through their quarterly communications with the investment community.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ12-2

The context for any analysis begins with who the user of the resulting analysis is and what information the user wants to know. This governs the type of analysis to be carried out. The following are some examples of common contexts for financial statement analysis: • An investor, acting either as an individual or as an advisor to others, is generally interested in the potential of a specific company to generate future profits and cash flows. This is the basis for making decisions about whether the shares of a company should be bought, held or sold. • Commercial lenders, such as banks, on the other hand would be more interested in assessing a company’s liquidity—its ability to meet its current obligations. This might be done to assess whether it is reasonable to extend short-term credit to a company. For longer term loan consideration, different analyses would be carried out to evaluate the company’s solvency, such as to determine the ability of the company to generate cash flows into the future, the extent to which it has met past debt requirements, whether the expected earnings are sufficient to cover the additional cost of carrying increased debt, and any risks associated with its capital structure.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-2 (Continued) • Suppliers would be interested in financial statement analysis to set appropriate credit terms for a potential customer. This analysis would likely zero in on the company’s liquidity and ability to manage its ongoing obligations to suppliers and its cash flow from operations. • An entity looking to expand by acquiring other already existing businesses would, as part of their due process, look very carefully at all aspects of operations of prospective businesses, and the potential for them to contribute to the acquiring company’s rate of return. The financial statements of each prospect are critical for this evaluation. LO 2 BT: C Difficulty: M Time: 20 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ12-3

The steps taken in the process of financial statement analysis can be described as follows: 1. Specify the context for the analysis – that is, what is its purpose, who wants to know, what kind of decisions are to be made based on results? 2. Gather appropriate information from a variety of sources that include economic information, industry outlooks, competitor information for comparison purposes, complete audited company financial statements, current and past MD&As, and information from recent management webcasts and other forms of communications related to company’s financial position, performance, key success factors and prospects. 3. Prepare common-size financial statements, develop trend data, and calculate appropriate ratios, ensuring they relate to the objective identified in step 1. 4. Prepare an analysis of the metrics developed in step 3, incorporating information from broadly sourced information gathered. It is important that information from all metrics prepared be assessed collectively. 5. Develop conclusions and recommendations specific to context, clearly differentiating between factual information and analyst’s judgements and opinions.

LO 1 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-4

Retrospective analysis is used to uncover trends and other information to help understand past relationships, which are then used to help with prospective analysis – the prediction of future performance and relationships. Past behaviour is often the best predictor of future behaviour. Prospective analysis is aimed at determining the potential for future profitability and cash flows that an investor would be interested in. Prospective analysis is difficult, however, because of the uncertainty involved with predicting the future. Two types of retrospective analysis are trend analysis and cross-sectional analysis. Trend analysis looks at developing patterns from how individual items on the financial statements changed over many fiscal periods, whereas cross-sectional analysis looks at how one company’s performance compares to others in the industry for the same time period.

LO 5 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ12-5

Investors would most likely perform a different analysis of a company’s financial statements than creditors would because these two users are interested in assessing two different performances. The creditor is interested in the availability of operating cash flows to meet ongoing interest charges and to meet principal repayments, whereas an investor is interested in the risk of the company and its prospects for the residual cash flows available to the owners relative to those of other companies. The creditor has a preferred entitlement to a fixed return as set out in a contract, whereas an investor bears an increased risk of loss, but also the potential for upside gains. Therefore, a creditor would have more interest in historic results related to liquidity and solvency measures, while an investor tends to be more interested in the future potential for profits and cash flows to support capital appreciation and dividends. While a company’s future cash flows are important to the creditor as a means of determining the company’s risk and ability to service its debt, the investor is more interested in the risk-return trade-off amongst alternatives.

LO 2 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-6

Knowledge of the company’s business is important for assessing both its operating activities and the underlying economic factors that affect the company, both over the short and long term. It is important when performing ratio analysis, that the interpretation and conclusions drawn are within the broader picture. This includes, but it not limited to, the overall economic environment within which a company operates, its markets, its competitors, its products, and its operating business strategies. This understanding provides the foundation upon which the analyst interprets the purely arithmetic results obtained from the ratios.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ12-7

Information contained in a company’s annual report, other than the financial statements, that might be of interest to an analyst includes the report of the officers of the company to shareholders, the management discussion and analysis (MD&A) report, the auditor’s report, and the five-to-ten-year summary financial data usually included at the back of the annual report. The least important of these is the officer’s report to shareholders as it tends to be a glossy representation of the past and bright predictions for the future. However, sometimes important non-financial statistics are included here that the analyst can legitimately use. The MD&A provides a very informative discussion of key aspects of the company’s business and operations such as its liquidity, capital structure, financing and investing activities, including how management interprets its results. This often will indicate what management’s objectives were for key variables and the extent to which its goals were met. The auditor’s report is an important piece of information, particularly the opinion on whether the financial statements have been presented fairly in accordance with IFRS or ASPE. The comparative summary financial information is also useful in providing trend information useful for analysis. Although summarized, they can point to which full annual reports the analyst should be referred to for further information.

LO 4 BT: C Difficulty: M Time: 15 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-8

Common-size statements of income tell the analyst the proportion each expense and other revenue item is of total Sales/Revenue. Using this technique, it is easier to make proportionate or relative comparisons; these are often not obvious using the raw data. For instance, in each year both the revenues and the cost of goods sold may increase, as evidenced by the raw data. If, however, the cost of goods sold increases faster than the revenues, the profit margin of the company will decline. This decline could easily be seen in a common size set of statements. Trend information can also be easily extracted from comparative common-size statements of income. In addition, common size statements also allow for the comparison of companies of different size, putting them on an equal footing.

LO 6 BT: C Difficulty: M Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ12-9

Common-size statements of financial position allow the analyst to easily tell what percentage each individual asset, liability and equity item is of the base amount of total assets. Differences from year to year become much more apparent from the trend lines developed over time from this data, as do differences between the subject company and other companies in the industry of different size.

LO 6 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

DQ12-10 A trend analysis is one in which financial statement data for a single company is analyzed across time. A cross-sectional analysis is one in which financial statement data from several companies are compared. The companies may be from the same industry or they may be from various sectors of the economy. Another version of the cross-sectional analysis would be to compare the company with industry average statistics. The cross-sectional analysis could also be conducted over time for a combined time-series, cross-sectional analysis. In summary, trend analyses are useful to highlight the trends of a company over time in order to predict the potential for returns, while cross-sectional analyses are used to compare one company to others when making decisions among companies, based on risk-return criteria. LO 5 BT: C Difficulty: E Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-11 The ratios discussed in the chapter are divided into five general categories, but they are all related. The categories relate to liquidity, activity, solvency, profitability, and equity analysis. Most of these ratios apply to any company regardless of the nature of its business, but some (such as inventory ratios) apply only to certain types of businesses. • Liquidity Ratios – Liquidity refers to a company’s ability to convert assets into cash to meet its short-term obligations. • Activity Ratios – The activity ratios provide additional insight into the major decisions management makes regarding asset use and liquidity. These ratios provide some quantitative measures of how efficiently a company manages its operations. • Solvency Ratios – Solvency, or long-term liquidity, refers to the company’s ability to pay its obligations in the long term (meaning more than one year into the future). • Profitability Ratios – Although much can be learned from studying the statement of income and statement of cash flows, in both their raw data and common size forms, profitability ratios complement that understanding and are used to assess the company’s ability to generate a return on assets invested. • Equity Analysis Ratios – Equity analysts and investors are uniquely interested in the relative value of the company’s shares. These ratios are used to assess potential returns to shareholders based on returns in the past. LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-12 Ratio helps the analyst assess:

1. 2.

4. 5.

An increase is generally perceived as: Whether current assets can meet Positive, unless it is a high current obligations (current liabilities) ratio to begin with Whether those current assets quickly Positive, unless it is a high convertible to cash (i.e. all current ratio to begin with assets except inventory and prepaid expenses) can meet current obligations Whether the company is effectively Positive, unless sales are managing the cash collection of being lost due to overly receivables activity stringent credit terms Whether the company is managing its Positive, unless stockouts inventory effectively are occurring Whether management is paying It depends; if already higher amounts owed to suppliers on a than its normal credit terms current basis would dictate – negative; if lower than its normal credit terms would dictate – positive (unless it creates a risk that suppliers will withdraw credit)

LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-13 Ratio helps the analyst assess:

1. 2.

An increase is generally perceived as: The risk associated with the company’s Unfavourable capital structure – a solvency measure The risk associated with using debt in the Unfavourable company’s capital structure – a solvency measure The extent to which the company generates Favourable earnings in excess of the interest that has to be paid on debt – a solvency measure The extent to which the company generates Favourable cash from operations relative to its current debt – a solvency measure The amount that remains from each dollar of Favourable sales (after the cost of sales is recovered) to cover all other expenses and contribute to profit – a profitability measure The amount that remains from each sales Favourable dollar (after deducting all expenses from gross margin) as a return to shareholders – a profitability measure The rate of return generated on the equity Favourable invested by shareholders – a profitability measure The rate of return generated by the company Favourable on all assets invested – a profitability measure

LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-14 Ratio helps the analyst assess:

1. 2.

An increase is generally perceived as: The amount of net income attributable to each Positive common share The relationship between how much a company Difficult to assess: it earns and how much investors are willing to pay depends on the for its shares, on a per share basis. This ratio is starting point and often used as a measure of risk by a reason for the shareholder. increase The extent to which a company’s earnings are Positive, as long as distributed to its shareholders instead of not too high already reinvested within the company The relationship between the cash return Positive distributed to each common share and the market price of the common share The extent to which the company is able to Positive generate cash from operations over and above what is necessary to maintain its current level of operations, incur capital expenditures and meet its preferred dividend obligations

LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-15 Liquidity ratios are used to provide information for an assessment of a company’s ability to meet its current obligations. These ratios, therefore, deal with current assets and current liabilities, such as when calculating the current ratio and the quick ratio. Solvency ratios, on the other hand, provide information for an assessment of a company’s ability to meet its long-term obligations.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-15 (Continued)

Because these obligations will not be met with its current assets at the reporting date, but rather with cash flows generated from operations into the future, profitability ratios are often used to support the usual solvency ratios. Solvency ratios, for the most part, are designed to provide an indication of the risk associated with a company’s capital structure. The higher the proportion of debt in the capital structure, the higher the interest charges and the higher the likelihood of not being able to meet specific interest and principal repayment obligations in the future. If this happens, the company is insolvent and may be required to wind up its operations. Solvency ratios include debt to equity and debt to total capitalization ratios as well as interest coverage and cash flow to total liability measures. LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-16 The basic earnings per share of a company is calculated by dividing the earnings of the company by the weighted average number of shares that were outstanding during the period. In some companies the possibility exists that more shares may be issued (other than those currently outstanding) due to agreements such as stock option plans and convertible securities (securities such as convertible debt or convertible preferred shares) that can be converted into common shares. Because of the potential to issue more shares, the actual earnings per share based on the actual number of shares outstanding during the period may be reduced (diluted) in the future because of these currently outstanding debt and equity instruments. Therefore, public companies are required to also calculate and report a “what if” earnings per share number called diluted earnings per share. It represents the maximum dilution, and therefore, the lowest EPS number, assuming all the potential issuances that would have been dilutive had been issued during the current year. Diluted earnings per share, therefore, reflects the worst-case scenario assuming outstanding issuances or conversions had already occurred. LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-17 Investors such as common shareholders earn a return from their investments in the common shares of companies in two different ways: the dividends received (if paid) and the capital appreciation (or devaluation) in the market value of the shares held. If a shareholder acquires shares at $10 each and the company pays an $.80 per share dividend in year 1, this represents an 8% return earned by the shareholder. Now assume that, in addition to the 8% dividend, the fair market value of the share increased from $10 to $12 per share. This $2 increase represents a 20% increase in market value. If the shareholder sells the shares at $12, then the total return earned is 28% -- 8% for the dividend and 20% for the increase in its value while it was held. In this case, the whole 28% has been realized; that is, it has been converted to cash. If the shareholder continues to hold the shares, the return would still be 28%, but only 8% is a realized gain; the 20% remainder is considered unrealized. Both should be considered in determining the return earned during the period. LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-18

Liquidity, or the company’s ability to meet its short-term obligations, depends upon several factors. Two of those factors are the accounts receivable and inventory policies a company applies. The faster accounts receivable are collected (as can be measured by the accounts receivable turnover ratio) and the faster a company sells or turns over its inventory into receivables (as can be measured by the inventory turnover ratio) the more liquid a company is. To illustrate how the accounts receivable and inventory turnover ratios can be used in assessing liquidity, consider two companies: Co. A and Co. B. Both companies have the same balances in the following accounts, and therefore, the same current ratio of $100,000/$80,000 = 1.25 times: Cash Accounts receivable Inventory Current assets

$ 10,000 40,000 50,000 $100,000

Current liabilities

$ 80,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-18 (Continued) If Co. A takes 15 days to sell its inventory and its receivables turn over every 15 days this means it takes 30 days from acquiring the inventory until cash is received. If suppliers require the inventory to be paid for by Co. A, with terms of net 30 days, Co. A’s cash flows are in place to meet those terms. Will not have a problem meeting its current obligations. Now assume that Co. B’s inventory takes 30 days to be sold and its receivables are collected on average in 30 days. This means that it takes 60 days from acquiring the inventory until cash is received from the customer. However, if Co. B’s suppliers are looking for payment of the inventory purchases within 30 days from delivery to Co. B, this means that Co. B is not going to have the cash to pay its accounts payable on time. It has a liquidity problem that could be addressed to some extent by increasing its accounts receivable and its inventory turnovers, thus reducing the length of time it takes to sell its inventory and collect the cash from the resulting receivables. The current ratio is the starting point when examining a company’s liquidity. The turnover ratios provide additional information to help in the liquidity assessment of specific current assets. LO 7 BT: AN Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-19

Cash flows are important to consider when analyzing a company that uses accrual accounting because you can’t make payments to suppliers with accounts receivable or with inventory; and you don’t need cash until the accounts payable and accruals come due for payment. In assessing liquidity, for example, it is the timing of the cash flows that dictates whether a company has problems. Also, accrual accounting includes estimates and historical costs and some of the data may be subject to manipulation. Cash flow information reflects cash only and therefore provides a better indication of a company’s ability to meet its financial commitments based on the cash (rather than “profits”) it can generate from operations.

LO 7 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-20 To explain how two companies in the retail clothing business can earn the same profit, yet have very different operating strategies, the following data is provided:

Sales Revenue Expenses Net Income

Company A

Company B

$ 50,000 40,000 $ 10,000

$ 200,000 190,000 $ 10,000

Note that although both companies are in the retail clothing business, Company A has chosen a strategy of stocking high end clothing with limited sales potential, but a healthy profit margin of $10,000/$50,000 or 20% of sales. Alternatively, Company B is following a different strategy: a popular line of clothing with rapid turnover and sales, even though its profit margin is low at $10,000/$200,000 or 5% of sales. Despite the differences between these strategies, both companies had the same net income (i.e. $10,000). LO 7 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-21 The current ratio can be manipulated to give a more desirable ratio than it would be otherwise by the timing of certain transactions. For example, a company with a 2 to 1 current ratio might postpone its usual large purchase of inventory before the reporting date because the ratio of the additional inventory (current asset) to the additional accounts payable (current liability) would be 1 to 1 and when both are included in the accounts, the 2 to 1 current ratio would be reduced. Alternatively, if a company is in a position of having a .8 to 1 current ratio and there is a debt covenant that requires the company to maintain a current ratio of at least 1 to 1, the company might arrange for a large shipment of product to a customer earlier than agreed and before the reporting date, so it can record the sale as a current year sale and account receivable. Even though the inventory is reduced, total current assets increase by the mark-up on the inventory and there is no change in current liabilities. In addition, the company could borrow money on a short-term basis from the bank (relationship of 1 to 1 between the cash and the payable) or, even better, borrow cash on a long-term basis. In this latter situation, the current assets would increase, with no increase in current liabilities.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-21 (Continued) Finally, the simplest of transactions can improve the current ratio. A business makes a payment to a supplier on account. The reduction of cash and accounts payable by the same amount causes a direct increase in the current ratio. LO 8 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-22 Ratio analysis, although very useful, does have its limitations, and the inability of the analyst to adequately understand the economy, the industry, the specific business, and the accounting all could limit the benefits that could be obtained. Assuming a good analyst, there are still some limitations: When comparing different companies in the same industry, it is important that differences in the choice of accounting policy and differences in the application of judgement to similar situations be taken into consideration to whatever extent is possible. The effects of some of these differences in estimates for example may not be evident to the analyst. Different organizations apply the same ratios in different ways. For example, debt to equity ratios can use a variety of definitions of “debt” in the numerator and different definitions of “equity” in the denominator. Many companies report the results of ratios in their annual reports but do not always clearly identify how the variables have been defined. Few companies have exactly, or even close to the same business as others. Differences in the way in which companies are financed will often be a source of profitability difference. The age of some businesses might influence the historical cost amounts paid for land for example on the statement of financial position. While the required segmented information disclosures are important sources of information, the segments are based on how each company is managed and accounted for internally and this will differ from company to company. Companies do not like to disclose more information than is required by the accounting standards, and many comply with the letter of the standard although perhaps not the spirit of the requirements.

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-22 (Continued) There is often information required for certain ratios that is not supplied in the financial statements. For example, the accounts receivable turnover ratio is best calculated using credit sales dollars in the numerator. The number of days of accounts payable outstanding requires a numerator equal to total credit purchases. These amounts are not provided in the financial statements. Ratios that relate statement of income amounts to statement of financial position (SFP) amounts are most meaningful when the SFP amounts are representative of their average balance for the year. Inventory and accounts receivable turnover calculations, for example, should ideally use a monthly average as any seasonal business will have wide variations in these amounts over the year. The year-end statements may be at a low point for both these amounts and this inflates the turnover ratio as a result. The best that can be done is to use the quarterly averages as this information is reported in public companies’ interim financial statements. In addition, management sometimes engages in “window dressing” the financial statements, by accelerating (or postponing) transactions that would result in improving (or hurting) key ratio results. This can also be accomplished by classifying certain items where judgement is a factor as current or long-term, depending on what makes certain ratios better. LO 8 BT: C Difficulty: H Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQ12-23

Financial measures or ratios that are prepared using information taken directly from audited financial statements prepared using IFRS are referred to as IFRS financial measures. An example of an IFRS measure is Earnings per share ratio (EPS). Non-IFRS financial measures are financial measures or ratios that are based on IFRS or GAAP information that has been adjusted by the company’s management. An example of a non-IFRS financial measure is EBITDA (earnings before interest, taxes, depreciation, and amortization). Finally, non-financial measures include information that is physical or non-financial in nature and include, for example, subscriber counts.

LO 9 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQ12-24

Caution should be exercised when using non-IFRS financial measures because: • There are no standard definitions for these measures, so management is free to define them as they see fit. • These measures are often not comparable across companies or across periods. • The information used in determining these measures is unaudited. One way management addresses these issues is by providing a reconciliation of the non-IFRS financial measure to an IFRS financial measure.

LO 9 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS AP12-1A a.

Alba Net sales $1,225,000 100.0% Cost of goods sold 398,000 32.5% Operating expenses 70,000 5.7% Interest expense 2,255 0.2% Income tax expense 13,460 1.1% Net earnings $741,285 60.5%

Matera $897,000 100.0% 623,000 69.5% 65,000 7.2% 2,450 0.3% 6,700 0.7% $199,850 22.3%

Total assets $2,862,000 2,653,000

Total shareholders’ equity $1,817,000 1,088,000

Average

2,757,500

1,452,500

Matera – 2024 – 2023

$943,250 685,000

$731,850 532,000

Average

$814,125

$631,925

b. Alba – 2024 – 2023

ROA = ROA ROE =

Alba $741,285 $2,757,500 = 26.9% $741,285 / $1,452,500 = 51.0%

Matera $199,850 $814,125 = 24.5% = $199,850 / $631,925 = 31.6%

c. All performance measures indicate Alba is more profitable than Matera. Its profit margin is 38.2% higher, its ROA is 2.4% higher and its ROE is 19.4% higher. d. One major reason for Alba Company’s better performance is its lower cost of goods sold (33% of net sales versus 70%) resulting in a higher net margin percentage of 61% (compared to 22% for Matera).

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-1A (Continued) The other major difference is Alba’s lower operating expense to sales ratio of 5.7% as compared to Matera’s 7.2%. Alba is using financial leverage more successfully. Its ROE is 24.1 % higher than its ROA. Finally, another major difference is to calculate Alba’s effective tax - the dollars of income tax expense to pre-tax income of 1.8% relative to Matera’s of 3.5%. LO 6,7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-2A a. 2021 2022 2023 2024

Current Ratio $2,540 / $1,540 = 1.65 $3,240 / $1,820 = 1.78 $4,020 / $2,120 = 1.90 $5,000 / $2,540 = 1.97

Quick Ratio ($2,540 – $1,500) / $1,540 = 0.68 ($3,240 – $2,040) / $1,820 = 0.66 ($4,020 – $2,780) / $2,120 = 0.58 ($5,000 – $3,820) / $2,540 = 0.46

The current ratio has shown an increasing trend over the four years and can be considered respectable, as seen in 2024. However, this four-year upward trend has resulted from stocking more inventories and this has resulted in a downward trend in the quick ratio, which is only 0.46 in 2024. The company’s short-term liquidity is not very good.

The analysis in part “a” is a trend analysis as it zeroes in on the same measure for one company over a number of years to discover what the trend is. A cross sectional analysis is based on comparing the relative amounts making up the components of particular financial statements across companies at a point in time.

The quick ratio is likely a better indication of short-term liquidity for Alouette since the upward trend in the current ratio can be deceiving. It is attributed to increasing levels of inventory, which take longer and may be difficult to convert to cash quickly.

LO 7 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-3A a. Working capital = ($154,000 + $185,000 + $21,000) – $165,000 = $195,000 The working capital is quite high, and indicates that there are more than enough current assets to satisfy current liabilities. In addition, since the company maintains a high cash balance of $154,000, cash required to finance operations is not a concern. b.

Current ratio = $360,000 / $165,000 = 2.18 Quick ratio = $154,000 / $165,000 = 0.93 Both the current ratio and the quick ratio exceed the criteria of 2.00 and 0.80, respectively. Based on these ratios, the company’s current asset position is strong, and short-term liquidity is not a concern. In fact, these ratios suggest that perhaps the company’s investment in current assets is more than what is required to support the sales function and to finance operations (i.e. it is holding too much cash).

A change from cash to credit sales would not affect the current ratio or quick ratio, if the previous cash-sale customers now purchased on account. The cash balance would decrease, and a receivable balance would be created. If the company starts to sell on credit, its total sales are likely to increase as it attracts new customers who would not buy before because of the cash-only policy. This would cause both the current ratio and the quick ratio to increase. The company will now have to establish credit terms for its customers and manage the collection of its receivables. The accounts receivable turnover ratio, which indicates how quickly accounts receivable are collected, will now be relevant.

If these balances existed following the completion of the primary selling season, then most of the current assets held would be unnecessary, and their high levels might reflect poor cash and inventory management. Inventory levels, particularly, should be short-term investments that a company makes to facilitate sales to customers. If the selling season is completed, then the company’s inventory should be reduced. It would then start to increase inventories in anticipation of its next selling season.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-3A (Continued) In particular, if the ski season were over, there would be a concern as to whether there are obsolete items in the inventory, or whether a write down of inventory might be required for items where the net realizable value is less than cost. This might be the case if the inventory reflected current fashion trends. e. A public company might be more attractive to a potential investor for several reasons. First, public companies whose stock is listed require audits, which provide some assurance to investors. A private company may, or may not be required to have its financial statements audited. Second, it is easier for investors to sell their shares when the company is listed on a stock exchange, and my intention is to liquidate my investment in two years. LO 7 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-4A Ratio a. A/R Turnover

Michaels’ Foods $60,600 / $7,150 = 8.5 times

b. Days to Collect 365 / 8.5 = 42.9 days

Sunshine Enterprises $30,100 / $1,925 = 15.6 times 365 / 15.6 = 23.4 days

c. Sunshine Enterprises appears to manage its receivables more efficiently. It collects its receivables in 23.4 days on average versus 42.9 days for Michaels’ Foods. d. Information regarding each company’s credit terms, the type of inventory (i.e., is it food or furniture?), and the type of customer would be helpful. LO 7 BT: AN Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-5A a.

Inventory Turnover 2020 $893,100 / $128,450 = 6.95 2021 $1,002,700 / $157,100 = 6.38 2022 $1,174,500 / $206,310 = 5.69 2023 $1,326,300 / $323,420 = 4.10 2024 $1,391,780 / $442,990 = 3.14

Number of days 365 / 6.95 = 52.5 days 365 / 6.38 = 57.2 days 365 / 5.69 = 64.1 days 365 / 4.10 = 89.0 days 365 / 3.14 = 116.2 days

b. The inventory turnover has decreased over the five-year period, indicating an increase in the time that the inventory is held before sale. In fact, the average number of days inventory is held has more than doubled over the five years, to close to four months. This is generally not favourable. Before reaching a definite conclusion, more information should be gathered on whether the type of inventory has changed, and whether its sales mix has changed. Is the company following a different strategy, perhaps toward carrying a greater variety of goods with a higher profit margin but with more limited sales potential? Is the inventory on hand obsolete, or is there a continuing demand for the inventory? c. It is possible that the increase in the average inventory and decrease in the inventory turnover is due to a change in the type of inventory that is being sold by the company and, therefore, might not indicate a major problem. It could be following a different business strategy, stocking higher priced goods with higher margins. It could be stockpiling inventory before entering new markets or anticipating rising costs from its suppliers. Information on such changes is needed to comment on the management of inventories. LO 7 BT: AN Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-6A a. Inventory turnover: Ken’s Fresh Fruits: $9,875,600 / [($695,000 + $695,600) / 2] = 14.2 times Al’s Supermarket: $53,885,000 / [($4,776,500 + $1,040,500) / 2] = 18.5 times

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-6A (Continued) b. Days to sell inventory ratio: Ken’s Fresh Fruits: 365 / 14.2 = 25.7 days Al’s Supermarket: 365 / 18.5 = 19.7 days c. The inventory turnover for a food store, especially one carrying perishable fruit and vegetables, should be high because food has a very limited shelf life and must be turned over fast so that spoilage does not occur. Therefore, considering that inventory, including non-perishables, for these companies is held for less than one month on average, the ratios appear reasonable. Both companies appear to be managing their inventory reasonably well, although Al’s Supermarket has almost a oneweek better turnover. This would not be expected since a supermarket would carry more non-perishable items in addition to fresh produce and would be able to accommodate a lower turnover. Al’s Supermarket is managing its inventory more efficiently. d. While Al's Supermarket appears to be managing their inventory better than Ken's Fresh Fruits, we cannot say that they are more profitable. Perhaps Ken’s Fresh Fruits also carries many non-perishables, but specializes in maintaining a superior fruit and vegetable section and can charge more for its produce. That is, the company name might represent the original strategy of the company in the past. We need more information, such as segmented information for the produce department of each. e. Fast inventory turnovers could be an indication that not enough inventory is being held. Because inventory is held to support the sales function, potential sales can be lost. Shortages might also result in the loss of customers if not enough inventory is maintained. If Ken’s Fresh Fruits deals only in fresh fruit, the turnover ratios developed for the company should be a concern. LO 7 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-7A a. Current ratio – 2024: $115 + $875 + $1,930 + $240 $400 + $995 + $40 = $3,160/$1,435 = 2.2 times Current ratio – 2023: $160 + $870 + $1,650 + $280 $200 + $950 + $80 = $2,960/$1,230 = 2.4 times Manitoba Manufacturing meets the current ratio requirements of the loan covenant, but whether it meets the loan limits is not known as the longterm portion of the bank loan is not provided. b. Maximum loan – 2024: ($1,930 X .33) + ($875 X .5) = $1,074.4 Maximum loan – 2023: ($1,650 X .33) + ($870 X .5) = $ 979.5 c. Based on the accounts receivable balances reported, indicating the similar amount of receivables, it does not appear that the sales have grown in 2024 over 2023. d. i. Management could have “managed” the statement of financial position by reducing its allowance for doubtful accounts in 2024, thus ensuring a higher level of current assets with no change in its current liabilities. ii. The company could have postponed an inventory purchase until after year end. An additional inventory transaction would have increased both current assets and current liabilities in a 1 to 1 ratio, therefore, reducing any pre-transaction ratio that was above 1 to 1. iii. In addition, management could have entered into a long-term loan in 2024, increasing its cash and total current asset amounts, with no effect on current liabilities. LO 7,8 BT: AN Difficulty: H Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-8A a. Accounts receivable turnover: = Credit sales / Average accounts receivable = $5,000,000 / (($585,500 + $558,800) / 2) = 8.74 Average collection period: = 365 / 8.74 = 41.8 days Ambroise's policy is to extend credit terms to its customers for 30 days; however, it is taking the company on average 41.8 days to collect their receivables, which is almost 12 days beyond their credit policy. b. Inventory turnover: = Cost of goods sold / Average inventory = $2,250,000 / (($770,800 + $707,400) / 2) = $2,250,000 / $739,100 = 3.04 Days to sell inventory: = 365 / 3.04 = 120.1 days It takes Ambroise just over 4 months, on average, to sell through its inventory. c. Purchases = Cost of goods sold – Beginning inventory + Ending inventory = $2,250,000 – $707,400 + $770,800 = $2,313,400 Accounts payable turnover: = Credit purchases / Average accounts payable = $2,313,400 / (($200,750 + $195,250) / 2) = 11.7 Accounts payable payment period: = 365 / 11.7 = 31.2 days

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-8A (Continued) Ambroise's policy is to pay its suppliers within the 30 days granted according to their credit terms, and the company is paying their payables quite timely, only a day or two beyond the 30-day terms the suppliers offer. d. Ambrose’s cash-to-cash cycle = Days inventory held – Days to pay A/P + days to collect A/R = 120.1 – 31.2 + 41.8 = 130.7 days e. Ambroise's current days to sell ratio is 120.1 days. If they were able to reduce this to 50 days, it would mean an inventory turnover ratio of: 365/50 = 7.3 This would imply an average inventory of $308,219 ($2,250,000 / 7.3) assuming no change in cost of goods sold. This would be a reduction of $430,881 ($739,100 - $308,219) in the size of Ambroise’s average inventory. This would shorten the company’s cash-to-cash cycle by 70.1 days (120.1 – 50) and reduce interest costs as the required working capital loan would be reduced. LO 7 BT: AN Difficulty: E Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-9A a. Net debt as a percentage of total Debt to equity ratio capitalization

Interest coverage

2022: ($2,000 - $50) / $4,250 = 45.9%

($2,000 - $50) / ($2,000 - $50 + $4,250) = 31.5%

$1,650 / $150 = 11.0 times

2023: ($4,000 - $115) / $5,500 = 70.6%

($4,000 - $115) / ($4,000 - $115 +$5,500) = 41.4%

$2,625 / $340 = 7.7 times

2024: ($4,500 - $225) / $7,250 = 59.0%

($4,500 - $225) / ($4,500 - $225 + $7,250) = 37.1%

$3,300 / $435 = 7.6 times

All three ratios show deteriorating trends between 2022 and 2023, with a considerable increase in the relationship between debt and equity and debt and total capitalization. This was caused by the 100% increase ($2,000 to $4,000) in the long-term bank loan accompanied by only a 30% increase ($4,250 to $5,500) in shareholders’ equity. Not surprisingly, the interest coverage ratio fell by a significant amount although a ratio of almost 8 times reported in 2023 is not particularly worrisome. In 2024, Artscan Enterprises appears to have taken steps to reverse this unfavourable trend from the previous year with the solvency ratios heading in the right direction, even if not back to the 2022 levels. While the long-term bank loan increased only 12.5% from the previous year ($4,000 to $4,500), shareholders’ equity increased by almost 32% ($5,500 to $7,250). The interest on the increased debt is continuing to take a bite out of earnings, but the interest coverage appears to have stabilized in 2024 as compared to 2023. The times interest earned ratio does indicate that the company is currently earning sufficient income to cover its interest obligations.

LO 7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-10A a. Return on Equity (ROE): 2022:

$715 / $14,664 = 4.9%

2023:

$1,845 / $22,415 = 8.2%

2024:

$3,580 / $31,515 = 11.4%

Smooth Suds’ return on equity is improving, having increased by 2.3 times between 2022 and 2024. b. Return on Assets (ROA): 2022:

$715 / $23,715 = 3.0%

2023:

$1,845 / $31,965 = 5.8%

2024:

$3,580 / $47,340 = 7.6%

Smooth Suds’ return on assets has improved, increasing by more than 150% between 2022 and 2024. c. Gross margin: 2022:

$9,180 / $18,360 = 50.0%

2023:

$13,954 / $25,840 = 54.0%

2024:

$19,866 / $36,120 = 55.0%

The gross margin has increased significantly between 2022 and 2024, with 2023’s margin 8% above that of 2022, and 2024’s 10% above that of 2022. This is a definite improvement in the rate of gross margin.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-10A (Continued) d. Smooth Suds has experienced significant improvement in its profitability over the 2022 to 2024 period. The company’s profit margin has increased from 3.9% ($715 / $18,360) in 2022 to 9.9% (3,580 / $36,120) in 2024. Not only have its investments in assets and the investment represented by equity doubled in the same period, its sales almost doubled during the same period as well. This combined with increasing profit margins has contributed to the improvements in returns on assets and equity. It appears that the company is making effective use of leverage as well, with higher returns on the shareholders’ investment than on the company’s investment in assets. LO 7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-11A a. Price-earnings ratios: Company 1 $11.82/$0.87 = 13.6 times Company 2 $25.26/$0.67 = 37.7 times Based on the P/E ratio, Company 1 is more affordable. It takes an investment of $13.60 to result in company earnings of $1.00, whereas with Company 2, you’d need to pay $37.70 for $1.00 of earnings. b. Ratio Dividend payout ratio Dividend yield

Company 1 $0.475/$0.87 = 54.6% $0.475/$11.82 = 4.02%

Company 2 $0.535/$0.67 = 79.9% $0.535/$25.26 = 2.12%

While Company 2 pays a higher dividend than Company 1, as well as a higher proportion of its earnings to shareholders as a dividend, the dividend from Company 2 represents only a 2.12% return on your investment as compared to the higher 4.02% return earned on Company 1.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-11A (Continued) c. Net free cash flows: Company 1 $64,621 - $6,155 = $58,466 Company 2 $235,786 - $75,042 = $160,744 The net free cash flows represent the cash available to each company, generated from operating activities over and above that reinvested in replacing and adding to its property, plant and equipment. This cash is available for repaying debt, taking advantage of new investment opportunities and for paying out to shareholders as dividends. d. From these ratios, Company 1 appears to be a riskier company with investors requiring a higher rate of return on their investment. This is evidenced by the fact that investors are only willing to pay 13.6 times earnings for its shares, while Company 2 investors are willing to pay 37.7 times earnings for its shares. It also appears that Company 2 is considerably larger, more mature and with more shares outstanding than Company 1. This is since Company 2’s cash flows from operations are so much greater than Company 1’s yet its earnings per share is lower. In addition, Company 2’s dividend payout is significantly higher than is Company 1’s, and it is usual for older, established and lower risk companies to have sufficient experience and history to pay out larger percentages of their earnings as dividends. Company 1 is probably growing at a slower rate than Company 2. This is supported by Company 1 reinvesting only $6,155/$64,621 = 9.5% of its cash generated from operations into additional capital expenditures, while Company 2 is reinvesting $75,042/$235,786 = 31.8%. This may also support the assessment regarding the age of Company 2, in that these additional capital expenditures may be required to replace older assets to maintain the company’s productive capacity. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-12A a. Ratio i. Return on assets

Company A Company B $100,000/$833,333 $63,000/$525,555 = 12.0% = 12.0% Even though Company A’s total assets are considerably higher than Company B’s, both companies earn the same 12% return on the assets they have invested. ii. Gross margin $1,250,000-$687,500 $1,400,000-$980,000 $1,250,000 $1,400,000 = 45.0% = 30.0% Company A earns a much higher (better) return per dollar of sales after the cost of goods sold is deducted from sales than does Company B, leaving $0.45 of each dollar to cover other costs and contribute to profit. Company B leaves only $0.30. iii. Profit margin $100,000/$1,250,000 $63,000/$1,400,000 = 8.0% = 4.5% Company A’s profit margin percentage is almost twice as high as is Company B’s. $0.08 of each dollar ends up in profit from each dollar of A’s sales, whereas only $0.045 of each of B’s is profit. iv. Inventory turnover $687,500/$215,800 $980,000/$150,600 = 3.2 times = 6.5 times Company B’s inventory turnover is much better than Company A’s, as it sells out its inventory in half the time it takes A. v. Days to sell inventory 365/3.2 365/6.5 = 114.1 days = 56.2 days Consistent with the inventory turnover ratio, this ratio indicates that Company A takes close to 4 months to sell out its inventory, whereas B takes under 2 months, indicating that B manages its inventory better. b. The low-cost producer appears to be Company B, as indicated by its lower gross margin ratio and lower profit margin ratio. The reason that B earns the same 12% return on assets as Company A is likely because its inventory turns over much more quickly, thereby generating significantly more sales on which to earn its lower gross margin. Company A, assuming it is in the same general business as Company B, probably carries goods with a higher price and higher margin and counts on this higher margin to earn its 12% return on assets, rather than from selling high volumes. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13A a. Ratio Gross margin

Profit margin

2024 ($210,000 - $85,000) $210,000 = 59.5% $25,000/$210,000 = 11.9%

2023 ($170,000 - $80,000) $170,000 = 52.9% $11,000/$170,000 = 6.5%

From the ratios calculated, it appears that the culinary lessons business has added substantially to the profitability of the company. The initial decision might be to emphasize the online lessons business as it appears to have a higher rate of gross margin and of profit to sales than does the diner, judging from the effect on the overall company ratios. This should be looked at more closely before making any final decision, however. The cost of goods sold has increased little, so further investigation of labour costs relative to the culinary lessons, for example should be carried out. Is the online lessons business using idle labour it would otherwise have to pay for if the diner were not operating or were downsized? Further, if diner sales were sacrificed, the online business would then have to cover more of the occupancy costs and other fixed costs associated with the property and equipment, interest costs and management salaries. In such a case, the results that appear to be attributed to the online culinary lessons operation would not continue as above. b. Ratio Current ratio

Quick ratio

2024

2023

$10,000+$20,500+$12,900 $6,500+$13,500+$7,000 $8,000+$2,400+$4,500 $7,500+$2,000+$4,500 = 2.91 times $10,000+$20,500 $8,000+$2,400+$4,500

= 1.93 times $6,500+$13,500 $7,500+$2,000+$4,500

= 2.05 times

= 1.43 times

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13A (Continued) The ratios indicate that the company is healthy as far as liquidity is concerned as its current assets are well in excess of its current liabilities. It is more liquid in 2024 than in 2023. This is evidenced by the fact that the increases in cash, receivables, and inventory are significantly higher than the increases in the related current liabilities such as accounts payable. c. Ratio Accounts receivable turnover Average collection period

2024 $210,000____ = ($20,500+$13,500)/2 365 days = 29.4 days 12.4

12.4 times

The company is collecting its receivables on average in 29.4 days. This collection period is reasonable, since the terms offered is due in 30 days. Sales at the diner using credit card are “cash” when the credit card slips are deposited with the bank. d. Ratio Accounts receivable – lessons turnover Average collection period

2024 $105,000____ = ($20,500+$13,500)/2 365 days 6.2

6.2 times

= 58.9 days

Under the assumption that 50% of the sales and all the receivables come from the online culinary lessons, it appears that the lessons business receivables are not well-managed. As indicated above, payment is expected 30 days after the lessons are held. It takes close to two months for these receivables to be collected. This situation would be worrisome to me as a manager or as an analyst.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13A (Continued) e. Ratio Inventory turnover Days to sell inventory

2024 $85,000____ ($12,900+$7,000)/2 = 8.5 times 365 days 8.5

= 42.9 days

Given the nature of the company’s inventory (i.e. food products), this seems to be a low inventory turnover and a lengthy number of days to sell. It may point to a high risk of spoilage or that the company is not using the freshest ingredients in the meals it prepares. If we assumed that half of the cost of goods sold is labour cost related to preparation of meals, the ratio becomes far more reasonable. f. Ratio Accounts payable turnover Accounts payable payment period

2024 $90,900*____ = 11.7 times ($7,500+$8,000)/2 365 days = 31.1 days 11.7

*Credit Purchases = Cost of goods sold – Beginning inventory + Ending inventory = $85,000 - $7,000 + $12,900 = $90,900 Assuming the suppliers’ terms are 15-day terms, Pure Eating is, on average, over 16 days late paying the suppliers. If we assumed that half of the cost of goods sold is labour cost related to preparation of meals, the ratio becomes far less reasonable. g. Using the analysis of the receivables and payables from above, I would recommend that the credit period be significantly reduced, even to the extent that the online culinary lessons should be sold on a “cash-ondelivery”, or on a seven-day payment basis. The company may also want to request deposits from the culinary lessons (i.e. 20% up front). With the cash from the receivables coming in faster, the company should be able to pay its suppliers in 15 days, the credit period set out by its suppliers. The company may even be able to take advantage of cash discounts offered by its suppliers.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13A (Continued) h. A segmented analysis would be useful to determine the results of each of the company’s operations. This would be particularly useful if gross margins could be developed and turnover ratios could also be calculated for each segment. Because many of the occupancy and management costs are likely fixed in nature, some reasonable basis would have to be found to allocate these costs to each product line, or there could be no allocation of these due to their nature. LO 7 BT: AN Difficulty: M Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-14A a. HomeStar has become less profitable because of the events of 2022, and from the decline in demand for its merchandise perhaps from having to lower its prices or sell goods with a lower profit margin. The company is earning a lower rate of return on its assets and on equity. b. The following ratios have deteriorated during the subsequent period: • Current ratio, very slightly, and still quite strong • Quick ratio, very slightly • Return on assets • Gross margin • Profit margin • Return on equity c. The company seems to have taken positive action on two fronts: inventory turnover and level of debt. HomeStar's inventory turnover has increased each year indicating that the inventory is moving out more quickly. This means that they must wait less time to turn the inventory into cash. The debtto-equity ratio indicates that HomeStar is less leveraged now than in 2022 and 2023, with debt a significantly lower proportion of total capitalization. These actions should lead to controlling inventory carrying costs and interest charges. LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15A a. Clabber’s financial statements show some troubling trends. Profitability: is declining, even though sales are increasing. A common size income statement helps to highlight the specific problem areas.

Sales Cost of goods sold Gross margin Other expenses Income taxes Net income

2022 100.0% 58.0% 42.0% 17.0% 5.8% 19.2%

2023 100.0% 69.6% 30.4% 22.6% 2.3% 5.6%

2024 100.0% 66.3% 33.8% 25.0% 2.2% 6.6%

The company’s net income has declined significantly between 2022 and 2023, from 19.2% of sales to 5.6%, but rebounded slightly to 6.6% in 2024. This is largely due to the declining gross margin, because cost of goods sold is taking an increasing bite out of each sales dollar. Although sales have been increasing over this period, the cost of goods sold has been increasing at a faster rate. The company is still in its initial growth period, and so the cost of goods sold in 2022 may not have been representative of the company’s plans. For example, if Clabber began offering new products with a lower gross margin, the reduction in the gross margin percentage might have been planned. The company may have decided to compete on a basis of price to increase the volume of sales. The inventory has increased significantly over this same period, perhaps to meet demand at the lower prices and perhaps in new markets. To date, however, this strategy has been only marginally successful. In 2024, sales have increased by 39.1%, cost of goods sold increased by 32.5%, but the gross margin has increased by only 3.4%. Over this same period, the other expenses have been well controlled, so that net income increased by 64% in 2024 over 2023.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15A (Continued) Liquidity: 2022 $240,000/$120,000 = 2 to 1

2023 $257,200/$85,000 = 3.0 to 1

2024 $487,800/$144,000 = 3.4 to 1

Quick Ratio

$108,000/$120,000 = 0.9 to 1

$97,200/$85,000 = 1.1 to 1

$210,600/$144,000 = 1.5 to 1

A/R Turnover

$500,000 / $81,000 = 6.2 times

$575,000 / [($81,000 + $800,000 / [($72,900 + $72,900) / 2] $170,100) / 2] = 7.5 times = 6.6 times

Average Collection Period

365 / 6.2 = 58.8 days

365 / 7.5 = 48.7 days

Inventory Turnover

$290,000 / $132,000 = 2.2 times

$400,000 / [($132,000 $530,000 / [($160,000 + + $160,000) / 2] $277,200) / 2] = 2.7 times = 2.4 times

Days to Sell Inventory

365 / 2.2 = 166 days

365 / 2.7 = 135 days

Current Ratio

365 / 6.6 = 55.3

365 / 2.4 = 152 days

The current ratio and the quick ratio appear to be excellent, if not a little high at 3.4 and 1.5 times, respectively at the end of 2024. It is unusual that the significant increase in the receivable and inventory balances has not been offset with a significant increase in current liabilities. It appears that these major current assets are being financed by long-term debt financing instead. It is not appropriate to finance current assets with interest-bearing long-term debt instead of making full use of “interestfree” payables. The accounts receivable balances are up significantly, having almost doubled from 2022 to 2024. The collection of receivables has remained almost flat averaging 54.3 days from 2022 to 2024. It appears that Clabber may have very forgiving or generous credit terms.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15A (Continued) In addition, inventory levels have more than doubled from 2022 to 2024 and cost of goods sold has increased by 83% over the same period. Accounts payable balances have remained relatively unchanged. Inventory in 2024 is turning over at about the same rate as it was in 2022, but 2023 had shown a significant improvement which the company was not able to maintain. The company is now carrying almost a 5.0 month supply of inventory. These declining ratios will result in slower cash flows for the company. Assuming a 30-day credit period for its accounts payable, the company must finance its inventory and receivables for 152 – 30 + 55 = 177 days, or close to six months. It appears they have done this with an infusion of long-term borrowings. Is this being paid down as cash is generated or has it been used to pay out significant dividends to shareholders? In the last three years, the company has generated $180,500 of net income, but retained earnings is only $35,000 at the end of 2024, a difference of $145,500! Assuming dividends of this amount, it is not good business practice to finance dividends with long-term debt. The increased debt load carries interest which will have a negative impact on profitability. With the considerable increase in debt over the past year, interest costs in the future will be higher to take into account the increased solvency risk. Furthermore, the after-tax cost of debt is high, since the company is currently paying taxes at a low tax rate. b. 2022

2023

2024

$292,700 - $24,300 / $670,000 = 40.1%

$604,000 - $40,500 / $665,000 = 84.7%

$32,000/[($1,047,700 + $1,034,400)/2

$52,500/[($1,413,000 + $1,047,700)/2

= 3.1%

= 4.3%

Debt to Equity $240,000 - $27,000 / $674,400 = 31.6% Return on Assets $96,000/$1,034,400 = 9.3% Return on Equity $96,000/$674,400 = 14.2%

$32,000/[($670,000 + $52,500/[($665,000 + $674,400) / 2]= 4.8% $670,000) /2]= 7.8%

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15A (Continued) In 2022, the company used leverage to good advantage, earning a 14.2% return on equity while only a 9.3% on total assets. 2023’s results were not very good with both ROA and ROE dropping considerably. 2024 indicates a small improvement over 2023, but it is not clear what Clabber’s strategy is going forward. The company significantly increased its long-term debt in 2024. Prior to this, the company’s debt to equity ratio was under 50%. With the increase in debt in 2024, this ratio has increased to 84.7%. While more information on the industry would be needed to determine if the company is highly leveraged, it does appear that it has been able to generate returns on equity in excess of its return on assets. The company should keep in mind the extremely high level of dividend payout when assessing the return on equity. If shareholders are getting disproportionately high amounts of dividends, they may be less alarmed by a low return on equity. LO 7 BT: AN Difficulty: H Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-16A 1

Quick ratio of 0.6 to 1

3 A/R turnover of 12 times

Current ratio of 1.2 to 1

Inventory turnover of 6 times

ROA of 10%

ROE of 15%

–

Ratio/ Transaction

LO 7 BT: AN Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17A a. Ratios for A-Tec and B-Sci: A-Tec

Bi-Sci

2024

2023

2024

2023

3.09

1.96

5.20

4.60

Current ratio

ii.

Acc. Rec. turnover

11.34 times

9.29 times

11.36 times

12.00 times

iii.

Inv. turnover

10.87 times

9.00 times

8.67 times

9.00 times

iv.

Debt to equity

50.0%

110.0%

n/a

Interest coverage

13.85

9.45

n/a

vi.

Gross margin

34.2%

30.8%

27.2%

25.0%

vii.

Profit margin

9.5%

10.0%

12.0%

10.8%

viii. ROA (return on assets)

29.1%

23.9%

34.1%

33.3%

ix.

62.1%

65.0%

38.5%

38.2%

ROE (return on equity)

Supporting calculations: A-Tec:

2024

2023

340/110

245/125

ii. Acc. receivable turnover (sales/net acc. rec. Ave)

1,900/167.5

1,300/140

iii. Inventory turnover (cost of goods sold/inv. Ave.)

1,250/115

900/100

iv. Debt to equity (long-term debt – cash) / Shareholder's Equity)

190/380

220/200

v. Interest coverage ([net income + income taxes + interest] / interest)

277/20

208/22

vi. Gross margin (gross margin / sales)

650/1,900

400/1,300

vii. Profit margin (net income / sales)

180/1,900

130/1,300

viii. ROA = net income/ total assets average

180/617.5

130/545

ix. ROE = ([net income – preferred dividends] / shareholders' equity Ave.)

180/290

130/200

i. Current ratio (current assets/current liabilities)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17A (Continued) Supporting calculations: Bi-Sci:

2024

2023

i. Current ratio (current assets/current liabilities)

260/50

230/50

ii. Acc. receivable turnover (sales/net acc. rec. Ave.)

1,250/110

1,200/100

iii. Inventory turnover (cost of goods sold/inv. average)

910/105

900/100

iv. Debt to equity (long-term debt - cash / Shareholder's Equity)

n/a

v. Interest coverage ([net income + income taxes + interest] / interest)

n/a

vi. Gross margin (gross margin / sales)

340/1,250

300/1,200

vii. Profit margin (net income / sales)

150/1,250

130/1,200

viii. ROA = net income / total assets average

150/440

130/390

ix. ROE = ([net income – preferred dividends] / shareholders' equity average)

150/390

130/340

The following analysis is separated into liquidity and activity, solvency, and profitability analysis. Liquidity and activity: Bi-Sci appears to be in a better liquidity position as its current ratio is much higher than A-Tec’s. Both companies’ current ratios improved in 2024, and both are satisfactory. The accounts receivable turnover and inventory turnover also measure liquidity because they measure the amount of time before these items will be converted to cash in the operating cycle. Both ratios decreased slightly for Bi-Sci in 2024. A-Tec’s ratios increased in 2024 and are now closer to or a little better than Bi-Sci’s. Management of both companies appear to be converting inventory into receivables and receivables into cash on a current basis.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17A (Continued) Solvency: Bi-Sci is in a much better solvency position as measured by the debt to equity and interest coverage ratios. Bi-Sci is financed completely by equity while A-Tec, equally financed by debt and equity in 2023, now has net debt equal to only 50% of equity. Capital structures usually have some long-term debt component to support the acquisition of capital assets and for the positive leverage effects for shareholders. A-Tec is using much more leverage than Bi-Sci. Since A-Tec splits its financing between long term debt capital and equity, it has an opportunity to earn returns on its assets that exceed the cost of the debt (interest expense) to its creditors. The excess return serves to increase or leverage the return to shareholders. Leverage is best measured by comparing the return on assets to the return on equity. With the use of leverage, and a return on assets in excess of interest rates, the return on equity for a company like A-Tec will be higher than its return on assets. The returns of the two companies that indicate the advantage leverage has for A-Tec are summarized as below. It is easy to see how debt acted as a lever to increase A-Tec’s return on equity.

Return on assets Return on equity

A-Tec 2024 2023

Bi-Sci 2024 2023

29.1% 62.1%

34.1% 38.5%

23.9% 65.0%

33.3% 38.2%

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17A (Continued) Profitability: The gross margin has increased in both years for both ATec and Bi-Sci, with A-Tec indicating considerably higher margins than Bi-Sci. A-Tec’s gross margin is a full 7% higher than Bi-Sci’s in 2024, a wider spread than 2023’s 5.8% difference. On a profit basis, however, Bi-Sci wins out, indicating better cost control over operations aside from the cost of the inventory sold relative to sales. Bi-Sci also benefits here by not having any debt as this also means it has no interest expense. Bi-Sci’s 2024 profit margin of 12.0% increased by 1.2% over 2023’s 10.8%; whereas A-Tec’s 2024 profit margin of 9.5% represents a drop of 0.5% over 2023’s results. Thus, overall, Bi-Sci has maintained profitability while A-Tec has fallen off slightly (based on profit margin and ROE). However, A-Tec increased its sales by 46% in 2024 to go along with the expansion in assets and Bi-Sci had minimal growth in the same year. While Bi-Sci appears to be a better credit risk for a lender because of the absence of long-term debt to begin with, A-Tec looks like the better investment for a shareholder or potential shareholder. The return on equity for A-Tec is very high. If the return on assets stays high, there will be a good leveraged return to shareholders. I would want to know whether the prospects for growth for the two companies are the same, and whether the growth in sales will continue at the same pace. Overall, Bi-Sci appears to be a very conservatively managed business with little risk for a lender at this point, while A-Tec’s higher risk makes it more attractive to a shareholder interested in the potential for higher returns. A-Tec’s solvency risk is higher than Bi-Sci’s but still within acceptable limits. LO 7 BT: AN Difficulty: H Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-18A a.

Zeus

Mars

i. Average collection period

38.1 days

42.3 days

ii. Days to sell Inventory

35.5 days

36.6 days

iii. Current ratio

1.77

1.95

21.7%

31.3%

0.73

0.66

vi. Interest coverage

2.1 times

3.8 times

vii. Return on assets

2.2%

7.0%

viii. Return on equity

9.6%

26.2%

iv Operating cash flow ratio v. Net debt to total capitalization

CALCULATIONS: Zeus Corporation i.

Mars Company

$3,350/$350 = 9.57 times;

$6,810/$790 = 8.62 times;

365 days / 9.57 = 38.1 days

365 days / 8.62 = 42.3 days

ii. $2,980/$290 = 10.28 times; 365 days / 10.28 = 35.5 days

$5,740/$575 = 9.98 times; 365 days / 9.98 = 36.6 days

iii. $1,020/$575

$1,620/$830

iv. $125 / $575 = 21.7%

$260 / $830 = 31.3%

v. $2,220/($2,220 + $810)

$3,130/($3,130 + $1,620)

vi. ($75 + $130 + $62)/$130

($375 + $175 + $110)/$175

vii. $75/[($3,250 + $3,605)/2]

$375/[($5,160 + $5,580)/2]

viii.$75/[($750 + $810)/2]

$375/[($1,245 + $1,620)/2]

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-18A (Continued) b. Liquidity and activity: Zeus Corp. and Mars Co. have similar current ratios with Zeus Corp. having almost a 10% edge in the collection period for its receivables, and a slight edge in selling through its inventory a little faster. Mars’ current ratio and operating cash flow ratio are somewhat higher than Zeus’, but when combined with Zeus’ better activity ratios, their liquidity is very similar. Solvency: Both companies have similar financing structures with between 2/3 and ¾ of their total capitalization financed by debt. Mars Co.’s debt ratio shows a little lower credit risk than that of Zeus, and Mars also has a stronger interest coverage ratio. Profitability and leverage: The two companies have very different ROA and ROE. Mars Corp. is much more profitable, generating a considerably higher return on its net assets invested and on its equity. This originates in Mars’ significantly higher sales dollars, its higher gross margin ratio (15.7% vs. Zeus’ 11%) and its higher profit margin (5.5% vs. Zeus’ 2.2%). Overall, Mars Corp. seems to be the better investment, with stronger overall ratios in each category with the exception of its activity ratios which are marginally poorer than those of Zeus. LO 7 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-1B a. Cool Brewery Net sales $206,700 100.0% Cost of goods sold 100,500 48.6% Operating expenses 85,400 41.3% Interest expense 7,800 3.8% Income tax expense 4,700 2.3% Net earnings $ 8,300 4.0%

Northern Beer $ 40,500 100.0% 15,300 37.8% 17,190 42.4% 370 0.9% 1,130 2.8% $ 6,510 16.1%

Total shareholders’ equity $132,200 121,800

Total assets Cool Brewery – 2024 $308,000 – 2023 300,100 Average

$304,050

$127,000

Northern Beer – 2024 – 2023

$41,800 40,600

$29,900 29,200

Average

$41,200

$29,550

ROA = ROA =

Cool Brewery

Northern Beer

$8,300 $304,050 2.7%

$6,510 $41,200 15.8%

ROE = $8,300 / $127,000 = 6.5%

= $6,510 / $29,550 = 22.0%

c. All performance measures indicate Northern Beer is more profitable than Cool Brewery. Its profit margin of 16.1% is 12.1% higher than Cool Brewery’s 4.0%. Its ROA is also 13.1% higher, and its ROE is 15.5% higher.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-1B (Continued) d. One major reason for Northern Beer’s better performance is its lower cost of goods sold (37.8% of net sales versus 48.6%) resulting in a 10.8% higher gross margin percentage of 62.2% (compared to 51.4% for Cool Brewery). The other significant reason is Northern Brewery’s lower interest expense relative to sales of 0.9% compared to Cool Brewery’s 3.8%. e. Debt to equity ratio - 2024: Cool Brewery LT liabilities $103,900 Less: cash ( 12,000) Net debt $91,900 D/E = $91,900 / $132,200 = 0.70 f. LT liabilities Less: cash Net debt Add: equity Total capitalization

Cool Brewery $103,900 ( 12,000) 91,900 132,200 $224,100

Net debt as a % of total capitalization: $91,900/$224,100 = 41.0% g.

Northern Beer $ 8,000 ( 4,500) $ 3,500 = $3,500 / $29,900 = 0.12 Northern Beer $ 8,000 ( 4,500) 3,500 29,900 $33,400

$3,500/$33,400 = 10.5%

Cool Brewery is much more highly leveraged than Northern Beer with debt equal to 70% of its equity, while Northern Beer’s debt is only 12% of its equity. This is further illustrated with Cool Brewery’s 41.0% of net debt to its total capitalization as compared to Northern Beer’s 10.5%. Has this greater use of leverage (a greater proportion of debt) been advantageous to its shareholders? It appears not. Cool Brewery has returned an additional 3.8% to its shareholders above its return on total assets (6.5% - 2.7%) as compared to an additional 6.2% that Northern Beer generated for its shareholders (22.0% - 15.8%).

LO 6,7 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-2B a. 2021 2022 2023 2024

Current Ratio $7,500 / $3,556 = 2.11 $6,128 / $2,968 = 2.06 $5,036 / $2,548 = 1.98 $4,056 / $2,156 = 1.88

Quick Ratio ($7,500 – $5,068 – $780) / $3,556 = 0.46 ($6,128 – $3,472 – $920) / $2,968 = 0.58 ($5,036 – $2,576 – $780) / $2,548 = 0.66 ($4,056 – $1,820 – $780) / $2,156 = 0.68

The current ratio has shown a decreasing trend over the four years. However, this four-year downward trend has resulted from stocking less inventories and this has resulted in an upward trend in the quick ratio, which is 0.68 in 2024. The company’s short-term liquidity is fair.

The analysis in part “a” is a trend analysis as it zeroes in on the same measure for one company over several years to discover what the trend is. A cross sectional analysis is based on comparing the relative amounts making up the components of particular financial statements across companies at a point in time.

The quick ratio is likely a better indication of short-term liquidity for Cumberland since the downward trend in the current ratio can be deceiving. By reducing its inventories, which take longer and may be difficult to convert to cash quickly, Cumberland is improving its liquidity.

LO 7 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-3B a. Working capital = ($270,600 + $299,000 + $29,400) – $231,000 = $368,000 The working capital is quite high, and indicates that there are more than enough current assets to satisfy current liabilities. In addition, since the company maintains a high cash balance of $270,600, cash required to finance operations is not a concern. b.

Current ratio = $599,000 / $231,000 = 2.59 Quick ratio = $270,600 / $231,000 = 1.17 Both the current ratio and the quick ratio exceed the criteria of 2.0 and 0.8, respectively. Based on these ratios, the company’s current asset position is strong, and short-term liquidity is not a concern. In fact, these ratios suggest that perhaps the company’s investment in current assets is more than what is required to support the sales function and to finance operations (i.e. it is holding too much cash).

d. If these balances existed following the completion of the primary selling season, then most of the current assets held would be unnecessary, and their high levels might reflect poor cash and inventory management. Inventory levels, particularly, should be short-term investments that a company makes to facilitate sales to customers. If the selling season is completed, then the company’s inventory should be reduced. It would then start to increase inventories in anticipation of its next selling season.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-3B (Continued) In particular, if the garden season were over, there would be a concern as to whether there are obsolete items in the inventory, or whether a write down of inventory might be required for items where the net realizable value is less than cost. e. A public company might be more attractive to a potential investor for several reasons. First, public companies whose stock is listed require audits, which provide some assurance to investors. A private company may, or may not be required to have its financial statements audited. Second, it is easier for investors to sell their shares when the company is listed on a stock exchange, and the club may need to sell the shares within the next few years. LO 7 BT: AN Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-4B Ratio a. A/R Turnover

Vintage Furniture $84,840 / $8,1101 = 10.5 times 1 [($6,880 + $9,340) /2]

b. Days to Collect

365 / 10.5 = 34.8 days

Victoria Foodland $42,140 / $1,5152 = 27.8 times 2 [$1,250 + $1,780)/2] 365 / 27.8 = 13.1 days

c. Victoria Foodland appears to manage its receivables more efficiently. It collects its receivables in 13.1 days on average versus 34.8 days for Vintage Furniture. It would be important to factor the nature of each business into this assessment as the two businesses are very different. d. Information regarding each company’s credit terms, the type of inventory (i.e., is it food or furniture?), and the type of customer would be helpful. Information on the standard credit terms in the industry would also be helpful. LO 7 BT: AN Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-5B a. 2020 2021 2022 2023 2024

Inventory Turnover $1,948,492 / $487,289 = 4.00 $1,856,820 / $388,104 = 4.78 $1,644,300 / $268,203 = 6.13 $1,403,780 / $219,940 = 6.38 $1,250,340 / $192,675 = 6.49

Number of days 365 / 4.00 = 91.3 days 365 / 4.78 = 76.4 days 365 / 6.13 = 59.5 days 365 / 6.38 = 57.2 days 365 / 6.49 = 56.2 days

b. The inventory turnover has increased over the five-year period, indicating a decrease in the time that the inventory is held before sale. In fact, the average number of days inventory is held has almost halved over the five years, to under two months. This is favourable. Before reaching a definite conclusion, more information should be gathered on whether the type of inventory has changed, and whether its sales mix has changed. Is the company following a different strategy, perhaps toward carrying a greater variety of goods with a higher profit margin but with more limited sales potential? Is the inventory on hand obsolete, or is there a continuing demand for the inventory? c. It is possible that the increased inventory turnover results from a decrease in the average inventory. If management deliberately reduces the average inventory by not replenishing it’s inventory, there is the possibility that these actions have caused stockouts and lost sales. Evidence of this consequence is reflected in the reduced costs of goods sold, from reduced sales. LO 7 BT: AN Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-6B a. Inventory turnover: M&G Restaurants: $1,382,584 / [($78,800 + $69,560) / 2] = 18.6 times Continental Buffet: $7,543,900 / [($191,060 + $41,620) / 2] = 64.8 times b. Days to sell inventory ratio: M&G Restaurants: 365 / 18.6 = 19.6 days Continental Buffet: 365 / 64.8 = 5.6 days c. The inventory turnover for a restaurant, especially one carrying perishable fruit and vegetables, should be high because food has a very limited shelf life and must be turned over fast so that spoilage does not occur. Therefore, considering that inventory, including non-perishables, for these companies is held for less than one month on average, the ratios appear reasonable. Both companies appear to be managing their inventory to the same degree, although Continental Buffet has almost a two-week better turnover. Continental Buffet is managing its inventory more efficiently. d. While Continental Buffet appears to be managing their inventory better than M&G Restaurants, we cannot say that they are more profitable. Perhaps M&G Restaurants also carries many non-perishables, but specializes in maintaining a higher-quality fresh food selection and can charge more for its meals. e. Fast inventory turnovers could be an indication that not enough inventory is being held. Because inventory is held to support the sales function, potential sales can be lost. Shortages might also result in the loss of customers if not enough inventory is maintained. LO 7 BT: AN Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-7B a. Current ratio – 2024: $161 + $2,100 + $1,352 + $336 $1,393 + $56 + $560 = $3,949/$2,009 = 1.97 times Current ratio – 2023: $224 + $1,218 + $2,310 + $392 $1,330 + $112 + $280 = $4,144/$1,722 = 2.41 times Value Seller Inc. does not meet the meet the current ratio requirements of the loan covenant in 2024 but did in 2023. VSI did meet loan limits in both years. b. Maximum loan – 2024: ($1,352 X .35) + ($2,100 X .55) = $1,628.2 Additional borrowing: $1,628.2 - $560 = $1,068.2 Maximum loan – 2023: ($2,310 X .35) + ($1,218 X .55) = $1,478.4 Additional borrowing: $1,478.4 - $280 = $1,198.4 35% of inventory 2023 $2,310 x 35 % = $808.5 2024 $1,352 x 35% = $473.2

55% of accounts receivable $1,218 x 55% = $669.9 $2,100 x 55% = $1,155

Maximum loan amount $1,478.4 $1,628.2

c. Based on the accounts receivable balances reported indicating the level of receivables is increasing, it appears that the sales may have grown in 2024 over 2023. d. The company could postpone inventory purchases until after the end of the reporting period. Inventory levels at the end of 2024 are already much lower than the levels at the end of 2023. This strategy had the added risk of possible stockouts, causing lost sales. Another possible strategy is to get additional financing, possibly through the issuance of shares, to improve the company’s working capital and to reduce the accounts payable. The risk to this strategy is that the added equity comes with shareholders’ expectation of a return on their investment. LO 7,8 BT: AN Difficulty: H Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-8B a. Accounts receivable turnover: = Credit sales / Average accounts receivable = $7,000,000 / (($939,700 + $902,230) / 2) = 7.60 Average collection period: = 365 / 7.60 = 48.0 days Atomister's policy is to extend credit terms to its customers for 30 days; however, it is taking the company on average 48 days to collect their receivables, which is 18 days longer than allowed under their credit policy. b. Inventory turnover: = Cost of goods sold / Average inventory = $3,150,000 / (($679,120 + $590,360) / 2) = $3,150,000 / $634,740 = 4.96 Days to sell inventory: = 365 / 4.96 = 73.6 days It takes Atomister about two and a half months, on average, to sell through its inventory. c. Purchases = Cost of goods sold – Beginning inventory + Ending inventory = $3,150,000 – $590,360 + $679,120 = $3,238,760 Accounts payable turnover: = Credit purchases / Average accounts payable = $3,238,760 / (($281,050 + $273,350) / 2) = 11.7 Accounts payable payment period: = 365 / 11.7 = 31.2 days

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-8B (Continued Atomister's policy is to pay its suppliers within the 30 days granted according to their credit terms, and the company is paying their payables quite timely, only a day or two beyond the 30-day terms the suppliers offer. d. Atomister’s cash-to-cash cycle = Days inventory held – Days to pay A/P + days to collect A/R = 73.6 – 31.2 + 48.0 = 90.4 days e. Atomister’s current cash-to-cash cycle is 90.4 days. If they were able to reduce the days to collect receivables to 40 days from 48 days, the cashto-cash cycle would be reduced by 8 days to 82.4 days and reduce interest costs as the required working capital loan would be reduced. LO 7 BT: AN Difficulty: E Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-9B a. Net debt as a percentage of total Debt to equity ratio capitalization

Interest coverage

2022 ($5,500 - $200) / $6,500 = 81.5%

($5,500 - $200) / ($5,500 - $200 + $6,500) = 44.9%

$6,900 / $380 = 18.2

2023 ($6,100 - $260) / $6,900 = 84.6%

($6,100 - $260) / ($6,100 - $260 +$6,900) = 45.8%

$7,200 / $340 = 21.2

2024 ($5,200 - $310) / $7,600 = 64.3%

($5,200 - $310) / ($5,200 - $310 + $7,600) = 39.2%

$5,700 / $280 = 20.4

b. The debt to equity and net debt as a percentage of total capitalization ratios both show improvements in 2024 over 2022, even though the debt to equity ratio spiked in 2023. The positive trend in these ratios is due primarily to a small reduction in long-term debt (and increase in cash balances) while shareholders’ equity increased steadily. The overall rates, however, appear to be on the high side. In addition, the interest coverage ratio has increased from a low of 18.2 in 2022 to a high of 21.2 and 20.4 times in 2023 and 2024, respectively. This is due to increased earnings and a reduction in interest expense over the 2022 to 2024 period. Overall, the company can quite comfortably cover its interest charges from its earnings, but an investor might want to monitor the debt/equity structure in the future. LO 7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-10B a. Return on Equity (ROE): 2022:

$1,000 / $17,990 = 5.6%

2023:

$4,600 / $23,000 = 20.0%

2024:

$9,760 / $35,000 = 27.9%

TwoDaLoos’ return on equity is improving, having increased by 5.0 times between 2022 and 2024. b. Return on Assets (ROA): 2022:

$1,000 / $45,606 = 2.2%

2023:

$4,600 / $51,990= 8.8%

2024:

$9,760 / $67,440 = 14.5%

TwoDaLoos’ return on assets has improved, increasing by more than 559% between 2022 and 2024. c. Gross margin: 2022:

$9,900 / $25,798 = 38.4%

2023:

$16,000 / $33,879 = 47.2%

2024:

$25,890 / $45,775 = 56.6%

The gross margin has increased significantly between 2022 and 2024, with 2023’s margin 8.8% above that of 2022, and 2024’s 18.2% above that of 2022. This is a definite improvement in the rate of gross margin.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-10B (Continued) d. TwoDaLoos has experienced significant improvement in its profitability over the 2022 to 2024 period. The company’s profit margin has increased from 3.9% ($1,000 / $25,798) in 2022 to 21.3% ($9,760 / $45,775) in 2024. Investments in assets increased and the investment represented by equity doubled in the same period, its sales almost doubled during the same period as well. This combined with increasing profit margins has contributed to the improvements in returns on assets and equity. It appears that the company is making effective use of leverage as well, with higher returns on the shareholders’ investment than on the company’s investment in assets. LO 7 BT: AN Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

AP12-11B a. Price-earnings ratios: Company A Company B

$46.42/$0.97 = 47.9 times $18.12/$0.87 = 20.8 times

Based on the P/E ratio, Company B is more affordable. It takes an investment of $20.80 to result in company earnings of $1.00, whereas with Company A, you’d need to pay $47.90 for $1.00 of earnings. b. Ratio Dividend payout ratio Dividend yield

Company A $0.585/$0.97 = 60.3% $0.585/$46.42 = 1.26%

Company B $0.375/$0.87 = 43.1% $0.375/$18.12 = 2.07%

Company A pays a higher dividend than Company B as well as a higher proportion of its earnings to shareholders as a dividend. However, the dividend from Company A represents only a 1.26% return on your investment as compared to the higher 2.07% return earned on Company B.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-11B (Continued) c.

Net free cash flows: Company A $330,100 - $105,059 = $225,041 Company B $90,469 - $8,617 = $81,852 The net free cash flows represent the cash available to each company generated from operating activities over and above that reinvested in replacing and adding to its property, plant and equipment. This cash is available for repaying debt, taking advantage of new investment opportunities and for paying out to shareholders as dividends.

From these ratios, Company B appears to be a riskier company with investors requiring a higher rate of return on their investment. This is evidenced by the fact that investors are only willing to pay 20.8 times earnings for its shares, while Company A investors are willing to pay 47.90 times earnings for its shares. It also appears that Company A is considerably larger, more mature and with more shares outstanding than Company B. This is based on the fact that Company A’s cash flows from operations are so much greater than Company B’s yet its earnings per share is only $0.10 higher. In addition, Company A’s dividend payout is significantly higher than is Company B’s, and it is usual for older, established and lower risk companies to have sufficient experience and history to pay out larger percentages of their earnings as dividends. Company B is probably growing at a slower rate than Company A. This is supported by Company B reinvesting only $8,617/$90,469 = 9.5% of its cash generated from operations into additional capital expenditures, while Company A is reinvesting $105,059/$330,100 = 31.8%. This may also support the assessment regarding the age of Company A, in that these additional capital expenditures may be required to replace older assets to maintain the company’s productive capacity. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-12B a. Ratio i. Return on assets

Company Alpha Company Omega $103,000/$792,308 $100,000/$769,231 = 13.0% = 13.0% Alpha and Omega are similar sized companies and both companies earn the same 13% return on the assets they have invested. ii. Gross margin $1,960,000-$1,762,000 $1,750,000-$1,487,500 $1,960,000 $1,750,000 = 10.1% = 15.0% Omega earns a higher (better) return per dollar of sales after the cost of goods sold is deducted from sales than does Alpha, leaving $0.15 of each dollar to cover other costs and contribute to profit. Alpha leaves only $0.10. iii. Profit margin $103,000/$1,960,000 $100,000/$1,750,000 = 5.3% = 5.7% Omega’s profit margin percentage is slightly higher than Alpha’s. $0.057 of each dollar ends up in profit from each dollar of Omega’s sales, whereas only $0.053 of each of Alpha’s is profit. iv. Inventory turnover $1,762,000/$150,600 $1,487,500/$215,800 = 11.70 times = 6.89 times Alpha’s inventory turnover is much better than Omega’s, as it sells out its inventory in half the time it takes Omega. v. Days to sell 365/11.70 365/6.89 inventory = 31.2 days = 53.0 days Consistent with the inventory turnover ratio, this ratio indicates that Omega takes close to 2 months to sell out its inventory, whereas Alpha takes 1 month, indicating that Alpha manages its inventory better. b. The low-cost producer appears to be Alpha, as indicated by its lower gross margin ratio and lower profit margin ratio. The reason that Alpha earns the same 13% return on assets as Omega is likely because its inventory turns over much more quickly, thereby generating significantly more sales on which to earn its lower gross margin. Omega, assuming it is in the same general business as Alpha, probably carries goods with a higher selling price and higher margin and counts on this higher margin to earn its 13% return on assets, rather than from selling high volumes of inventory. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13B a. Ratio Gross margin

Profit margin

2024 ($262,000 - $110,000) $262,000 = 58.0% $28,000/$262,000 = 10.7%

2023 ($220,000 - $103,000) $220,000 = 53.2% $9,700/$220,000 = 4.4%

From the ratios calculated, it appears that the contracting business has added to the profitability of the company. The initial decision might be to emphasize the contracting business as it appears to have a higher rate of gross margin and of profit to sales than does the home market, judging from the effect on the overall company ratios. This should be looked at more closely before making any final decision, however Superior will want to assess the market potential of both the contracting and home markets. They will also want to consider other factors. For example, the cost of goods sold has increased little, so further investigation of labour costs relative to contracting, for example should be carried out. Is the contracting business using idle labour it would otherwise have to pay for if the home market wasn’t operating or was downsized? Further, if home market sales were reduced, additional contracting business would then be required in order to pay occupancy costs and other fixed costs associated with the property and equipment, interest costs and management salaries. b. Ratio Current ratio

Quick ratio

2024

2023

$12,040+$19,700+$15,260 $4,480+$13,000+$8,400 $13,300+$2,520+$3,500 $11,200+$0+$3,500 = 2.43 times $12,040+$19,700___ $13,300+$2,520+$3,500

= 1.76 times $4,480+$13,000__ $11,200+$0+$3,500

= 1.64 times

= 1.19 times

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13B (Continued) The ratios indicate that the company is healthy as far as liquidity is concerned as its current assets are well in excess of its current liabilities. It is more liquid in 2024 than in 2023. This is evidenced by the fact that the increases in cash, receivables, and inventory are significantly higher than the increases in the related current liabilities such as accounts payable. c. Ratio 2024 Accounts receivable $262,000____ = turnover ($19,700+$13,000)/2 Average collection period 365 days = 22.8 days 16.0

16.0 times

The company is collecting its receivables on average in 22.8 days. This credit period seems good given the nature of the products being sold. We would expect contracting and home market clients to pay very soon after the jobs are completed. d. Ratio 2024 Accounts receivable $131,000____ = contracting turnover ($19,700+$13,000)/2 Average collection period 365 days = 45.6 days 8.0

8.0 times

Under the assumption that 50% of the sales and all of the receivables come from the contracting business, it appears that the contracting business receivables are not well managed. Contracting customers are offered 30-day payment terms, yet the average collection period is 45.6 days – meaning payments are more than two weeks late on average. Collection efforts need to be enhanced and accounts closely monitored. Contractors who fail to meet the 30-day payment terms should be put on a cash on delivery policy. Alternately, Superior could charge interest on late payments.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13B (Continued) e. Ratio Inventory turnover

2024 $110,000____ ($15,260+$8,400)/2 = 9.3 times

Days to sell inventory

365 days 9.3

= 39.2 days

Given the nature of the company’s inventory (kitchen and bathroom furniture and accessories), this seems to be a decent inventory turnover and an average number of days to sell. f. Ratio Accounts payable turnover Accounts payable payment period

2024 $116,860*____ = 9.5 times ($13,300+$11,200)/2 365 days = 38.4 days 9.5

*Credit Purchases = Cost of goods sold – Beginning inventory + Ending inventory = $110,000 - $8,400 + $15,260 = $116,860 Assuming the suppliers’ terms are 30-day terms, Superior is, on average, over 8 days late paying the suppliers. g. Using the analysis of the receivables and payables from above, I would recommend that the credit period be significantly reduced. The company may also want to request deposits from contracting customers (i.e. 20% up front). With the cash from the receivables coming in faster, the company should be able to pay its suppliers in 30 days, the credit period set out by its suppliers. The company may even be able to take advantage of cash discounts offered by its suppliers.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-13B (Continued) h. A segmented analysis would be useful to determine the results of each of the company’s operations. This would be particularly useful if gross margins could be developed and turnover ratios could also be calculated for each segment. Because many of the occupancy and management costs are likely fixed in nature, some reasonable basis would have to be found to allocate these costs to each product line, or there could be no allocation of these due to their nature. LO 7 BT: AN Difficulty: M Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-14B a. Pine Boutique has become less profitable because of the strategy adopted in 2022. The gross margins on the lower cost imported furniture were lower in each year since the strategy was implemented, which also resulted in lower overall profit margins. These lower profits, coupled with the increased assets resulted in the company earning a lower rate of return on its assets. b. The following ratios have deteriorated during the subsequent period: • Debt-to-equity ratio (have made significant equipment purchases) • Return on assets • Gross margin • Profit margin c. The company seems to have taken positive action on four fronts: current ratio, quick ratio, receivables turnover and inventory turnover. Both the current ratio and the quick ratio have improved, indicating that Pine Boutique has the ability to pay off their short-term debt. Pine Boutique’s receivable turnover has increased indicating that they are collecting their receivable more quickly. Pine Boutique's inventory turnover has increased each year indicating that the inventory is moving out more quickly. This means that they have to wait less time to turn the inventory into cash. The company is successfully using financial leverage, its return on equity is quite a bit higher than its return on assets. LO 7 BT: AN Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15B a. Tableak’s financial statements show some improving trends. Profitability: Profit and sales are both increasing. A common size income statement helps to highlight the where this increase is coming from.

Sales Cost of goods sold Gross margin Other expenses Income taxes Net income

2022 100.0% 72.5%

2023 100.0% 71.0%

2024 100.0% 70.0%

27.5% 24.3% 1.4% 1.8%

29.0% 23.0% 1.5% 4.5%

30.0% 24.2% 1.7% 4.0%

The company’s net income has increased over the last three years from 1.8% of sales to 4.0%, but increased even more in 2023 to 4.5%. This is largely due to the increasing gross margin, because cost of goods sold represents a small portion of each sales dollar.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15B (Continued) Liquidity: 2022 $300,000/$150,000 = 2 to 1

2023 $345,000/$170,000 = 2.0 to 1

2024 $395,000/$190,000 = 2.1 to 1

Quick Ratio

$135,000/$150,000 = 0.9 to 1

$150,000/$170,000 = 0.9 to 1

$205,000/$190,000 = 1.1 to 1

A/R Turnover

$1,050,000/ $101,250 = 10.4 times

$1,200,000 [($101,250 + $1,350,000 / [($120,000 $120,000) / 2] + $167,500) / 2] = 10.8 times = 9.4 times

Average Collection Period

365 / 10.4 = 35.1 days

365 / 10.8 = 33.8 days

Inventory Turnover

$761,250 / $165,000 = 4.6 times

$852,000 / [($165,000 + $945,000 / [($195,000 + $195,000) / 2] $190,000) / 2] = 4.7 times = 4.9 times

Days to Sell Inventory

365 / 4.6 = 79.3 days

365 / 4.7 = 77.7 days

Current Ratio

365 / 9.5 = 38.8 days

365 / 4.9 = 74.5 days

The current ratio and the quick ratio appear to be excellent at 2.1 and 1.1 times, respectively at the end of 2024. It is unusual that the significant increase in the receivable and inventory balances has not been offset with a significant increase in current liabilities. It appears that these major current assets are being financed by long-term debt financing instead. It is generally not advisable to finance current assets with interest-bearing long-term debt instead of making full use of “interest-free” payables. The accounts receivable balances are up 40% from 2023 to 2024. This is inconsistent with what should happen with only a 12.5% increase in sales. The collection of receivables has started to slow down as well, so that it appears that the credit terms have become less stringent and the credit term extended. This may explain the reduced turnover and the increased time to collect.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15B (Continued) In addition, inventory levels have increased by 15% from 2022 to 2024 and cost of goods sold has increased by 24% over the same period. Accounts payable balances have increased by 27% from 2022 to 2024. Inventory is turning over at about the same rate in all three years. The company is now carrying almost a 3.5-month supply of inventory. These declining ratios will result in slower cash flows for the company. Assuming a 30-day credit period for its accounts payable, the company must finance its inventory and receivables for 38.8 – 30.0 + 74.4 = 83.2 days, or close to three months. It appears they have done this with an infusion of long-term borrowings. Is this being paid down as cash is generated or has it been used to pay out significant dividends to shareholders? In the last three years, the company has generated $127,650 of net income, but retained earnings is only $47,100 at the end of 2024, a difference of $80,550! This means that dividends of this amount were declared. It may have been better to retain some of these profits and reinvest them in the business rather than taking on additional long-term debt. The increased debt load carries interest which will have a negative impact on profitability. With the considerable increase in debt over the past year, interest costs in the future are likely to be higher to take into account the increased solvency risk. Furthermore, the after-tax cost of debt is high, since the company is currently paying taxes at a low tax rate. b. 2022 2023 2024 Debt to Equity ($300,000 - $33,750) / $843,000 = 31.6%

($325,000 - $30,000) ($520,000 - $37,500) / $840,000 = 35.1% / 834,600 = 57.8%

Return on Assets $19,050/$1,293,000 = 1.5%

$54,000/(($1,293,000 $54,600/(($1,335,000 + 1,335,000)/2) + $1,544,600)/2) = 4.1%

= 3.8%

Return on Equity $19,050/$843,000 = = 2.3%

$54,000/(($843,000 + $54,600/(($840,000 + $840,000)/2) = 6.4% $834,600)/2) = 6.5%

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-15B (Continued) In 2022, the company was under leveraged, earning a 2.3% return on equity while only an 1.5% on total assets. 2023’s results improved with both ROA and ROE increasing. 2024 indicates a small improvement over 2023, in ROE but a slight decline in ROA but it is not clear what Tableak’s strategy is going forward. The company significantly increased its long-term debt in 2024. Prior to this, the company’s debt to equity ratio was under 50%. With the increase in debt in 2024, this ratio has increased to 58%. While more information on the industry would be needed to determine if the company is highly leveraged, it does appear that it has been able to generate returns on equity only slightly in excess of its return on assets. The company should keep in mind the extremely high level of dividend payout when assessing the return on equity. If shareholders are getting disproportionately high amounts of dividends, they may be less alarmed by a low return on equity. LO 7 BT: AN Difficulty: H Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-16B 1

4 Inventory turnover of 7.8 times

Quick ratio of 0.8 to 1

3 A/R turnover of 10.6 times

Current ratio of 1.9 to 1

ROA of 12%

Profit Margin of 10.4%

–

Ratio/ Transaction

LO 7 BT: AN Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17B a. Ratios for Day and Night: Day Manufacturing

Night Production

2024

2023

2024

2023

3.2

2.1

2.8

Current ratio

ii.

Acc. Rec. turnover

11.3 times

9.3 times

6.9 times

7.3 times

iii.

Inv. turnover

10.9 times

9.0 times

9.3 times

10.5 times

iv.

Debt to equity

48.1%

102.5%

73.8%

83.8%

Interest coverage

13.9

9.4

11.3

11.8

vi.

Gross margin

34.2%

30.8%

27.2%

25.0%

vii.

Profit margin

9.5%

10.0%

12.0%

10.8%

viii. ROA (return on assets)

29.1%

23.9%

29.7%

29.5%

ix.

62.1%

65.0%

72.4%

75.8%

2024

2023

486/154

363/175

ii. Acc. receivable turnover (sales/net acc. rec. Ave)

2,660/234.5

1,820/196

iii. Inventory turnover (cost of goods sold/inv. Ave.)

1,750/161

1,260/140

iv. Debt to equity (long-term debt – cash) / Shareholder's Equity)

256/532

287/280

v. Interest coverage ([net income + income taxes + interest] / interest)

388/28

291/31

vi. Gross margin (gross margin / sales)

910/2,660

560/1,820

vii. Profit margin (net income / sales)

252/2,660

182/1,820

viii. ROA = net income/ total assets average

252/864.5

182/763

ix. ROE = ([net income – preferred dividends] / shareholders' equity Ave.)

252/406

182/280

ROE (return on equity)

Supporting calculations: Day Manufacturing: i. Current ratio (current assets/current liabilities)

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17B (Continued) Supporting calculations: Night Production:

2024

2023

i. Current ratio (current assets/current liabilities)

476/170

392/140

ii. Acc. receivable turnover (sales/net acc. rec. Ave.)

1,750/255

1,680/230

iii. Inventory turnover (cost of goods sold/inv. average)

1,274/137

1,260/120

iv. Debt to equity (long-term debt - cash / Shareholder's Equity)

251/340

201/240

v. Interest coverage ([net income + income taxes + interest] / interest)

329/29

284/24

vi. Gross margin (gross margin / sales)

476/1,750

420/1,680

vii. Profit margin (net income / sales)

210/1,750

182/1,680

viii. ROA = net income / total assets average

210/707

182/616

ix. ROE = ([net income – preferred dividends] / shareholders' equity average)

210/290

182/240

The following analysis is separated into liquidity and activity, solvency, and profitability analysis. Liquidity and activity: While both companies have solid current ratios, Day appears to be in a better liquidity position as its current ratio is higher than Night’s. Day’s current ratios improved in 2024, and Night’s stayed the same. The accounts receivable turnover and inventory turnover also measure liquidity because they measure the amount of time before these items will be converted to cash in the operating cycle. Both ratios improved for Day in 2024. Night’s ratios were worse in 2024 and are worse than Day’s. Management of both companies appear to be converting inventory into receivables and receivables into cash on a current basis.

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17B (Continued) Solvency: Day is in a much better solvency position as measured by the debt to equity and interest coverage ratios in 2024 than 2023. Both are financed by both debt and equity. Day is financed by about 1/3 debt and 2/3 equity in 2024, which is a dramatic change from 2023 when the ratio was over 100%. Night’s debt to equity ratio is higher, 74% and 84% in 2024 and 2023. Capital structures usually have some long-term debt component to support the acquisition of capital assets and for the positive leverage effects for shareholders. Night is using much more leverage than Day. Since Day splits its financing between long term debt capital and equity, it has an opportunity to earn returns on its assets that exceed the cost of the debt (interest expense) to its creditors. The excess return serves to increase or leverage the return to shareholders. Leverage is best measured by comparing the return on assets to the return on equity. With the use of leverage, and a return on assets in excess of interest rates, the return on equity for companies like Day and Night will be higher than its return on assets. It is easy to see how debt acted as a lever to increase Day’s and Night’s return on equity.

Day

Return on assets Return on equity

2024

2023

Night 2024 2023

29.1% 62.1%

23.9% 65.0%

29.7% 72.4%

29.5% 75.8%

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-17B (Continued) Profitability: The gross margin has increased in both years for both Day and Night. Day’s gross margin ratio is a full 7% higher than Night’s in 2024, a wider spread than 2023’s 5.8% difference. On a net profit basis, however, Night is superior, indicating better cost control over operations aside from the cost of the inventory sold relative to sales. Night’s 2024 profit margin of 12.0% improved by 1.2% over 2023; whereas Day’s 2024 profit margin of 9.5% represented a drop of 0.5% over 2023’s results. Thus, overall, Night has maintained profitability while Day has fallen off slightly (based on profit margin and ROE). However, Day increased its sales by 46% in 2024 to go along with the expansion in assets and Night had lower growth (4.2%) in the same year. Day looks like the better investment for a shareholder or potential shareholder. The return on equity for Day and Night are very high. If the return on assets stays high, there will be a good leveraged return to shareholders. I would want to know whether the prospects for growth for the two companies are the same, and whether the growth in sales will continue at the same pace. LO 7 BT: AN Difficulty: H Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-18B a.

Eonline

Paperky

i. Average collection period

42.3 days

50.6 days

ii. Days to sell Inventory

36.6 days

44.2 days

iii. Current ratio

2.05

1.77

66.2%

43.5%

0.65

0.70

vi. Interest coverage

2.5 times

3.5 times

vii. Return on assets

2.9%

2.3%

viii. Return on equity

11.0%

10.2%

ix. Gross margin

15.7%

11.0%

x. Profit margin

2.3%

2.4%

iv. Operating cash flow ratio v. Net debt to total capitalization

CALCULATIONS: Eonline Corporation i.

Paperky Company

$9,534/$1,106 = 8.62 times;

$4,690/$650 = 7.22 times;

365 days / 8.62 = 42.3 days

365 days / 7.22 = 50.6 days

ii. $8,036/$805 = 9.98 times; 365 days / 9.98 = 36.6 days

$4,172/$506 = 8.25 times; 365 days / 8.25 = 44.2 days

iii. $2,258/$1,100 = 2.05

$1,428/$805 = 1.77

iv. $728 / $1,100 = 66.2%

$350 / $805 = 43.5%

v. ($4,444 - $310)/($4,444 - $310 + $2,268)

($3,108 - $428)/($3,108 - $428 + $1,134)

vi. ($220 + $154 + $525 + $410)/$525

($111 + $85 + $182 + $260)/$182

vii. $220/[($7,812 + $7,224)/2]

$111/[($5,047 + $4,550)/2]

viii. $220/[($2,268 + $1,743)/2]

$111/[($1,134 + $1,050)/2]

ix. ($9,534 - $8,036)/$9,534

($4,690 - $4,172)/$4,690

x. $220/$9,534

$111/$4,690

Burnley, Understanding Financial Accounting, Third Canadian Edition

AP12-18B (Continued) b. Liquidity and activity: Eonline and Paperky have similar strong liquidity ratios with Eonline having an 8-day edge in both the collection period for its receivables, and selling through its inventory. Eonline’s current ratio and operating cash flow ratio are somewhat stronger than Paperky’s, so Eonline has better liquidity. Solvency: Both companies have similar financing structures with between 2/3 and ¾ of their total capitalization financed by debt. Eonline Co.’s debt ratio shows a little lower credit risk than that of Paperky, but Paperky has a slightly stronger interest coverage ratio. Profitability and leverage: The two companies also have very similar ROA and ROE. Eonline is slightly more profitable, generating a slightly higher return on its assets invested and on its equity. This originates in Eonline’s significantly higher sales dollars, its higher gross margin ratio (15.7% vs. Paperky’s 11%) and similar profit margin (2.3% vs. Paperky’s 2.4%). Eonline also has a stronger cash flow to total liabilities at 13% versus Paperky’s 9%. Overall, Eonline Corp. seems to be the better investment, with stronger overall ratios in each category. LO 7 BT: AN Difficulty: M Time: 50 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

USER PERSPECTIVE SOLUTIONS UP12-1

The creditor is very interested in the ability of the company to pay off debts. The debt to equity ratio measures the extent to which the company utilizes debt to finance its operations. The more debt it takes on, the higher the risk of default on a particular loan. The creditor would be interested in restricting the level of debt in the company to limit the risk of default. The current ratio measures short-term liquidity and is a measure of the company’s ability to pay its debts in the short term. The creditor would be very interested in ensuring that this ratio is maintained at some minimum level to increase the likelihood that payments for interest are made on a timely basis. LO 5 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

UP12-2

In choosing companies for comparison using a cross-sectional analysis, analysts must be mindful of the industries and countries in which the companies operate. Cross-section analyses are often used for comparing companies only in the same industry. This is because different industries support different relationships between financial statement components. For example, profit margins, current ratios, turnover ratios, debt-equity relationships that are very valid in companies in one industry may not be appropriate for companies in a different industry. The closer the nature of the operations of two different companies, the more valid is the comparison. Companies should also be resident in the same country. This is because exchange rates, market interest rates, levels of risk, opportunities for returns, and other economic variables in different countries can have a significant effect on how financial statement measures are interpreted. Also, of course, the accounting policies for companies in different countries and different industries may not be similar and financial data will therefore not be comparable. When comparing companies from different industries or countries, the analyst must be careful to accommodate any significant differences in accounting policies and standards. For all these reasons, they may not be comparing apples to apples, so to speak; therefore, any such comparison may not be useful.

LO 5 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-3 a. Three ratios that would be useful in evaluating the performance of a retail clothing store that operates inside malls would be: inventory turnover (or days to sell inventory), gross margin, and profit margin. These are chosen because they all relate to critical success variables for businesses in the retail business, particularly those that do not own a significant amount of property, plant and equipment, and therefore, not likely to have large amounts of long-term debt outstanding. Success in the retail clothing business depends to a large extent on the company’s ability to sell its inventory on a timely basis and before the next season’s goods are displayed. The inventory turnover ratio provides information on this. The gross margin is another key ratio to ensure that adequate margins are being realized and that the store is not selling off too many of their clothes at low sales prices. The profit margin is also important to ensure that the overheads associated with running the operation are appropriate for the level of sales and gross margin that must cover such costs as rent, personnel costs, advertising, packaging, etc. The bottom line must be adequate to ensure an appropriate return on investment to the owners. The accounts payable turnover or average payment period would also be an appropriate metric to see whether the business creditors are being paid on a timely basis. b. A hydro-electric utility facility would be in an industry that is heavily capitalized with a significant amount of debt and equity and a high level of investment in very long-lived capital assets. Key performance and efficiency success factors for such a facility would include being able to generate sufficient revenue from its large investment in its facilities, its ability to use leverage to the benefit of its shareholders, and its ability to generate sufficient operating cash flow for repayment of debt and reinvestment. To this end, the following ratios and metrics would be key measures to calculate in any review of this entity: the total asset turnover, return on assets, return on equity, and free cash flow. LO 3 BT: C Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-4

Management intent on maximizing its compensation could make a number of decisions that positively affect the company’s ROA but which are contrary to the long-term best interests of the company and its shareholders. For example, research and development costs, most of which are required to be expensed for financial reporting purposes, could be reduced or eliminated, employee training and development costs (also expensed) could be eliminated, a policy of continued use of older equipment instead of having a program of equipment renewal could be followed, decisions could be made to enter into less economical leasing instead purchasing equipment, for example. In all these cases, either expenses and/or total assets would be minimized, thus increasing the return on assets ratio above what it would otherwise have been.

LO 8 BT: C Difficulty: H Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

UP12-5

Because the financial statements are prepared using judgments, estimates, and choices amongst accounting policies, these factors are naturally carried over into the ratios used for analysis. Cash flow is not affected by estimates and therefore may be considered more reliable or less biased. Despite this, management has been known to make reporting decisions that show the cash flows from operations, a key metric, in a better light than they otherwise would have been. This involves reporting certain inflows as operating inflows (instead of investing or operating), and certain expenditures as investing or financing outflows (instead of operating) so that the cash flows from operations look better than they otherwise would have. It should also be noted that the term “reliable” in accounting also has the meaning of “faithful representation.” With this meaning of the term, the accrual basis revenue and accrual basis expense and the resulting net income are more reliable measures of performance during an accounting period. The accrual measures of revenue and expense better represent the level and results of the operating activity during the accounting period even though not all the revenue has yet been received in cash or expenses have been paid or are payable in cash.

LO 8,9 BT: C Difficulty: H Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-6 a. Looking at and evaluating the financial statements, while an excellent way to find out about a company’s financial strength and how it has performed in the past, is not enough. Any investor’s concern must be with what the business is expected to do in the future. The underlying numbers used in ratios must be investigated for possible abnormal balances. Financial ratios must be combined with other available information. This should include the economic outlook in general, and for specific industries; recent analyst reports and consensus recommendations on a variety of companies; recent news items in the financial press about companies you are interested in; and, most important of all, an investigation of alternative investment vehicles generating fixed income such as investment certificates and other interest-bearing investments, particularly keeping in mind the level of risk you want to take on and are able to deal with and the liquidity that is required. b. I would not recommend using the ROE ratio as the sole criterion. High returns often are accompanied by high risk and high variability of returns. Because you will need the money in one year’s time, this metric is not a good one to zero in on. I would recommend, if you are limiting yourself to ratio analysis, that you look at trends related to several specific companies. Important trends would include sales growth, profit margin (both gross and net) performance, trends and stability, history of share price relative to earnings (price-earnings ratio), dividend payout ratios and history, company reputation etc. Your primary goal should be protection of your capital with a reasonable return on your investment in terms of dividends or interest and/or capital appreciation. LO 6,7 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-7 A working capital loan should be related to the operating cycle and the cash-to-cash cycle of the business. The accounts receivable turnover ratio, inventory turnover ratio, and accounts payable turnover ratio are all measures within the cash-to-cash cycle that indicate how long the inventory and receivables need to be financed, and therefore the amount of the loan needed. Essentially, they measure the speed of the flow of cash through the organization. For example, inventory purchases must be financed from the time the related payable has to be paid until cash is received from the sale of the inventory. This cycle is determined by: Number of days of financing needed = Days to sell inventory – Accounts payable payment period + Average collection period for receivables. The amount borrowed depends on the level of inventory carried on a continuing basis and the level of receivables outstanding. These can be reduced by speeding up the time to sell inventory and collect receivables. LO 5,7 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-8

Ratios that would help the decision-maker in arriving at a decision or to identify areas for further analysis include: a. Decrease in net income from a/an: i. Decrease in sales or an increase in cost of sales: gross margin ii. Increase in total operating expenses: gross margin and profit margin, as well as trend analysis and a common size statement of income iii. Increase in an individual operating expense: trend analysis and a common-size income statement b. Collection of accounts receivable on a timely basis: accounts receivable turnover ratio and average collection period. This can be compared with the credit terms offered to customers. c. Long-term debt financing higher than the industry as a whole: debt to equity ratio and net debt as a percentage of total capitalization ratio d. Effective utilization of assets: asset turnover ratio, and return on assets e. Effective use of capital invested in company: return on equity f. Whether the decline in economic activity affected the payment of accounts payable: accounts payable turnover and payment period g. Whether the company was successful in reducing inventory with new ordering system: inventory turnover, trend analysis and common-size statement of financial position

LO 6,7 BT: C Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-9

Comparability is very important when it comes to financial statements and any analysis of an individual company’s financial reports or a crosssectional analysis with other companies in the same industry. The issue is one of how limiting the choice of standards should be.

In support of limiting accounting choices (rules-based approach) Because investment decisions require choices among different companies, all companies should be required to use the same policies, principles and methods.

In support of allowing accounting choices (principles-based approach) One size does not fit all organizations. Companies should choose the accounting methods for its transactions that best meet the objectives of particular measurements. Disclosure of information about the policies chosen can be done so that analysts can adjust one company’s reported numbers to a comparable basis with others. Because past financial The business world changes, new types statements of a company are of transactions are entered into, better used to develop trends to help ways of measuring economic predict future prospects, no transactions and events are found over changes in accounting policies, time. These must be allowed to be used principles and methods should where appropriate. Accounting must be permitted. adapt as its environment changes. The effects on the financial statements of these changes on any analysis can be mitigated by proper disclosure. Users will be able to better The business environment and understand what accounting is organizations are complex, and all about; and students will find it accounting for entities therefore is also easier to study and learn the complex. While some aggregations and discipline. simplifications are possible to enhance understandability, oversimplification will negatively affect the relevance and faithful representation of the resulting information.

Burnley, Understanding Financial Accounting, Third Canadian Edition

UP12-9 (Continued) There will be little need for professional judgement to be applied.

This approach was the one followed in setting U.S. accounting standards with the result that specific rules had to be put in place for each industry and often, for specific situations. The result has been too many “rules” in place for situations with similar economic characteristics and the system became unwieldy. In addition, it also results in considerable “financial engineering” as management knows what “bright lines” it must meet to get the accounting treatment it wants so it can report the numbers it wants.

Dictating one required accounting method for all similar transactions for all companies is too tight a box as there are too few transactions that are the same. It is reasonable to have to apply judgement in the choice of methods to some extent to ensure that the economic effects of each transaction are appropriately represented in the financial statements. This approach is the one Canada and the IFRS took. It relies on the professional judgement of accounting professionals to choose the best methods in a company’s specific circumstances as they attempt to measure and represent the economics of the transactions faithfully. This also results in fewer standards because the objectives to be met by recognizing and measuring economic events are identified, requiring fewer rule-based standards.

LO 9 BT: C Difficulty: H Time: 40 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIP12-1

Although paying down accounts payable with cash reduces the current assets and current liabilities by the same amount, it will only not affect the current ratio if the ratio is one. If the ratio is above 1 (the current assets are greater than the current liabilities) then reducing the current liabilities by the same amount as the current assets will increase the current ratio. For example, if your current assets are $50 and your current liabilities are $25 your current ratio would be $50/$25 = 2 to 1, if you paid off $10 of current liabilities with current assets, your new current ratio would be $40/$15 = 2.7 to 1. You would be able to increase your ratio by paying off accounts payable as your ratio is close to the 2 to 1 mark. This tactic will not go unnoticed by the bank as the activity in the bank account is visible to them. Assuming the debt covenant is with the bank, this is the sort of manipulation or management of the financial position of the business they would be watching for, particularly at the end of the fiscal year.

LO 7,8 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

WIP12-2

Company A has a higher profit margin which your friend has correctly noted is a good thing. This means that Company A has been able to control all of its non-product costs, which is key in the pharmaceutical industry as research costs for new drugs would normally be a significant expense. In the pharmaceutical industry, the gross margin is not a good measure of performance. The costs of making medication is extremely small in relation to their selling price. A better measure for future profitability can be found by investigating the research and development costs that are incurred by each company. This comparison will help you predict additional sales that may be generated in the future from new drugs that are currently being developed. Additional costs that are of interest include the advertising and promotional costs used to generate the sales for the current year. Comparing these costs to the sales revenue will give a better indication of which company should be selected for the club’s investment.

LO 3,7 BT: C Difficulty: H Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WIP12-3

Having a current ratio above 2.0 is a positive sign. However, if the increase in the current ratio is due to increases in accounts receivable and inventory, it may not indicate that the business can pay their shortterm debt quickly. If the increase is due significantly to inventory, the short-term ability is limited as it takes longer to convert inventory to cash, the quick ratio should be looked at as well to assess liquidity. Also, the current ratio is focused on paying short-term liabilities only it does not say anything about the company’s long-term debt paying abilities as it is not included in the calculation.

LO 7,8 BT: C Difficulty: E Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

WIP12-4

An increasing return on assets can be a positive trend but is shouldn’t be looked at in isolation. If Company A has decreasing assets and stable net income, it may mean that they are not investing in new long-lived assets. Their assets are depreciating, they will have to be replaced when they reach the end of their useful life which could mean that the company will have to incur large capital expenditures in the future. The increase in ROA is an artificial one if net income is staying the same, it isn’t the result of anything management is doing, it is just depreciating its assets normally. Company B has increasing assets and increasing income which means they are in a growth period with them investing in assets to increase their net income, so although they may have a lower ROA, they are likely in a better position.

LO 7,8 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

READING AND INTERPRETING PUBLISHED FINANCIAL STATEMENTS SOLUTIONS RI 12-1 Dollarama Inc. a.

Ratio i. ii. iii. iv.

Gross margin Profit margin Inventory turnover Debt to equity Net debt to total capitalization ROA ROE.

2021

2020

43.8% (1) 14.0% (3) 3.61 (5) 902% (7)

43.6% (2) 14.9% (4) 3.42 (6) N/A (8)

90.0% (9) 14.2% (11) 465% (13)

102.9% (10) 15.2% (12) N/A (14)

(1) $1,765,011 / $4,026,259 (2) $1,652,358 / $3,787,291 (3) $564,348 / $4,026,259 (4) $564,039 / $3,787,291 (5) $2,261,248 / [($630,655 + $623,490)/2] (6) $2,134,933 / $623,490 (7) ($1,044,079 + $1,401,769 + $832,821 + $181,893 - $439,144) / $334,854 (8) ($1,270,289 + $1,332,016 + $606,494 + $182,732 - $90,464)/ $(92,196) (9) ($1,044,079 + $1,401,769 + $832,821 + $181,893 - $439,144) / ($1,044,079 + $1,401,769 + $832,821 + $181,893 - $439,044 + $334,854) (10) ($1,270,289 + $1,332,016 + $606,494 + $182,732 - $90,464) / ($1,270,289 + $1,332,016 + $606,494 + $182,732 – $90,464 + $92,196) (11) $564,348/[($4,223,746 + $3,716,456)/2] (12) $564,039/$3,716,456 (13) $564,348/[($334,854 - $92,196)/2] (14) $564,039/ - $92,196 b. Dollarama’s profitability is improving with a slightly higher 2021 gross margin rate than in 2020. The profit margin deteriorated in 2021. The deficit on the statement of financial position is not caused by poor profitability but by the charges to retained earnings for the repurchase of shares. Its inventory management is better in 2021 with higher inventory turnover. With increased profitability, the company was able to obtain debt to finance the repurchase of shares.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-1 (Continued) The reduction on the number of shares increased the earnings per share. Debt charges are at a manageable level for the business. c. Ratio Current ratio Quick ratio (1) (2) (3) (4)

2021 .83 (1) 0.35 (3)

2020 .70 (2) 0.11(4)

$1,100,362 / $1,321,165 $764,497 / $1,092,484 ($439,144 + $20,546) / $1,321,165 ($90,464 + $34,965) / $1,092,484

Dollarama has experienced a substantial improvement in both of these ratios in 2021. The main reason for the increase in the current ratio is the large amount of cash at the end of 2021. In both fiscal years, there is a high amount of current portions of long-term debt. Dollarama will likely do some refinancing before the due date of these debt repayments. The financing activities section of the statement of cash flows shows that considerable new debt was obtained during 2021 along with the repayment of old debt. Dollarama’s refinancing plans for 2021 did not rely on its current ratio. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-2 Leon’s Furniture Limited and Sleep Country Canada Holdings Inc. a. Common size Statements of Earnings (Loss)

Sales Cost of sales Gross profit Selling, general and administration expenses Finance costs Income before income taxes Income tax Net Income (Loss)

Leon’s Furniture 2020 2019 % % 100.0 100.0 55.7 56.3 44.3 43.7

Sleep Country 2020 2019 % % 100.0 100.0 67.7 68.7 32.3 31.3 17.8 17.7

33.8

36.4

1.0 9.5

1.1 6.3

3.4 11.1

2.9 10.8

2.1 7.4

1.6 4.7

2.7 8.4

3.0 7.8

Leon’s has an advantage on a lower cost of sales percentage, and a corresponding higher gross margin percentage. This is likely due to them selling higher end furniture compared to Sleep Country’s mattresses. Furniture tends to sell at a higher mark-up than mattresses. Leon’s has lower finance costs as a percentage compared to Sleep Country. Sleep Country has the advantage of much lower general and administrative expenses.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-2 (Continued) b. and c. Leon’s Furniture 2021 2020 Current $982,025/ $702,402/ ratio $820,739 = $602,196 1.20 = 1.17 Quick ($982,025- ($702,402ratio $332,072 - $334,443 $11,095 $9,273 10,725) / $10,994) / $820,739 = $602,196= 0.77 0.58 Inventory $1,236,258/ $1,284,826 turnover $333,257.51 / $334,443 = = 3.7 times 3.8 times 1 2

Sleep Country 2021 2020 $123,313/ $136,308/ $178,557 = $125,880 = 0.69 1.08 ($123,313 ($136,308 $68,717 $65,361 $6,611)/ $6,008)/ $178,557 = $125,880 = 0.27 0.52 $513,203/ $67,0392 = 7.7 times

$489,082/ $65,361 = 7.5 times

average inventory ($332,072 + $334,443) / 2 average inventory ($68,717 + $65,361) / 2 Leon’s has a significantly higher current ratio than Sleep Country and is therefore more liquid. This is in spite of the fact that Sleep Country has over double the inventory turnover than that of Leon’s. Leon’s has a broader product line which would likely lead to larger inventory quantities on hand. Not surprisingly, because of the high levels of inventory, the quick ratio is much lower that the current ratio for both companies. Sleep Country is turning over their inventory faster, approximately 7.7 times per year compared to Leon’s who is turning over 3.7 times per year.

LO 6,7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-3 Waterloo Brewery Ltd. a. Ratio i. Current ratio

2021 $24,944,817/ $54,396,558 = 0.46 $9,871,061 / $54,396,558 = 0.18

2020 $16,246,586 / $30,999,384 = 0.52 4,976,226 / $30,999,384 = 0.16

iii Operating cash flow $12,877,717 / ratio $54,396,558 = 0.24

$13,410,558 / $30,999,384 = 0.43

ii. Quick ratio

iv. Inventory turnover

v. Days to sell inventory

$66,000,997 ($14,344,496 $10,482,912)/2 = 5.32 times 365 days/5.32 = 68.6 days

$42,483,862 + $10,482,912 = 4.05 times 365 days/4.05 = 90.1 days

b. Waterloo’s liquidity position has deteriorated in 2021. Its current ratio has declined from 0.52 to 0.46. The quick ratio is slightly better but extremely low. This indicates that Waterloo may now be experiencing difficulty in paying its current liabilities as they come due. The company is more efficient in selling its inventory as the inventory now turns over every 68.6 days, whereas in 2020 it took about 90 days to turn over. All else equal, this should reduce the cash-to-cash cycle, helping the liquidity position. Cash flow from operations decreased in 2020 in spite of the improved net income.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-3 (Continued) c. Ratio i.Return on assets

2021 2020 $3,000,013/ $497,602/ 1 $104,297,352 $93,131,018 = 2.9% = 0.5% ii.Return on equity $3,000,013/ $497,602/ 2 $33,790,432 $33,886,502 = 8.9% = 1.5% 1 average total assets ($115,463,685 + $93,131,018) / 2 2 average shareholders’ equity ($33,694,361 + $33,886,502) / 2 Waterloo Brewery has substantially improved its return on assets and return on shareholder’s equity. The lower net income in 2020 generated a smaller return in both ratios. d. In both years, Waterloo Brewery has benefited from using leverage, earning a higher return on shareholders’ funds invested than on the assets. The return on equity improved in 2021 due to net income for 2021 being 6 times the level of 2020. The improvement in profit has been caused by growing sales and an unusual charge in 2020 for a loss on misappropriation of funds of close to $1.9 million. e. 2021 Net free cash flow $12,877,105 $18,407,338 = $(5,530,233)

2020 $13,410,558 $11,013,763 = $2,396,795

In 2021, the company has a significant negative amount of free cash. In both years, Waterloo made significant capital expenditures that have been financed through operations and long-term debt. This approach limits Waterloo’s flexibility and it could impact their ability to obtain more long-term debt in the future.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-3 (Continued) f. Because Waterloo Brewing’s basic and diluted earnings per share are almost the same, this indicates that the company does not have a material amount, if any, of potentially dilutive securities outstanding in its capital structure. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-4 Acadian Timber Corp. a. Ratio Accounts receivable turnover Average collection period Inventory turnover Days to sell inventory Accounts payable turnover

2020 $91,031 / $9,666.51 = 9.42 times 365/9.42 = 38.7 days

2019 $100,048 / $11,602 = 8.62 times 365/8.62 = 42.3 days

$60,897 = 48.68 times $1,2512 365/48.68 = 7.5 days

$67,260 = 43.53 times $1,545 365/43.5 = 8.4 days

$60,897 $8,9153 = 6.83 times 365/6.83 = 53.44 days

$67,260 $9,190 = 7.32 times 365/7.32= 49.86 days

Accounts payable payment period Average accounts receivable 1 ($7,731 + $11,602) / 2 Average inventory 2($957 + $1,545) / 2 Average accounts payable 3 ($8,640 + $9,190) /2

i The activity ratios calculated above all indicate that, overall, Acadian is operating more effectively in 2020 than in 2019. It is taking the company less time to collect its accounts receivable (38.7 days vs. 42.3 days), and sell out its inventory (7.5 vs. 8.4 days) but on the other hand, its accounts payable are outstanding for a longer period before being paid (53 vs. 50 days). ii. In order to properly assess its management of these working capital items, I would like to know the credit terms it extends to its customers who pay on account, and the payment terms its creditors set out for Acadian to pay its payables. It is difficult to fully assess the turnovers without this information. Also, I would be interested in its operating cash flows and its current and quick ratios to see if the company is experiencing liquidity problems.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-4 (Continued) b. Ratio i.Current ratio ii.Quick ratio

iii.Debt to equity ratio iv.Interest coverage

2020 $19,361 = 1.44 $13,479 ($19,361 - $957) $13,479 = 1.37 $90,9271 = .31 $293,241

2019 $22,993 = .20 $114,906 ($22,993 - $1,545) $114,906 = 0.19 $85,4832 = .30 $286,701

$35,8583 $4,324 = 8.3 times

$26,2404 $4,130 = 6.4 times

Net debt (2020) = $101,185 - $10,258 = $90,927 Net debt (2019) = $93,084 - $7,601 = $85,483 3 ($22,080 + $4,324 + $2,709 + $6,465 + $280) = $35,858 4 ($17,325 + $4,130 + $111 + $4,388 + $286) = $26,240 2

The current ratio and quick ratios in 2020 are strong. In 2019 there was a large current maturity of long-term debt that affected the current and quick ratio drastically. The increase in the debt to equity ratio would suggest that the company’s financial risk has increased slightly over the year. However, the interest coverage of over 8 times in 2020 indicates that the interest is well covered by income earned.

Burnley, Understanding Financial Accounting, Third Canadian Edition

RI 12-4 (Continued) c. Ratio Profit margin

2020 $22,080 = 24.3% $91,031 Return on equity $22,080 = 7.6% 1 $289,971 Return on assets $22,080 = 4.4% $506,053.52

2019 $17,325 = 17.3% $100,048 $17,325 = 6.0% $286,701 $17,325 = 3.5% $498,709

Average shareholders’ equity ($293,241 + $286,701) / 2 Average total assets ($513,398 + $498,709) / 2

1 2

The profitability ratios all show a significant increase in 2020 over 2019. The profit margin increased dramatically in spite of a decrease in sales. There was a one-time charge of $18 million in 2019 for management agreement termination fee which exceeded net income. The increase in net income carried through to the return on equity and assets ratios. d. Net free cash flow (assumes no preferred dividends): 2020: $20,617 - $351 = $20,266 2019: -$4,140 - $86 = -$4,226 The net free cash flow has increased significantly in 2020. This trend follows the trends exhibited in the profitability ratios. LO 7 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

RI 12-5 Instructor-determined company Answers to this question will depend on the company selected. LO 7 BT: AN Difficulty: M Time: 60 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

CASE SOLUTIONS C12-1 Cedar Appliance Sales and Service Limited To improve the company’s liquidity, and in particular the current ratio, the company will have to increase current assets and/or decrease current liabilities. This can be accomplished in several ways: • Take advantage of cash discounts offered by suppliers. This would reduce payables more than it would reduce cash because the discount reduces the amount of cash that is paid to suppliers. The result would be increases in the current and quick ratios. • With an industry average account receivable turnover of 12 times, this indicates industry credit terms to customers of 30 days (365/12 = 30.4). Speak to customers about reducing the terms to closer to the industry average. This will increase the amount of cash available and reduce your investment in accounts receivable. Strategize to determine another way you could compete for customers such as the provision of exceptional customer service. • Reduce the amount of inventory carried. By using supplier catalogues and websites to show products to the customer and by developing strong supplier contacts, the company could reduce its investment in inventory and shorten the time between when cash is owed to suppliers and cash is collected for sales. Although the reduction in inventory would decrease current assets, hopefully the corresponding reduction in payables would cause the overall current ratio to increase. Decreasing the amount of inventory while maintaining the current level of sales would also improve the inventory turnover ratio. • Sell any long-term assets that are not generating revenue, for cash. For example, if a company has long-term investments that are not profitable or capital assets that are not currently employed in the business, selling these assets would increase cash and therefore improve the current ratio. However, the company must be careful not to sell long-term assets that are valuable to the company’s future performance. It would be irresponsible for management to sacrifice long-term growth for short-term liquidity.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C12-1 (Continued) • Refinance short-term debt on a long-term basis so that it will be reclassified as long-term, thereby reducing the current liabilities and improving the current ratio. For example, a line of credit that was used to finance the acquisition of a piece of equipment could be converted to a long-term note payable. *Note to instructors: Students will present a variety of responses for this solution. The key to the question is to make the student realize that the solutions must be economically sound and ethical. LO 5 BT: C Difficulty: H Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

C12-2 Christine’s Yogourt Venture Common size selected financial information:

Sales Gross margin Other expenses Net income

Year 1 100.0% 70.0% 66.7% 3.3%

Year 2 100.0% 70.0% 64.3% 5.7%

Year 3 100.0% 70.0% 60.6% 9.4%

Other ratios:

Sales per sq. ft. Gross margin % Operating costs % Profit margin %

Mark’s Yogourt Plus Year 1 Year 3 $200 $275 70% 70% 66.7% 60.6% 3.3% 9.4%

Industry Average Year 1 Year 3 $267 $433 70% 75% 50% 43% 70% - 50% 75% - 43% = 20% = 32%

Burnley, Understanding Financial Accounting, Third Canadian Edition

C12-2 (Continued) Investment required: 1,500 sq. ft. store Machines

6 machines

Seating

For 20

Initial investment

$350,000 + $50,000 = $400,000

Proportionate for a 1,200 sq. ft. store (1,200/1,500) X 6 = 4.8 = 5 (1,200/1,500) X 20 = 16 (1,200/1,500) X $400,000 = $320,000

Equity investment*

2/3 X $400,000 = $267,000 1/3 X $400,000 = $133,000

2/3 X $320,000 = $213,000 1/3 X $320,000 = $107,000

Borrowing*

* Amounts rounded to the nearest $1,000

Selected ratios (assume Mark’s Year 3 income) Return on equity: If pay $320,000 (Proportional Price) – $31,000/$213,000 = 14.6% If pay $400,000 (Asking Price) – $31,000/$267,000 = 11.6% Franchise return on equity, Yr. 3, assuming a 2/3 equity investment Return on assets: If pay $320,000 (Proportional Price) – If pay $400,000 (Asking Price) –

($650,000 X 32%)/$267,000 = $208,000/$267,000 = 77.9%

Franchise return on total assets, Yr. 3, assuming $400,000 assets Cost per square foot: If pay $320,000 (Proportional Price) – If pay $400,000 (Asking Price) – Cost per square foot: Industry average –

($650,000 X 32%)/400,000 = $208,000/$400,000 = 52.0%

$31,000/$320,000 = 9.7% $31,000/$400,000 = 7.8%

$320,000/1,200 = $267 $400,000/1,200 = $333 $400,000/1,500 = $267

Burnley, Understanding Financial Accounting, Third Canadian Edition

C12-2 (Continued) a. Mark’s store has not performed well relative to the average Yogourt franchise. This can be seen by the “Other ratios” calculated above. After three years, the Yogourt franchise outlets generate $433 in sales per square foot, whereas after three years, Mark’s store only brings in $275 per square foot. This is 36% less – a significant difference. As well as not generating the volume of sales it should, Mark’s operation also earns a lower gross margin (70% vs. 75% of sales), higher operating costs (60.6% vs. 43% of sales), and a lower profit margin (9.4% vs. 32% of sales). b. If Christine pays Mark’s asking price of $400,000 for the total assets, the return earned by the store would represent only a 7.8% return on the $400,000 of total assets Mark indicates he has. This compares to a 52.0% return earned by the franchise stores. With a 2/3 equity investment, her return on equity would amount to only 11.6% as compared to the 77.9% return on equity earned by a franchise store. If Christine paid only $320,000 for the assets, based on the 1,200 sq. ft. store vs. a 1,500 sq. ft. operation, her return on total assets and on equity would only be 9.7% and 14.6%, respectively, still far below the franchise store results. c. Some other factors to consider before making a decision: • To what extent, if at all, are the franchise store results inflated as a means of attracting new franchisees. Is it a legitimate comparator group? • The potential for Mark’s location to grow its sales and margins: is there excess operating capacity that can be filled, street traffic currently and expected in the future, selling prices vs. those of franchise stores, how much salary is Mark taking out of the operation, the cost of debt capital required, operating cash flows, etc. • The comparative cost of buying a franchise from Yogourt Yogourt and the potential it offers; other investment alternatives. • Are Mark’s financial statements reliable? Have they been audited or at least been subject to a review by an auditor?

Burnley, Understanding Financial Accounting, Third Canadian Edition

C12-2 (Continued) d. No, I do not recommend that Christine purchase Mark’s store. Mark is asking too high a price for his operation. Even if the price were reduced to $320,000 to compensate for the 1,200 sq. ft. store relative to the 1,500 sq. ft. operation so that the $267 per square foot cost would be the same, the rates of return that can be earned from the 1,200 sq. ft. operation that Mark has are too far from what a franchise operation could deliver, assuming the statistics provided are correct. LO 6,7 BT: AN Difficulty: M Time: 70 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

C12-3 Hencky Corporation For a company to be solvent and be able to continue as a going concern, it must have the ability to generate sufficient cash to meet both its maturing obligations and current operating expenditures. The short-term liquidity and long-term solvency ratios, as well as the turnover ratios, will provide a strong indication as to the ability of a business to continue to be solvent and operate as a going concern. The current ratio tells the investor the relationship between current assets and current liabilities. A ratio of 1.8:1 means that the company has $1.80 in current assets to pay toward every $1.00 of current liabilities. Ideally, and depending on the industry, this ratio should be between 1:1 and 2:1. A ratio of 1.8: 1 falls in a comfortable range for most businesses. It is important to remember that current assets generally do not provide a high return since return is sacrificed for liquidity. Therefore, a current ratio that is too high may indicate that a company is holding too many current assets and not maximizing possible returns.

Burnley, Understanding Financial Accounting, Third Canadian Edition

C12-3 (Continued) One of the problems with using the current ratio to assess liquidity is that the ratio incorporates assets that cannot be quickly converted into cash. Assets such as inventory are not readily available to pay currently maturing liabilities because the inventory must be sold before the company will be entitled to any cash, and this only after collecting its receivables. The quick ratio is a more stringent measure of liquidity because it backs out of the current assets all assets that cannot be quickly converted to cash. The rule of thumb is that the quick ratio should be greater than 1:1. Hencky’s quick ratio, at 1.10:1, is higher than this, which supports the ability of the company to meet its current commitments and therefore, to continue as a going concern. The turnover ratios provide an indication of the company’s ability to manage its cash-to-cash cycle. The better the company’s ability to convert inventory into cash the more likely it is to be able to pay its bills on time and continue as a going concern. Receivables are turning over 10 times a year or about every 36 days. This appears to be a reasonable level since most receivables are for terms around 30 to 40 days. The inventory is turning over six times a year or every 61 days. Although this seems reasonable and is an improvement over the previous year, some industry comparisons would provide the investor with a better indication of the ability of Hencky to manage its inventory levels. The debt/equity ratio provides investors with an indication as to the degree of leverage in the company. The more debt a company carries the higher the chance that it will not be able to repay the interest and principal related to its debt and be pushed into insolvency. Since Hencky has only 20% of its total assets financed by debt and there has been an improvement in the ratio over the past year, the company appears to have significant equity financing and no going-concern problems associated with being too highly leveraged. LO 7 BT: AN Difficulty: M Time: 40 min. AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

Appendix B REVENUE RECOGNITION AND LONG-TERM CONTRACTS Learning Objective 1. Determine the appropriate method for recognizing revenue from long-term contacts.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT 1

Discussion Questions C 3 1 C Application Problems Work in Process

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQB-1

Progress on a long-term contract can be measured using an input method or an output method. Input methods recognize revenue on the basis of the company’s efforts or inputs on the contract to date relative to the total efforts or inputs expected to be required to satisfy the performance obligations. Output methods recognize revenue on the basis of the work completed to date relative to total work required in order to satisfy the performance obligations.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQB-2

A company will have a contract liability on a long-term contract if its progress billings exceed the sum of its unbilled costs under the contract plus the gross profit earned to date.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQB-3

The percentage-of-completion method of recognizing revenue on a long-term contract must be used when the company is able to reasonably measure its progress under the contract. When using this method, revenue, expenses and gross profit are recognized for the portion of the contract completed to date. The zero-profit method is used when a company is unable to reasonably measure its progress on a long-term contract but is able to recover its costs. When using this method, revenue is recognized equal to the amount of expenses while the contract is in progress. The gross profit is recognized in the year the project is completed. This is because it is only at the end of the contract that the measurement of the gross profit is possible.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS APB-1A a.

Estimated contract cost Total costs incurred to date % of completion

2024

(a) (b) (c) = (b) ÷ (a)

$35,700,000 9,282,000 26.0%

2024

Contract amount (d) % of completion (c) above Revenue earned to date (e) = (d) x (c) less: Revenue earned in prior year Revenue earned in current year (f) Costs for year (g) Gross profit (h) = (f) - (g)

$42,000,000 26.0% 10,920,000 10,920,000 9,282,000 1,638,000

2025

$36,600,000 27,084,000 74.0%

2025

$42,000,000 74.0% 31,080,000 10,920,000 20,160,000 17,802,000 2,358,000

2026

$36,200,000 36,200,000 100.0%

2026

$42,000,000 100.0% 42,000,000 31,080,000 10,920,000 9,116,000 1,804,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-1A (Continued) b. Contract Asset/Liability

2024 9,282,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

13,000,000

Contract Asset/Liability To record construction expenses

19,000,000

11,500,000

19,000,000 18,200,000

11,500,000 10,920,000

Revenue from Long-Term Contracts To record revenues Construction Expenses

17,802,000

13,000,000

Accounts Receivable To record collections Contract Asset/Liability

17,802,000 9,282,000

Contract Asset/Liability To record progress billings Cash

2025

18,200,000 20,160,000

10,920,000 9,282,000

20,160,000 17,802,000

9,282,000

17,802,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-1A (Continued) 2026 Contract Asset/Liability

9,116,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

9,116,000 10,000,000

Contract Asset/Liability To record progress billings Cash

10,000,000 12,300,000

Accounts Receivable To record collections Contract Asset/Liability

12,300,000 10,920,000

Revenue from Long-Term Contracts To record revenues Construction Expenses Contract Asset/Liability To record construction expenses

10,920,000 9,116,000 9,116,000

LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-2A a. Revenue earned in current year (equal to costs for all but year of completion) Cost for year Gross profit

2024

(a) (b) (c) = (a) - (b)

$9,282,000 9,282,000 -

2025

$17,802,000 17,802,000 -

2026

$14,916,000 9,116,000 5,800,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-2A (Continued) b. Contract Asset/Liability

2024 9,282,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

13,000,000

Contract Asset/Liability To record construction expenses

19,000,000

11,500,000

19,000,000 18,200,000

11,500,000 9,282,000

Revenue from Long-Term Contracts To record revenues Construction Expenses

17,802,000

13,000,000

Accounts Receivable To record collections Contract Asset/Liability

17,802,000 9,282,000

Contract Asset/Liability To record progress billings Cash

2025

18,200,000 17,802,000

9,282,000 9,282,000

17,802,000 17,802,000

9,282,000

17,802,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-2A (Continued) 2026 Contract Asset/Liability

9,116,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

9,116,000 10,000,000

Contract Asset/Liability To record progress billings Cash

10,000,000 12,300,000

Accounts Receivable To record collections Contract Asset/Liability

12,300,000 14,916,000

Revenue from Long-Term Contracts To record revenues Construction Expenses Contract Asset/Liability To record construction expenses

14,916,000 9,116,000 9,116,000

LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-3A a.

Estimated contract cost Total costs incurred to date % of completion

2024

(a) (b) (c) = (b) ÷ (a)

$82,560,000 29,721,600 36.0%

2024

$98,200,000 36.0% 35,352,000 35,352,000 29,721,600 5,630,400

2025

$84,310,000 69,134,200 82.0%

2025

$98,200,000 82.0% 80,524,000 35,352,000 45,172,000 39,412,600 5,759,400

2026

$83,740,000 83,740,000 100.0%

2026

$98,200,000 100.0% 98,200,000 80,524,000 17,676,000 14,605,800 3,070,200

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-3A (Continued) b. Contract Asset/Liability

2024 29,721,600

Cash or Materials or A/P To record cost of construction Accounts Receivable

30,000,000

Contract Asset/Liability To record construction expenses

45,000,000

27,000,000

45,000,000 41,000,000

27,000,000 35,352,000

Revenue from Long-Term Contracts To record revenues Construction Expenses

39,412,600

30,000,000

Accounts Receivable To record collections Contract Asset/Liability

39,412,600 29,721,600

Contract Asset/Liability To record progress billings Cash

2025

41,000,000 45,172,000

35,352,000 29,721,600

45,172,000 39,412,600

29,721,600

39,412,600

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-3A (Continued) 2026 Contract Asset/Liability

14,605,800

Cash or Materials or A/P To record cost of construction Accounts Receivable

14,605,800 23,200,000

Contract Asset/Liability To record progress billings Cash

23,200,000 30,200,000

Accounts Receivable To record collections Contract Asset/Liability

30,200,000 17,676,000

Revenue from Long-Term Contracts To record revenues Construction Expenses Contract Asset/Liability To record construction expenses

17,676,000 14,605,800 14,605,800

LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-1B a. Estimated contract cost Total costs incurred to date % of completion

2024 (a) (b) (c) = (b) ÷ (a)

$74,000,000 47,360,000 64.0%

2024

$86,000,000 64.0% 55,040,000 55,040,000 47,360,000 7,680,000

2025 $75,000,000 75,000,000 100.0%

2025

$86,000,000 100.0% 86,000,000 55,040,000 30,960,000 27,640,000 3,320,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-1B (Continued) b. Contract Asset/Liability

2024 47,360,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

27,640,000 47,360,000

47,100,000

Contract Asset/Liability To record progress billings Cash

47,100,000

Accounts Receivable To record collections

Contract Asset/Liability To record construction expenses

38,900,000 38,900,000

47,100,000 55,040,000

Revenue from Long-Term Contracts To record revenues Construction Expenses

27,640,000 38,900,000

47,100,000

Contract Asset/Liability

2025

38,900,000 30,960,000

55,040,000 47,360,000

30,960,000 27,640,000

47,360,000

LO 1 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

27,640,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-2B a. Revenue earned in current year (equal to costs for all but year of completion) Cost for year Gross profit

2024

(a) (b) (c) = (a) - (b)

$47,360,000 47,360,000 -

2025

$38,640,000 27,640,000 11,000,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-2B (Continued) b.

2024

Contract Asset/Liability

47,360,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

27,640,000 47,360,000

48,000,000

Contract Asset/Liability To record progress billings Cash

48,000,000

Accounts Receivable To record collections

Contract Asset/Liability To record construction expenses

38,000,000 38,900,000

47,100,000 47,360,000

Revenue from Long-Term Contracts To record revenues Construction Expenses

27,640,000 38,000,000

47,100,000

Contract Asset/Liability

2025

38,900,000 38,640,000

47,360,000 47,360,000

38,640,000 27,640,000

47,360,000

LO 1 BT: AP Difficulty: M Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

27,640,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-3B a. 2024

Estimated contract cost Total costs incurred to date % of completion

(a) (b) (c) = (b) ÷ (a)

$48,800,000 10,736,000 22.0%

2024

Contract amount (d) % of completion (c) above Revenue earned to date (e) = (d) x (c) less: Revenue earned in prior year Revenue earned in current year (f) Costs for year (g) Gross profit

(h) = (f) - (g)

$52,500,000 22.0% 11,550,000

2025

$49,200,000 27,552,000 56.0%

2025

2026

$49,600,000 49,600,000 100.0%

2026

11,550,000 10,736,000

$52,500,000 56.0% 29,400,000 11,550,000 17,850,000 16,816,000

$52,500,000 100.0% 52,500,000 29,400,000 23,100,000 22,048,000

814,000

1,034,000

1,052,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-3B (Continued) b. Contract Asset/Liability

2024 10,736,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

10,000,000

Contract Asset/Liability To record construction expenses

22,000,000

8,200,000

22,000,000 20,700,000

8,200,000 11,550,000

Revenue from Long-Term Contracts To record revenues Construction Expenses

16,816,000

10,000,000

Accounts Receivable To record collections Contract Asset/Liability

16,816,000 10,736,000

Contract Asset/Liability To record progress billings Cash

2025

20,700,000 17,850,000

11,550,000 10,736,000

17,850,000 16,816,000

10,736,000

16,816,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APB-3B (Continued) 2026 Contract Asset/Liability

22,048,000

Cash or Materials or A/P To record cost of construction Accounts Receivable

22,048,000 20,500,000

Contract Asset/Liability To record progress billings Cash

20,500,000 23,600,000

Accounts Receivable To record collections Contract Asset/Liability

23,600,000 23,100,000

Revenue from Long-Term Contracts To record revenues Construction Expenses Contract Asset/Liability To record construction expenses

23,100,000 22,048,000 22,048,000

LO 1 BT: AP Difficulty: M Time: 35 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIPB-1

While it is true that the total amount of revenue, expenses and profit recognized under the contract will be the same whether using the percentage-of-completion method or the zero-profit method, the percentage-of-completion method of recognizing revenue on a long-term contract must be used when the company is able to reasonably measure its progress under the contract. Companies do not have the choice to use the zero-profit method under GAAP when reasonable measures of progress can be arrived at during the contract. The zero-profit method is used when a company is unable to reasonably measure its progress on a long-term contract but is able to recover its costs.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

WIPB-2

It is true that the zero-profit method must be used when a company is unable to reasonably measure the degree of completion on a long-term contract but is able to recover its costs. It is also true that the gross profit under the contract will not reported on the statement of income until the year of completion of the contract. It is incorrect to state that no revenue and expenses would be recognized in the accounting periods during which the contract is in progress. When using the zero-profit method, revenue is recognized equal to the amount of expenses each year while the contract is in progress. Failure to recognize revenue and expenses during the contract would understate both revenue and expenses on the statement of income. Recognizing all of the revenue and the expenses in the final year of the contract would overstate revenue and expenses on the statement of income in that year.

LO 1 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

Appendix C REVALUTION METHODS Learning Objective 1. Explain the asset valuation method for property, plant, and equipment.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT 1

Discussion Questions C Application Problems AP Work in Process

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQC-1

The advantage of using the proportionate approach under the revaluation model is that the amount of accumulated depreciation does not get eliminated in the adjustment. Users of financial statements can therefore have an indication of the relative age of the asset being revalued and it would be clear that this is not a new asset.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQC-2

The disadvantage of using the asset adjustment approach under the revaluation model is that the balance of the accumulated depreciation account is eliminated. By doing so, a user of financial statements could believe that the asset being revalued is a new asset, which it is not. The user cannot get a feel for the relative age of the asset, as no accumulated depreciation would be reported.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS APC-1A a.

Revaluation Adjustment Depreciation Expense = Cost – Estimated Residual Value Estimated Useful Life = $3,100,000 - $148,000 = $98,400 30 In 2022 annual depreciation prorated to 9 months: ($98,400 x 9/12) = $73,800 Beginning Ending Carrying Depreciation Carrying Year Amount Expense Amount 2022 $3,100,000 $73,800 $3,026,200 2023 3,026,200 98,400 2,927,800 2024 2,927,800 98,400 2,829,400 $270,600 Revaluation Adjustment = Fair value – Carrying Amount = $3,000,000 - $2,829,400 = $170,600

Asset adjustment method Dec. 31 Accumulated Depreciation, Wharf 270,600 Wharf 270,600 To eliminate the balance of accumulated depreciation Dec. 31 Wharf Revaluation Surplus (OCI) To adjust wharf

170,600 170,600

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-1A (Continued) c.

Proportionate Method Wharf adjustment = ((Fair value ÷ Carrying Value) x Cost) - Cost = (($3,000,000 ÷ $2,829,400) x $3,100,000) - $3,100,000 = $186,916 Accumulated Depreciation adjustment = ((Fair value ÷ Carrying Value) x Accumulated Depreciation) - Accumulated depreciation = (($3,000,000 ÷ $2,829,400) x $270,600) - $270,600 = $16,316 Dec. 31 Wharf 186,916 Accumulated Depreciation, Wharf 16,316 Revaluation Surplus (OCI) 170,600 To adjust wharf and accumulated depreciation

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-2A a.

Revaluation Adjustment Depreciation Expense = Cost – Estimated Residual Value Estimated Useful Life = $480,000 - $0 = $96,000 5 In 2022 annual depreciation prorated to 2 months: ($96,000 x 2/12) = $16,000 Beginning Ending Carrying Depreciation Carrying Year Amount Expense Amount 2022 $480,000 $16,000 464,000 2023 464,000 96,000 368,000 2024 368,000 96,000 272,000 $208,000 Revaluation Adjustment = Fair value – Carrying Amount = $302,500 - $272,000 = $30,500 Proportionate Method Equipment adjustment = ((Fair value ÷ Carrying Value) x Cost) - Cost = (($302,500 ÷ $272,000) x $480,000) - $480,000 = $53,824 Accumulated Depreciation adjustment = ((Fair value ÷ Carrying Value) x Accumulated Depreciation) - Accumulated depreciation = (($302,500 ÷ $272,000) x $208,000) - $208,000 = $23,324 Dec. 31 Equipment 53,824 Accumulated Depreciation, Equipment 23,324 Revaluation Surplus (OCI) 30,500 To adjust equipment and accumulated depreciation

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-2A (Continued) b.

Asset adjustment method Dec. 31 Accumulated Depreciation, Equipment 208,000 Equipment 208,000 To eliminate the balance of accumulated depreciation Dec. 31 Equipment Revaluation Surplus (OCI) To adjust equipment

30,500 30,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-1B a.

Revaluation Adjustment Depreciation Expense = Cost – Estimated Residual Value Estimated Useful Life = $4,600,000 - $100,000 = $150,000 30

Year 2022 2023 2024 2025

Beginning Ending Carrying Depreciation Carrying Amount Expense Amount $4,600,000 $150,000 $4,450,000 4,450,000 150,000 4,300,000 4,300,000 150,000 4,150,000 4,150,000 150,000 4,000,000 $600,000

Revaluation Adjustment = Fair value – Carrying Amount = $4,360,000 - $4,000,000 = $360,000 for the building = $1,800,000 - $1,000,000 = $800,000 for the land

Asset adjustment method Dec. 31 Accumulated Depreciation, Buildings 600,000 Buildings 300,000 To eliminate the balance of accumulated depreciation Dec. 31 Buildings Revaluation Surplus (OCI) To adjust building Dec. 31 Land Revaluation Surplus (OCI) To adjust land

360,000 360,000 800,000 800,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-1B (Continued) c.

Proportionate Method Building adjustment = ((Fair value ÷ Carrying Value) x Cost) - Cost = (($4,360,000 ÷ $4,000,000) x $4,600,000) - $4,600,000 = $414,000 Accumulated Depreciation adjustment = ((Fair value ÷ Carrying Value) x Accumulated Depreciation) - Accumulated depreciation = (($4,360,000 ÷ $4,000,000) x $600,000) - $600,000 = $54,000 Dec. 31 Buildings 414,000 Accumulated Depreciation, Buildings 54,000 Revaluation Surplus (OCI) 360,000 To adjust building and accumulated depreciation Dec. 31 Land Revaluation Surplus (OCI) To adjust land

800,000 800,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-2B a.

Revaluation Adjustment Depreciation Expense = Cost – Estimated Residual Value Estimated Useful Life = $432,000 - $0 = $72,000 6 In 2022 annual depreciation prorated to 3 months: ($72,000 x 3/12) = $18,000 Beginning Ending Carrying Depreciation Carrying Year Amount Expense Amount 2022 $432,000 $18,000 $414,000 2023 414,000 72,000 342,000 2024 342,000 72,000 270,000 $162,000 Revaluation Adjustment = Fair value – Carrying Amount = $324,000 - $270,000 = $54,000 Proportionate Method Equipment adjustment = ((Fair value ÷ Carrying Value) x Cost) - Cost = (($324,000 ÷ $270,000) x $432,000) - $432,000 = $86,400 Accumulated Depreciation adjustment = ((Fair value ÷ Carrying Value) x Accumulated Depreciation) - Accumulated depreciation = (($324,000 ÷ $270,000) x $270,000) - $270,000 = $54,000 Dec. 31 Equipment 86,400 Accumulated Depreciation, Equipment 54,000 Revaluation Surplus (OCI) 32,400 To adjust equipment and accumulated depreciation

Burnley, Understanding Financial Accounting, Third Canadian Edition

APC-2B (Continued) b.

Asset adjustment method Dec. 31 Accumulated Depreciation, Equipment 270,000 Equipment 270,000 To eliminate the balance of accumulated depreciation Dec. 31 Equipment Revaluation Surplus (OCI) To adjust equipment

32,400 32,400

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIPC-1

While it is true that the revaluation model must be used for all of the company’s assets in the same class, not all companies can choose to use the revaluation model. Only companies following IFRS have this option. It is also not correct to state that when the asset values are increasing due to the use of the revaluation method it will mean that net income and the current ratio will improve. Increases in value are recorded to the account Revaluation Surplus (OCI), an equity account, and net income in not affected. Net income will be affected in the subsequent accounting periods with a decrease caused by the increased depreciation expense. As for the current ratio, it is not affected as the asset that is revalued is not a current asset.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legal Notice Copyright

Burnley, Understanding Financial Accounting, Third Canadian Edition

Appendix D INVESTMENTS Learning Objectives 1. Explain why companies make investments and distinguish between the different types of investments. 2. Explain how non-strategic investments are accounted for. 3. Explain how strategic investments are accounted for.

Burnley, Understanding Financial Accounting, Third Canadian Edition

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO BT Item LO BT Item LO BT Item LO 1. 2.

1 1

C C

3. 4.

3 2

1. 2.

2 2

AP AP

3. 4.

2 2

Discussion Questions C 5. 2 C 7. C 6. 3 C Application Problems AP 5. 3 AP 7. AP 6. 3 AP 8. Work in Process C

BT Item LO BT

3 3

AP AP

Burnley, Understanding Financial Accounting, Third Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO BT

Difficulty:

Time: AACSB

CPA CM

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO DISCUSSION QUESTIONS DQD-1

A strategic investment is an investment in equity securities that is purchased with the intention of exercising some influence or control over another entity. A non-strategic investment is an investment in debt or equity with the intention of earning interest income or dividend revenue and to sell the investment in the near future to realize a gain from the change in the fair value of the investment.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQD-2

An economic entity can be made up of several legal entities that are owned and controlled by a single parent company. Each corporate entity is a separate legal entity that pays income taxes and that reports to its board of directors and shareholder, the parent company.

LO 1 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQD-3

Consolidated financial statements are financial statements of the economic entity of a parent company combined with its subsidiaries as if they had merged. In the process of consolidating the financial statements, the account Investment in Subsidiary in the books of the parent company is eliminated and replaced with the assets and liabilities of the subsidiary company.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQD-4

Investment in debt, such as bonds, are accounted using the amortized cost model when management’s intent is to hold the investment to maturity and to earn interest income and receive the principal at the maturity date.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

DQD-5

Investments are accounted for at fair value through other comprehensive income when management makes an investment (in either a debt or equity instrument) with the intent to collect interest or dividends and also to sell it as part of its efforts to manage the company’s liquidity needs or rates of return. On the other hand, for investment that are accounted for as fair value through profit or loss, management makes an investment (in either a debt or equity instrument) with a plan to sell the investment in the near future or the investment is part of a portfolio that is managed collectively with a pattern of short-term profit-taking.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQD-6

A company has the ability to exercise significant influence over another company it has invested in when it owns between 20% and 50% of that company’s voting shares. Aside from the percentage of share ownership, there are a number of other factors that are also considered when determining whether or not the investor is able to exercise significant influence. These include: • representation of the board of directors, • participation in policy-making processes (including decisions regarding the declaration of dividends), • material transactions between the investor and investee, • interchange of managerial personnel, and • provision of essential technical information.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

DQD-7

Investments in associates are investments where the investor exercises significant influence over the investee, but not control. Investments in subsidiaries are investment where more than 50% of the shares are owned by the investor and therefore control over the investee is obtained.

LO 3 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

SOLUTIONS TO APPLICATION PROBLEMS APD-1A a. Bond Discount Amortization

Amortized Cost of Bonds Beginning amortized cost + Bond discount amortization for period $143,751

Cash Received

Interest Income

Principal to be received at maturity × (Contract rate of interest ÷ 2)

Amortized cost × (Yield rate of interest ÷ 2)

7-01-2024

$ 2,250

$3,234

$984

144,735

1-01-2025

2,250

3,257

1,007

145,742

7-01-2025

2,250

3,279

1,029

146,771

1-01-2026

2,250

3,302

1,052

147,823

7-01-2026

2,250

3,326

1,076

148,899

1-01-2027

2,250

3,351

1,101

150,000

$19,749

$6,249

Date

Interest income – Cash received

1-01-2024

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-1A (Continued) b. 1-01-2024 Bond Investment at Amortized Cost Cash The initial investment purchase

143,751 143,751

7-01-2024 Cash Bond Investment at Amortized Cost Interest Income The receipt of the first interest payment

2,250 984 3,234

12-31-2024 Interest Receivable Bond Investment at Amortized Cost Interest Income The interest accrual at the end of the first year 1-01-2025 Cash

2,250 1,007 3,257

2,250

Interest Receivable The receipt of the second interest payment

2,250

1-01-2027 Cash Bond Investment at Amortized Cost The payment of bond principal at maturity

150,000 150,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-2A a.

Date

Cash Received

Interest Income

Principal to be received at maturity × (Contract rate of interest ÷ 2)

Amortized cost × (Yield rate of interest ÷ 2)

Bond Premium Amortization

Cash received Interest income

1-01-2024

Amortized Cost of Bonds Beginning amortized cost - Bond premium amortization for period $256,885

7-01-2024

$7,500

$6,422

$1,078

255,807

1-01-2025

7,500

6,395

1,105

254,702

7-01-2025

7,500

6,368

1,132

253,570

1-01-2026

7,500

6,339

1,161

252,409

7-01-2026

7,500

6,310

1,190

251,219

1-01-2027

7,500

6,281

1,219

250,000

$38,115

$6,885

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-2A (Continued) b. 1-01-2024 Bond Investment at Amortized Cost

256,885

Cash The initial investment purchase 7-01-2024 Cash

256,885

7,500

Bond Investment at Amortized Cost Interest Income The receipt of the first interest payment 12-31-2024 Interest Receivable Bond Investment at Amortized Cost Interest Income The interest accrual at the end of the first year 1-01-2025 Cash

1,078 6,422

7,500 1,105 6,395

7,500

Interest Receivable The receipt of the second interest payment

7,500

1-01-2027 Cash Bond Investment at Amortized Cost The payment of bond principal at maturity

250,000 250,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-3A a. If shares were held for trading and classified as measured at fair value through profit or loss 1-15-2024 FVPL Investments Cash (350 x $50)

17,500

2-28-2024 Cash (350 x $0.40) Dividend Revenue

140

17,500 140

3-31-2024 Investment Income or Loss FVPL Investments (350 shares x ($50.00 - $45.00))

1,750

4-15-2024 FVPL Investments Investment Income or Loss (350 shares x ($76.00 - $45.00))

10,850

4-15-2024 Cash (350 shares x $76) FVPL Investments

26,600

1,750

10,850

26,600

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-3A (Continued) b. If shares were classified as measured at fair value through other comprehensive income 1-15-2024 FVOCI Investments Cash (350 x $50)

17,500

2-28-2024 Cash Dividend Revenue

140

17,500 140

3-31-2024 Unrealized Gain or Loss - OCI FVOCI Investments (350 shares x ($50.00 - $45.00))

1,750

4-15-2024 FVOCI Investments Unrealized Gain or Loss – OCI (350 shares x ($76.00 - $45.00))

10,850

4-15-2024 Cash (350 shares x $76) FVOCI Investments

26,600

4-15-2024 Unrealized Gain or Loss - OCI Retained Earnings ( -$1,750 + $10,850 )

9,100

1,750

10,850

26,600

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

9,100

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-4A a. If shares were held for trading and classified as measured at fair value through profit or loss 3-15-2024 FVPL Investments Cash (700 x $75)

52,500

4-01-2024 Cash (700 x $1.20) Dividend Revenue

840

52,500 840

6-30-2024 FVPL Investments Investment Income or Loss (700 shares x ($75.00 - $80.00))

3,500

7-22-2024 Investment Income or Loss FVPL Investments (700 shares x ($60.00 - $80.00))

14,000

7-22-2024 Cash (700 shares x $60) FVPL Investments

42,000

3,500

14,000

42,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-4A (Continued) b. If shares were classified as measured at fair value through other comprehensive income 3-15-2024 FVOCI Investments Cash (700 x $75)

52,500

4-01-2024 Cash (700 x $1.20) Dividend Revenue

840

52,500 840

6-30-2024 FVOCI Investments Unrealized Gain or Loss – OCI ((700 shares x $80.00) - $52,500)

3,500

7-22-2024 Unrealized Gain or Loss - OCI FVOCI Investments (700 shares x ($60.00 - $80.00))

14,000

7-22-2024 Cash (700 shares x $60) FVOCI Investments

42,000

7-22-2024 Retained Earnings Unrealized Gain or Loss – OCI (-$3,500 + $14,000 )

10,500

3,500

14,000

42,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

10,500

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-5A a. Investment Income Statement of Income For the Year Ended December 31, 2024

Other Revenues Investment IncomeSee Below

Equity Method $32,000

FVPL $44,000

FVPL Dividend Revenue ($20,000 x 20%) Investment Income ($8.80 - $8.00) x 50,000 shares

$4,000 40,000 $44,000

Equity Method Investment Income ($160,000 x 20%)

32,000

b Investment Account Statement of Financial Position 12-31-2024 FVPL Current Assets FVPL Investments (50,000 x $8.80) Non-Current Assets Investment in Associate*

* Initial Investment (50,000 x $8.00) Share of income (20% x $160,000) Share of dividends (20% x $20,000)

Equity Method

$440,000

$428,000

$400,000 32,000 (4,000) $428,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-5A (Continued) c. Aside from the percentage of share ownership, there are a number of other factors that are also considered when determining whether or not the investor is able to exercise significant influence. These include: * Representation of the board of directors; * Participation in policy-making processes (including participation in decisions about dividends); * Material transactions between the investor and investee; * Interchange of managerial personnel; or, * Provision of essential technical information. LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-6A 1-01-2024

Investment in Associate Cash

3,200,000

12-31-2024 Investment in Associate Investment Income ($2,500,000 x 40.00%)

1,000,000

12-31-2024 Cash Investment in Associate ($1,000,000 x 40.00%)

400,000

3,200,000 1,000,000

400,000

LO 3 BT: AP Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

APD-7A 1-01-2024

Investment in Associate Cash

8,300,000

12-31-2024 Investment in Associate Investment Income ($6,500,000 x 25.00%)

1,625,000

12-31-2024 Cash Investment in Associate ($1,200,000 x 25.00%)

300,000

8,300,000 1,625,000

300,000

LO 3 BT: AP Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-8A Purchase Price Carrying amount of Rachel Inc.'s net assets Assets Liabilities

$ 1,900,000 a

$ 3,100,000 1,700,000 1,400,000

Acquisition differential Allocated as follows: Fair value excess Assets Liabilities

Fair value Carrying Amt $3,500,000 $3,100,000 1,700,000 1,700,000

Goodwill a.

DR Investment in Subsidiary CR Cash

1,400,000 b 500,000 c= a-b

400,000 d - e $ 100,000 f=c-d-e

1,900,000 1,900,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-8A (Continued)

(Parent)

(Subsidiary)

Adjustments Debit Credit

Consolidated

Assets Cash Accounts receivable Investment in Subsidiary

1,060,000 1,500,000 1,900,000

100,000 400,000 -

Inventory

3,000,000

1,000,000

300,000

4,300,000

Capital assets

4,000,000

1,600,000

100,000

5,700,000

Goodwill Total assets

11,460,000

3,100,000

100,000

100,000 13,160,000

Liabilities & Shareholders’ Equity Accounts payable Long-term liabilities Common shares Retained earnings Total liabilities and shareholders' equity

2,500,000 2,300,000 5,400,000 1,260,000

400,000 1,300,000 900,000 500,000

$11,460,000

$ 3,100,000

1,900,000

900,000 500,000 $1,900,000 $1,900,000

1,160,000 1,900,000 -

2,900,000 3,600,000 5,400,000 1,260,000 $13,160,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-8A (Continued) PORTER LTD. Consolidated Statement of Financial Position July 31, 20XX Assets Cash Accounts receivable Inventory Capital assets Goodwill Total assets

$ 1,160,000 1,900,000 4,300,000 5,700,000 100,000 $13,160,000

Liabilities & Shareholders’ Equity Accounts payable Long-term liabilities Common shares Retained earnings Total liabilities & shareholders’ equity

$ 2,900,000 3,600,000 5,400,000 1,260,000 $13,160,000

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-9A Purchase Price

$ 3,560,000 a

Carrying amount of Topp's net assets Assets Liabilities

$ 5,670,000 3,140,000 2,530,000

Acquisition differential Allocated as follows: Fair value excess Inventory Building Land Liabilities Goodwill

Fair value Carrying Amt $ 910,000 $ 680,000 1,500,000 1,400,000 1,990,000 1,700,000 2,100,000 2,100,000

2,530,000 b 1,030,000 c= a-b

230,000 100,000 290,000 -

d e f g

$ 410,000 h=c-d-e-f-g

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-9A (Continued)

Adjustments (Parent) Assets Inventory Building Land

(Subsidiary) -

680,000 1,400,000 1,700,000

Debit

Credit

230,000 100,000 290,000

Consolidated 910,000 1,500,000 1,990,000

Investment in Subsidiary Goodwill Other assets

3,560,000 9,340,000

3,560,000 1,890,000

Total assets

12,900,000

5,670,000

16,040,000

Liabilities Shareholders' Equity Total liabilities and shareholders' equity

5,250,000 7,650,000

3,140,000 2,530,000

2,530,000

8,390,000 7,650,000

$12,900,000

$5,670,000

$3,560,000

410,000

$3,560,000

410,000 11,230,000

$16,040,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-9A (Continued) a. $16,040,000 (see above) b. $ 8,390,000 (see above) c. $ 7,650,000 (see above) d. It is necessary to eliminate the balance in the account for Down's Investment in Topp Company when preparing the consolidated statement of financial position as the purpose of this statement is to show the financial position of the two entities combined. As such, the investment of the parent in the subsidiary and the shareholders' equity of the subsidiary at acquisition must be eliminated. LO 3 BT: AP Difficulty: E Time: 20 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-1B a.

Date

Cash Interest Received Income Principal to be received at maturity × (Contract Amortized cost rate of × (Yield rate interest ÷ 2) of interest ÷ 2)

Bond Discount Amortization

Interest income – Cash received

1-01-2024

Amortized Cost of Bonds Beginning amortized cost + Bond discount amortization for period $283,748

7-01-2024

$6,000

$8,512

$2,512

286,260

1-01-2025

6,000

8,588

2,588

288,848

7-01-2025

6,000

8,665

2,665

291,513

1-01-2026

6,000

8,745

2,745

294,258

7-01-2026

6,000

8,828

2,828

297,086

1-01-2027

6,000

8,914

2,914

300,000

52,252

$16,252

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-1B (Continued) b. 1-01-2024 Bond Investment at Amortized Cost Cash The initial investment purchase

283,748 283,748

7-01-2024 Cash Bond Investment at Amortized Cost Interest Income The receipt of the first interest payment

6,000 2,512 8,512

12-31-2024 Interest Receivable Bond Investment at Amortized Cost Interest Income The interest accrual at the end of the first year

6,000 2,588 8,588

1-01-2025 Cash

6,000

Interest Receivable The receipt of the second interest payment

6,000

1-01-2027 Cash Bond Investment at Amortized Cost The payment of bond principal at maturity

300,000 300000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-2B a.

Date

Cash Received

Interest Income

Principal to be received at maturity × Amortized cost (Contract rate × (Yield rate of interest ÷ 2) of interest ÷ 2)

Bond Premium Amortization

Cash received Interest income

1-01-2024

Amortized Cost of Bonds Beginning amortized cost - Bond premium amortization for period $205,242

7-01-2024

$9,000

$ 8,210

$790

204,452

1-01-2025

9,000

8,178

822

203,630

7-01-2025

9,000

8,145

855

202,775

1-01-2026

9,000

8,111

889

201,886

7-01-2026

9,000

8,075

925

200,961

1-01-2027

9,000

8,039

961

200,000

$ 48,758

$5,242

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-2B (Continued) b. 1-01-2024 Bond Investment at Amortized Cost Cash The initial investment purchase

205,242 205,242

7-01-2024 Cash

9,000

Bond Investment at Amortized Cost Interest Income The receipt of the first interest payment

790 8,210

12-31-2024 Interest Receivable Bond Investment at Amortized Cost Interest Income

9,000 822 8,178

The interest accrual as the end of the first year 1-01-2025 Cash

9,000 Interest Receivable

9,000

The receipt of the second interest payment 1-01-2027 Cash Bond Investment at Amortized Cost The payment of bond principal at maturity

200,000 200,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-3B a. If shares were held for trading and classified as measured at fair value through profit or loss 1-15-2024 FVPL Investments Cash (400 x $60)

24,000

2-28-2024 Cash (400 x $0.80) Dividend Revenue

320

24,000 320

3-31-2024 Investment Income or Loss FVPL Investments (400 shares x ($60.00 - $55.00))

2,000

4-15-2024 FVPL Investments Investment Income or Loss (400 shares x ($80.00 - $55.00))

10,000

4-15-2024 Cash (400 x $80) FVPL Investments

32,000

2,000

10,000

32,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-3B (Continued) b. If shares were classified as measured at fair value through other comprehensive income 1-15-2024 FVOCI Investments Cash (400 x $60)

24,000

2-28-2024 Cash (400 x $0.80) Dividend Revenue

320

3-31-2024

Unrealized Gain or Loss OCI FVOCI Investments ((400 shares x $55.00) - $24,000)

24,000 320 2,000 2,000

4-15-2024 FVOCI Investments Unrealized Gain or Loss – OCI (400 shares x ($80.00 - $55.00))

10,000

4-15-2024 Cash FVOCI Investments (400 shares x $80)

32,000

4-15-2024

Unrealized Gain or Loss OCI Retained Earnings (-$2,000 + $10,000 )

10,000

32,000

8,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

8,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-4B a. If shares were held for trading and classified as measured at fair value through profit or loss 6-15-2024 7-01-2024 8-31-2024

10-16-2024

FVPL Investments Cash (2,000 x $10)

20,000

Cash (2,000 x $0.25) Dividend Revenue

500

20,000 500

FVPL Investments Investment Income or Loss (2,000 shares x ($15.00 - $10.00))

10,000

FVPL Investments Investment Income or Loss (2,000 shares x ($18.00 - $15.00))

6,000

Cash FVPL Investments (2,000 shares x $18.00)

36,000

10,000

6,000

36,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-4B (Continued) b. If shares were classified as measured at fair value through other comprehensive income 6-15-2024 FVOCI Investments Cash (2,000 x $10)

20,000

7-01-2024 Cash (2,000 x $0.25) Dividend Revenue

500

20,000 500

8-31-2024 FVOCI Investments Unrealized Gain or Loss – OCI ((2,000 shares x $15.00) - $20,000)

10,000

10-16-2024 FVOCI Investments Unrealized Gain or Loss - OCI (2,000 shares x ($18.00 - $15.00))

6,000

10-16-2024 Cash FVOCI Investments (2,000 shares x $18.00)

36,000

10-16-2024 Unrealized Gain or Loss – OCI Retained Earning ($10,000 + $6,000)

16,000

10,000

6,000

36,000

16,000

LO 2 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-5B a. Investment Income Statement of Income For the Year Ended December 31, 2024

Other Revenues Investment IncomeSee Below

FVPL

Equity Method

$65,000

$40,000

FVPL Dividend Revenue ($25,000 x 20%) Investment Income ($11.00 - $10.25) x 80,000 shares

$5,000 60,000 $65,000

Equity Method Investment Income ($200,000 x 20%)

$40,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-5B (Continued) b. Statement of Financial Position 12-31-2024 FVPL

Equity Method

Current Assets FVPL Investments (80,000 x $11.00)

880,000

Non-Current Assets Investment in Associate*

* Initial Investment (80,000 x $10.25) Share of income (20% x $200,000) Share of dividends (20% x $25,000)

855,000

820,000 40,000 (5,000) 855,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-5B (Continued) c. Aside from the percentage of share ownership, there are a number of other factors that are also considered when determining whether or not the investor is able to exercise significant influence. These include: * Representation of the board of directors; * Participation in policy-making processes (including participation in decisions about dividends); * Material transactions between the investor and investee; * Interchange of managerial personnel; or, * Provision of essential technical information. LO 3 BT: AP Difficulty: M Time: 25 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-6B 1-01-2024 12-31-2024

12-31-2024

Investment in Associate Cash

6,475,000

Investment in Associate Investment Income ($3,000,000 x 35.00%)

1,050,000

Cash Investment in Associate ($1,250,000 x 35.00%)

437,500

6,475,000 1,050,000

437,500

LO 3 BT: AP Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

APD-7B 1-01-2024 12-31-2024

12-31-2024

Investment in Associate Cash

9,000,000

Investment in Associate Investment Income ($8,000,000 x 30.00%)

2,400,000

Cash Investment in Associate ($1,050,000 x 30.00%)

315,000

9,000,000 2,400,000

LO 3 BT: AP Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

315,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-8B

Purchase Price

$3,400,000 a

Carrying amount of PEI Excavation’s net assets Assets $4,650,000 Liabilities 2,800,000 1,850,000 Acquisition differential

1,850,000 b 1,550,000 c= a-b

Allocated as follows: Fair value excess Inventory Equipment Building Land Liabilities

Fair value $430,000 1,680,000 1,500,000 1,990,000 2,800,000

Carrying Amt $250,000 1,400,000 1,300,000 1,100,000 2,800,000

Goodwill a.

DR Investment in Subsidiary CR Cash

$ 180,000 280,000 200,000 890,000

3,400,000 3,400,000

d e f g h i=c-d-e-f-g-h

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-8B (Continued) b.

Adjustments (Parent)

(Subsidiary)

Debit

Credit

Consolidated

Assets Cash Accounts receivable Investment in Subsidiary

780,000 1,200,000 3,400,000

250,000 350,000 -

Inventory Equipment

3,500,000 2,500,000

250,000 1,400,000

180,000 280,000

3,930,000 4,180,000

1,300,000

200,000

1,500,000

11,380,000

1,100,000 4,650,000

890,000

1,990,000 14,180,000

Building Land Total assets

Liabilities & Shareholders’ Equity Accounts payable 750,000 Long-term liabilities 3,500,000 Common shares 6,000,000 Retained earnings 1,130,000 Total liabilities & shareholders’ equity $11,380,000

3,400,000

250,000 2,550,000 1,000,000 1,000,000 850,000 850,000 $ 4,650,000 $3,400,000 $3,400,000

1,030,000 1,550,000 -

1,000,000 6,050,000 6,000,000 1,130,000 $14,180,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-8B (Continued) KEJIFO LTD. Consolidated Statement of Financial Position May 1, 20XX Assets Cash Accounts receivable Inventory Equipment Building Land Total assets

$ 1,030,000 1,550,000 3,930,000 4,180,000 1,500,000 1,990,000 $14,180,000

Liabilities & Shareholders’ Equity Accounts payable Long-term liabilities Common shares Retained earnings Total liabilities & shareholders’ equity

$ 1,000,000 6,050,000 6,000,000 1,130,000 $14,180,000

LO 3 BT: AP Difficulty: M Time: 30 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-9B Purchase Price

$3,548,000 a

Carrying amount of Right’s net assets Assets Liabilities

$ 3,910,000 1,777,000 2,133,000

Acquisition differential

2,133,000 b 1,415,000 c= a-b

Allocated as follows: Fair value excess Inventory Equipment Liabilities Goodwill

Fair value Carrying Amt 640,000 385,000 3,200,000 2,720,000 1,777,000 1,777,000

255,000 d 480,000 e - f 680,000 g=c-d-e-f

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-9B (Continued)

(Parent) Assets Investment in Subsidiary Inventory Equipment Goodwill Other assets Total assets Liabilities Shareholders’ Equity Total liabilities and shareholders' equity

$3,548,000

(Subsidiary)

Debit

6,117,000 $9,665,000

$385,000 2,720,000 805,000 $3,910,000

3,192,000 6,473,000

1,777,000 2,133,000

2,133,000

$9,665,000

$3,910,000

$3,548,000

Credit

Consolidated

$3,548,000

$640,000 3,200,000 680,000 6,922,000 $11,442,000

$255,000 480,000 680,000

4,969,000 6,473,000 $3,548,000

$11,442,000

Burnley, Understanding Financial Accounting, Third Canadian Edition

APD-9B (Continued)

a. $11,442,000 (see above) b. $ 4,969,000 (see above) c. $ 6,473,000 (see above) d. It is necessary to eliminate the balance in the account for Left's Investment in Right Company when preparing the consolidated statement of financial position as the purpose of this statement is to show the financial position of the two entities combined. As such, the investment of the parent in the subsidiary and the shareholders' equity of the subsidiary at acquisition must be eliminated LO 3 BT: AP Difficulty: E Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition

WORK-IN-PROGRESS WIPD-1

While it is true that the change in the fair value of equity investments is recognized in the financial statements, not all investments have the fair value adjustment reported through net income. Fair value adjustments for fair value other comprehensive income investments are recorded in other comprehensive income and cumulative balances appear in the statement of financial position as a separate equity account called Accumulated Other Comprehensive Income.

LO 2 BT: C Difficulty: M Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

WIPD-2

Investments in associates are accounted for using the equity method. They are not reported at fair value on the statement of financial position. Under the equity method, the percentage share ownership, which in this case is 35%, is applied to the amount of the net income of the associate for the year. This amount is added to the investment account and this increase is reported as investment income on the statement of income. On the other hand, dividends received reduce the investment account as they are a return of equity. Your investment in 15% of Y Ltd. does not have increases in the account for your share of the income earned by the investee nor does it have decreases for the amount of dividends received. Rather, fair value adjustments cause an increase or decrease in the investment account reported on that statement of financial position.

LO 3 BT: C Difficulty: M Time: 15 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Burnley, Understanding Financial Accounting, Third Canadian Edition